What is the likely economic and financial market impact following the outbreak of the coronavirus (or Covid-19) in China, and its global spread? Naturally, the main focus – as it should be – is on the health implications and containment of this contagious virus. Also, the better the health responses are in limiting the virus’s spread, the more short-lived it will be and the lower the economic cost.
“Don’t panic, but avoid complacency” is the main message. Thus, markets need to not only reflect on the risks associated with the virus but also need to factor in the most likely scenarios, including policy actions (whether to address the virus itself or to minimise the economic fallout).
Let’s consider the downside economic risks first.
The immediate risk is contagion as the virus spreads not only within China but also in a globalised world economy with travel and integrated supply chains. The other immediate challenge is uncertainty, so much so that the fear of the virus spreading forces people across the globe to act – cancelling travel and going out, for instance – and dampens economic activity. The latter is already happening across Asia, and it could happen in any country (even the UK but this seems very unlikely at present) if there was a fear that the virus was now at large within it.
At the beginning of this year, China and the rest of Asia were expected to account for approaching two-thirds of global growth this year. Now, China, the world’s second largest economy, appears at a standstill, reflecting the impact of quarantine and the limit on travel and trade. It is hard to predict how long this stagnation of the Chinese economy will last, but it will certainly linger throughout Q1.
Then there is the negative impact on trade in a globalised world economy with integrated supply chains. The longer the virus persists, the more regional trade will suffer across Asia and further afield. Because this virus has a long incubation period and thus requires quarantine to limit its spread, this compounds the likely near-term negative effect and could make it longer to determine whether the virus has spread, or has been contained.
The biggest downside risk is one that the markets are not yet discounting, that the virus becomes a global pandemic that is hard to control. The measure of how it impacts people may not be captured by a normal distribution, with a low probability of extreme outcomes, but rather by a higher possibility of something going wrong, which in this case unfortunately means much higher mortality rates.
In a nutshell, if it goes badly wrong the impact on health and economies is huge. It is more likely it won’t go this way but we can’t be certain.
While these are the risks, market attention is focused on a host of metrics showing whether the virus is being brought under control, or not.
Currently markets appear to be relatively relaxed about the virus. That is because the expectation is that the crisis will be contained and that economic policy will be eased (as is the case already in China) or remain accommodative (as in the US and the UK too, although largely driven by other factors) to mitigate any economic impact.
Based on the assumption it will be contained and that fatality rates are low, the virus would be expected to have a temporary V-shaped impact on Chinese growth, while also dampening global activity temporarily. The scale of the initial downward economic move in China may be significant – as the nature of the virus clearly necessitates draconian action to contain its spread.
Given this, the three most likely paths are: