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The coronavirus's impact on the economy and financial markets

January 2020

The economic cost of the coronavirus

The coronavirus is spreading across China and beyond. What impact will the epidemic have on the global economy and financial markets?

The outbreak of the coronavirus could deal a blow to the global economy, threatening consumption and tourism. It also risks undermining business sentiment.

History offers a guide to how developments might unfold.

Most economic studies of the impact of pandemics such as the SARS virus in 2003 have been undertaken by epidemiologists who tend to focus on the cost-benefit of vaccination.

There are only a handful that analyse the broader economic impact. Still, a 2006 study by the World Bank provides some useful insight.

While the World Bank model is based upon a flu-style epidemic similar to that in 1918 – which killed 50 million people and affected up to a fifth of the global population - its assumptions are relatively conservative: a fatality rate of 2.5 per cent and a 20 per cent decline in tourism and services output (restaurants, air travel and other non-essential consumer spending).1

 Its epidemiological assumptions are more or less in keeping with what is currently estimated for the coronavirus, known as 2019-nCoV.

According to the model,  world output would shrink by as much as 3 per cent were 2019-nCoV to spread as broadly as the 1918 epidemic, with differences between regions fairly negligible. For comparison, in the aftermath of the US subprime mortgage crisis, global GDP contracted by 0.1 per cent in 2009, with advanced economies shrinking 3.4 per cent and developing markets expanding by 2.9 per cent.

The SARS outbreak of 2003 is another point of reference, though in this case the impact was largely confined to China and its neighbours. For the whole of that year, air travel declined 75 per cent between Hong Kong and China while retail sales dropped some 15 per cent in the mainland.

Household surveys in China taken immediately after the SARS epidemic indicated that, in the second quarter of 2003, the virus caused disposable income to drop more than 20 per cent (due to illness, absenteeism, increased spending on prevention and healthcare).

The economy rebounded rapidly in the subsequent quarters, which meant the epidemic ended up shaving only about 1 percentage point from China's growth that year. Such a recovery would be less likely in the event of a full-blown flu pandemic, which typically lasts a year or so.

Even if the epidemiological assumptions turn out to be excessively pessimistic, it appears likely that 2019-nCoV will have a more severe economic impact than SARS. The timing of the outbreak at Lunar New Year is unfortunate. The effect on New Year retail spending has already been dramatic. Passenger travel has decreased by 29 per cent compared to last year’s first day of the Lunar New Year. Cinemas have been mostly shut and ticket receipts are down 99 per cent.

(Conversely, manufacturing would have been largely at a standstill during the public holidays in any case, so the impact on the supply side is somewhat reduced.)

It appears likely that 2019-nCoV will have a more severe economic impact than SARS

While the authorities in China appear to have been speedier in their response this time around (compared to 2003) – 15 cities in Hubei province are in lockdown and the New Year break has been extended - the risk is that a significant portion of the Chinese workforce will be stranded in the wrong place once the holidays end.

And China matters more to the global economy now than it did in 2003. Much more. Then, it represented 4.4 per cent of global GDP. Now its share is 15.4 per cent.

What is more, its integration into global supply chains is significant, particularly in technology. Then there’s the Chinese consumer. China’s consumer spending now accounts for a bigger proportion of domestic and world growth. Which means the impact of a decline in household expenditure could be far greater this time round.

Thankfully, China has the tools to soften the economic hit. According to our calculations, China’s central bank has room to deliver plenty of monetary stimulus, having been more restrictive than average during the past two years. Cutting Chinese banks’ reserve requirement ratios by 200 basis points, for instance, would amount to a liquidity injection equivalent to USD460 billion, equivalent to 3 per cent of China’s GDP.

There is also room for fiscal stimulus – in fact in 2003 China cut both business tax and corporation tax.

This would come as a relief to equity investors. It’s worth remembering that the MSCI global index sold off by up to 4 per cent in the month after the SARS epidemic started, only to recover very strongly afterward – though the Asian equity markets lagged by around six months.