Boiled down to the simplest math, Latin America’s short-term economic fate relies on two factors: the cost of international capital and the price of commodities. The former is most influenced by interest rate targets set by the US federal reserve. Commodity prices are largely determined by Chinese domestic demand. There are armies of analysts at work predicting the future movements of the Fed and the risk-adjusted cost of capital to borrowers (governments and business) in Latin America. No one has a clear idea of where Chinese domestic demand is headed in 2023.
In the early 2000s, Stephen Poloz, the esteemed Canadian economist and former Central Bank Governor opened a speech by calling China “the greatest thing to happen to the world’s economy since 1870.” He went on to explain the perplexing remark. 1870 was roughly when the United States evolved from a low-cost manufacturing threat to Europe into a global engine of consumption. Over the last twenty years, more than half the world’s nations have grown to rely on China as the #1 demand engine of their export growth. Neighboring countries like Japan, Taiwan, and Korea as well as the US sell high-value components and software to Chinese assemblers who in turn export tech products around the world. Global demand for Chinese assembled consumer electronics kept growing through the depths of COVID. In contrast, suppliers of commodities and food products like Latin America sell their goods to Chinese domestic buyers. Their business has slowed in 2022.
A Big Drop in Domestic Demand
China’s projected 2022 GDP growth of 2.7% masks a more telling story. While China’s exports will grow an estimated 12% in 2022, domestic consumption is expected to shrink by 1.5%. Automobile sales could plummet by 15% in 2022. Consumer and business spending is constricted by China’s Zero COVID policies, which led to dramatic lockdowns in several urban centers this year. China’s economic power is distributed across dozens of mega-cities, scattered across the country. However, China’s private sector business center, its New York, is located in Shanghai. When lockdowns brought Shanghai to its knees for two months in Q2, 2022, not only were 26 million consumers curtailed, over 700 multinational and thousands of Chinese corporate headquarters were operationally crippled, impacting businesses across the country. Chinese domestic demand dropped close to 6% in Q2, an unprecedented blow to an economy that grew at enviable rates for 40 years.
The Chinese are fed up with Zero COVID. Over 10,000 millionaires have already left China this year, second only to Russia. Another c. 500,000 have moved out of China each year since the start of COVID, a small number considering its 1.4 billion people but still notable given the additional bureaucratic hurdles put in place since China closed down most of its international flights. Just as importantly, the Chinese Communist Party’s Zero COVID propaganda-fueled legitimacy has begun to crumble. The rolling lockdowns in 2022 have inspired millions to download VPN apps that allow them to access otherwise banned overseas news and social media sites.
President Xi Jinping is all but set to be re-elected to a record third 5-year term soon after the 20th party congress opens on October 16th, 2022. President Xi earned his first re-election in 2017 by purging the party of much of its corrupt practices, an obsession that has guided his rise to power for over twenty years. Since the start of the pandemic, his legitimacy has been built on leading a national war against COVID. The draconian measures employed under Xi earned him the praise of millions at home and the envy of leaders around the world. But as the rest of the world has opened up after achieving herd immunity through a combination of infection and vaccination, China has remained hermetically sealed. China’s inability to vaccinate more than 60% of its elderly population with what appears to be less effective vaccine formulas means that a more lenient approach to controlling COVID could easily kill five million Chinese, undermining Xi’s legitimacy.
The Impact of Re-Opening
Both Hong Kong and Macau are taking bold steps to open their territories to foreign visitors. Some speculate that this is a pilot test of next year’s opening of China. Once President Xi is re-elected (and possibly promoted to the title of Chairman), he will enjoy a five-year runway for any new initiatives he wants to employ. He cannot achieve much of anything if China’s Zero COVID policies remain in place. It is hard to imagine that the most ambitious leader in China since Mao Zedong is going to sit on his hands for five years and watch his economy stagnate and voter resentment explode. Instead, we expect Zero COVID to be gradually unwound. Restrictions on inter-province movement will be loosened. Future lockdowns will be far less severe, designed to avoid overwhelming hospitals rather than stop the spread of COVID (i.e. bend the curve, not break it). International travel will resume. Visitors will be welcome under less restrictive terms, with mandatory testing but without lengthy quarantines. Quietly, mRNA vaccines will be deployed (and welcomed by Chinese citizens) to bolster immunity. The collective impact of these measures will have a material impact on domestic demand.
The Effect on LatAm Exports
In 2023, China’s overall GDP growth is forecast to reach 4.5% (versus 2.7% in 2022). Driving that growth will be Chinese domestic spending which could easily grow by 5%, even with moderate COVID policy loosening. That will be a welcome countermeasure to weak Chinese exports as European spending on all things other than energy collapses and US demand wanes under the pressure of higher interest rates. Over the last 12 months, new Chinese deposits have grown 38% (7.45 to 10.33 trillion Yuan). That’s US$400bn additional unspent savings burning a hole in the pockets of Chinese consumers. Coupled with additional government spending on new healthcare measures to mitigate the impact of spreading infections and there is every reason to anticipate a jump in demand for Latin American exports in 2023, and an even larger increase in 2024.
The China wild card ought to be a positive surprise for Latin America in 2023 and just one of the insights that our leadership team at AMI delivered in its annual forecasting webinar.