China: about the current impact of Covid-19 on the functioning of the economy

• The PMI for industry fell in February to 35.7, well below the consensus (45.0) and well below the January reading. 50.0.
• Non-production PMI decline to 28.9, also well below consensus (50.5), ie a decrease of almost 50% compared with 54.1 in January.

Observing ‘alternative’ economic indicators, such as real-time measurements of air pollution (proxy for industrial production), daily coal consumption (indicator of electricity consumption and production) and levels of congestion (proxy for trade and mobility) at the turn of months and in the first three weeks of February, we find that the Chinese economy has stopped.

Chart: daily coal consumption immediately before and after the New Year (T: 25 January 2020 – Rat Year)
Index, previous year = 100

Source: NHC, J.P. Morgan

Among some of the largest Chinese cities, including Guangzhou, Shanghai and Chengdu, a clear pattern was visible – air pollution accounted for only 20-50% of the historical average. As Morgan Stanley says, “This could mean that human activities, such as traffic and industrial production in or near these cities, reach 50-80% below their potential.”

Chart: Average traffic in China between the 100 largest cities

Source: Capital Economics, RCieSolution

Chart: Structural steel sector in which demand literally reached its lowest point, falling unprecedentedly by 88% y/y.

Source: Capital Economics, RCieSolution

Chart: Total collapse of passenger traffic (measured by change per person-kilometer y/y, in%), mainly due to the quarantine imposed on hundreds of millions of Chinese citizens.

Source: Capital Economics, RCieSolution

The epidemic is likely to maintain a recession in the manufacturing sector in Hl 2020. Electronics and computers are most at risk. Due to business interruptions in China caused by a virus outbreak that has exposed several sectors to the risk of disruption of the supply chain and reduced global demand, inventory levels in sectors such as textiles, machinery and transport equipment and goods may rise above long-term averages. Meanwhile, shortage of goods is a risk in sectors with lower than average long-term stocks (electronics, computers). In 2019, the unusually high level of company inventories caused a recession in industrial production, especially in developed economies. Inventory absorption over the past few months has been only partial, lower global demand and greater uncertainty are likely to increase inventory in the coming months. That is why we expect the global manufacturing sector to remain in a shallow recession.

Potential losses of exports of goods and services to China can reach as much as USD 26 billion a week. We have revised our forecast of global trade growth for 2020 by -0.5 percentage points to + 1.1%. Hong Kong, the United States, Japan, South Korea and Germany are the most vulnerable. In terms of goods, Hong Kong, South Korea, Japan, Germany and the US are the most vulnerable countries. The cost can be USD 18 billion per week. In terms of services, travel costs from China account for 20% of the world total, compared with 11% in the US and around 30% in Europe. This corresponds to a potential global loss of around USD 6bn per week, Hong Kong, the United States, Japan, the United Kingdom and South Korea being hit hardest. In addition, losses related to transport services (imports from China) can reach USD 2 billion per week.

The macroeconomic impact should remain limited if the interruption of economic activity in China does not last longer than one month and the economic activity returns to normal after three months. Assuming a positive scenario of further developments (30%), the negative side effects of the epidemic will not last more than three to five months. We believe that the recession in the manufacturing sector and global trade in goods will be extended to a minimum of Hl – QIII 2020. We changed our forecast of global GDP growth by 2020 by -O.3 pp to + 1.6%, based on the revised forecast for China (+ 4.3%, i.e. -1.6 pp), the euro area (+ 0.7%, i.e. -O.3 pp) in the optimistic variant. Monetary policy will remain very active, and the ECB and the FED will introduce another rate cut in Hl 2020, given that China’s “isolation” due to the outbreak of the epidemic may have a strong negative impact on trade in goods and services.

Over the past two decades, China has become a global factory supplying goods and raw materials to many industries. Factory closures can cause disruptions in supply. For example, Wuhan – the virus epicenter – is a production center for telecommunications equipment, from fiber optic cables (displays) to printed circuit boards (PCBs). The impact on the production of these components can have broader implications for technology supply chains, both in China and potentially around the world, if the disruptions persist for a long time.

Chart: Wuhan’s share in the production of Chinese industrial goods data from 2017

Data from December 31, 2017
Source: China International Capital Corporation

Even without accurate knowledge of the virus and the magnitude of its epidemic threat, potential macroeconomic effects can be assessed. Efforts to stop the spread of the virus by locking people in homes and quarantining entire cities will, of course, have a real impact on the economy through production and consumption.

Chart: Effects of the Corona virus outbreak in China and around the world

Source: Allianz Research, RCieSolution Research

The views expressed in this document do not constitute research, are not investment or commercial advice and do not necessarily reflect the views of all management teams. They change over time.