The Outlook: February 2020 economic commentary
Coronavirus: some thoughts on the economic fallout
The coronavirus known as 2019-nCoV, which started in the Chinese city of Wuhan, has unsettled global financial markets in recent weeks. Equity markets in Asia have borne the brunt of the selling: on 3 February the Shanghai Composite stock index posted its largest one-day fall in nearly four years. Nervous investors have sought refuge in so-called ‘safe-haven’ assets, such as gold and government bonds.
The question going forward is whether the outbreak will merely be a source of short-lived volatility, or a fundamental factor in shaping the longer-term direction of global financial markets.
There is little doubt that, in the short-term, the virus will have a big negative impact on Chinese economic activity. The effective quarantining of nearly 50 million people in at least 15 cities, along with the extension of the Lunar New Year holiday will deliver a big hit to spending in the retail, leisure, travel and hospitality industries.
A bigger impact than SARS?
Comparisons have inevitably been made to the outbreak of severe acute respiratory syndrome (SARS) in 2002-03, which estimates suggest knocked around one percentage point off China’s growth rate. However, this time around, there is potential for nCoV to create a bigger drag. For a start, in 2003 the authorities did not lock down cities in the way they are now. Such measures should help contain the spread of the virus, but they will have a larger short-term impact on economic activity. Moreover, the services sector – which includes the retail, tourism and hospitality sectors that have been most affected by recent quarantine measures – is now considerably more important to the Chinese economy, accounting for around 52% of GDP compared with 42% in 2003. The timing of the outbreak ahead of the Lunar New Year - a period when Chinese consumers tend to spend a lot – will also exacerbate the economic fallout (although the increased prevalence of online shopping could benefit some retailers).
The ramifications for the global economy are also likely to be greater. China now represents around 20% of global GDP, compared with about 9% in 2003. From a demand perspective, a reduction in expenditure will be a headwind for businesses that sell in to China. Taiwan, Vietnam and Malaysia – where exports to China account for a big part of economic output - look particularly vulnerable in this regard. With reports suggesting that passenger transport volumes over the holiday period are down more than 70% compared to a year earlier, the outbreak has also weighed on the oil price, with Brent Crude currently trading near 14-month lows.
Reduced levels of tourism will have a significant impact on some economies. As a result of a marked increase in disposable income in recent decades, Chinese travellers have become an increasingly important source of demand, accounting for around 20% of global tourist expenditure compared with around 4% in 2003. Again, countries in Asia look set to suffer most: in Thailand, spending by Chinese tourists accounts for around 3% of GDP.
Given that China is the world’s largest manufacturing economy and biggest goods exporter, disruption to production resulting from the virus also threatens a significant supply shock. China is a crucial link in global supply chains, and delays in opening factories following the Lunar New Year holiday raise the risk that manufacturing production outside China will be affected due to component shortages.
Having been weighed down by uncertainty due to the US-China trade war during 2018-19, the expectation had been that the signing of the ‘phase one’ trade deal would usher in a pick-up in global trade and manufacturing activity this year. Indeed, data for January showed the global manufacturing PMI (an indicator of activity in the sector) rising to a 9-month high. However, in light of recent developments, it would not be surprising to see the PMI fall back in February.
We have argued that there are good grounds for a modest upswing in global growth this year (see our December 2019 Economic commentary). Whether the coronavirus merely puts back the expected upturn or derails it will depend on how long it takes for the authorities to get the virus under control. There is a considerable degree of uncertainty in this regard. One prominent Chinese scientist has predicted that the coronavirus will peak around mid-February. However, studies by academics in Hong Kong suggest that the number of cases has been under-reported and it will be months before the pace of growth starts to fall back.
We are obviously not epidemiologists, but tentative signs of a slowdown in the daily rate of growth of new cases provide grounds for optimism. The relatively swift response of the Chinese authorities to take preventive measures, along with technological innovation will hopefully limit the spread of the disease. At the time of writing, the number of cases outside of China is relatively low at 212, which suggests the episode is more likely to represent a regional rather than global shock.
Although there are clear downside risks, the best guess at the current juncture is that Chinese economic activity will take a significant hit during the first quarter, but go on to bounce back later in the year. Such a pattern would mimic the short-term growth profile during earlier epidemics. However, given the sharp build-up of corporate debt in China in recent years, there is a clear risk that a number of highly-indebted Chinese companies could go bankrupt, raising the risk of a more sustained deterioration in business and consumer confidence.
Certain factors could cushion the blow. On 2 February, China’s central bank – the People’s Bank of China – announced it would nudge down official interest rates and inject liquidity into money markets. Further stimulus, in the form of both looser monetary policy and increased government spending, looks likely. Outside of China, the recent fall in US government bond yields will reduce mortgage rates for US borrowers. In addition, lower oil prices, if sustained, will cut household fuel bills, providing more disposable income to spend elsewhere.
While downside risks have clearly increased, we see no reason yet to change our view that a global recession will be avoided this year. Although the news flow regarding nCoV clearly carries the capacity to generate short-term volatility, we continue to take the view that a gradual firming in global growth (albeit delayed by the virus outbreak) and supportive monetary policy provide a favourable backdrop for global equity markets. Equity markets in Asia have fallen back sharply, but the experience of previous epidemics suggests that markets are likely to recover once the number of new cases starts to slow and the virus ceases to dominate the news headlines. Uncertainty surrounding the virus provides another reason for the major central banks to keep interest rates low and continue expanding their balance sheets – factors that should continue to support equity markets. Developments regarding the virus need to be monitored closely, but long-term investors should not panic.
5 February 2020
This article is for generic information only and is not suggesting a suitable investment strategy for you. You should seek independent financial advice that takes your individual circumstances into account prior to proceeding with any course of action.