China Markets

Bad, Worse, Ugly Or ‘Unthinkable’? One Bank Goes ‘Dystopian Hollywood’ With Coronavirus Scenario Analysis

"Let’s all pray it does not come to pass."

The good news on the coronavirus is that, at least if you go by the official data from the National Health Commission, China’s measures to curb the spread of the deadly illness have been some semblance of effective.

There were 2,009 new cases reported on Sunday, down for a third straight day and markedly lower than the 2,641 announced on Saturday. The number of new cases in Hubei dove from 2,420 to 1,843.

The death toll, unfortunately, was barely lower at 142 (from 143 the previous day). 138 of the new casualties were in Hubei.

Meanwhile, aboard the Diamond Princess cruise ship quarantined in the port of Yokohama, Japan found an additional 70 cases. The total on the ship is now 355. You’d be forgiven for asking whether keeping people sequestered in a closed environment with a virus that is airborne is a good idea. In addition to the US, South Korea, Canada, Hong Kong and Israel are brining back citizens stranded on the vessel. Three Israelis tested positive aboard the ship, giving the country its first confirmed cases.

Taiwan confirmed its first death on Sunday, and health officials in Hawaii are on high alert after a couple who vacationed there late last month was diagnosed with the virus after returning to Japan. “The man fell ill during the second week of his vacation. At the time, the couple was staying at a time-share in Honolulu, on the island of Oahu”, The New York Times said over the weekend, adding that “the couple had been in Maui, but the man showed no symptoms while he was there [and] it remained unclear if the woman showed any symptoms while on vacation”.

This continues to cast a pall over the outlook for the global economy. On Sunday, Chinese Finance Minister Liu Kun detailed additional fiscal measures Beijing will take to cushion the economic blow, including tax and fee cuts and reducing “the burden on enterprises and individuals and promoting epidemic prevention and control”. The piece is unusually long as far as nebulous pronouncements from Party officials go. It was published in “Seeking Truth”, a bi-monthly from the Politburo. I’ll reprint a translated version later Sunday.

“The Covid‐19 coronavirus could be more disruptive than markets are currently pricing in, not in the least because the ‘true’ number of infected people remains uncertain, as the recent surge in cases exemplifies”, Rabobank wrote, in an expansive note out Friday called “The Bad; The Worse; The Ugly; and The Unthinkable”.

The bank writes that the “bad” scenario is “actually the ‘good’ one” – it entails a sharp slowdown in Chinese growth, but a relatively swift rebound as the economy ramps back up. To wit, from the note:

This is a relatively benign scenario with the economic effects mostly concentrated in Q1 and part of Q2 2020. Regardless, we still envisage that China’s Q1 growth rate in this scenario could fall to 2.9% y‐o‐y, which is 3% lower than our previous forecast of 5.9%. Assuming the most draconian containment measures are gradually withdrawn during Q2, the impact on Q2 growth is likely to be smaller but still negative. Only in H2 would we expect a partial rebound. For 2020, our ballpark growth figure is 4.8% ‐ 5.6% y/y GDP growth, and then and between 5.5% ‐ 6.3% for 2021. 

Those aren’t Rabobank’s house calls for the Chinese economy – yet. As with many other banks, they’re still trying to decide how much of an impact from the coronavirus to bake into their official calls. For now, these are all just scenario analyses.

Obviously, Rabobank expects more stimulus, both fiscal and monetary. They note that the PBoC has injected nearly 3 trillion yuan already, but you should be apprised that a good portion of that is simply for the rolling of maturing funding. China of course cut OMO rates when mainland markets reopened earlier this month, and most analysts see an MLF cut in the cards, paving the way for a 10bps cut to the loan prime rate later this month.

“Interest rates, such as where they matter in a quantity‐driven credit economy like China, will also be lowered”, Rabobank notes, adding that “the fiscal taps will have to open too, we are again already seeing accelerated issuance of local government special bonds, and the central government fiscal deficit will also widen as needed to ensure the economy gets back on track as soon as possible”.

The problem with all of that is it entails abandoning the de-leveraging effort. Rabobank writes that none of this is “a cost‐free exercise”, cautions on “already‐high debt‐ratios of corporates” and declares that “the narrative of deleveraging… will be comprehensively debunked”.

Read more: Coronavirus And China’s Never-Ending Spinning Plates Routine

Make no mistake, aggressive measures to shore up the world’s second-largest economy are necessary. China is the world’s engine of global growth, trade and credit creation.

At a high level, Rabobank demonstrates this with a simple calculation. To wit:

The sensitivity of the world economy to China’s growth rate was 0.17 between the 1980s and 2000, which has almost tripled to 0.47 in the last 15 years. Thus each percentage point of Chinese GDP growth coincides (we don’t say ‘leads to’) with about half a percentage point in world GDP growth. This scenario will see 2020 world GDP growth ‐ 0.2ppts lower than our current estimate of 2.9%.

Clearly, Asian economies are highly exposed, but as we’ve discussed at length over the past two weeks, Germany is imperiled too, and at just the wrong time.

The world’s fourth largest economy is mired in a truly nasty manufacturing slump and data out Friday suggested there’s no light at the end of the tunnel just yet.

Remember, Volkswagen, BMW, Daimler and others produced just 4.66 million vehicles in German factories last year, the least since 1996.

The epidemic has the potential to add insult to injury.

“7% of Germany’s exports (EUR 96 bln) go to China, a quarter of which are cars [and] the rest of Asia constitutes 11% of German exports”, Rabobank goes on to write. The simple read-though from the bank is this:

A full 18% of German exports will be hit directly or indirectly be less demand from China as well as disruption of transport routes. With German automotive output already at its lowest level since 2010 significant weakness in Chinese demand could be a serious headwind for Germany.

Auto sales in China plunged a dastardly 22% last month, the largest ever decline for January, according to data out Thursday from the China Passenger Car Association.

China’s auto market – the largest in the world – is in a historic slump. Sales have fallen in 19 of the last 20 months.

There’s more, but you get the idea. This “bad” scenario wherein the epidemic yanks the rug from beneath the Chinese economy for one quarter is already enough to send shockwaves through a global economy that’s still reeling from the trade war.

That “bad” scenario is what the market is currently pricing in, Rabobank says. And “pricing in” is something of a misnomer. After all, equities are at record highs and seem intent on looking past all of this, even as commodities and bonds are taking a more cautious approach.

As far as Rabobank’s other scenarios, suffice to say they get progressively scarier the more of the note you read. The “Worse” scenario, for example, finds the coronavirus spreading further within China and lasting “longer than six to nine months”. That would entail annual GDP for China falling into the 3.8% to 4.6% range, denting global growth by a full 1%.

To be sure, global growth does not need to take that kind of hit. 2019 marked the most sluggish pace of growth since the crisis. If you trim 1% from the IMF’s 2020 forecast (and you should note that the IMF cut their 2019 forecast around a half-dozen times by the time the full year was finally in the books) it would mean growth of around 2.3%, lower than 2008 (the current projection from the fund for this year is 3.3%).

In Rabobank’s “Ugly” scenario, there’s a global depression. Once you get to this point in the bank’s analysis, it becomes clear that paraphrasing doesn’t do it justice any longer, so here is a longer passage from the “Ugly” section:

If the virus spreads in the West public panic would naturally be the immediate response. Just as seen in China today, people would stop going out and shopping to stay safe at home, or make panic purchases on fears of supply shortages and then stay at home. In short, the economy would largely grind to a halt. Naturally, the services sector on which the West relies far more than China would be smashed: restaurants; pubs; bars; cinemas; concerts; conferences would all grind to a halt. International travel bans would be put in place. Supply chains would be broken. International trade would collapse along with domestic demand. In this kind of scenario it is impossible to estimate the precise impact on the global economy – because there would be little *global* economy to speak of. Suffice to say, it would be a true depression: a sharp downturn like in 2008‐09 that grinds on ‐ and a recovery based on medical breakthroughs rather than monetary‐policy ones. 

As far as the “Unthinkable” scenario goes… well, suffice to say the bank’s take on that exceedingly unfortunate tail risk isn’t very long. And that’s intentional. We’ll just leave you with one last quote from Rabobank:

This scenario is very short. The virus spreads globally and also mutates, with its transmissibility increasing and its lethality increasing too. The numbers infected would skyrocket, as would casualties. We could be looking at a global pandemic, and at scenarios more akin to dystopian Hollywood films than the realms of economic analysis. Let’s all pray it does not come to pass and just remains a very fat tail risk.


2 comments on “Bad, Worse, Ugly Or ‘Unthinkable’? One Bank Goes ‘Dystopian Hollywood’ With Coronavirus Scenario Analysis

  1. You don’t need to be a peddler in dystopian prophesies to view the current range of base case predictions across the investment community as overly optimistic. The truth on the ground in Asia (and, I suspect, beyond) is that people are not going out as much, they are already reviewing travel plans and large-scale gatherings, concerts and events are being cancelled or postponed. The travel and tourism sector alone, at over 10% of global GDP and a disproportionate engine of growth, could quite conceivably halve global GDP growth this year without any secondary impacts taken into account and with no other industries adversely impacted. I applaud Rabobank’s efforts to recast their prediction, but this journey has only just begun.

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