As of 26 February, the number of coronavirus cases in mainland China currently stands at almost 80,000 (already 16 times higher than during the 2003 SARS episode). The measures the Chinese government has deemed necessary to get the coronavirus under control have greatly restricted the movement of people and economic activity.
Clearly, this strategy has come at an economic cost. However, it seems to have been effective: new cases in China appear to be slowing down, suggesting that infections could peak between the end of February and the middle of March.
The hitherto benign view from the markets partly rested on the coronavirus coming under control in the near future. A second key market assumption – that it remains primarily a Chinese phenomenon – has come under pressure as outbreaks in Korea and Italy threaten two more major economies. Reports from Iran suggest that coronavirus has taken hold in the holy city of Qom. In the extreme, we could be looking at a global pandemic. Correspondingly, risk assets have sold off as some of this risk has been priced in.
It could still be that cases peak soon and the coronavirus does not get a grip in other countries, but that the resulting shock to the Chinese economy and the corresponding spillover to other countries is much larger than expected. Daily indicators still suggest that China is struggling to get back to business.
Chart 1 – Manufacturing is expected to recover more quickly than services
Source: Aberdeen Standard Investments Research Institute
Our base case is that Chinese manufacturing catches up with its January level by around April and to its previous trend by the middle of the year. In contrast to manufacturing, we assume only modest improvements in services until June, reflecting a longer drag on consumer behaviour. Services may not fully recover until early 2021.
Threat to global supply chains
The different behaviour of the manufacturing and service sectors prolongs the whole economy shock within China, but unwinds the spillover via manufacturing to other countries.
Clearly, if the coronavirus takes hold in Korea (and/or other countries deeply embedded in global supply chains) there is a heightened risk that global supply chains will face serious disruption.
The necessary steps to stop the spread of the virus also act to constrain the economy.
The necessary steps to stop the spread of the virus also act to constrain the economy. But after the virus is under control, the policy reaction can do more to help ’solve’ the corona-shock, allowing GDP to catch up to where it would have otherwise been.
In China, monetary policy has been easing marginally. The medium-term lending facility has been cut by 0.1 percentage point, and the one-year loan prime rate is down by the same amount. Chinese credit growth is likely to be maintained, but not unleashed (Total Social Financing was at least robust ahead of the virus, with credit rising by RMB5.1 trillion in January, 0.4 trillion above market expectations). Meanwhile, steps to encourage forbearance – such as extending loan maturities – should stop the financial system amplifying the shock on the real economy.
Will fiscal policies be effective?
Gauging the combined effect of the smorgasbord of the announced fiscal policies is hard. However, the most significant appear to be:
- measures to cut employer contributions to social security, and generally shore up SMEs; and
- the bringing forward of local government special bond issuance, which typically supports infrastructure spending.
A more concrete fiscal package and an annual growth target may be announced in early March, even if the National People’s Congress – China’s annual parliamentary meeting – is cancelled. An aggressive growth target could go hand-in-hand with a larger stimulus package than we expect.
Elsewhere in the Asia-Pacific region, we largely expect fiscal policy to do the heavy lifting, although some monetary easing is likely in a number of economies. Indeed, the Bank of Thailand cited the coronavirus as a motivating factor behind its recent rate cut.
There is a risk that some economies may struggle to offset the shock. For example, the Bank of Japan appears to be running low on policy space, while government debt is at a very high level, perhaps limiting its ability to run a significantly looser fiscal stance.