Economy In The Time Of An Epidemic

COVID19 has its epicenter in the second-largest economy, sending out shockwaves across the globe.

Source: Tavaga Research

When the world’s second-largest economy gets hit, the tremors are bound to be felt by both large economies such as the US and developing ones like our own.

The coronavirus epidemic, with its epicenter in Wuhan, the capital of the busy province of Hubei in China, has claimed more than 2,800 lives and infected over 80,000. It has spread to over 48 countries and sent shockwaves through financial markets. Beyond its pathological implications, lies its impact on the global economy. 

A large part of the world’s factory, China, has ground to a halt, sea-traffic with cargo has thinned out, travel curbs in Asian neighbors and China are in place — all of then to avoid the Covid-19 virus from spreading but also all of them leading to supply-side disruptions for global business output. 

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Of course, the lockdown in China has meant denting demand in one of the largest consumer bases in the world.

The ripples in Europe saw stocks plunge 4 percent in Italy, home to the largest outbreak of the coronavirus outside Asia.

The fast-spreading coronavirus has the potential to drag the world into a recession, with pre-existing slowdowns in economies big (Japan, Germany), growing (China, India), and small (Southeast Asian countries), compounding their woes.

Covid-19

COVID-19 stands for Corona Virus Disease 2019.

Having learned from the Sars outbreak nearly two decades back, China has deployed its sharp and targeted response to containing the coronavirus, with the reinforced medical response for the disease and fiscal measures for the economy. 

Not only has China sealed off Wuhan from the rest of the country, but residential lockdowns, workplace shutdowns, and limited movements have covered 760 million of its people, more than half its population, outside of Wuhan, according to a New York Times estimate. A concerted social control exercise deploying a huge number of party workers and volunteers has kicked in. But the virus is proving to be a formidable foe. 

With its origin still unknown, the potent Covid-19 virus could result in a pandemic as South Korea has reported a jump in infection and most of the other countries are yet to see it abate. 

China’s toll

The sectors of retail, tourism, transportation including aviation, and logistics have been the most affected. 

The lockdown and social control in a large part of China have caused labor shortages, making it difficult for those factories still open to function. In the stricken provinces, factories have been roped in to reconfigure their production lines to produce face masks, disinfectants, and other medical supplies that may prevent contamination and spread of the coronavirus.

Impact on India

The trade between China and India is worth $87 billion, of which we import goods worth $70 billion from China. It includes everything from electric components and machines, medical instruments and pharma raw materials, vehicles and auto parts, iron and steel components to nuclear machinery.

While China takes 5.1 percent of our total exports, in the form of cotton, salt and organic chemicals, and mineral and metal ores among others, we get 13.7 percent of our total imports from China alone.

Needless to say then, when our second-largest trading partner hits the brakes on its factory output, companies in India break into a sweat.

We may have pushed for smartphone manufacturers to increase their domestic production, but they still depend on China for their components. Other electronic goods manufacturers would also be facing production issues. 

A supply shortfall in consumer electrical and electronic goods in India (either due to coronavirus-led Chinese cuts or our economic slowdown) would also trouble online sales, as they form a sizable portion of e-commerce goods sales.

Pharma companies bring in key raw ingredients from China to make medicines. Automobile manufacturers, too, are heavily dependent on their components on their Chinese suppliers.

However, the Chinese New Year in January-February would have proved to be a greater boon than usual as companies would have stocked up by December last year, anticipating the Chinese holiday season. 

The extra stock will act as a cushion for some weeks until March, as will India’s weak consumer demand. But if the Covid-19 virus continues its rampage, the second quarter could see more manufacturing disruption in this slowdown. 

Shareholders of companies, with their tier I and II providers facing shutdowns, would then have to brace for a tough results season.

India’s stock market

Epidemics have struck Indian stock markets in the past as well. Often, the blow has been harder when other factors have been simultaneously at play. For example, in 2009, the swine flu epidemic broke just as the waves made by the US subprime crisis of 2008 reached our shores. Global and domestic cues, along with the epidemic’s ramifications, brought the markets down. 

The coronavirus too has reared its head up at a time when the Indian economy is in the doldrums and the markets are volatile, with frequent ups and downs.

In the following table, we analyzed how the nifty index reacted when these outbreaks happened in the past.

Of course, the economic fallout of epidemics is never restricted to just one country and given China’s status as the world’s largest production hub, India may do well to look out for the global ramifications. We sum up a few of the key developments in other economies so far.

Fiscal and monetary policy

Apart from China, other Asian economic hubs such as  Hong Kong and Singapore which have been afflicted, have promised additional fiscal stimulus to counter the coronavirus impact on their economies. So has Japan. 

Central banks of smaller economies but which have been affected by the virus’ spread, such as Malaysia, the Philippines, Thailand have all cut interest rates, as has the People’s Bank of China (PBoC).

For China, it is an extra strain as it has been locked in a trade war with the US since last year and is in a slowdown as well.

China cut its loan prime rate (LPR by 5-10 basis points) last week to help lower the borrowing cost for businesses.

China’s small and medium enterprises have borne the brunt of factories shutting for over a month, and the prospect of low production in the months to come. They continue to pay wages and other expenses and are facing cash flow problems.

PBoC and other financial regulators have rolled out no less than 30 policies to support the manufacturing sector, makers of medical supplies, small and medium businesses, and private enterprises that have been severely affected by the epidemic’s losses, by facilitating access to credit and arming large and local banks in Hubei and other affected provinces with funds. 

Taxes on overtime income of medical professionals have been waived and there may be a cut in corporate taxes too.

China’s fiscal deficit target is expected to be set higher this time in March because of the pressures compounded by Covid-19’s progress.

Hong Kong is facing “tsunami-like” shocks, according to officials, that could result in a wide budget deficit. 

Japan, too, has been mulling fiscal policy changes to curb the epidemic’s economic toll. Japan’s economy saw its tightest contraction since 2014 in the quarter ended in December 2019.

Singapore is staring at one of its biggest budget deficits in nearly 20 years, a gap of 1.5 percent of its GDP in fiscal 2021. It is said to be losing out on 20,000 tourists daily due to travel bans and is eyeing a package of budget measures soon.

Goods and services

Goods and services across the world are suffering the aftermath of the quick spread of the Covid-19 virus. Global exports and imports and Chinese exports and imports are so intertwined that it is unavoidable.

Analysts at Dun & Bradstreet say that at least 51,000 (including 163 ‘Fortune-1,000’) companies around the world have direct suppliers based in the Hubei province. At least 5 million companies worldwide have tier-II suppliers in that region. Goods and services all over, then, have been struck by the area’s necessary lockdown.

China manufactures 90 percent of the globe’s 300-million computers, 70 percent of its 2-billion phones and 80 percent of its 110-million ACs made and sold in a year.

One of the coveted stocks in the world, Apple, has warned that it will likely not meet its second-quarter revenue estimate, owing to lower iPhone supply and lower Chinese demand due to the epidemic.

Hubei and Wuhan together house some of the biggest global automobile and auto component manufacturers, making everything from the myriad nuts and bolts needed in auto plants to the actually finished vehicles. 

Among the largest automobile manufacturers, Hyundai Motors temporarily has stopped production because of the components-shortage.  Fiat Chrysler Automobiles is planning to halt operations at its assembly plant in Serbia due to a lack of parts from China. 

The spillover of disruption has been the most acute in China’s neighbors as seen in their monetary policy responses.

A regional supply chain analysis expectedly shows China’s significant trade with most of southeast Asia. Countries like South Korea and Taiwan depend on Chinese markets for exports of their intermediate products to the tune of 40 percent. These two countries along with Vietnam would face economic challenges due to a delay in downstream production or a shortage of upstream raw materials supply.

Goods movement

Shipping has been heavily affected with curbs on movement to stem the spread of the Covid-19 virus. 

Shipping companies have cut back on their ships sailing from China to the rest of the world, carrying goods, to prevent the virus from advancing to other areas. 

It has a direct bearing on the world’s supply chain as 80 percent of global goods trade by volume is transported in ships and China itself houses seven of the world’s 10 busiest container sea-ports, says the United Nations Conference on Trade and Development. The contagious coronavirus is a threat to business infrastructure in adjoining countries as well, as Singapore and South Korea, too, have busy ports and have seen the disease escalate.

The far-reaching supply constraints have affected the US economy as well, besides its darling stocks like Apple, with its manufacturing and services activities at their lowest levels this February in over six years on fears of the coronavirus outbreak slowing global demand, according to a monthly private survey. 

Businesses are worried about tepid demand as well as managing the limited supply for existing demand, with news of how even e-commerce giant, Amazon, taking precautions as Chinese sellers cut back on their visibility and promotions to limit orders.

Commodity prices

With business activity suffering, it is only to be expected that investors will look towards gold for assurance. Gold prices rose by more than 1.5 percent last Friday to a seven-year-high amidst fear of the fallout from coronavirus felt in markets.

Oil prices, on the other hand, moved south. China is the largest importer of crude oil and the stalling in its business activity and factory output has meant less consumption. 

A report by Bloomberg suggests that China’s oil demand has dropped by 3 million barrels a day or roughly by 20 percent of its usual consumption. 

Coupled with oil producers who are reluctant to decrease their production, crude prices have fallen. 

For India, this could bring some relief amidst a crippling trend of high inflation and flagging consumer demand. After all, we import 86 percent of our crude oil requirements.

Global GDP

The global GDP will be compromised due to the economic fallout of the coronavirus. China accounts for around 18 percent of the global GDP (2019) compared to 4 percent when the Sars epidemic had broken out in 2003. Chinese businesses are now more ingrained in global supply chains.

Sars had robbed China of 1 percent of its economic growth in the eight months it had lasted. The coronavirus has shaved off 6.8 percentage of China’s GDP growth in the first quarter of 2020. 

Even then, observers are hopeful of China’s financial resilience and expect it to be a quarter’s setback and not more. 

The analyst, S&P, says the slowdown in China due to coronavirus would be the most in the first quarter and peter out in the second, with a recovery in the third. 

Investor takeaway in times of epidemics

Contagious epidemics bring uncertainty to the investing community worldwide, prompting them to move towards traditional assets such as golds and bonds that are perceived to be more stable, instead of the assets with systemic risk like equities. 

That is where smart investment planning involving diversification and asset allocation comes in. It allows us to stay out of troubled waters and focus on our health, instead.