The Chinese government is facing its biggest quandary in decades. On the one hand, fighting the biggest COVID-19 outbreak since the pandemic began nearly three years ago, and on the other, seeking to contain massive demonstrations over lockdown policies initiated to limit the virus’ spread. 

Protests roiling China – the largest in more than 30 years – illustrate how demoralized and restless parts of the country have grown after years of harsh zero-COVID-19 measures.  

At the same time, China is suffering its largest COVID-19 outbreak since the pandemic began, something that would normally compel the government to take even harsher measures to stamp out the virus.

What does the ruling Communist Party do – double down on the lockdowns or permit new degrees of freedom? 

The situation is a no-win for the government and the country. Heavier lockdowns would fuel further unrest, while relaxing zero-COVID-19 restrictions would likely lead to thousands, if not millions, of deaths.

At stake are not only countless lives and the Communist Party’s grip on power, but the Chinese economy. This year, China’s GDP growth is expected to slow to 2.8%, according to the World Bank, the lowest level in five decades outside of 2020. 

Harsher zero-COVID-19 policies would only slow the rate of growth further, with dire consequences for the longer-term potential of China’s economy.  

Disillusioned by China’s on-again-off-again lockdowns, foreign companies are rethinking their dependency on Chinese manufacturing. This year, Apple revealed plans to move some iPhone production to India and Vietnam. 

The threat of protests and economic damage might push Chinese President Xi Jinping’s government to err on the side of opening up the country, which it started to do earlier in November.  

But the most recent wave of COVID-19 cases has put China in a box. If COVID-19-related deaths surge, that might also lead to unrest and economic damage. A no-win situation indeed.

Investing in tumultuous times  

For investors in China ETFs, how this tricky situation plays out is of great consequence. The top five China ETFs in the US, which are down anywhere from 26% to 30% so far this year, were beaten down as investors feared China’s zero-COVID policies would remain in place indefinitely.

Earlier this month, China ETFs jumped after the government released a 20-point plan that slightly eased stringent lockdown policies.  

The recent mix of protests and surging COVID cases puts China, and by extension, these ETFs, at a significant crossroads.  

Amid the crosscurrents, one thing that feels certain is the status quo isn’t sustainable and something must give. China ETF investors want to see a relaxation of Covid measures, something that would be bullish for the funds. But if the government doubles down on zero-COVID, the ETFs could resume their descent.  

How China handles the situation will ripple beyond its borders. Apple makes up 6.5% of S&P 500-tracking ETFs such as the iShares Core S&P 500 UCITS ETF (CSPX) and 13% of the Invesco Nasdaq-100 UCITS ETF (EQQQ). If the company continues to sink due to iPhone-14-related production snags, that will weigh on the many ETFs that hold big positions in the stock. 

For now, investors seem optimistic, betting that China moves away from zero-COVID-19. The Xtrackers MSCI China UCITS ETF (XCX6) is trading near recent highs, up 20% over the past month following President Xi Jinping’s re-election as leader of the Communist Party.

This article was originally published on ETF.com

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