COVID-19: Repercussions could worsen before they improve

History teaches that epidemics tend to have short-term effects on economies and markets, but great uncertainty remains about the coronavirus.

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Fear of the fallout from the coronavirus has roiled markets, but while economies are likely to slow - dramatically in some regions - growth should rebound after the outbreak abates.

Still, at this stage there is great uncertainty. There remains the possibility of a sharper-than-expected contraction in China, and the potential for quarantines and other measures to directly disrupt economic activity outside of China. Indeed, disease experts widely predict the spread of the virus could get worse before it gets better.

China - where the first case of the coronavirus disease was reported in early December - is suffering the most.

Authorities have imposed quarantines across various provinces, including those along the east coast that contribute the lion's share of the country's GDP, manufacturing and trade activity. Despite reports that factories and businesses are reopening after the extended Chinese New Year holiday, high frequency data on traffic congestion and port shipments suggest activity remains severely depressed.

The longer quarantines depress Chinese economic activity, the more economic costs will rise. Weaker businesses that can't withstand cash flow disruptions will start to feel stress, which could spill over into financial markets, tighten financial conditions and exacerbate economic weakness.

Because China now accounts for an estimated 25% of global manufacturing activity, the ramifications will be felt worldwide.

It's both a supply and demand shock. For most countries, there will be a direct hit as exports to China slow. Already, falling Chinese demand for commodities has led to lower prices for industrial metals and oil.

On the supply side, a key concern is that reduced production of components made in China could lead to price hikes and force manufacturers outside China to find new sources of supply, or at worst, halt production. However, moving supply chains is a complex process that would likely take three to five years to play out - so near-term supply disruptions to economic activity could be significant.

In China, we estimate growth in first quarter real GDP could contract by 6% (at a quarterly annualized rate), which is a dip to 3% year-over-year growth. Last year, China averaged 6% growth.

The next-hardest-hit economies will likely be in Asia, especially Singapore, Malaysia and Vietnam in Southeast Asia, and Japan and South Korea in Northeast Asia. We expect economies in Europe and the U.S. will also be affected, with Europe likely hit harder than the U.S. given the region's higher exposure to exports to China and the greater openness of its economy to global trade.

The sectors most vulnerable to the shock include energy and autos, followed by gaming, cruise lines, hospitality and airlines.

 

Tiffany Wilding is a PIMCO economist focusing on the U.S. and  Nicola Mai is a portfolio manager and leads sovereign credit research in Europe. Both are regular contributors to the PIMCO Blog

 

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