The coronavirus, China and the global economy
28 February 2020 | Markets and Economy
The article below is based on analysis completed by Vanguard’s Investment Strategy Group near the end of the week of the 17 February, assuming the virus would remain contained in mainland China (as one of three scenarios analysed).
The coronavirus COVID-19 is likely to slow 2020 global economic growth by about 0.15 percentage points, according to Vanguard economists. That equates to roughly $135 billion in goods and services not produced, or at least delayed1.
The epidemic's economic consequences this year will be driven by three factors—the virus's reach and duration; fear, which inhibits travel, consumer spending, manufacturing and trade; and government actions both to arrest the virus and stimulate faster growth. The net effects won't become clear for at least several months.
This uncertainty is why investors with well-considered investment plans and long time horizons should resist any urge to alter their portfolios in response to the outbreak, or in anticipation of how it might affect the financial markets.
In China, economic activity nearly halted
The onset of the coronavirus adds great uncertainty to China's economic path, said Qian Wang, Vanguard's chief economist for the Asia-Pacific region. In addition to concerns about data collection and transparency, the emergence of the virus coincides with the government's annual merging of macroeconomic data releases for January and February, a process that smooths distortions due to the Lunar New Year holiday.
As noted in our economic outlook for 2020, the effects of the multiyear escalation in US-China trade tensions became evident in 2019, and stimulus measures struggled to rejuvenate a fraught private sector. Thus, we entered the year expecting a continuation of the decade-long moderation in Chinese economic growth, into the upper-5% range this year.
The virus clearly has changed the Chinese economy—to say nothing of everyday life for roughly 20% of the world's inhabitants. Many Chinese have not returned from traditional Lunar New Year trips, countless factories have been shut and millions of students have had to rely on online schooling.
Empty streets and rail depots reflect near-halt of Chinese economy
Notes: A traffic congestion rate of 1.0 represents free-flowing roads. In 2020, the first day of the Lunar New Year was January 25. Data are as of February 17, 2020.
Sources: Vanguard calculations, based on data from Gaode.
Our Investment Strategy Group estimates that the virus will take about 0.5 percentage points of growth from China's economy this year, said Ms. Wang. That represents roughly 534 billion yuan, or $76 billion, in goods and services not produced, or at least delayed2. We now expect China's 2020 growth to be in the range of 5.0%–5.5%.
More than one path is possible for China's economy
A couple of scenarios could leave China's 2020 economic growth in the 5.0%–5.5% range. The more optimistic scenario would be if economic activity, following a peak in the number of confirmed coronavirus cases, returns to normal between late February and mid-March. Even so, we'd expect first-quarter growth to be noticeably affected by the virus, given that manufacturing and consumption largely stood still in February. In this scenario, first-quarter growth would be modest at the best, bringing full-year growth down to the mid-5% range from a reported 6.1% last year.
A second, more plausible, path to 2020 growth in the low-5% range is a continuation of mass quarantines and business shutdowns, with economic activity not returning to normal until perhaps early in the second quarter. In this scenario, we'd expect a meaningful decline in economic output from the fourth quarter of 2019 and a sharp, V-shaped recovery afterward. There would be moderate supply-chain disruptions around the globe.
A less likely but important scenario to watch for is the “false recovery,” with activity getting back to normal only to be followed by a re-emergence of the virus. In this case, output would lag through the first half of the year, the government would enact more aggressive stimulus programs, and full-year Chinese growth would fall into the high-4% range. Global growth would slow by perhaps half a percentage point.
China's 2020 economic path will not be clear for months
Vanguard forecasts before and after the coronavirus's emergence
Source: Vanguard. Previous forecast issued in December 2019, as part of our 2020 economic and market outlook, The new age of uncertainty. New scenarios as of February 21, 2020.
It's important to note, Ms. Wang said, our assumption that the virus will stay primarily contained in mainland China. If it spreads more widely outside China, a bigger global slowdown could occur.
The coronavirus's economic consequences outside of China
Adam Schickling, a US economist for Vanguard, estimated that $59 billion or more in economic activity outside of China would be lost or at least delayed by virus-related reductions in trade and travel3. His estimate reflects the size of the Chinese economy and its links to much of the rest of the world. China now accounts for roughly 18% of global economic activity, including 31% of manufacturing, 12% of exports and 18% of travel spending.
Coronavirus-driven slowdown in China will curb economic activity elsewhere
Estimated impacts of a 0.5 percentage point drop (Vanguard's base case) in China's 2020 growth rate
Sources: Vanguard calculations, based on data from Thomson Reuters Datastream, CEIC, and Bloomberg as of February 21, 2020.
The longer-term economic outlook for China
“The coronavirus brings volatility to China and the world, but it does not change long-term trends, such as globalisation, technology and demographics,” said Ms. Wang.
China joined the World Trade Organization in 2001, and export and housing booms followed. Real (inflation-adjusted) annualised growth peaked at a government-reported 14% in 2007.
But the country's economic growth has been slowing more or less steadily since the global financial crisis of 2008–2009. The slowdown is a natural part of the transition from an industrial-led to a consumer-driven economy. It also reflects an aging population and, more recently, the US-China trade conflict, which only in late 2019 was partly resolved with a “phase one” pact.
Changes in trading relationships, politics and governance have complicated China's transition to a developed economy. And rising uncertainty externally may increase the temptation for Chinese policymakers to emphasise short-term growth stability to the detriment of longer-term financial stability and structural reforms. The result could be Japanese-style stagnation or emerging-market-style instability, in which falling productivity growth and lower capital investment lead to much lower growth.
On the other hand, US-China tensions could prompt Chinese leaders to pursue reforms and greater economic productivity. Under such circumstances, the chance of both a smooth rebalancing and a hard landing would increase, with smooth rebalancing more likely given adequate policy cushions and recent progress on excess economic capacity.
China's medium-term growth outlook is complicated by external tensions
Four scenarios for year-over-year economic growth
Sources: Vanguard calculations, based on data from the International Monetary Fund, the World Bank, and CEIC as of December 2019.
Investing sometimes requires courage
For more than a decade now, globally diversified investors have enjoyed a more or less uninterrupted run of rising stock and bond prices. Risk at times may have seemed more theoretical than real. But if the risk of investing is not always as visible, it is ever-present just the same.
As ever, we encourage our investors to keep their eyes fixed on their long-term goals and to maintain portfolios that are balanced across asset classes and diversified within them, in mixes that reflect their tolerance for risk.
Read Vanguard chief investment officer Greg Davis's blog on how the coronavirus has introduced new uncertainty into economies and markets and the reasons why investors should remain disciplined.
1 Sources: Vanguard (for 0.15-percentage-point estimated drop in global economic growth) and the International Monetary Fund (for 2020 global economic growth estimate of $90.52 trillion, made in October 2019).
2 Sources: Vanguard (for 0.5-percentage-point estimated drop in China's economic growth), the International Monetary Fund (for 2020 China economic growth estimate of $15.3 trillion, made in October 2019), and the Federal Reserve Bank of St. Louis (for China-US exchange rate).
3 Sources: Vanguard (for estimated declines in economic output) and the International Monetary Fund (for 2020 economic growth estimates, made in October 2019).
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