China Descends Further Into Crisis With Megacity Lockdown

Markets warily eyed a bevy of inauspicious developments as September dawned, including a new COVID lockdown in China, where residents of Chengdu, home to more than 21 million people, will be subjected to mass testing beginning immediately.

“The current situation is extremely complex and severe,” local officials said. “All residents will stay at home, and non-residents of the community will not be allowed to enter,” a notice read. “There will be no crowds or gatherings in the community, and each resident can arrange one person per day to go out to buy daily necessities with a negative nucleic acid certificate within 24 hours.”

Suffice to say Xi hasn’t acquiesced to the reality of an endemic virus.

The restrictions were imposed after cases rose 14-fold, which sounds bad until you consider that the “surge” amounted to less than 1,000 total cases over 10 days. The worst day was Monday, when the city, which accounts for almost 2% of Chinese GDP, recorded 211 cases (figure below).

No other country on Earth, and certainly no major city, would bat an eye at a few hundred cases.

The restrictions threaten to further undermine China’s efforts to keep economic growth in a “reasonable range,” to employ the favored Party line. Top officials have all but abandoned this year’s 5.5% target, which most analysts viewed as wholly unrealistic following a draconian, two-month lockdown in Shanghai which, ominously, was presaged by a four-day mass testing campaign similar to that begun in Chengdu on Thursday.

For what it’s worth, I alluded to this on Sunday, when I gently suggested it’s time to “at least consider the possibility that the Party has finally reached the limits of the death-defying tightrope act they’ve so deftly managed over the past six or seven years. Beijing has proven astoundingly capable at balancing competing priorities, but it’s just not possible to reconcile “COVID zero” with a commitment to 5% growth.

As The New York Times wrote, in a good summary, China’s southwestern region “had fared relatively well over nearly three years of the pandemic,” but the situation took a turn over the past several weeks. In Chongqing, another nearby megacity, “millions of residents waited for hours in the hot sun and extreme heat while officials carried out mass testing last week.”

The “outbreaks” (with the scare quotes there to indicate that a few hundred cases in communities of 20 million only count as “outbreaks” in China) are insult to injury for the region, which is grappling with a severe heatwave and the worst drought in decades. Chengdu is the capital of Sichuan province, where drought conditions have crippled power generation. Hydroelectric plants, which generate more than three quarters of the province’s electricity, are struggling against low water levels on the Yangtze, impacting industrial production in the region. As SCMP noted, “Sichuan province normally generates almost 30% of China’s hydroelectric power, but the 2022 heatwave saw historically low water levels and, as a result, a massive drop in electricity production.”

The situation is so severe that China’s Meteorological Administration dispatched a pair of drones on an “artificial rain enhancement operation” last week. “Seeding works by dropping an ice-forming agent like silver iodide into a cloud that already contains ample moisture,” Bloomberg explained. “Rain droplets gather around the agent, gaining weight until they begin to fall.” More simply: Xi will force clouds to rain.

Already, regional plants and factories were compelled to curtail operations due to power shortages brought on by the drought. Multinationals including Volkswagen and Toyota were impacted. In Chengdu, rolling blackouts meant some neighborhoods were without electricity for nearly half the day. It was 113 degrees in Chongqing last week. Now, the area faces COVID lockdowns.

Clearly, this complicates an already fraught outlook for the world’s second largest economy, as does the prospect of more stringent virus containment measures in Shenzhen. Both the official and Caixin manufacturing PMIs printed in contraction territory for August, data out this week showed (figure below).

Lockdowns threaten to curtail non-manufacturing activity at a time when sentiment is very poor and the PBoC is at pains to stimulate domestic demand and bolster the credit impulse.

“Right now, the economy is still slowly recovering from a widespread outbreak of COVID in the first half of the year [but] local flare-ups and the punishing heat wave have disrupted the trend and created new downward pressures, posing a threat to the recovery,” Wang Zhe, Senior Economist at Caixin Insight Group, said Thursday. “Although the central bank has recently cut key policy interest rates to guide banks to lower financing costs for companies and individuals, the effect will depend on market players’ confidence about the future,” Caixin added, noting that “in the face of adverse factors such as recurring COVID cases and natural disasters, there needs to be further subsidies and assistance for poor and low-income groups amid a sluggish job market and shrinking consumer demand.”

All of this comes ahead of what will amount to a coronation ceremony for Xi, who’s set to secure a third term as leader and effectively cement a claim on a lifetime tenure atop the Party’s power structure.

More broadly, the evolving, multi-faceted crisis in China is indicative of the extent to which humanity’s problems are compounding one another. As Bloomberg wrote, citing Chengdu health commission chief Yang Xiaoguang, “extremely hot weather in the city” encouraged “frequent contact among people in indoor entertainment venues including water parks,” which in turn “led to increased transmission of the virus.”

At the same time, the drought is forcing China to fall back on coal, reminiscent of Germany’s predicament. In Germany, the world’s fourth largest economy, there’s an extra layer of tragic irony: Efforts to get coal where it needs to go are complicated by low water levels brought on by Europe’s own 500-year drought.

Unlike Germany, China can still count on Russia. “Beijing has sought to offset at least part of the lost hydropower from the drought by ramping up the use of coal-fired power plants,” the Times wrote, in a piece dated August 26 and updated this week. “China’s domestic mining of coal has been at or near record levels, and customs data shows that its imports of coal from Russia reached a new high last month.”