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Economic Research: COVID-19 Now Threatens More Damage To Asia-Pacific

The wider global spread of COVID-19 will prolong the economic fallout in Asia-Pacific. S&P Global Ratings now estimates 4.0% growth in 2020 and a US$211 billion income loss across the region from the coronavirus outbreak. The loss will be distributed across households, firms, banks, and governments.

Our U-shaped recovery has been pushed back to later in 2020 due to a harder hit to China's economy in the first quarter, viral transmission outside China, and tighter financial conditions.

We forecast China to grow by 4.8% in 2020 with a plausible downside scenario of below 3%. Other economies including Australia, Japan, and Korea will flirt with recession as growth falls well below trend.

Risks are still on the downside. Duration matters more than initial impact. Emerging markets face non-linear risks from virus transmission and financial conditions.

Downward Revisions Mainly Due To Global Viral Spread

Asia-Pacific's outlook has darkened due to the global spread of the coronavirus. This will exert domestic supply-and-demand shocks in Japan and Korea. It will mean weaker external demand from the U.S. and Europe, where our colleagues have just cut 2020 GDP forecasts by 0.3 percentage points (ppt) and 0.5 ppt, respectively. We also reflect a harder first-quarter hit to China's economy than we had anticipated. The final consideration is the tightening of global financial conditions that will amplify these economic shocks. We factor in global policy easing, but this will only cushion the blow.

A U-shaped Recovery But Losses Will Be Sustained

A U-shaped recovery is likely to be delayed until the third quarter if signs emerge by the second quarter that the virus is globally contained. Activity should naturally bounce back once fears of infection recede and policies restrictions lift. We assume that the coronavirus will not permanently impair the labor force, the capital stock, or productivity--hence, the region's economies should be employing as many people and producing as much output by the end of 2021 as it would have done in the absence of the virus.

Still, even our U-shaped recovery will mean a regional economic loss of about US$211 billion that will put large holes in some balance sheets. Some economic activities will be lost forever, especially for the service sector. This loss will be distributed across the household, non-financial corporate, financial, and sovereign sectors based on the economics of the impact but also the policy response. The more that governments step in to cushion the blow with public resources, the more the burden will be shifted to the public sector. Of course, these policies should also mean that the overall loss is smaller, especially if targeted at the labor market.

Two Shocks

Forecaster are "flying blind" to some degree given the unique uncertainties of the coronavirus. To ground our forecasts, we use a framework that identifies the specific nature of the shocks, how they spillover to other economies, and how they can be amplified.

There is a demand-and-supply shock for countries battling major coronavirus outbreaks within their borders. The demand shock is centered on consumers who are either unable or unwilling to venture out in public or travel overseas. The supply shock relates to the inability of firms to continue operations because facilities have been disrupted by government restrictions or infection of employees. This is a simplification and there are second-order effects. However, these are the shocks most likely to move the macro needle.

Four Channels

If these shocks fade through the second quarter, as in our baseline, then activity could quickly normalize. Still, even for economies without major viral outbreaks, there will be large spillovers through four channels, in order of importance for Asia-Pacific, in our view:

People flows.   Travel, tourism, and education.

Supply chains.   Industries in outbreak hotspots and with specialized production.

Goods trade.   Global imports of discretionary consumer goods, potentially capital goods.

Commodity prices.   Travel hits oil, weaker investment affects iron ore and coal.

One Amplifier

The big amplifier is financial conditions, that is the price and availability of financing for borrowers but also the signal provided for others in the economy. This has emerged as a key downside risk. Risk-asset volatility has risen, equity prices are lower, and credit spreads are wider. If this makes banks more cautious in their lending, this could amplify the real economic shocks in Asia-Pacific.

For emerging markets, less external financing could force a rise in the current account balance. The remedy would be either higher interest rates (compared to where they would be if financial conditions were calm), tighter fiscal policy (to pull down domestic demand and imports), or a much weaker currency. The currency option appears least painful but this could require a large depreciation. In thin foreign exchange markets, this threatens overshooting which could un-anchor inflation expectations and stress balance sheets with currency mismatches.

China To Grow 4.8% In 2020

We make four important assumptions for our growth forecast for China. First, secondary infections remain limited. Second, the government shows flexibility with the growth target, recognizing that the coronavirus is a unique shock. Third, policy stimulus remains targeted, temporary, and modest in size. Fourth, the official GDP print reports on-the-ground conditions without excessively smoothing the data.

So far, developments are broadly consistent with our previous view (see "Coronavirus To Inflict A Large, Temporary Blow To China's Economy," Feb. 6, 2020) although a larger first-quarter hit and slower growth in the U.S. and Europe are likely to push growth somewhat lower to 4.8% (from our previous forecast of 5%).

Reported COVID-19 cases in China continue to fall, especially outside Hubei province, suggesting initial containment. Still, signs point to a large contraction in China's activity in the first quarter and a glacial recovery. Hard data for February such as daily coal consumption, traffic flows, and property sales indicate an annual decline in activity in excess of 50%. Soft data, including the official Purchasing Managers' Index, touched record lows over the same period across manufacturing, service, and construction industries. Notably, the employment component of these surveys touched record lows. While the central government has stressed the need to balance health risks with economic costs, local governments are lifting restrictions on economic activity only slowly.

We had originally assumed that the economy would stall in the first quarter. But a sequential contraction of up to 10% from end-2019 levels now looks likely, driven by a collapse in consumer spending outside the home and weak investment. This would be equivalent to year-on-year growth falling to 2.0% in the first three months. Even if this results in more pent-up demand and stimulus later in the year, it will be hard for China to grow above 5% because of the drag from supply-chain disruptions, income losses for households and firms, and weaker external demand.

Table 1

China: Summary Of Economic Growth Projections
Virus peak 2019 2020f 2021f
Old baseline - 6.1 5.7 5.6
New baseline Mar-20 6.1 4.8 6.6
Downside scenario Apr-20 6.1 2.9 7.6
f--forecast. Source: S&P Global Economics.

One Key China Assumption Is A Tempered Policy Stimulus

The raft of measures announced to date, even if fully implemented, is likely to just cushion the blow. The defining feature of the policy response is the provision of temporary relief to the corporate sector. Taxes, utility tariffs, and welfare system contributions have been cut for a specified period, with most relief granted to firms directly affected by the virus. The central bank has reduced interest rates slightly but has focused more on maintaining orderly conditions in systemic interbank funding markets. Banks are being guided to show forbearance to stressed borrowers and ease classifications for nonperforming loans. Local governments have been directed to provide tailored policy support which has focused on some easing of housing policies, subsidies for consumption, and infrastructure investment.

We assume policymakers will step lighter on the policy gas compared with past downturns for three reasons. First, policymakers have noted that they still anticipate a temporary setback with activity naturally recovering quickly should containment succeed. Second, the short-term impact of macroeconomic policy easing will be limited by constraints on supply and the risk-averse behavior of households. Third, policy space has been eroded. This may influence how much policymakers want to ease (due to concerns about debt) but also practically limit how much easing is possible. This is most relevant for local governments who may find it hard to borrow through off-balance sheet funding vehicles or lift housing markets without risking a damaging boom-bust cycle down the road.

Chart 1


Reinfection Downside Scenario For China Of 2.9%

Our new moderate downside scenario is growth of 2.9% in 2020. This is well below our previous downside of 4.4% because a weaker first half has large full-year effects. This downside assumes localized reinfections as people return to work and the re-imposition of some restrictions on activity. Our moderate downside scenario does not include widespread financial stress, especially among indebted corporates, that may emerge from a prolonged delay of normalization. This downside would mean a much larger rebound for 2021, again assuming the level of activity eventually returns to normal.

The Rest Of Asia-Pacific Will Flirt With Recession

Let's first define recession for a group of economies whose trend growth rates range from 0.8% to near 6%. We do not mean two quarters of negative growth. That is the "technical" definition and it is technically wrong. Two quarters of negative growth would feel very different in Australia than Japan. What we do mean is at least two quarters of growth substantially below trend and sufficient to cause unemployment to rise, underlying inflation to fall, and policymakers to react with stimulus.

The hardest-hit economies remain Hong Kong, Singapore, Thailand, and Vietnam where people flows are large. In all of these economies, tourism is a large share of GDP (almost 10% on average) and tourists from China account for a large share of visitors. Supply-chain exposure in the electronics and autos industries are also high. It is no surprise that here we also see the most robust fiscal policy response, especially transfers and subsidies to households and affected sectors. These measures will likely cushion the blow but they may be less effective than normal and will not prevent a recession. For these economies, we expect a hit to full-year growth of close to or well over 1 ppt.

Chart 2


Australia's Labor-Intensive Sectors Will Be Affected

Australia is also a vulnerable economy and we expect a 1 ppt hit to leave growth in 2020 at 1.2%, well below trend which is closer to 2.5%. The initial spillover from the coronavirus came from people flows which were already depressed from the bushfires. Although travel and tourism export receipts, including education, at about 3.2% of GDP are smaller than those of some regional peers, exposure to China is high and the decline could be very large. Many of these visitors, especially students, also brought many benefits to the real economy through their demand for local goods and services.

The affected sectors are labor-intensive. Services account for almost 80% of employment with accommodation and catering alone making up over 7%. Compared with past cycles, many of these jobs are now casual, either part time or fixed-term contracts and more easily terminated. If the unemployment rate rises by up to 1 ppt, as our models suggest, this will further dampen consumer confidence, drag on spending, and could stall the nascent property market recovery. We expect the central bank to cut rates once more to 0.25% which leaves the Reserve Bank of Australia on the cusp of quantitative easing. We also expect moderate, targeted fiscal stimulus aimed at the most-harmed sectors.

Local Transmission Means Even Slower Growth in Japan and Korea

One new and hard-to-predict element for Japan and Korea is the local transmission of the virus. This is changing government policies and the behavior of households. The same supply-and-demand shocks that hit China are now disrupting these countries, albeit to a smaller degree for now. Some major Korean production facilities in the autos and electronics sectors are temporarily shuttered due to infections among employees. Both Japan and Korea are the key upstream suppliers in Asia's supply chains and this exacerbates problems caused by Chinese outages and further delays any output recovery across the region.

Most importantly, households are likely to respond to a greater risk of infection by avoiding public spaces, which will depress spending on discretionary goods and services. In Japan and Korea, we estimate that discretionary consumption accounts for about 25% of GDP. Even a small decline in this spending could have outsized effects on growth as the reaction to Japan's recent consumption tax hike proves. As in China, this will hit the service sector, including small and midsized businesses, the current engine of job creation in these economies. For Japan and Korea, we expect the impact of the coronavirus be a hit of 0.5 ppt and 1 ppt, respectively. Inflation will continue to fall and the threat of outright deflation (and higher real interest rates) is rising for both economies. These estimates are subject to very high uncertainty as they depend on viral transmission.

More Policy Easing To Come, Fiscal More Effective

More policy easing is likely across the region but financial conditions are key for emerging markets policies. Targeted fiscal measures will remain prominent in almost all economies with further support to disrupted sectors and households in the form of temporary tax relief and transfers. While this will not engineer a quick rebound so long as the virus remains uncontained globally, they can soften the impact and help reduce the overall income loss faced by regional economies. Policies that encourage firms to hold on to their staff until the crisis abates, such as the temporary payroll tax cut in China, will be substantially positive for growth.

Monetary easing is also likely in Australia (25 basis points [bps]), Korea (50bps), and Japan (10bps and more asset purchases). These economies already suffer from persistently below-target inflation and are now running short of monetary policy space. Policy rates are either at or approaching the effective lower bound. Our view is that more is likely to be gained in terms of supporting growth from a fiscal response to the slowdown.

In emerging markets, especially those running current account deficits such as India, Indonesia and the Philippines, further rate cuts are dependent on the space afforded by the U.S. Federal Reserve and global financial conditions given the risk of igniting capital outflows. If the Fed cuts rates two or three times this year, these central banks and others such as Malaysia and Thailand are likely to follow with 50bps-75bps of cuts. In Vietnam, policy easing is more likely to come with an exchange rate devaluation.

Risks Still On The Downside

The balance of risks remains to the downside due to local transmission, including in economies with low reported cases, secondary transmissions in China as people return to work, and tighter financial conditions. There are economies where COVID-19 testing capacity is limited, and this may explain very low reported cases. While low reported caseloads may discourage governments from putting broad restrictions on economic activity, it could result in broader viral spread.

Asia's Emerging Markets Face Non-Linear Risks

At face value, emerging markets such as Indonesia, Malaysia, the Philippines, and India appear somewhat insulated. Exposure to China varies but the dependence on large people flows and supply chains is quite low. One unique channel for emerging markets is foreign direct investment from China, Japan, and Korea, which is likely to slow given disruptions in these economies. Reported infections are, for the most part, low. For now, this explains why we have not cut growth forecasts by more. However, the outlook could get worse, very quickly, for two reasons.

The first is infection risk. Low reported cases is likely due, in part, to minimal testing. While this may limit the immediate impact on households and firms, it will do little to inhibit the spread of the virus where it is present. In turn, this could at some point have substantial supply-side effects if a large share of the workforce either falls ill or needs to stay at home to care for sick relatives. Weak healthcare infrastructure will make it hard to arrest spread and keep case fatality rates low, and this could have damaging effects on household and business confidence.

The second risk is from financial conditions. We have already had a taster of what can happen with overshooting exchange rates in response to a pick-up in the world's fear gauge, i.e., the implied volatility index of the S&P 500 or CBOE Volatility Index (VIX). For the most part, peaceful financial conditions have afforded policymakers space to ease policies and central banks have cut rates in Indonesia, Malaysia, the Philippines, and Thailand since the coronavirus emerged. The Fed's 50 bps rate cut announced on March 4, 2020, and its willingness to do more if needed will be important to prevent a sudden stop in capital flows to these economies.

However, if financial condition re-tighten, Asia's emerging economies, especially those either running current account deficits, with weakly anchored inflation, or foreign currency mismatched on balance sheets, may be forced into pro-cyclical policy tightening. This would worsen the downturn and impose substantial losses across sectors. We should watch global credit markets as much as asset prices in our region, particularly as some investors trade high-yield assets across both developed and emerging markets. This increases the risks of financial contagion stemming from potential dislocations in U.S. credit markets.

Table 2

Asia-Pacific 2020 Economic Growth Will Be Sharply Lower
Real GDP growth, year-on-year % change
New baseline (%) December 2019 baseline (%) Difference (ppt.)
2020 2021 2020 2021 2020 2021
Australia 1.2 3.3 2.2 2.3 (1.0) 1.0
China 4.8 6.6 5.7 5.6 (0.9) 1.0
Hong Kong (0.8) 3.0 0.2 2.1 (1.0) 0.9
India 5.7 6.5 6.5 7.0 (0.8) (0.5)
Indonesia 4.7 5.5 5.1 5.1 (0.4) 0.4
Japan (0.4) 1.3 0.1 0.8 (0.5) 0.5
South Korea 1.1 3.2 2.1 2.3 (1.0) 0.9
Malaysia 3.9 5.1 4.5 4.6 (0.6) 0.5
New Zealand 2.0 2.9 2.4 2.5 (0.4) 0.4
Philippines 5.8 6.7 6.2 6.4 (0.4) 0.3
Singapore 0.0 3.2 1.4 2.0 (1.4) 1.2
Taiwan 1.9 2.8 2.4 2.2 (0.5) 0.6
Thailand 1.6 4.1 2.8 3.2 (1.2) 0.9
Vietnam 6.0 7.3 6.7 6.6 (0.7) 0.7
Eurozone 0.5 1.5 1.0 1.2 (0.5) 0.3
APAC 4.0 5.5 4.8 4.9 (0.8) 0.6
APAC ex-China 3.3 4.6 4.0 4.4 (0.7) 0.2
ppt.--percentage point. APAC--Asia Pacific.
Note on coronavirus assumption

While there continues to be high uncertainty about the rate of spread and timing of the peak of the COVID-19 disease, modeling by academics with expertise in epidemiology indicates a likely range for the peak of up to June 2020. For the purpose of assessing the economic and credit implications, we assume the global outbreak will subside during the second quarter 2020, consistent with our report, "Global Credit Conditions: COVID-19's Darkening Shadow," published March 3, 2020. As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

  • Global Credit Conditions: COVID-19's Darkening Shadow, March 4, 2020

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;
Vincent R Conti, Singapore + 65 6216 1188;

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