COVID-19 - a view beyond Q1:20

The viral spread inside China now seems contained; new daily infections peaked on 3 February. The health-care system at the epicenter of Hubei Province too has managed to contain the spread and treat those taken ill. Worryingly, though, COVID-19 is spreading globally, including to Africa; on 2 March the Health Ministers of Morocco, Senegal and Tunisia reported their first infections, adding to cases in Algeria, Egypt and Nigeria.

China’s economic activity is improving daily but still is at just half capacity at the end February. The latest manufacturing and non-manufacturing PMI for February released 1 March both predictably plunged to a record lows, and also lower than the trough during the global financial crisis. Caixin’s manufacturing PMI yardstick also fell to the lowest since records began in April 2004. Reportedly, 60% of larger business and 40% of SMEs have re-opened but are still operating below full capacity. Given that SMEs account for 60% of China’s total output, the economy is still some way off full potential. This is being demonstrated by a wide variety of high frequency data points such as daily transport volumes and traffic congestion; FX transactions at financial institutions; movie, auto and property sales; coal consumption and pollution emissions. Each is improving but all remain at depressed levels.

So, when will the Chinese economy return to business as usual? Beijing has encouraged local governments to shift their focus to rolling out measures to aid the return to business as usual. And, the more draconian viral containment measures across most of China’s cities are being rolled back. Therefore, in principal, business conditions could be back to normal by end March. But, with likely episodes of recurring outbreaks, the road ahead will be bumpy, and disruptions will likely linger into Q2:20.

Policy response so far is focused on easing immediate stress: authorities have generally stuck to a policy playbook which focuses on immediate concerns, increasing central level policy support in a targeted manner, instead of stimulating for growth’s sake. Specifically, the central bank has focused on ensuring enough liquidity in the financial system, guided borrowing costs lower, and provided funds – around CNY800bn – to banks to re-lend at concessional rates. The CBIRC has eased macroprudential restraints and instructed banks to provide forbearance to qualified SMEs through end of June. Meanwhile, actions at the local level have been more aggressive, but consistent in the plight to relieve various cost burdens on small businesses.

Beijing is less concerned about growth than markets might believe; policy measures to stem the viral outbreak are not about juicing growth. Indeed, measures are proving critical in keeping China’s estimated 18 million SMEs afloat and limiting the impact on employment through this period of disruption, uncertain future cashflows, and depressed orders. However, these measures will not unleash the sort of credit-fueled stimulus that supported the economy in past downturns. Instead, policymakers are leaning heavily on banks to act as a buffer against stalled business activity confronting a large swathe of China’s private sector companies. This may impair asset quality and slow banks’ capacity for expanding credit later in 2020.

Growth in Q1:20 remains improbable. At end January, we lowered forecasts for 2020 to 4.5% (and emphasized downside risks to that forecast), expecting growth of any kind in Q1:20 to be unlikely. It seems now that China would be fortunate to see 0% y/y nominal growth in Q1:20. Nominal GDP in Q1:19 was CNY21.8trn, and even getting to CNY20tr in Q1:20 would require a sudden rise to full capacity in March. Worse still, Q4:20 GDP was CNY27.8tr, so the quarter-on-quarter reading will likely be record-breaking. Keep in mind that March last year was the high-water mark for most of the monthly macroeconomic data: for instance, industrial production surged to 8.5% y/y in March, beating consensus expectations by near 3pps, before slumping to 5.4% in April. The hard data in China’s news can only be bleak.

Full-year GDP will likely slow from 6.1% y/y in 2019 to 4.5% in 2020. However, the arc of possible outcomes is far wider after Q1’s poor showing. The prognosis will largely depend on the how quickly business can be back to usual; the impact the shutdowns have had on sentiment, employment and incomes; the pervasiveness of supply chain disruptions in coming months; and the impact bank forbearance has on NPLs, the pace of bad asset disposals, and capital needs of financial institutions. One obvious technical issue is that many of the macro data points measure year-on-year growth of a specific variable, like fixed asset investment, on a year-to-date to basis. China’s economy will therefore be playing catch-up for most of 2020.

Much will depend on Q2:20. Some continue to forecast a V-shaped recovery with growth in Q2:20 that fills some of the hole made in February. We doubt it. The best-case scenario would be for the Chinese economy to gradually trend towards the level of economic output that was anticipated before COVID-19 hit, which is likely to occur in Q3:20. Even considering potential foregone production in Q1:20, restocking inventories and catching up on any build-up of orders, it seems unlikely that the economy will reach a level expected prior to COVID-19 in Q2:20. Recall that usually, due to Chinese New Year occurring in Q1, nominal GDP is around 12% larger in Q2 than Q1. That means to get back to pre-COVID-19 expected levels, nominal GDP will have to rise from around CNY21.8tr in Q1:20 (which is still in doubt) to CNY26.5 in Q2:20. In absolute terms, that is nearly two times more “new” production on a quarter-on-quarter basis than China has ever managed and four times the average increase in 2009.

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