By Wen Qi

The outbreak of the COVID-19 in Wuhan， the Peoples Republic of China （PRC）， prompted an unprecedented government response to arrest the negative impacts of COVID-19， putting peoples health and welfare first. In order to effectively contain the spread of the outbreak on a nationwide scale， anti-virus measures brought the economy of China to a standstill in the first quarter （Q1） of 2020. Strict lockdowns and quarantines disrupted business activities and many enterprises temporarily stopped production. Migrant workers， who account for a sizable share of manufacturing labor， were confined to their provinces and were unable to return to work. Households scaled back their expenditure amid lockdowns and growing health and labor uncertainties.

As a result， Chinas gross domestic product （GDP） contracted by 6.8% in Q1 2020， which was the first decline on record since 1992， and industrial production， retail sales， and investment all plummeted. The labor market was also adversely affected， with the surveyed urban unemployment rate surging to 6.2% in February 2020， a full percentage point higher than at the end of 2019. The cooling in domestic demand was also compounded by shorter working hours， further depressing household income.

This sharp economic contraction was followed by a fast rebound which was driven by industry. Benefiting from changes in global value chains during the pandemic， export orders increased due to the high global demand for home office and personal protective equipment， which also boosted industrial production， a trend that made Chinas economy one of the very few in the world to register economic growth in 2020 （2.3%）.

This fast recovery also created challenges. The rebound was uneven as industry improved faster than services， and household consumption， which was dragged down by increased precautionary savings， remained negative in 2020. The monetary stimulus accentuated vulnerabilities in the financial sector. The impact of the pandemic disproportionally affected lower-income households， and the economic recovery fell short of efforts to ensure a green recovery.

Measures and policies that contributed to recovery

Pandemic-control， reopening， and the role of technology in effective pandemic-control strategies. The pandemic-control strategies adopted by the city of Wuhan in late January 2020 restricted the spread of the infectious outbreak nationwide. Efforts included a total city lockdown， mobility restrictions， successful community management， and compulsory quarantines， which effectively contained the infectious outbreak in just a few months. In parallel， China increased its testing capacity by scaling up the production of testing kits and reducing the time needed to get the results. The daily testing capacity increased to approximately 20，000 tests per day from 300 at the beginning of the pandemic， and the time needed for testing was reduced from 6 days to just a few hours.

This approach was replicated nationwide， and by June 2020， cities such as Beijing had the capacity to test over a million people per day. The country also accelerated its vaccine development， production， and rollout plans. By June 2021， six vaccines were approved for use， and China had the capacity to administer over 20 million doses of COVID-19 jabs per day， with the aim of fully vaccinating at least 70% of its target population by the end of 2021.

Gradual reopening. Once the number of new COVID-19 infections stabilized in late February 2020， China focused on a gradual reopening， allowing essential sectors and low-risk regions to reopen first. Regions were categorized as low-risk， medium-risk， or high-risk based on their exposure to COVID-19. Within these， critical sectors that ensured the supply of functional needs， such as transportation and logistics， were prioritized under strict safety standards. Restrictions on other sectors were gradually lifted based on updated risk assessments and business needs. As a result， in early March 2020， more than 90% of industrial enterprises in 41 cities had resumed production， with key industries such as petroleum， telecommunications， power， and transportation operating at 95% capacity.

Technology was key. Digital technology played a critical role in both the containment of the outbreak and the reopening of the economy. China swiftly developed health QR codes to identify high-risk individuals and trace close contacts of confirmed cases.

Policy actions and financial support. In February 2020， China launched targeted fiscal and monetary stimulus policies to mitigate the adverse impact of COVID-19 on the economy which amounted to USD 2.3 trillion or 16.1% of the GDP by the end of May 2021. Special policies were deployed to support micro-， small-， and medium-sized enterprises（MSMEs） to reduce their operational costs—through wider and more affordable access to credit and extended deadlines for qualified loan repayments—and retain employment.

Fiscal support to stimulate the economy was multi-pronged. It consisted of tax cuts and social security contribution exemptions， support for infrastructure investment， industry-specific programs， and consumers subsidies.

1. Tax relief and social security contributions exemptions. Tax relief was targeted. For instance， companies involved in pandemic prevention and control were granted tax incentives. The value-added tax of small-scale taxpayers and vulnerable sectors was exempted or reduced， tax payments of qualified enterprises were deferred， and social security contributions were temporarily waived. A total of RMB 1？trillion in special COVID-19 bonds were issued to strengthen local government finances. Increased public spending and falling revenue due to supportive policies （RMB 2.5 trillion in cuts in taxes and fees， and a RMB 1.5 trillion reduction in social insurance contributions） were effective in fueling the economic rebound， but increased the annual budget deficit by 1.3% to 6.2% of GDP in 2020.

2. More infrastructure spending. The quota for new local government special bonds was raised to RMB 3.60 trillion in 2020 from RMB 2.15 trillion in 2019 to boost public infrastructure development. In May 2020 alone， the issuance of new local government special bonds reached nearly RMB 1 trillion， with investments prioritizing building new infrastructure including 5G network， the Internet of Things， smart transportation， smart energy， and research facilities.

3. Industry-specific support. Overall， the industrial sector benefited from service fee reductions， such as lower electricity and internet broadband rates. For industries that were hit hard by the pandemic， specific polices were designed， including incentives for car sales， favorable tax policies for the film industry， fee reductions for the shipping and aviation industries， and higher tax rebates for exporters.

4. Consumer subsidies. Chinas plan to boost consumption was more modest than the one adopted to stimulate production， leading to a slower recovery in household consumption. The main initiatives consisted of vouchers for stimulating consumption， with over RMB 6.5 billion in consumer vouchers being distributed by local governments in 42？cities by April 2020 to boost spending and incomes.

Monetary policy aimed at expanding credit and reducing the financing costs for the real economy. Measures included reduced interest rates， increased non-interest rate instruments， and relaxation of selected financial regulations. This approach proved effective in supporting credit growth and mitigating the adverse impact of COVID-19 on the economy. Shortterm interbank rates went down and credit in the real economy increased. By the end of 2020， the total outstanding social financing—a broad credit aggre- gate—expanded by 13.3% compared to the 10.7% seen a year before.

Challenges

The economic rebound in China was swift but still faced challenges. These included an uneven recovery， rising financial sector vulnerabilities， income inequality， and a missed opportunity for a greener recovery.

The recovery was uneven. Investment， industrial output， and exports triggered the recovery in Q2 2020. In contrast， the contraction in consumption and the slow rebound in services， two important sources of growth for the economy， slowed down economic growth in 2020. This is partly due to the modest consumption stimulus plan， which accounted for less than 1% of the countrys total COVID-19 policy package， and the severe impact of the pandemic on key services， such as accommodation， catering， and transportation， which were hit hard by lockdowns and mobility restrictions.

Financial risks increased. The government call for more infrastructure spending and support for credit expansion， underpinned by increased local government special bonds， led to a higher level of debt. The general government debt increased by 9.7% up to 67.1% of the GDP in 2020. In addition， the relaxation of selected financial regulations （e.g. loosening NPL recognition standards） added risk to the financial sector.

According to the central banks estimates， the NPL ratio of banks could reach 5.49% by the end of 2021， up from 1.84% at the end of 2020. The pandemic has also likely worsened income inequality as it affected income groups differently， as suggested by the fast recovery of high-end consumption， such as that of luxury goods and cars. High-income groups are more likely to work in sectors which were less affected by COVID-19， e.g. information technology and finance. In addition， they could also resume work quickly by making use of home office arrangements. In contrast， low-income workers in the hardest-hit sectors， especially migrant workers， faced job losses during lockdowns or lower income growth due to weak domestic demand. For？instance， the average income for migrant workers increased by only 2.8% in 2020， which was much lower than the 7.8% increase recorded a year before.

Environmental challenges persisted. The COVID-19 shock led to a temporary reduction in air pollution and energy consumption with lower greenhouse gas emissions， with fine particulate matter （PM2.5） concentration levels in 168 cities falling by 12% in 2020. However， as the economy rebounded and GDP growth was prioritized， the share of green spending in Chinas recovery measures was comparatively low at 12% compared to those of more advanced countries such as Canada （75%）， Germany （47%）， and France （38%）.

Policy recommendations

Moving ahead， it is critical to consolidate the economic recovery by adopting policy initiatives that address these challenges， including efforts to strengthen private consumption and service development， policy normalization， and an inclusive and green recovery. The following policy recommendations are proposed.

A rebalancing of the economy boosting household consumption. The impact and uncertainty brought about by the pandemic increased households precautionary savings， pushing national savings to 45.7% of GDP in 2020， from 44.1% a year earlier. While a larger consumption stimulus pack- age can stimulate consumption in the short run， improved social protection is needed to reduce precautionary savings and support household consumption in the long run. Support should be targeted at vulnerable groups， including migrant workers and the unemployed. These policies can include lower social security contribution rates， conditional cash transfers， increased unemployment benefits， job training， and more affordable access to health care.

Foster service sector development. The service sector was hit hard by the pandemic， which reduced its contribution to GDP growth from 63.5% in 2019 to 47.3% in 2020. As the sector employed approximately 48% of the labor force in 2020， this contraction depressed the labor market. Given the importance of services as a source of growth and employment， it is essential to support the sectors development， in particular with policies and investments focusing on high-value services （i.e. information technology， health care， education， and professional services）. In terms of this pursuit， the sector will also benefit from increased productivity， which can be achieved by a greater opening-up and liberalization of the sector that currently remains highly regulated and suffers from excessive red tape.

Narrow the income inequality gap. Besides continued efforts to support the vulnerable， moving toward a more comprehensive personal income tax could make the tax system more progressive and equitable， thus helping reduce income inequality. At the same time， reforms in central–local government relations are needed to address local governments fiscal pressures. Such reforms include higher transfers to economically weaker local governments， as well as improved local government own-source revenue by granting local governments limited taxation power， e.g. relating to a local recurrent property tax.

Green and inclusive recovery

Prioritize inclusive recovery. The combined health and economic crisis has highlighted weaknesses in the countrys basic systems， including the low public spending on health care （public health care expendi- ture accounts for 2.9% of the GDP in China compared to 6.5% across member countries of the Organisation for Economic Co-operation and Development）， inadequate social protection， and the lack of a progressive taxation system， which accentuated inequality during the pandemic. More fiscal spending on public health care， strengthened social safety nets， as well as tax reforms to balance income distribution could reduce inequality and make the recovery more inclusive. Digitalization will enhance the impact of these measures， as digital solutions（such as telemedicine， and online education and training programs） can widen the access of vulnerable groups to basic public services and upgrade their skills to maximize employment opportunities. Under a well-designed regulatory and supervisory framework， fintech lending to MSMEs will also contribute to financial inclusion.

Make the recovery green. Policies that address climate challenges must be brought to the forefront to ensure a green recovery for China in order to meet its ambitious commitments to carbon neutrality. As the economy in China is consolidated， policymakers should incorporate environmental factors into their budgeting process and allocate public investments to green and sustainable sectors. This could include promoting green jobs and businesses to support the green transition， which should be underpinned by wider access to green and sustainable finance that involves the private sector.

（Source： Asian Investment Bank）