The biting impact of coronavirus

At the start of 2020, concerns about the health of global economy began to ease with a signed trade agreement, easing geopolitical tension and Germany having escaped the recession threat. However, the outbreak of the novel coronavirus (2019-nCov) in China that spread through the globe raised fears on the health of both the global economy and markets. For now, we are not revising our 2.8% global GDP outlook for 2020 with the lower end at 2.6%. Although questions remain unanswered about the development and nature of the coronavirus, many countries are better prepared in pandemic management following the shortfalls identified in the 2003 SARS outbreak. In our view, the full-blown impact from the coronavirus will be felt in 2Q2020 and tapers thereafter. Any downward revision to our 2020 global GDP will depend on the severity and duration of the coronavirus impact.

Meanwhile, China is notably different today compared to when it was hit by the SARS outbreak in 2003. Ongoing structural transformation of the economy saw consumption, services and retail sales represent a bigger share of its output. Besides, China is already facing headwinds. With 2020 GDP projected to grow slightly below 6% prior to the coronavirus outbreak due to transitory trade tensions and structural changes, the current outbreak will weigh on the economy. But the impact is more likely to be felt in the near term, possibly in 2Q2020 before the economy starts to recover due to China’s fast and aggressive containment measures. If we assume the outbreak will reach its full-blown stage in 2Q2020, it should shave off the Chinese GDP growth by 0.5%–1.0% in our base case. Our worst case is between 1.5% and 2.0%.

Just like China, we find Malaysia’s growth is also notably different today from the time of the outbreak of SARS in 2003. Today, underpinned by external uncertainties and domestic challenges and prior to the coronavirus outbreak, the economy is likely to grow around 4.6%. The coronavirus outbreak is likely to have some dampening impact on the economy. Impact will be felt in the areas like services; tourism-related sectors and other sectors, indirectly or induced; investment from lower demand, heightened uncertainties and risks; and raising government spending to mitigate the adverse impact from the new issue that is challenging given the fiscal flexibility remains limited.

If the full-blown impact from coronavirus is felt in 2Q2020 and ease off thereafter, it could reduce our GDP growth by 0.6%–1.0% which is the base case and 1.2%–1.6% as the worst case. Irrespective of falling into our base or worst-case scenario, it will be strenuous on the economy under the current conditions, unlike in 2003. Much depends on how fast and effective the policies are rolled out as containment measures. Such policy measures can result in a higher cost on the economy in the near term. Are we prepared to “bite” the bullet of higher cost or adopt a wait-and-see strategy?

Global risk conditions will be weak in the short term due to a high degree of uncertainty. Hence, the demand for defensive assets will rise. There will be stronger appetite for the Japanese yen and Swiss franc. Interest will also be on assets with high liquidity like the US Treasuries. It means the dollar will also gain some support. As for emerging markets, the worry will be on the lack of liquidity and that could undermine their currencies. Affected countries’ currencies risk more upside against the dollar. Focus will be on the Korean won and Chinese yuan. If infections become more widespread and region-wide, the rest of Asia would likely suffer, especially the Singapore dollar and Thai baht. The ringgit will depend on the direction of yuan and oil price, besides the domestic policy measures instituted.

Finally, global central banks will remain alert. Just as the central banks started to feel slightly more optimistic over the growth outlook, their optimism is now being dented from the fresh unease of the coronavirus. Overall, the bias for global monetary easing is likely to continue. There is still room for more rate cuts. Bank Negara Malaysia (BNM) could still reduce rates by another 25bps to 50bps if the external risk continues to be the main concern from the current 2.75% level.

A. Low risk of global recession

• At the start of 2020, concerns about the health of global economy began to ease. The US and China signed a trade agreement that led to a vague pause in a trade war. The threat of open hostilities between the US and Iran returned to deadlock. Although Europe remained stagnant, Germany escaped the recession threat. Even prior to the outbreak of the novel coronavirus (2019-nCov), policymakers across the globe instituted ways to support growth by keeping interest rates low to pushing fiscal measures.

• However, the outbreak of the 2019-nCov in China that spread through the globe raised fears on the health of both the global economy and markets. The risk of the world economy heading for another shock and offsetting the benefits of the trade pact and the geopolitical easing has dented both business and consumer sentiments.

• Will the global economy head towards a recession? The current shock from the coronavirus is unlikely to have a significant impact had the world economy grew more vigorously prior to the outbreak. Unfortunately, after a 3.0% growth outlook for 2019 that was underpinned by uncertainties, the effect from the coronavirus is not just concentrated on Asia — long the fastest-growing region in the world and the one area that had basically been keeping the global economy afloat — but has spread across the globe.

• That said, past pandemics and other disasters had hardly any lasting effect on the global economy. Today, many countries are better prepared in pandemic management following the shortfalls identified in the 2003 SARS outbreak, with improved screening measures already in place around the world.

• In our view, a faster containment will stem the coronavirus outbreak, that should be more of a near-term disaster. The implementation of effective containment measures against the coronavirus by China and a number of economies since January will provide support. It should gradually start curbing the coronavirus. Already, millions of people have been quarantined, all forms of travel restricted, the long Lunar New Year holidays extended, with some tourist destinations closed.

• Nonetheless, the impact on the economy will be felt in businesses like: (1) retail; (2) casinos and theme parks; (3) hotels; (4) airlines; (5) global carmakers which started pulling foreign staff from plants across parts of China that have been hit by the coronavirus; and (6) global banks with significant operations in China that have been ring-fencing potentially exposed staff, putting in place travel bans, and disinfecting their Asia offices.

• Technology could prove be a blessing in these difficult times. With the increasing use of smartphones for payments, food ordering and other transactions every day, it should help contain the coronavirus outbreak. Delivery could still be done but at the “doorstep” instead of face-to-face.

• For now, we are not revising the growth projection. Our 2.8% global GDP projected for 2020 with the lower end at 2.6% remains unchanged (Chart 1). Questions remain unanswered about the development and nature of the coronavirus complicate the analysis of its impact. Any downward revision to our 2020 global GDP will depend on the severity and duration of the coronavirus impact. In our view, the full-blown impact from the coronavirus will be felt in 2Q2020 and tapers thereafter.

B. China seems a bit more vulnerable today

• Today, China is notably different compared to when it was hit by the SARS outbreak which happened between 1 Nov 2002 and 31 July 2003. First, the ongoing structural transformation of the Chinese economy means that consumption represents a bigger share of its output. Retail sales, which made up 33% of nominal GDP in 2002, is at 43% as in 2018. The contribution of the services sector accounts for 54% of GDP in 2018 compared to 42% in 2003 and creating 46% of employment against 29% in 2003.

• Besides, China is already facing headwinds. The 2019 GDP should grow around 6.1% and slow down in 2020 to 5.8% (Chart 2) prior to the coronavirus outbreak due to transitory trade tensions and structural changes in the economy. Investments and exports are weak. Exports grew only 0.5% in 2019 from 10% in 2018 (Chart 3). Fixed asset investment rose 5.2% y/y for the first 11 months of 2019 against 5.9% y/y in 2018 (Chart 4). And the central bank is far more measured in fuelling further credit growth after recent deleveraging efforts.

• Meanwhile, the impact from the coronavirus is expected to be felt strongly in 2Q2020. If we assume the coronavirus outbreak will reach its full-blown stage in 2Q2020, it should shave off the Chinese GDP growth by 0.5%–1.0% in our base case. Our worst case is between 1.5% and 2.0%.

• Whether the growth reduction falls along our base case or worst case, the fact remains that the shock on its GDP growth to a slowing economy provides more downside risk than on a fast-growing economy well above 10% during the SARS outbreak. As such, it could add downward pressure on our 5.8% full-year base case GDP growth for 2020. Growth could tilt towards our lower end of 5.3%–5.5%.

• Much will now depend on the policy efforts (monetary and fiscal) to sustain growth. Fast and aggressive containment measures are needed, though such measures are likely to impose a sharper cost on the economy —at least temporarily. The Chinese authorities have been quick to respond to the current outbreak with strict containment measures.

C. Downside risk on Malaysia’s growth

• Just like China, we find Malaysia’s growth is also notably different today from the time during the outbreak of SARS in 2003. The economy grew 5.8% in 2003 supported by a more robust external demand and increased private sector activities. Today, underpinned by external uncertainties and domestic challenges and prior to the coronavirus outbreak, the domestic economy is likely to grow around 4.6%, which is our base case, with the lower end growth target of 4.0%–4.3% from an estimated 4.5% in 2019 (Chart 5).

• Growth will be anchored by private consumption and supported by investment and trade. Services will play a crucial role, in which tourism is expected to be one of the growth pillars, especially 2020 being “Visit Malaysia Year” and the hosting of APEC.

• With the outbreak of the coronavirus, it is likely to have some dampening impact on the economic performance. How serious the impact depends on the duration, seriousness of this virus and the structure of the economy. For now, it is tough to ascertain the severity given that there is no clear clue on the development and nature of coronavirus. Hence, it complicates our impact analysis for now.

• Nonetheless, the impact of coronavirus will be felt in the following areas: 1. The services sector, which accounts for 53% GDP in 2018 from 47% GDP in 2003. Tourism contributes about 5.8% of the GDP in 2018 (5.1% of GDP in 2003) will be hard hit. The impact will be on tourism-related sectors and other sectors of the economy, indirectly or induced. Tourism-related businesses that will be affected are: (1) accommodation; (2) food & beverages; (3) travel & transport; (4) entertainment; (5) shopping; and (6) miscellaneous services. A 1% change in tourism receipts and capital investment in the tourism industry will impact our GDP by 0.2% and 0.6% respectively. 2. Consumer confidence would decline and hurt private consumption spending which remains the growth anchor for 2020. A combination of uncertainty and fear generated by the coronavirus will drive people to stay home to reduce the probability of an infection. It will weigh on retail sales which accounts for 16.4% of nominal GDP, compared to 10.5% in 2003. However, the use of smartphones for payments, food ordering and other transactions every day may cushion the downside of private consumption and retail sales. 3. Investment will also be affected from lower demand, heightened uncertainties and risks. Our manufacturing is currently flirting with the “recession” mode. Business orders are low with postponement of business expansion. With the outbreak of the coronavirus, the risk of excess capacity emerging or increasing cannot be ruled out. Furthermore, foreign investments’ inflow may be delayed or reduced in reaction to the outbreak. 4. Raising government spending may be necessary to mitigate the adverse impact from the new issue i.e. the coronavirus, besides the ongoing external and domestic challenges which are s seen dragging consumer and business sentiments. The challenge here is will be how much fiscal flexibility remains.

• Assuming the full-blown impact from coronavirus is felt in 2Q2020 and ease off thereafter, it could reduce our GDP growth by 0.6%–1.0% which is the base case and 1.2%–1.6% as the worst case. Irrespective of falling into our base or worst-case scenario, it will be strenuous on the economy under the current conditions, unlike in 2003. Hence much depends on how fast and effective the policies are rolled out as containment measures. Such policy measures can result in a higher cost on the economy in the near term. Are we prepared to “bite” the bullet of higher cost on the economy or adopt a wait-and-see strategy?

D. Risk appetite will be weaker

• With the outbreak of the coronavirus, global risk conditions will be weak in the short term, particularly with a high degree of uncertainty over the impact. Under this environment, the demand for defensive assets will tend to rise. There will be stronger appetite for the Japanese yen and Swiss franc.

• The yen exchange rates have already gained defensive support. The USD/JPY retreated from its 8-month high above 110.2 to 109.2 (Chart 6), while the EUR/CHF is at 32-month low of below 1.0750 from 1.0765 (Chart 7).

• Besides, there will also be interest on assets with high liquidity. Here, demand for US Treasuries will gain significant support (Chart 8). They are the most liquid global asset. It means the dollar will also gain some support which has climbed to 98.018 (Chart 9).

• In the case of emerging-market currencies, the worry will be on the lack of liquidity. It will undermine emergingmarket currencies. Affected countries’ currencies risk more upside against the dollar. Focus will be on the Korean won (Chart 10) and Chinese yuan (Chart 11). Both the onshore and offshore Chinese yuan weakened against the dollar to 6.911 and 6.966, respectively from 6.867. The Korean won is at 1,177, from 1,167.

• If infections become more widespread and become region-wide, the rest of Asia would likely suffer, especially the Singapore dollar (Chart 12) and Thai baht (Chart 13). The Singapore dollar and Thai baht are at 1.358 and 30.824, respectively from 1.347 and 30.354, respectively on January 20.

• In the case of the ringgit, it weakened to 4.086, from 4.060 (Chart 14). The local currency will depend on the direction of yuan and oil price, besides the domestic policy measures instituted. The oil price could continue to stay low, hurt by lower demand and Opec’s supply response taking some time to address the demand shock (Chart 15).

• Wider commodity prices could also come under sustained pressure which would damage the Australian dollar. Gold would tend to gain support, although there is no evidence of this so far (Chart 16). Chinese investors could be drawn to cryptocurrencies although bitcoin has lost ground this week.

E. Central banks will be on alert

• Current global economic issues prior to the coronavirus outbreak are a result of the US-China trade frictions and the imposition of tariffs on US and Chinese exports. While tension may have eased with the signing of the phase-one trade deal, still the underlying dispute has had an important impact in disrupting supply chains and exports.

• The bulk of existing tariffs is still in place, maintaining important stresses in the economy. Chinese companies are already in a vulnerable position which will make them more difficult to adjust and respond to a fresh crisis i.e. the coronavirus outbreak.

• Hence, the global economy remains vulnerable. And now, the impact from the coronavirus outbreak will somewhat add downwards pressure, though much depends on the duration of the crisis. While the acute phase may last for a while, eventually, the coronavirus will die down slowly. But it remains an important story for the global markets that could last for months. As such, the tendency is to look at currencies riding on safe-haven status like the yen and Swiss franc.

• As such, global central banks are expected to remain alert. They have been cutting interest rates over the past year in response to concerns over the trade and growth outlook, especially given the imposition of tariffs. Just as the central banks started to feel slightly more optimistic over the growth outlook, their optimism is now being dented from the fresh unease of the coronavirus.

• Overall, the bias for global monetary easing is likely to continue. There is still room for more rate cuts. Bank Negara Malaysia (BNM) could still reduce rates by another 25bps to 50bps if the external risk continues to be the main concern from the current 2.75% level.

Source: AmInvest Research - 30 Jan 2020