2 March 2020: ACCA's chief economist Michael Taylor offers the following analysis
Until mid-February the COVID-19 outbreak and its economic effects had been confined predominantly to mainland China. But the virus has now spread widely with a total of 40 countries reporting at least one case, and significant numbers of cases in Italy and South Korea. Fears are growing of a pandemic with global economic consequences. Big falls in global equity markets signal the transmission of these concerns to financial markets.
The Economic Impact
Economic shocks such as this virus outbreak tend to have temporary effects on economic activity, which is then recovered quickly once the crisis has passed. This was the case with the SARS outbreak in 2003 for example. For now, this is still our central case – whatever the short-term effects, we expect activity to recover, such that by the second half of 2020 global economic activity is growing at the rate it would have been if the coronavirus outbreak had not occurred. But the risks of a prolonged crisis have increased in recent weeks and the effects of this would be more long-lasting. A rise in business failures and job losses, for example, would further depress output and extend the economic damage well into the second half of the year.
The travel restrictions within China and extended factory closures are having a major drag on the economy Consumer spending – now a key driver of economic growth – will be very weak in the first few months of this year. For example, data for early February recorded annual falls in excess of 90% for both car sales and property sales. The Chinese economy will contract in the first three months of this year; the exact scale of this is impossible to judge at present but could be at an annualised rate of around 10%. The annual growth rate of GDP will drop from 6% in Q4 2019 to as low as 3% in Q1 this year.
China’s significance in the global economy and its integration into global supply chains means that there is potential for a wider economic effect. China now accounts for 19% of world GDP and 13% of global exports. (Hubei Province, the source of the virus, is an important region for manufacturing and supply chains.) China is a big importer too, especially of commodities. Over the last month oil prices have fallen by around 20%, for example.
An extended and significant slowdown in the Chinese economy would reduce world GDP growth and reverse the recent stabilisation in global trade volumes. An interruption in global supply chains caused by extended factory closures is the biggest risk to the global economy. Within Asia Vietnam, Taiwan and South Korea are particularly vulnerable. The major virus outbreak in South Korea itself adds to supply chain concerns: Samsung, the world’s biggest producer of smartphones and computer chips, is at risk of suffering disruption to its output. Elsewhere, European carmakers could be affected too but so far have not reported interruptions to production.
The boom in overseas Chinese tourists in recent years has boosted service sector exports in many countries. The macroeconomic impact of the virtual absence of Chinese tourists is very modest in most cases, but Cambodia and Thailand are notable exceptions and their economies are being affected. Travel restrictions have now been extended beyond China, including within northern Italy. Cancellation of major sporting events would further undermine travel and tourism – the biggest risk here being the Tokyo Olympics. But the macroeconomic impact of this is likely to be relatively limited.
China cannot do much to offset the short-term economic impact of the virus other than providing extra liquidity and other measures to help cash flow in order to prevent corporate distress. However, other economies in the region can attempt to boost their domestic economies to offset the external headwinds from China. For example, Thailand and the Philippines have already cut interest rates in response. Last year several Asian economies successfully mitigated the effects of a slowdown in China with monetary and fiscal ease. Major central banks such as the US Federal Reserve are not likely to respond with easier policy. But because the virus adds to near-term downside risks to the global economy the current easy stance of policy is likely to be maintained.
To sum up, the short-term economic effect of COVID-19 will be significant in China with spill-over effects elsewhere in Asia. Historical comparisons suggest that economic recovery will be quick – provided that the virus is swiftly brought under control. But if not, and especially if widespread restrictions on the movement of people are introduced, then the economic effect would be much greater and long lasting.
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