China: Larger economic impact of #coronavirus to push for laxer demand policies
The outbreak of coronavirus has struck yet another blow to the Chinese economy after some relief in business confidence since the Phase One trade deal was announced in mid-December last year. How severe the coronavirus may be for Chinese economy will not only depend on the extent and depth of the virus outbreak but also on the government response.
This report draws lessons from the SARS outbreak in 2003 focusing on the differences, given China’s economic transition over the past 17 years. We conclude that the immediate impact of the coronavirus outbreak is bound to be larger for two main reasons. First, the service sector, especially service consumption, is China’s key growth engine nowadays while this was not the case in 2003. Based on the SARS’s experience, the service sector is likely to be more severely affected than the manufacturing sector, especially for the transportation sector, which is an important component of services. The second reason is that investor’s confidence has already been hardly hit by the trade war so it is will be hard to bring it back to a positive territory. Furthermore, behind the negative investor confidence there is the harsh reality that China is going through a structural deceleration due to negative population dynamics and the end of a long urbanization process. In other words, the coronavirus is hitting a weaker economy than was the case with SARS. Based on the above, and assuming that the peak of the coronavirus outbreak happens in the first quarter, we should be expecting a rapid deceleration in growth in the first quarter of 2020, and gradual stabilization for the rest of the year.
However, this slow pace of recovery will not be enough for the Chinese government to reach the very important target of the Nation’s Rejuvenation, namely that of doubling China’s GDP from 2010 to 2020. Given the importance of this objective, it seems clear that demand policies will be used to stimulate the economy as soon as possible. The bigger the shock now, the larger the policy expansion will be needed to achieve the growth target.
Such policy expansion, however, has an important constraint, namely inflation, which will might be pushed higher by the limited supply of certain goods. This means that, in the short run, the PBOC’s may not be able to use interest rate policy but may need to rely on targeted lending and window guidance to steer the cost of funding down for the private sector. Against this backdrop, the exchange rate might be an easier demand policy to use and possibly more effective. We are already seeing signs of the latter. Moreover, weaker economic fundamentals and potentially laxer monetary policy will exert downward pressure on the RMB. Finally, fiscal policies in the form of targeted subsidies and potentially infrastructure investment may also be used.
As such, we expect the quick policy reaction to avoid a sharp correction in growth so that the Party’s objective of income doubling can be achieved. As such, we only lower the forecasts from our previous 5.7% for 2020 to around 5.5%. Within this context, expect a weaker RMB and laxer liquidity environment for the real economy, even if not necessarily lower PBoC’s official rates.
Full report available for NATIXIS clients or journalists and also on your Bloomberg terminal