Coronavirus – getting back to work?

This note focuses on the potential economic impact of coronavirus as well as an initial view from the companies and sectors that we follow. In general, the focus is all about getting back to work. However, supply chains in some areas will have ongoing impact given the need to secure approval for re-opening, shortage of labour and lack of components. There will also be delays through the transport network and the ports, again due to the lack of labour and bureaucratic controls. Assuming the spread of the virus peaks over the next few weeks, business should return to normal over the next couple of months. However, there will be plenty of companies which find their supply chain more disrupted than expected and there will inevitably be longer-term implications.

The response thus far has been sensible, with the initial weakness in equity prices short-lived as investors recognise that this is likely to have a short term impact on the global economy. It is also highly likely that the Chinese decide to pump prime the economy to stimulate activity, particularly with the 100th anniversary of the Communist Party of China in 2021.

Company updates. There have been a number of formal updates, with only a few companies warning of material impact. The majority are stating that it is too early to tell, which is understandable given the uncertainty over the scale of the issue. As mentioned above, the focus is on restarting production, but most companies will be operating at below capacity and impact on the supply chain will take time to unfold.

Medium/long-term impact. Travel restrictions are likely to be in place for some time, which will impact on sectors such as leisure and trade events. For example the Chinese Grand Prix has been postponed, Macau closed and the Singapore air show severely impacted. It will also impact on the ability to deliver on any strategies to expand in China and to source products. There will be many companies assessing their supply chain risk and considering de-emphasising Chinese exposure. Clearly this has been a trend in any event due to the trade war and rising wage cost. Health concerns will be added to the list, with the added issue of difficulties in auditing supply chains whilst travel restrictions remain.

There will, of course, be some beneficiaries. Plenty of companies will be enjoying the reduction in oil prices, which are currently down c20% and are likely to stay depressed in the short term. Companies with operations outside China, but competitors inside China, could see both a short term and a long-term boost as supply from China is reduced and supply chains are altered.

How deadly is the virus
The reported death rate is 2.5%, which compares to 9.6% for SARS. The deaths are predominately in the elderly and those with underlying conditions, with the majority recovering relatively quickly. The authorities response has clearly been more aggressive than other viruses due to the virulence of the virus and the higher than normal death rate. To put it into perspective, norovirus is far more widespread (685m cases per annum) and resulted in many more deaths(200,000), but has a far lower death rate (0.03%).

According to the New Scientist “early estimates of the death rate from new diseases are typically much higher than the true figure, because only serious cases are detected. Initial reports of a >2% death rate from the coronavirus are based on dividing the number of deaths by the number of confirmed cases. But this doesn’t take into account the delay between people falling ill and either recovering or dying, or the fact that doctors were testing only people who already had pneumonia – the most serious cases.”

SARS spread across 29 countries in 2002/3, infecting 8,098 and resulting in 774 deaths (as reported). In comparison, coronavirus has now been reported in 26 countries.

Economic impact of the coronavirus
With the likely timescale and spread of the infection unpredictable, any estimates about the potential economic impact on China and the rest of the world naturally involve a degree of guesswork. The latest data available suggest that the pace of the outbreak is slowing down. China reported 97 more deaths on 12 February, taking the total toll in the country to 1,113. There were 2,015 new confirmed cases on the mainland, the lowest daily total since 30 January, bringing the total to 44,653. Hubei province reported 1,638 new cases and 94 new deaths on 11 February, both totals lower than the previous day.

The Chinese government's senior medical adviser asserted that the outbreak is already hitting a peak this month and may be over by April. The forecast is based on the latest data, mathematical modelling, recent events and government action. It should be noted that his previous forecast of an earlier peak turned out to be premature.

The timing of the coronavirus outbreak was especially unfortunate for the Chinese economy, coinciding not only with the Lunar New Year holiday but also arriving at a point when the economic activity readings were showing signs of improvement. GDP growth of +6.0% YoY for Q4 and +6.1% for 2019 overall was in line with expectations, albeit the slowest rate since 1990. The official 2020 target has already been trimmed to +6.0% YoY and now even that forecast looks unachievable.

The policy response to the economic impact of the coronavirus will require a combination of monetary and fiscal measures. The PBoC has already taken an aggressive approach, providing huge injections of liquidity into the banking system via its reverse repo mechanism in order to restore confidence and maintain the flow of credit to affected companies. Another RRR cut is likely at the official policy meeting on 20 February. Increased government spending and tax reliefs will be targeted at the most exposed sectors including retail, catering, tourism and transportation. The budget deficit may approach 3% of GDP this year, and local infrastructure measures will also be encouraged.

President Xi reportedly warned officials that measures to contain the outbreak had gone too far and threatened the economy. The Xinhua news agency reported that“party committees and governments of all levels were urged to achieve the targets of economic and social development this year.” The National Development and Reform Commission (NDRC) urged companies and factories to resume work, especially in industries such as food and pharmaceuticals. The pressure is intense in tertiary industries and on SMEs with tight cash flows, which may prompt a rise in bankruptcies and put upward pressure on the unemployment rate in Q1. Reports have suggested that more than 300 Chinese companies are seeking bank loans totalling at least 57.4bn yuan ($8.2bn) to help to soften the impact.

Before there is convincing evidence that the disease is under control, equity markets (outside Asia) had shrugged off the second major geo-political shock of 2020. European indices have regained their pre-virus levels and the US S&P and NASDAQ indices stand at all-time highs.

Given that much of 2019 was spent worrying about how the US-China trade dispute might hamper global growth,the resilience to a more immediate threat to economic activity is impressive, if puzzling. It is true that previous comparable episodes proved to be a buying opportunity, but China is now a much more significant part of the global supply chain, hence the impact of any slowdown will be felt more widely. The offsetting factor is that another headwind to a fragile global economic upturn provides further justification for central banks to extend their liquidity support. Interest rate markets are already pricing in additional Fed easing by the summer.