Economic impact of the Coronavirus

2020/3/12 15:10:48

Under the assumption that the lockdown measures will be largely suspended by mid-March and businesses can produce at full capacity again going into the second quarter, we expect a rebound of economic activity in the second and third quarters, as a result of pent-up demand and production. We also expect further policy easing measures from the Chinese authorities in the coming months to stabilise market sentiment and consumption demand. This is in addition to those policy easing measures already provided by the People’s Bank of China to keep liquidity ample as well as further support measures for businesses and sectors hit by the virus outbreak.

However, we do not expect a massive demand-side stimulus programme in China as in previous periods of growth headwinds, but rather a continuation of targeted measures. Policy space is limited and conventional stimulus measures might not work to boost investment and consumption in the current environment of supply disruptions. Furthermore, once the recovery led by pent-up demand and production has started, a massive stimulus programme could lead to overheating.

The rebound in economic activity and the policy support will cushion the overall growth impact of the virus outbreak. In our base-case scenario, our growth forecast for the Chinese economy in 2020 is 5.4%. In particular, in the first quarter, we expect a growth rate of 4.5% year-on-year, which corresponds to a zero-growth scenario on a quarter-on-quarter basis. In the following two quarters, growth would rebound to 5.5% and 5.9%, respectively.

The worse-case scenario

In a worse-case scenario, prolonged lockdown measures in China would continue to hinder the full resumption of production also in the second quarter. The period of production losses and supply chain disruptions would be prolonged, pulling Chinese economic activity further down and postponing the recovery into the second half of the year and 2021. Such a scenario would drag down growth to 4.3% in 2020.

The worse-case scenario relies on the assumption that the virus outbreak remains largely under control in Europe and the United States and the public fear factor remains subdued, ensuring that the impact of the local spreading of the virus on domestic economic activity remains relatively mild. However, the longer consumption and production shutdown in China has consequences globally.

Asian economies are most strongly affected, as is the eurozone relative to the United States. The eurozone is more dependent on the global economy, in particular with regard to the economic dynamics in China. Moreover, the structurally lower growth levels make the European economies more vulnerable to external shocks, and policy support from the European The situation in China with regard to the virus outbreak has improved. The number of newly-infected cases has peaked and the level of emergency was lowered in many provinces. However, as the virus is spreading across the world, uncertainty about the further proliferation of its outbreak remains high, complicating the assessment of the economic impact. We outline three scenarios.

The base-scenario

In our base-case scenario, we expect the situation to continue to improve in China and to remain under control in Europe and the United States. In China, we foresee that the impact on growth will be substantial, but short lived. Ongoing contagion measures have hindered the recovery of economic activity so far.

Central Bank is unlikely, due to the limited monetary policy space. Growth in the United States remains driven by domestic factors, such as private consumption, residential construction and a confident middle class. The external shock caused by the production shutdown in China is still expected to have an adverse effect on the US economy. The US Federal Reserve (Fed) will provide support with an ‘insurance’ rate-cut if growth pessimism starts to tighten US financial conditions by depressing stock market valuations and widening corporate bond spreads. Relaxing overall financial conditions by a Fed rate cut could offset the dip in US growth due to the coronavirus outbreak, keeping annual growth unchanged.

The worst-case scenario

In a more extreme case, which we believe is a tail risk, the epidemic turns into an uncontrollable global pandemic, with a second wave of new infections in China and the virus spreading exponentially through the rest of the world, with panic spreading in lockstep.

Economies in Europe and the United States would become fully exposed to the fear factor on domestic demand and supply disruptions. Global production losses and severe disruption of supply chains would lead to a more significant slump in growth globally. In such a bear case, the tightening of financial conditions would become more severe and central banks and governments would need to step up stimulus measures so that a recovery could follow in the second half of 2020 and in 2021.

Impact on global supply chains

The longer that Chinese factories remain closed, the greater the risk that cross-country supply chains break down as firms run out of inventories. The consequences of supply chain disruptions will be most strongly felt in Asian economies and markets, specifically, in those with strongest linkages to China through regional supply chains, and among intermediate goods producers who depend on China as an export market. 

The Port of Guangzhou reaches over 300 ports in more than 80 countries.

Many Asian economies are tightly connected to China in global value chains and trade with China accounts for a large portion of domestic gross output. To assess a country’s exposure to supply chain disruptions in China, we looked at the value added of Chinese intermediate goods to a country’s export goods.

Vietnam’s economy seems to be the most dependent on intermediate goods from China, followed by Malaysia, Thailand, Taiwan and South Korea. The latter two countries are not only exposed as importers of Chinese intermediate goods but also as upstream suppliers to China’s information technology industry; production suspensions in China will thus lead to disruptions in their own shipments to China.

Our base-case scenario assumes that the coronavirus will be controlled in the first quarter of the year and that production in China will run again at full capacity in the second quarter. Thus, the supply chain disruptions should be a temporary phenomenon. If the virus outbreak causes prolonged lockdown measures, as outlined in our worse-case scenario, this would result in more persistent disruptions. In this case, the countries mentioned above would face more challenges.

From: Julius Baer Group