Author: Yana Grigoryeva
Yana Grigoryeva, Intern at the Russian National Committee on BRICS Research - special for InfoBRICS
Considering the consequences of coronavirus, it is necessary to note the key points: the epidemic itself is not as dangerous as the consequences of fighting against it, primarily for economic development. Following the impact on the economy are two more profound aspects – the consequences for China's emergency response system and, more broadly, the country's governance, as well as the impact on China's international positioning. Turning to the consequences of the COVID-19 epidemic, it is necessary to identify the main reason for such a significant impact of this disease on the world economy – the actions of the governments of the world's largest countries. The tone of these actions was set by the Chinese government, which failed to effectively stop the threat at the early stages, and then, for fear of a public reaction, resorted to the only means available within the framework of the established management system – national quarantine and complete blocking of social and economic life. This initially raised the level of tension regarding the new coronavirus, and the world's second largest economy went into a state of siege.
Later, a new wave of the disease, now outside of China, led to the need for similar measures in other countries. This led to the suspension of human and commodity flows, and also spun the flywheel of panic, thereby disrupting business activity. The impact on the Chinese economy, according to forecasts of Chinese and international experts, in particular the IMF, Deutsche Bank and the Chinese Academy of Social Sciences, will be most noticeable in the first and second quarters. The outbreak of the virus will affect the following development parameters: direct economic growth in the short term, the level of inflation and the size of unemployment.
The first and immediate impact has already been taken by the service and consumer sector. This sector of the economy is always on the front line of the strike in the event of epidemics or other natural disasters. The service sector has a significant number of small and medium-sized businesses that are most vulnerable to such crises.
It was the SMEs that were hit hard by the consequences of the SARS epidemic in 2003: then the growth rate of SMEs in the second quarter of the year that the epidemic fell by 5%. In 2020, the impact on services and consumption may be much heavier. In contrast to the mid-2000s, the service sector accounted for 54% of China's GDP in 2019, so the overall impact will be more significant than during the previous epidemic. According to surveys of SME entrepreneurs conducted by Peking University, about 30% of businessmen said that they expect revenue to fall by more than 50% by the end of 2020.
The quarantine also affects the situation with unemployment. Before the epidemic, China also had problems with employment. The unemployment rate in the country's cities in 2019 reached a record high of 5.3%, and as a result of the epidemic may exceed 6% in 2020.
The epidemic is also affecting the manufacturing sector and investment. Due to the forced holidays in China, almost all production was suspended. Published on February 28, the PMI index showing a drop in economic activity was 35.7%, having decreased by 14.3% over the month. This indicates an actual slowdown in the Chinese economy, and within two months, the Chinese government will revise its forecasts.
Production is now gradually recovering. By the beginning of March, industrial activity was restored almost completely in the Eastern coastal provinces and a number of regions within the country: in 13 of the 34 administrative divisions at the provincial level, production was restored by more than 80%. Meanwhile, a full quarantine is still in effect in Hubei province. And this province is a significant transport hub and manufacturing center. Wuhan is one of the leading centers of the automotive industry. In the province itself, there are more than 100 factories for the production of automotive components, including the companies Robert Bosch, Valeo and ZF Friedrichshafen. The shutdown of these factories is already affecting the entire Chinese economy.
Another significant consequence of the national quarantine will be the acceleration of inflation. Inflation will increase along with the consumer price index. Consumer inflation in China in January 2020 was higher than expected and amounted to 5.4% in annual terms compared to 4.5% in December 2019. The main growth factor was the increase in the price of food products by an average of 4.4%, compared with a decrease in the price of food in December by 0.4%. This is so different from the expectations for inflation, which were based on a decline in prices due to the normalization of the situation in the pork market. Investors ' expectations for easing the Chinese government's monetary policy in 2020 were not met. The coronavirus outbreak has affected the production of many goods. After the epidemic, consumption will recover quickly, but production will recover much more slowly. Therefore, we should expect a high price level in the first half of 2020.
In order to cope with these problems, the Chinese government will take certain actions. They will be implemented in the following four main areas: fiscal policy, monetary policy, financial regulation and structural reforms.
In the area of fiscal policy, the Chinese government is expected to continue its policy of reducing the tax burden for lower-middle-income people and SMEs. This policy has already produced positive results in 2019: after reducing the tax burden on SMEs by 2 trillion RMB, China's GDP growth further accelerated by 0.8%. In 2020, the state Council of the People's Republic of China is likely to adopt new measures to simplify taxation. The government is already taking the first steps in this direction. The introduction of tax deductions and subsidizing lending for SMEs is discussed. Tax incentives, however, there is a downside – a possible increase in the budget deficit. Economist Zhang Ming predicts that the budget deficit will grow to 3% of GDP. By increasing the budget deficit, China will invest in healthcare, creating new jobs and stimulating economic activity.
In the area of financial regulation, the Chinese government will face a dilemma. On the one hand, in 2017-2019 there was a tightening of regulation, the Chinese government fought for the purity of assets of local governments and state-owned companies. However, faced with the epidemic, the financial authorities have already moved to a policy of quantitative easing. In early February, the state Council of China allowed local governments to issue 290 billion RMB ($41.6 billion) of special bonds, in addition to 1 trillion RMB of such debt approved in November 2019 to increase infrastructure spending. On February 11, a second round of local government debt distribution worth 558 billion RMB ($79.7 billion) was announced. In total, according to the forecasts of economist Zhang Ming, local governments may issue bonds worth more than 3 trillion RMB during 2020. The people's Bank of China has already allocated 1.2 trillion RMB ($174 billion). This money will be used for large-scale infrastructure projects and stimulating economic activity, which goes against the policy of tightening regulation that has been implemented so far.
In addition, monetary policy easing is also expected. However, given the increase in inflation in the first half of the year, easing will probably occur in the second half of the year. Chinese economists expect a 50-basis point reduction in the reserve ratio for banks. This should reduce the mandatory reserve requirements, thus freeing up additional funds for investment. In addition, interest rates are expected to fall by 50 basis points. The People's Bank of China on February 17 has already lowered the base rate by 10 bps, to 3.17%, reaching the lowest level since 2017. This should reduce the cost of loans, making them more accessible to affected companies. The bank lowered its benchmark 1-year Loan Prime Rate (LPR) by 10 bps to 4.05% on February 20th 2020, in an attempt to inject more liquidity into the financial market and lower financing costs for companies.
The impact of the Chinese coronavirus on the global economy will be limited in time, but it will have a significant impact on a number of sectors, primarily transport, services and industry. According to Deutsche Bank, the virus will reduce the growth rate of the world economy in the first quarter of 2020 by 0.5%, or $0.4-0.5 trillion, provided that the growth rate of China's GDP in the first quarter will fall by 1.4%. The fall in stock markets will be short-term, but will not be limited to short-term fluctuations.
The decline in global stock markets, which began after news of the spread of coronavirus in Italy and South Korea, reflects investors fear of a possible blockade of these countries, as well as the spread of the disease and, consequently, quarantine to other countries. However, this fall is supported only by the fear of trading participants and falls under the definition of "stock market volatility". The shock of falling quotes will be consolidated in the time period of the epidemic itself. On the one hand, players on the exchange will try to play on the downside. On the other hand, there are investment funds that will be willing to buy undervalued assets.
The quarantine will have a direct impact on global production chains. Production in other countries will decline in the first quarter of 2020. According to Nikkei data, a $ 10 billion drop in output in China will reduce production in the rest of the world by $6.7 billion. The economies of South Korea, Japan and the United States are most exposed to this risk. There is one significant uncertainty in the outlook for the global economy – a new wave of the epidemic is gathering strength, this time outside of China. Regardless of the actual death rate, the spread of the disease outside of China can lead to general panic and harsh actions by the authorities of the world's leading economic powers. In this case, a fairly long wave-like correction may occur.