- Our baseline is that the virus is contained globally in March 2020, allowing travel and other restrictions to be unwound by mid-Q2.
- We expect a peak hit to China's growth in the first quarter with a rebound only taking a firm hold by Q3. We forecast growth of 5.0% in 2020 (from 5.7% previously) and above-trend 6.4% in 2021 (from 5.6%) as lost ground is made up.
- We provide a range around our baseline by assuming reported cases peak somewhat earlier and later with growth of 5.5% and 4.4% in 2020, respectively. If the virus cannot be contained, a material risk, the economic impact could develop exponentially with significant credit implications.
The new coronavirus outbreak is hitting China's people and economy hard. S&P Global Ratings believes most of the economic impact will be felt in the first quarter, and that a recovery will be firmly in place by the third quarter of this year. Full-year growth will fall to 5.0%, by our estimates. However, we expect lost ground to be made up in next year, with GDP expansion at 6.4%.
We base our economic assessment on the public information we have at hand and our interpretation of what this may mean for government policies, especially those that affect the movement of people, and the behavior of consumers and firms. Uncertainty remains high, and our conviction in any particular forecast is lower than usual. Still, we feel that there is now sufficient information to refresh our baseline for China's economy this year and next.
What We Know About Coronavirus So Far
The severity of the economic impact of the coronavirus will depend upon two key parameters. First, how far the virus spreads which is captured by the reproduction ratio (the number of secondary infections produced by one infected individual). Second, how dangerous the virus is as measured by the case fatality rate (the proportion of those infected that subsequently die).
Estimates for the coronavirus are converging, albeit slowly, for the reproduction ratio to be between 1.5 and 3.5 and the case fatality rate of about 2%. Compared with severe acute respiratory syndrome (SARS), this new coronavirus seems to be more infectious but less severe. Both the reproduction ratio and the case fatality rate are influenced by not only the epidemiology of the virus but also the policy response and the effectiveness of the medical system.
Our Baseline Assumption Is Virus Containment By March
Notwithstanding uncertainty, S&P Global Ratings' baseline assumption is that the coronavirus crisis will stabilize globally in March 2020, with virtually no new transmissions in April. With this assumption in hand, we can take a first pass in assessing the impact on China's economy. Of course, the virus has global reach and there will be feedback effects on China as other economies adjust and global financial conditions shift. However, as China is at the epicenter of outbreak and a very large economy, it makes sense to start here.
SARS Is A Useful But Limited Benchmark
The SARS impact on China's economy was very short lived. This episode can help us benchmark the potential impact, but we should be careful about too much reliance. Isolating the impact of any infectious outbreak on the economy is hard, and China's economy is very different compared with 2003.
That said, one clean way to assess the impact of SARS on the level of activity is to compare it to what might have occurred if there had been no viral outbreak. So for SARS, we looked at the seasonally adjusted level of real GDP at a quarterly frequency around that event. We then compare the path of the economy in the period just before and after the SARS outbreak to what we might have expected in the absence of a virus. We measure this with a linear trend estimated over the 2000-2007 period and find that in 2003, China's trend rate of real growth was over 10% in annual terms.
There are, of course, flaws in this approach. One might question whether we can reliably seasonally adjust China's national accounts and whether drawing a straight line is the right way to measure trend growth. Both are valid questions but we are trying to keep the exercise simple and transparent.
We find that SARS had a large but short-lived impact on activity. The peak impact appears to have been in the second quarter of 2003, six months after the first infections were reported, when we estimate that the quarter-on-quarter change in real GDP was about 0.8% compared with trend quarterly growth of 2.5%. The difference between these two numbers gives us our rough estimate of the hit which is a 1.7 percentage point (ppt) decline. Thus a defining feature of the SARS episode is that it was very short lived--in fact, the loss was recovered in the subsequent two quarters when sequential quarterly growth hit an above-trend 4% and 3%, respectively.
SARS is a useful but limited benchmark. In particular, we should acknowledge that the new coronavirus appears to be more infectious than SARS--indeed, the global number of reported cases is likely to be at least an order of magnitude higher than the 8,100 cases of SARS. Another key difference with 2003 is that the contribution of consumption to overall growth has risen to almost 60% from about 36%. Given that viral infections are likely to have the largest short-run impact on consumers, this suggests a larger effect, notwithstanding mitigating factors such as an improved healthcare system and the rise in online consumer spending. In addition, unprecedented measures taken to contain the spread of the new coronavirus are likely to affect the transportation network more now than during SARS (see "Coronavirus Will Take A Big Toll On China's Transport Operators," Feb. 3, 2020).
Travel Restrictions And Risk Aversion Could Persist Until Q2
The higher reproduction ratio of the new coronavirus relative to SARS and the vigorous policy response--including travel restrictions within and to and from China--suggest a longer impact than during SARS. These restrictions directly affect economic activity. They also have indirect signaling effects, because households and firms may feel governments possess more information than they do. As a result, such restrictions are likely to discourage other activities, including travel along unaffected routes and discretionary consumption (e.g., accommodation, catering, and entertainment).
Even if the number of cases reported peaks in the first quarter, as we assume based on specialist opinion and the most recent data, some travel restrictions will likely remain in place for some time after, perhaps until the middle of the second quarter. This is a key factor in why we model the shock over two quarters compared with the one-quarter shock of SARS. A firm recovery in activity, which we define as sequential growth well above trend, may only take hold in the third quarter. Given that the shock happened early in the year, the math implies a large effect on full-year growth.
Consumption To Take The Main Hit
We forecast the potential impact bottom-up. We start with each component of aggregate expenditure and make plausible assumptions based on what we know about the virus, the structure of spending, and the benchmark of SARS. Of course, there will be supply-side effects in the short run but we can incorporate these into a demand perspective by thinking about the effect on household spending (as casual workers miss wage payments) and investment (especially as firms run down inventories due to supply outages).
We expect household consumption to take the main hit, especially spending on discretionary goods and services as individuals avoid public spaces to minimize the risk of infection. A delayed return to work for migrants and other casual workers paid by the hour or day will also hurt incomes. Some data suggest that consumer activity is already sharply lower, for example domestic travel by rail and air. International companies operating in China are hardly representative samples of domestic spending but some global consumer-facing firms are reporting indefinite closures of 10% to 50% of their outlets.
We assume that the peak impact will reduce household spending on discretionary goods and services by 10% and slow spending growth on necessities during the first quarter. Based on expenditure shares reported by China's benchmark household survey, private consumption growth could fall by almost 2% from end-2019 to March 31, 2020. That equates to a year-on-year rise of just 3.3% during the first quarter. In the absence of the virus, we would have expected year-on-year consumption to rise by above 6%. Offsetting this impact to some extent will be a moderate pick-up in government consumption, mainly due to higher healthcare spending.
Investment spending will be hit on two fronts in the short run. On a purely short-term basis, as firms run down warehouse stocks in some sectors due to supply outages, we should see inventories (included in gross capital formation) drag on growth. Given that the outbreak originated in the central city of Wuhan--a logistics, transport, and autos production hub--this drag could become quite large. If inventories fall to the point that manufacturing activity outside the affected area ceases--as is beginning to occur in the autos sector--product shortages will result, which would further depress consumption and investment.
At the same time, firms are likely to delay new investment decisions and slow down the execution of current projects as they focus on managing the short-run impact on their operations. We expect the peak impact to slow investment growth during the first quarter to about 3.7% compared to a normal pace of growth of about 5.5%.
Trade will also be affected but determining the net effect on growth is hard. The demand shock is larger for China than its trading partners, so all else equal, this should mean that the decline in imports of goods and services (including tourism) will be larger than that for exports. At the same time, trade in goods in both directions will be substantially affected by supply outages and disruptions to the logistics networks. Overall, it seems likely that imports will be hardest hit and this will provide an offsetting but moderate positive contribution to growth that will unwind later in 2020.
Timing Is Everything For Our 5.0% GDP Growth Forecast For 2020
The immediate impact on the economy is a 1 ppt knock to sequential growth. This is the difference between a quarter-on-quarter expansion of just 0.4% in the first quarter compared to our 1.4% estimate of trend. This is a conservative estimate and is lower than the hit we calculated for SARS above. We expect activity to only grow at around trend in the following quarter. We build in a firm recovery with above-trend growth thereafter. The effect is more drawn out than in SARS given the longer time to reach peak infections and the greater extent of travel restrictions in this episode.
In annual terms, our first pass growth forecast is 5.0% for 2020 (previously 5.7%) and 6.4% for 2021 (previously 5.6%). This growth path would bring GDP almost back to the same level it would have reached in the absence of the virus by the end of 2021.
The timing of the peak, even to the month, is important for how forecasts fall out of our assumptions. To assess the sensitivity, we shifted the peak in reported cases forward or back one month compared with our March baseline to generate upside and downside scenarios. In both cases, the profile of recovery is similar but the effect can be quite large on full-year outcomes.
|China: Summary Of Economic Growth Projections|
|GDP (YoY growth, %)|
|YoY--Year on year. f--Forecast. Source: S&P Global Economics.|
Our forecasts assume that the official GDP releases do not smooth the impact and that the government accepts some flexibility regarding growth outcomes for this year. If either of these assumptions turns out to be incorrect, reported GDP may come in higher than our estimates. We will know more about possible changes to the growth target after the annual government meetings, which are initially scheduled for March.
Duration Matters For The Property Market
Any sensible forecast must take a view on prospects for real estate, which remains a key driver of growth in China. Sales activity has all but ground to a halt nationally as local governments discourage visits to showrooms and large group gatherings such as lotteries and closing ceremonies. The good news is that the impact may be recoverable since January and February are traditionally quiet months for sales. S&P Global Ratings' property team had already forecast national residential sales growth to decline to 0%-5% in 2020; this may shrink further (see "China's Illiquid Developers Ask, How Long Will The Coronavirus Crisis Last?," Feb. 3, 2020).
Many developers count on steady cash flow as a liquidity lifeline. As such, for the property firms at least, the key issue of the coronavirus crisis will not be its intensity but its longevity. The industry will come under more pressure if the virus holds back sales activity moving deep into the second quarter of third quarter. For the real economy, this would mean weaker investment (of which real estate accounts for over 30%) and pressure on upstream commodity sectors, such as steel, which supported manufacturing output last year.
Policy Stimulus To Be Limited In Size And Effect
Our forecasts assume that both the level and effectiveness of policy stimulus will be limited. In our view, recent large liquidity injections by the People's Bank of China (PBOC) were aimed at preserving orderly short-term funding markets. For the broader monetary policy stance, pay more attention to the signaling from policy rates. For example, the reverse repo rate was cut by 10 basis points after the lunar new year. We view this as a moderating easing, given the onshore swap market is pricing in a large decline in actual repo rates of 25 basis points over the next 12 months. Lower rates are likely to find their way to the real economy and this should be reflected in a moderate decline in the loan prime rate (LPR) in the coming months.
One risk might be that notwithstanding a moderate easing in monetary policy, financial conditions could tighten as banks become more risk averse. However, while banks' nonperforming loan ratios are likely to rise materially as a result of the hit to growth this year, S&P Global Ratings believes that financial conditions will remain supportive to the real economy. In part, this reflects our view that PBOC policy rates will be kept low and stable, supported by liquidity injections or reserve requirement ratio cuts, when needed.
Banks have also been asked by regulators to soften the blow to the real economy. To facilitate this support, the regulator has asked banks to show forbearance toward individuals struggling to service debt and corporates that are playing a role in combatting the virus or are in the most heavily affected regions or industries (see "Coronavirus In China: Domestic Banks To Face Stress Test," Feb. 3, 2020).
Fiscal policy will also likely ease as a result of lower tax revenues and increased health spending, including from the commitment by the government to fully cover the costs of medical treatment for coronavirus. Much of this will show up as a larger general government deficit, but the change is unlikely to be large unless the severity of the virus worsens. It is possible that local and regional governments' off-budget debt could rise further than we forecast, undoing strides made to reform fiscal transparency. But even here we expect some restraint.
The impact of stimulus on the economy may be blunted given the nature of the virus shock to demand. If consumers are staying at home because of restrictions on their movements or due to concerns about infection, it is unlikely that lower interest rates or taxes will convince them to venture out and spend. Likewise, if quarantines prevent firms from fully restarting operations, it is hard to see how traditional stimulus measures can provide much short-term relief.
A Temporary Rather Than Permanent Hit To GDP
Whether the coronavirus inflicts permanent damage to China's economy will be determined by its supply-side effects--that is the labor force, the capital stock, or productivity. We assume the impact will be temporary and that near-term losses in activity can be made up later. In other words, once the crisis abates, growth should push above trend for a period of time so that the level of GDP returns to where it would have been in the absence of the virus. We do not envisage any permanent impairment to the labor force or capital stock. Productivity could be affected if the virus forces businesses to make costly changes to their business models. For example, to mitigate the effect of future pandemics, firms in both the manufacturing and service sectors might have to re-engineer processes or diversify their production facilities. This is harder to gauge but would likely depend on the duration of the crisis.
Risks Of An Uncontained Virus And Exponential Economic Damage
The tail risk is that the virus is not contained, whether in China or globally. A number of renowned epidemiologists have noted that because the virus is proving highly transmissible, the prospects for containment may not be high.  Focusing on China, this would mean that the policy measures designed to limit the spread would remain in place for a sustained period while consumer spending remains depressed.
This would clearly come with tragic human costs. It would also extend the economic damage through all the channels we discuss above. The effects may not be linear, however, in the sense that each quarter of rising cases inflicts the same hit to activity. In part, this reflects a networked modern economy where turning off nodes over time--such as different parts of the supply chain--has an increasingly large effect.
High debt levels could also be a factor. The property sector is a good example where a prolonged halt to sales activity and vanishing cash flows will, at some point, start to stress highly indebted developers and other vulnerable firms in the property supply chain. In turn, this would transmit stress to some parts of the financial system that could quickly spread given interconnectedness. The outlook for credit would darken substantially in this scenario.
Global Spillovers From The Coronavirus Shock In China
China accounts for one-third of global growth so a 1ppt slowdown in the country's growth rate is likely to have a material effect on global growth. The global impact will be felt through four real economy channels: sharply reduced tourism revenues, lower exports of consumer and capital goods, lower commodity prices, and industrial supply-chain disruptions. These spillovers could become larger if markets start to price in the risk of a material global slowdown and financial conditions tighten as risk premia rise across asset classes. Pressure on the renminbi exchange rate will be important to track.
Tourism revenues from mainland Chinese visitors have plummeted based on anecdotal reports and may stay weak even as infections peak. We estimate that Chinese tourists generated about US$260 billion in revenues for trading partners in 2019. If we assume that in 2020, these revenues in the first and second quarters fall by 50% and 25% from the previous year's totals, respectively, this would represent a 30% or US$80 billion decline. As a share of GDP, the impact of this loss would be felt most by economies such as Hong Kong and Thailand where revenues from Chinese tourists are equal to more than 5% and 3% of GDP, respectively. (These are gross revenue estimates and the added value domestically will be lower). Australia will be affected by reduced tourism revenues from China (about 0.7% of GDP) but also the potential knock on visiting Chinese students (see "Coronavirus Will Dent Australia's Higher Education Revenues," Feb.6, 2020). The U.S. dollar losses would also be large for Japan and South Korea but they would move the macro needle much less as tourism is a far smaller share of GDP.
The impact on global goods trade will depend on the size of the GDP decline in China and the sensitivity of imports to growth. Typically, so-called "import elasticities" are greater than 1, which means that a 1ppt decline in growth (relative to what would have occurred in the absence of the virus) will mean a greater than 1ppt decline in real import growth. Measuring this elasticity is hard for China given the structural changes in the economy, including relatively less processing trade and more imports for domestic consumption. Still, it is likely that import volume growth could fall by over 1.5ppt and this may initially be concentrated in discretionary consumer goods. Over time, capital goods are likely to be more affected as firms' investment plans begin to be seriously disrupted. This will clearly entail some flexibility from the United States on the recently agreed Phase 1 U.S.-Sino trade deal.
In terms of commodities, reduced passenger and freight traffic will mainly affect oil imports. More important for the region is the outlook for property and infrastructure investment which affect coal and iron ore, key exports for Australia and Indonesia. Much here will depend on the longevity of the crisis and the impact on property developers and local governments.
Crisis longevity is also the key factor for supply chain disruptions. For now the autos sector is in the eye of the storm. S&P Global Ratings' auto team estimates that current shutdowns in China are likely to knock 2%-4% off total annual production in the Wuhan region, which is home to about 9% of the total Chinese auto production. China may further extend shutdowns beyond Wuhan's Hubei province to limit contagion risk, possibly affecting up to one-half of China's auto and auto-parts production (see "The Coronavirus Dashes Recovery Hopes For Global Autos," Feb. 5, 2020).
(Hopefully) A Blip In China's Gradual Inescapable Slowdown
The coronavirus does not change our view that China's economy is still in the midst of a gradual but inescapable slowdown that should see growth average less than 5% through 2030 (see "China Credit Spotlight: The Great Game And An Inescapable Slowdown," Aug. 29, 2019). After four Golden Decades, China must now manage a shrinking workforce and deleveraging across its economy and financial system. At the same time, as China becomes richer and rebalances toward services, productivity growth will slow. Should the coronavirus crisis pass as we envisage, we anticipate a return in policy focus to managing the delicate tradeoff between slowing growth and reducing financial risks across the economy. If the crisis persists through the summer months, managing this tradeoff will become much harder.
- Coronavirus Will Dent Australia's Higher Education Revenues, Feb. 6, 2020
- Coronavirus Impact: Key Takeaways From Our Articles, Feb. 5, 2020
- Coronavirus Will Take A Big Toll On China's Transport Operators, Feb. 3, 2020
- China's Illiquid Developers Ask, How Long Will The Coronavirus Crisis Last?, Feb. 3, 2020
- The Coronavirus Dashes Recovery Hopes For Global Autos, Feb.5, 2020
- Coronavirus In China: Domestic Banks To Face Stress Test, Feb. 3, 2020
- China Credit Spotlight: The Great Game And An Inescapable Slowdown, Aug. 29, 2019
This report does not constitute a rating action.
|Asia-Pacific Chief Economist:||Shaun Roache, Singapore (65) 6597-6137;|
|Asia-Pacific Economist:||Vishrut Rana, Singapore (65) 6216-1008;|
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