Despite recent developments, our baseline assumption is that the number of global cases of Covid-19 (the coronavirus) will peak in the first half of March. As a result, the biggest economic impact should be felt during Q1 2020, followed by a full recovery in Q2. The main risks are that the contagion may last longer and/or that the virus may become more virulent.
A pandemic impacts economies via three channels:
A pandemic impacts economies via three channels...
The two channels impact China in two ways. First, via supply shock: output is severely reduced as fewer people are going to work due to illness & quarantine. This is combined with a prolonged factory shutdown after the extension of the Lunar New Year holidays.
China will be impacted by supply and demand shocks
The second is via demand shock. Quarantine and the 'fear- factor', restrict people’s mobility and lead to a temporary large decline in activity in services. We estimate the sectors most impacted represent 52% of China's GDP. Yet services that will be most impacted represent 18% of GDP (transport 4.5%; wholesale & retail 10%; accommodation 2%; entertainment, culture & sport 1%).
Our forecast takes into account the additional policy-easing we believe China will implement. This is best described as rescue measures rather than stimulus. Although monetary policy has already become more accommodative (7-day and 14-day repo rates were lowered by 10bps to 2.40% and to 2.55% respectively), we think fiscal policy will take the leading role in helping corporates to survive the large shock.
Similar to the SARS episode, Beijing will give more targeted support such as tax exemptions to certain businesses for a limited period of time. Anecdotal evidence reveals that local governments in Suzhou, Ningbo, Shenzhen, Shanghai have already announced supportive measures: waiver of office rental by 1-2 months; postponed tax filing; and a subsidy on interest payment of new corporate loans.
The impact of the virus on EM will mainly happen through three channels:
Quarantine & fear factor will hit tourism: the speed of government response suggests a larger impact than in 2003, with governments across Asia issuing travel advice as well as outright travel restrictions on travel to/from China.
Fall in Chinese demand will impact trade: China's demand accounts for 16% of the world's economy.
Shutdown of firms will disrupt global supply chain: the disruption to supply chains could be significant given China sits at the centre of Asian manufacturing. Wuhan is where disruption could originate from; local sectors most at risk are the auto and IT (see Figure 3).
The economic shock from the outbreak will likely increase the pressure for more accommodative monetary policy in the region. That said, most central banks are unlikely to react immediately as they may need more time to evaluate whether the impact is transitory. The notable exceptions are Thailand and the Philippines where the central banks have already eased and will likely cut their policy rates again this year.
Elsewhere, Brazil and Russia have also cut rates. Meanwhile, the Monetary Authority of Singapore declared it has “sufficient room” to weaken the policy band of the Singapore dollar’s effective exchange rate. Overall, we expect the first line of support to come from fiscal policy for most economies.
A severe short-term impact that should be followed by strong recovery. Impact on global growth should be of some 0.15 percentage points.
It is worth stressing that global economic momentum was strengthening at the time of the outbreak and should naturally resume if the assumption of a transitory shock proves right.
Global economic momentum was strengthening...and should naturally resume if corona remains a 'transitory shock'.
In particular we would cite the following three tailwinds:
Overall, the coronavirus outbreak does not change our constructive view on emerging markets. We still expect the emerging markets growth gap to widen relative to developed markets, it has just been delayed.
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