Trade disputes and geopolitical uncertainties had already made the prospects for global economic growth uncertain. A coronavirus has added to the challenges facing financial markets.
The epicenter of the virus is Wuhan, an important commercial hub in China that is home to 11.9 million people, including the country’s largest student population. It is also a manufacturing hub, with around 500 factories that would usually make car parts, pharmaceutical products and steel.
Wuhan is home to China’s third-largest car manufacturer, Dongfeng Motor, while German conglomerate Siemens has a transformer plant there. It is also the headquarters for Baowu Steel Group’s Wuhan Iron and Steel Corp, or Wisco, which transports its raw materials - including iron ore - along the Yangtze River.
Production at these plants and across China had already wound down for Lunar New Year, making it hard to distinguish between a seasonal business slump and any more serious disruptions the virus might be causing.
Remember too that the Chinese economy has been slowing for several years after a decade of exponential, mostly double-digit, growth. That slowdown has been carefully managed by the government while it works to transition from a manufacturing-led to a consumer-driven economy without disturbing jobs and/or creating a boom-bust effect.
In 2019, China’s year-on-year gross domestic product growth was 6.1%, and is widely expected to contract further in 2020. According to Lasse Sinikallas, macroeconomics analyst at Fastmarkets RISI, the current outlook for Chinese GDP growth in 2020 is 5.8%.
That is still strong in a global context, but as the country faces its slowest growth rate in almost three decades, the rest of the world is feeling the pinch. That is particularly true for commodity-exporting countries that benefited from the boom in demand for non-ferrous metals, steel and oil to fuel China’s growth.
Existing Chinese problems
The added drag of a coronavirus comes as China’s financial system is threatened by a debt-to-GDP ratio of around 300% for public, household and corporate borrowing along with ongoing real estate and other asset bubbles. This means the Chinese government may find that its ability to stimulate growth after the virus is somewhat constrained by a push to deleverage and keep the nation’s economic balance intact.
The country has been facing a trade war with the United States. While a “Phase 1 agreement” has been reached, it requires China to purchase $200 billion in US imports over two years in addition to pre-trade war purchase levels. Before the virus outbreak, these targets were considered aspirational; now they seem even more unlikely to be met.
It is important to note that China has consistently said it will only purchase US goods according to its domestic demand requirements, potentially setting the stage for a future trade spat if it seeks to reduce agreed import targets.
There is also the fact that the logistics of transporting goods, including along the Yangtze and Hanshui rivers in central China but also in and out of the key port of Shanghai, could be severely hampered if major ports are closed or disrupted for an extended period of time.
Much of this will be moot if work to contain the virus is successful and normal business resumes. The response from the Chinese government has been significant, with steps to contain the spread of the illness including grounding flights, placing cities on lockdown and extending the Lunar New Year holiday.
But with World Health Organization director general Tedros Adhanom Ghebreyesus warning of the “high risk” of the outbreak in China as well as regionally and globally, a slowdown in growth seems unavoidable.
Regional, global impact
For sure, this is not just a Chinese phenomenon.
The major SARS - severe acute respiratory syndrome - outbreak in 2002-2003 that resulted in more than 700 deaths in more than 30 countries reduced Chinese GDP by 1% and had a knock-on impact on global growth as exports to China fell.
Bear in mind too that China’s economy is way more interconnected to the global economy than it was in 2003, meaning the effects of a Chinese slowdown would be more deeply felt now. The current outlook for world GDP growth in 2020 is 3.0%, Fastmarkets RISI analyst Sinikallas said.
Unlike SARS, the ability to transmit the current coronavirus without showing symptoms means the potential for it to spread is much higher. SARS killed 774 people; deaths due to the coronavirus are currently over 130 people, a level that it took six months for SARS to achieve.
More than 6,000 others are infected in at least 16 countries worldwide. Major economies such as the US, France, Australia and Japan have reported cases of the virus, and evacuations of expats from Wuhan along with their quarantine afterwards are taking place.
The financial markets are clearly rattled: Equities, particularly airline, casino and consumer goods stocks, are lower; commodities prices have fallen; and companies are gearing for potential disruption to supply chains. Foreign firms are already being hit: Starbucks is closing more than 2,000 stores in China, while McDonald’s is also closing restaurants in five Chinese cities.
Beneficiaries have been mask manufacturers, gaming firms and food delivery companies.
In the background, the trade spats that have plagued financial markets for the past couple of years have not gone away. Analysts estimate that protectionism among Group of 20 countries has already affected $1 trillion worth of trade flows - or around 7% of global goods trade - since 2018.
While there has been temporary truce in a transatlantic spat over digital taxes, the US has threatened tariffs on European Union automotive exports as recently as last week. Add to the mix Brexit, India’s worst economic slowdown in a decade, and stalling progress on the EU-Mercosur trade agreement, and threats to growth were already there.
There are obviously bright spots: The signing by US President Donald Trump of the US-Mexico-Canada Agreement on Wednesday January 29 is obviously one.
Most critically for global growth now is whether the virus can be contained enough for restrictions to be lifted to allow normal business conditions to resume in the near future. An important insight into that prospect will be given on Thursday January 30, when the World Health Organization holds an emergency meeting.