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Date: 6 February 2020 at 3:04:25 PM HKT
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Subject: Coronavirus update: Amplified supply shock and further revision on China's growth and policy forecasts
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Coronavirus update: Amplified supply shock and further revision on China's growth and policy forecasts
By Haibin ZhuAC, Grace Ng, Carol Wei Liao, Anita Xu
Click here for the full Note and disclaimers
The coronavirus is an unexpected, tentative demand shock, and it has also become a notable supply shock due to prolonged factory shutdown. The magnitude of the supply shock depends on the pace of production recovery.Amplified supply shock leads us to further revise down China’s growth forecast. In the new baseline scenario (contagion peaks in March and production recovery starts gradually from Feb 10), 1Q GDP growth is revised down to 1%q/q saar, followed by a rebound in 2Q to 9.3%q/q saar and back to pre-virus track in 4Q. Full-year growth is revised down to 5.4%yoy.In a more severe scenario (contagion peaks in April and production shutdown extended by one week vs. baseline), 1Q GDP will contract 3.9%q/q saar, followed by a rebound in later 2Q and 3Q, and full-year growth will slow to 4.6%yoy.We also add further policy support, in addition to fiscal easing (0.5%pt of GDP) and monetary easing (2 RRR cut and 10bp rate cut) included in our pre-virus forecasts. We expect 0.3%pt (of GDP) additional fiscal support, mainly as rescue measures for distressed corporates, 1 more RRR cut and 10bp more rate cut.It is likely that the government may not stick to the generally expected growth target of “around 6%” for 2020. If so, it will be a positive signal that the government will not sacrifice its long-term policy agenda because of an unexpected tentative shock.Latest developments
The coronavirus outbreak completely changed the dynamics of the Chinese economy. The situation has evolved quickly. As of February 5, the number of confirmed cases has risen to 28,275 globally (including 19,665 from Hubei, 8,353 from mainland China excluding Hubei and 257 outside mainland China). The confirmed cases have spread to 24 countries outside China. On January 30, the World Health Organization (WHO) declared the 2019-nCoV as a Public Health Emergency of International Concern (PHEIC).
Meantime, the control measures have become more forceful. According to JPM Equity Research ( link), 20 provinces (accounting for 77% of China’s GDP) announced postponement of factory reopening no earlier than February 9th, one week longer than the extended public holiday (until February 2nd). Outside China, 31 countries have announced travel restrictions after the WHO’s declaration of PHEIC.
Uncertainty in the nCoV outlook
Forecasting the development of the epidemic is not easy. News flow has been mixed. The situation is still stressful, with the number of confirmed cases still rising at a rapid pace and the death toll increasing to 565 by February 5. Outside Hubei, the daily increase in confirmed cases seemed to show early signs of decline this week (especially outside mainland China), and the death toll has stayed low (cumulatively 16 death cases reported outside Hubei including two from outside mainland China). The number of recovered cases has steadily increased every day (cumulatively 1,175 cured cases by February 5th).
Developments in the next 1-2 weeks are critical, as non-factory workers have gradually come back to work from February 3rd onwards, and factory workers are expected to gradually come back after February 10th. This increase in population flow could run the risk of another round of contagion. Major destinations of returning workers include Guangdong, Zhejiang, Shanghai, Jiangsu and Beijing.
One key question is when the number of confirmed cases will peak. According to JPM Equity research ( link), we expect the number of confirmed cases will peak in mid-March at around 85,000. In an optimistic scenario, the peak will come in early March at around 42,000; and in a pessimistic scenario, the peak will arrive in late March at around 128,000.
The other key question is when factories will reopen. Most provinces announced that factory shutdowns will last until at least February 9, but it is not clear whether the shutdown will be further extended. In the past few days, some cities (e.g. Shenzhen) announced that factory reopening should meet certain criteria: 5-day notice to local authority; need to have preventive and control measures in place; 14-day self-quarantine for workers returning from other cities. In some other cities (e.g. Wenzhou, Taizhou, Fuzhou, Zhengzhou), local authorities strengthened community management (limiting outings and traffic) and self-quarantine for outside returnees. The list includes some key manufacturing hubs. For instance, 60% of iPhones are made in Foxconn Zhengzhou plant. The dilemma between public health concern and disruption in economic activity will intensify as time goes by. In our assumption, even if factory reopening is allowed, the catchup in production will be at best gradual in February.
An amplified supply shock
We have argued that the 2019-nCoV is an unexpected exogenous shock for the Chinese economy. The impact is temporary but large. There are two main channels by which the shock will affect the economic activity.
The first channel is the demand shock, in which the fear factor will restrict people’s mobility and hence lead to a temporary large decline in related activity, such as tourism, offline retail sales, transportation, catering services, entertainment, etc. This is similar to the SARS episode.
The second channel is via supply shock, i.e. prolonged shutdown in factory and disruption in supply in the near term. With stepped-up control measures across provinces, the magnitude of supply shock tends to increase over time. For instance, when we revised our GDP forecast on January 29, only five provinces had postponed factory reopening until no earlier than February 9th, and the number increased to 20 (accounting for about 77% of China’s GDP). The expansion in factory shutdown leads us to further revise down China’s GDP forecast (see below). If factory suspension is further extended, it will point at additional downside risk.
The supply shock could have important consequence. First, if factory shutdown is extended and goes beyond a sustainable level (i.e. supply chain producers can sustain the shock via inventory management), it will lead to a disruption in the supply chain. Second, travel restrictions and constraints on ports/ship operations could affect trade activity and have a spillover effect on the rest of the world. Third, the shutdown could hurt SMEs in particular, as they need to pay operation costs during the shutdown period, e.g. rental, salary and social security contribution, and prolonged shutdown could lead to a wave of SME bankruptcy and unemployment. Lastly, the supply shock could also intensify the demand shock, as most self-employed workers or those workers paid by daily wages could suffer an income shock.
Revising China’s growth forecasts
We revise China’s 2020 growth forecasts in response to the latest developments as described above. In the new baseline scenario, we assume: (1) contagion will peak in March (using the baseline contagion assumption as mentioned above), consumption quickly recovers in 2Q; (2) factories reopen on Feb 10th in most provinces, though further delayed in a few provinces (e.g. Hubei, Zhejiang, Guangdong, Jiangsu). The supply shock will be most significant in February. Recovery in production is gradual and slow in February (after February 10), and will pick up in March and fully recover in 2Q.
We also consider a more severe scenario, for which we assume: (1) contagion will peak in April (using the pessimistic contagion assumption), consumption rebound will be delayed to mid-2Q and 3Q; (2) factory reopening will be postponed by another week compared to the new baseline scenario, i.e. longer disruption in production, transportation and shipping.
Table 2 summarizes our forecast changes. In the new baseline scenario, GDP growth will slow notably to 1%q/q saar in 1Q (or 4.6%oya) and rebound to 9.3%q/q saar in 2Q. The growth will be back to pre-virus track and recover to 5.6%q/q saar in 4Q (or 5.7%oya) in 4Q. Full year 2020 growth will slow down to 5.4%yoy. IP will contract 4.2%q/q saar in 1Q, and rebound to 16.5% q/q saar in 2Q. Retail sales will contract 3.4% q/q saar in 1Q, and rebound to 17.6% q/q saar in 2Q. Fixed investment and trade activity will also be affected as shown in the charts below.
In the more severe scenario, the negative shock will be larger in 1Q, with the rebound coming later in 2Q and 3Q. GDP will contract 3.9%q/q saar in 1Q (or 3.3%oya), followed by rebound in 2Q (9.1%q/q saar) and 3Q (11.3%q/q saar). 4Q growth will move back to pre-virus track at 5.6%q/q saar, but in yoy terms at 5.4% reflecting the prolonged consequence of virus shock (vs. baseline scenario). The collapse in IP in 1Q is much larger at -11.6%q/q saar due to prolonged disruption in production, and retail sales will contract 5.2%q/q saar in 1Q. In this scenario, full-year GDP growth in 2020 will slow to 4.6%yoy.
Overall, the key message from our new baseline scenario is that there will be significant slowing in 1Q GDP growth, followed by a V-shaped rebound in 2Q. The tentative, exogenous shock should not affect the economy’s medium-term growth dynamics. In the more severe scenario, the tentative shock is larger and lasts longer by 1-2 months.
How will macro policies react?
Regarding the authorities’ latest policy reaction, the PBOC has issued 1.7 trillion yuan reverse repo this week, along with OMO rate cut: the 7-day repo rate was lowered by 10bp to 2.4%, and 14-day repo rate also lowered by 10bps to 2.55% ( link). In addition, local governments in Suzhou, Ningbo, Shenzhen, Shanghai have announced supportive measures including: waiver of office rental by 1-2 months; postponed tax filing; subsidy on interest payment of new corporate loans; ensured loan extension and increased credit availability for corporates; credit enhancement service at favorable terms; delayed payment or partial refund of social security contribution; public service support for legal disputes arising from virus outbreak, etc.
Our pre-virus forecasts have assumed fiscal easing (augmented fiscal deficit is 0.5%pt higher than 2019) and monetary easing (2 RRR cuts and 10bp rate cut) in 2020. In response to the coronavirus shock, we add additional policy support for 2020. On fiscal policy, we expect an additional 0.3%pt (as % of GDP) fiscal deficit compared to our original forecasts, to release near term stress and provide support for the corporate sector (along the line of measures announced by selected local governments as mentioned above). Meanwhile, we do not expect additional fiscal support for infrastructure activity compared to what we have already factored in our initial forecast. On monetary policy, we have penciled in one more RRR cut, with additional 10bp MLF/LPR rate cut.
Overall, the additional policy easing is more of rescue measures rather than stimulus. Fiscal policy will take a leading role to help corporates to survive the large tentative shock. In addition, credit availability is crucial at this juncture, as policymakers aim to prevent distresses triggered by shortage of working capital at the corporate level, especially for SMEs. Structural monetary policy to support targeted borrowers (including SMEs and sectors most affected by the virus) by lowering funding costs and help vulnerable firms to get through the challenging period is also likely. Meanwhile, rate cuts, such as this week’s OMO rate cut, is seen to send the signaling effect to manage expectation in the financial markets.
On the exchange rate front, our FX strategy team has revised the CNY forecast this week ( link), looking for USD/CNY to end 1Q at 7.00 (vs. 6.85 previously), with the yearend forecast remaining at 6.99. In our view, near-term CNY depreciation reflects market concerns about tentative shock on growth. It does not mean a shift in exchange rate policy framework. First, exchange rate adjustment is not as effective as domestic macro policy to offset the domestic demand and supply shocks. Second, the agreement with the US in the Phase One deal will limit the use of currency movements as an offsetting policy instrument.
Overall, we believe additional policy easing is necessary to address the near term shock and to avoid the tentative shock from imposing permanent damage on the economy (e.g. large scale factory shutdown, SME bankruptcy or significant rise in unemployment).
Another important question is if China will stick to 2020 growth target (consensus around 6%). It is likely that the NPC meeting (likely to be postponed) may announce a lower growth target than 6%, in response to the unexpected change in economic condition. If so, it is a positive signal that the government will not sacrifice its long term policy agenda because of an unexpected tentative shock.
Click here for the full Note and disclaimers
Greater China Economic Research
Haibin ZhuAC
(852) 2800-7039
haibin.zhu@jpmorgan.com
J.P. Morgan Securities (Asia Pacific) Limited/JPMorgan Chase Bank, N.A., Hong Kong
Grace Ng
(852) 2800-7002
grace.h.ng@jpmorgan.com
JPMorgan Chase Bank, N.A., Hong Kong
Carol Wei Liao
(852) 2800-2801
carol.w.liao@jpmorgan.com
JPMorgan Chase Bank, N.A., Hong Kong
Anita Xu
(852) 2800-2163
anita.xu@jpmorgan.com
JPMorgan Chase Bank, N.A., Hong Kong
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