How is Coronavirus expected to impact Financial Markets?
The virus also known as the COVID19 has been fast spreading within China and beyond. The total number of reported cases globally as of the 14th of February is well over 64,000. What is the impact of this epidemic on global economy and financial markets?
Introduction
The rapid outbreak of the coronavirus has already started to have effects on the Chinese economy. Forecasts for GDP growth have already been trimmed with S&P cutting China’s GDP to 5% from an earlier forecast of 5.7%. While, Nomura has predicted a growth rate of 3.8% for the March quarter as compared to 6% in the quarter ending December 2019.
Previous Epidemics/Pandemics
With no real clarity on how this epidemic might unfold and if will turn into a pandemic, it is tough to tell what kind of impact this may have on global growth or financial assets. But in order to analyse how businesses might be affected, one of the best ways is to look at some similar historical epidemics.
The SARS outbreak of 2003 is amongst the best reference points that we have. The impact was mostly confined to China and its neighbouring countries. Due to this the air travel for the whole year was down to only a quarter of the annual averages. Retail sales were down approximately 15%.
A study by the World Bank in 2006 about the 1918 epidemic that killed 50 million people offers some good insights. With a fatality rate of 2.5 per cent and a 20 per cent decline in tourism and services, the assumptions are pretty much in line with what we are seeing from the COVID 19. According to the model, the world output could shrink by as much as 3 per cent is COVID 19 spreads like the 1918 epidemic had. To put this in perspective, after the subprime mortgage crisis the world GDP had fallen by 0.1%.
Expected Effect of Coronavirus
Impact on Consumption
As this epidemic continues to rise, the household disposable incomes are expected to drop a fair bit. This could be on account of higher medical expenses, job losses or even weaker sentiments. This is already been noticed in the most affected regions of China, specially Hubei. In case the spread to countries outside of China starts to quicken, this could be a problem which every economy could be facing.
The trickle-down effects of even a 20% drop in disposable income can be quite catastrophic. Given how controlling the virus is getting tougher by the day, not only will economies have to deal with a lower spending, but that will be coupled with a prolonged drop in spends.
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Impact on Raw Materials
China matters much more to the global economy now than it did in 2003. In 2003, China’s GDP represented 4.4% of the global GDP. The share has now risen to over 15%. According to a report from Dun & Bradstreet, more than 50,000 companies all around the globe have at least one key supplier in China. Over 50 Lakh companies have one or more Tier 2 suppliers in the region. This could have a major adverse impact on global supply chains and businesses around the world. The unavailability and higher lead times for procuring raw materials are expected to put pressure on the profit margins of companies worldwide.
The chart below shows countries whose companies have branches or subsidiaries in the affected region. The number of such companies as per a Dun & Bradstreet report is upward of 49,000.
Global Headquarter Distribution of Businesses in the Impacted Region
Source: D&B report on “Business impact of Coronavirus”
The Future
At this stage one can assume that the impact to India’s growth would be negligible. Only companies that have direct dealing with companies in the affected region may be impacted. However, it is too early to predict the spread of the virus and if it is to spread to India, the impact could be much more. Also, the slowdown in China is expected to negatively influence the services sector, primarily tourism.
However, one can take heart from the fact that the MSCI global index had sold off 4 per cent in the month after the SARS epidemic started. This was then followed by a huge rally, which not only recovered the losses but gained much more.
What should Indian investors do?
As mentioned above, we see minimal effect on the Indian economy. Also, in case the spread worsens, and we are to see an impact on the equity markets, for long term investors it is only an opportunity to add to their holdings. Events such as these generally do not have a very long-lasting effect. Also, Governments across the world have taken measures for prevention on a war-footing and we hope the spread of COVID 19 will be arrested soon.
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