China isolates more than 10 million against Covid; understand why it hits global market

Many countries around the world have decided to live with the coronavirus, even as a new subvariant fuels another wave of infections. But China is an extremely important exception.

China continues to implement lockdowns as it tries to eliminate transmission of Covid-19 within its borders. Politics is looming over the outlook for the global economy and financial markets, presenting more unknowns as investors scramble to assess the impacts of the war in Ukraine and rising inflation.

As of Monday, some 11 million residents in the eastern half of Shanghai will be banned from leaving for four days when the mass testing begins. The staggered lockdown will move to the other half of the city, which has about 14 million residents, from Friday.

The announcement caused global oil prices to drop sharply as traders bet the restrictions would reduce demand from a major consumer. China imports about 11 million barrels of oil a day.

Stocks are holding firm, however. The Shanghai Composite Index ended Monday nearly 0.1% higher. The Shanghai Stock Exchange remained open and said it will offer online services to companies wishing to go through the stock listing process.

How vital is Shanghai?

The lockdown in Shanghai is a big problem not only because of the scale of the city, but also because of its deep financial and economic ties.

Shanghai accounts for about 4% of China’s economic output, according to Larry Hu of Macquarie Capital. But because it is a “key hub of the Chinese economy… the indirect impact could also be substantial,” he told clients.

The lockdown and uncertainty over what Beijing will do next, as it continues its fierce fight against the virus, is a threat to China’s economic growth target of around 5.5%, already the lowest in three decades.

“China should be able to contain the virus in the coming weeks as the lockdown is effective,” Hu said. “But Covid poses a substantial growth risk for the rest of this year as the lockdown is very expensive.”

Consumer spending and China’s housing sector, which was already under severe pressure, are likely to take the brunt of the pain.

Outside of China, the big question is whether manufacturing and shipping will be affected, increasing pressure on global supply chains and driving up prices further.

Shanghai’s main ports are operating normally, according to state media. And during a lockdown in the southern Chinese city of Shenzhen earlier this month, manufacturers shifted operations to other parts of their network to limit the impact of the temporary rules.

“The impact on manufacturing activities is likely to be manageable, especially if these lockdowns are short and sporadic,” Bank of America economists said in a release note on recent research.

But there will likely still be interruptions. The media are reporting that the Tesla to suspend production at its Shanghai factory for four days.