The coronavirus and the emerging world - Capital Economics
Emerging Markets Economics

The coronavirus and the emerging world

Emerging Markets Economics Focus
Written by William Jackson
Cancel X

The impact of the coronavirus means aggregate EM GDP is likely to have contracted in q/q terms for the first time since the global financial crisis in Q1. If the outbreak is contained quickly, most lost output should be recovered later in the year. But if the virus spreads further or supply chain disruptions persist for much longer, we think this could plausibly knock as much as a percentage point off EM growth this year. And EM asset prices would suffer renewed falls.

  • The impact of the coronavirus means aggregate EM GDP is likely to have contracted in q/q terms for the first time since the global financial crisis in Q1. If the outbreak is contained quickly, most lost output should be recovered later in the year. But if the virus spreads further or supply chain disruptions persist for much longer, we think this could plausibly knock as much as a percentage point off EM growth this year. And EM asset prices would suffer renewed falls.
  • We have written a separate Focus which looks specifically at the impact on the Chinese economy, and our full suite of research on the coronavirus can be found on our website. This Focus looks at the economic implications of the outbreak for the rest of the emerging world. There are four main channels through which the outbreak has affected – and could affect – these countries.
  • The first is via the travel industry, which has already been severely affected. The impact has probably been largest in East Asia – particularly in Hong Kong, Thailand and Singapore. And the effects could become much bigger if the virus spreads more widely, resulting in lower visitor arrivals not just from China but from elsewhere too.
  • The second channel is supply chain disruptions. Extended factory closures in China have already reduced demand for many East Asian manufacturing economies, as well as commodity producers, which have close trade links with China. And given China’s pivotal role in global supply chains, the longer the disruptions go on for, the greater the risk that firms elsewhere face shortages of crucial component parts.
  • The third channel is lower commodity prices, which is a particularly large risk for oil producers, such as Saudi Arabia and Russia, as well as metals producers like Chile.
  • And the final channel is a deterioration in risk appetite. Markets appear to be pricing in a pretty benign outcome for China’s economy and risk aversion hasn’t increased significantly. But if the downturn in China proves to be steeper, risk aversion would increase and EM asset prices would fall. The economies of Argentina, Turkey and South Africa look most vulnerable to disruptions to capital flows.
  • Prior to the virus outbreak policymakers across much of the emerging world were already loosening fiscal and monetary policy. Concerns about the growth outlook are likely to lead to more monetary easing than we had previously expected in parts of East Asia. And if the effects of the coronavirus worsen, governments in some countries, like Indonesia and Malaysia, would probably abandon plans to tighten fiscal policy.
  • We had previously expected a steady recovery in aggregate emerging market GDP growth this year. We now think that GDP will have contracted this quarter, by about 2.5% q/q annualised. Our central view is that most lost output should be recovered from Q2 onwards, and EM GDP growth will average about 3.8% over 2020 as a whole (broadly in line with our 2019 estimate of 3.7%).
  • But there are clear downsides risks to this view. If the virus spreads or the economic disruptions in China’s economy persist into Q2, the effects would become more widespread and severe. Economies in East Asia as well as commodity producers would be hardest hit. In this pessimistic scenario, we think EM GDP growth would be more likely to average 3% this year. The slowdown would probably be sharper than that in 2015, when China’s botched devaluation of the renminbi triggered fears of a hard landing.

The coronavirus and the emerging world

This Focus is an adapted version of a presentation given at the Capital Economics Emerging Markets Forecast Forum held in London in February 2020.

The outbreak of the coronavirus has injected a huge amount of uncertainty into the outlook not just for China but for other emerging markets too. This Focus concentrates on the impact in emerging markets other than China.

We begin with an overview of what was happening in emerging markets before the outbreak of the coronavirus. We then turn to the channels through which the virus has affected and could affect economies outside China, before looking at the policy response. And we conclude with the implications for emerging market growth.

Setting the scene

It’s helpful to set the scene by showing how emerging markets had been faring before the outbreak. Aggregate emerging market growth (in this case including China) slowed over the second half of 2018 and in early 2019 before stabilising at a little over 3.5%. (See Chart 1.)

The weakness in the emerging world last year was broad based. Growth slowed across major EMs, including India, Brazil, Russia and Mexico. And Hong Kong and Argentina both fell into recession

Chart 1: Emerging Market GDP
& CE GDP Tracker (% y/y)

Sources: Refinitiv, Capital Economics

Leading indicators also suggest that EM growth had stabilised in recent months. The emerging market manufacturing PMI has been steady since the third quarter of last year, suggesting that the pace of recovery had levelled off. (See Chart 2.)

Chart 2: EM Manufacturing PMI

Source: Markit

A recap of the view on China

We have looked at the economic impact of the coronavirus on China’s economy in a separate Focus. (Key charts as well as our publications on the topic can be found on our website.) In short, we think the impact of the virus will result in China’s GDP growth slowing by 4%-pts to 2% year-on-year in Q1, based on our proprietary Activity Proxy measure. That would be consistent with a fall in output of 10% on a quarterly annualised basis.

Our central view is that the virus is brought under control quickly and China lifts its quarantine restrictions. That should allow the economy to recover lost output over the remainder of the year, and our forecast for 2020 remains 5.0%. However, if the economic disruptions become worse, we think the effects could plausibly knock some 2%-pts off Chinese GDP growth this year.

The SARS comparison

As with China, the SARS epidemic in 2003 offers a useful starting point when considering the economic impact. Outside China, the economic effects of SARS were concentrated in a few countries which suffered cases of the virus, most notably Taiwan, Hong Kong, and Singapore.

Growth in those countries slowed even more sharply than it did in China, at least according to our own measure of the country’s GDP. However, growth then picked up sharply later in the year and in 2004 as these economies recovered lost output. And growth in the rest of the emerging world was largely unaffected. (See Chart 3.)

Chart 3: GDP (% y/y)

Sources: Refinitiv, CEIC, Capital Economics

It was a somewhat similar story in financial and commodity markets. Industrial metals prices and emerging market equities both initially fell, but recouped ground over the rest of the year. That was also supported by other factors including policy easing by the US Federal Reserve as well as the start of the Iraq war. (See Chart 4.)

Chart 4: S&P GSCI Industrial Metals Index & MSCI Emerging Market Equity Index (1st Jan. 2003 = 100)

Sources: Refinitiv, Capital Economics

So one lesson we can draw from the SARS experience is that, if the outbreak is brought under control quickly, economic activity and asset prices should rebound.

However, the SARS comparison only takes us so far. China’s quarantine measures this time have been much more draconian, which might limit the spread of the virus beyond its borders. But it has also caused a shutdown in China’s economy. And, of course, China plays a far more important role in the global economy now. Its economy accounts for a fifth of global GDP, compared with 9% in 2003. And it share of world trade is now twice as large as it was in 2003.

As a result, it helps to think of the channels through which the coronavirus has had or could have an effect on EMs. There are four main ones.

1. Falls in visitor arrivals

The travel industry was the first sector to feel a hit as China banned outbound tour groups, countries introduced restrictions on visitors from Mainland China, and airlines cancelled flights. Daily figures published by the Thai authorities suggest that total international arrivals at major airports are down by 30-40% compared with 2019. (See Chart 5.)

Chart 5: International Visitor Arrivals at Bangkok & Phuket Airports (Thousands)

Source: Thai Tourism Authority

It’s hard to quantify the impact of this. Travel disruptions can have many economic effects, but one distinct aspect of the travel industry that we can look at is tourism. There’s not much data to go on, but we’ve tried to estimate the size of Chinese overseas tourism spending. In some of the Asian economies on the left, Chinese tourism spending is 2-4% of GDP, or as much as 7% in Hong Kong. (See Chart 6. For more, see here.)

Chart 6: Chinese Overseas Tourism Spending (% of GDP)

Sources: Refinitiv, Bloomberg, Capital Economics

The hit to these countries’ tourism sectors has already have been large. And there could be much bigger losses if the virus spreads more widely, reducing visitor arrivals not just from China but from elsewhere too.

In emerging markets outside Asia and developed markets, Chinese tourism spending is pretty small, at about 0.2% of GDP or less.

2. Supply chain disruptions

The second channel through which the coronavirus is having an impact on the emerging world is through supply chains.

Countries integrated into Chinese supply chains have already been affected by decision to extend the Lunar New Year holiday by an extra week. And the impact will become larger if factories remain closed or are slow to return to full capacity.

There are two angles through which this can have an effect. The first is reduced import demand from China. To give a sense of scale, Chart 7 shows the origin of value added embedded in China’s imports. For countries in East Asia such as Taiwan, Malaysia, Singapore and Korea, value added equivalent to 10-20% of the size of their economies goes into products that China imports. Some commodity producers, like Chile, are also very dependent on China.

Chart 7: Domestic Value Added in China’s Imports
(% of GVA, Latest)

Sources: Refinitiv, OECD, Capital Economics

But most other emerging markets, as well as developed markets are much less dependent on China as a source of external demand.

The second angle – and the one that’s more unpredictable – is the degree to which supply chain disruptions mean domestic firms can’t source parts.

Chart 8 shows our estimates of manufacturing inputs sourced from China as a share of total value added. These are very high in East Asian economies – most notably Vietnam, where component parts sourced from China are 16% of the size of its economy. (For more, see our Global Economics Update.)

Chart 8: Manufacturing Inputs from China
(% of Total GVA, Latest)

Sources: Refinitiv, OECD, Capital Economics

Some Korean car firms already have halted production. And given the prevalence of just-in-time supply chains, it’s no surprise that other firms are warning of shutdowns.

Most EMs outside Asia as well as developed markets have limited supply chain exposure. But, of course, all it takes is a shortage of one crucial component to bring downstream production to a halt.

For example, the floods in Thailand in 2011 caused a shortage of specific auto parts that led to Toyota cutting production at plants as far away as North America and South Africa. If supply chain disruptions do start to become more widespread, we could see a sharper downturn in China and broader effects on the emerging world.

3. Lower commodity prices

The third channel through which the coronavirus is having an impact is lower commodity prices. In fact, we have already seen quite a large adjustment in the prices of oil, copper and iron ore, which have all fallen by at least 10% since concerns about the coronavirus intensified in late January. (See Chart 9.)

Chart 9: Commodity Prices (Index, 1st Jan. 2020 = 100)

Sources: Refinitiv, Capital Economics

Oil producers have the highest dependence on commodities. Russia and Saudi Arabia’s net commodity exports are 15-20% of GDP. (See Chart 10.) Others exposed to lower prices include Chile, the third column from the left, and Brazil and South Africa, which are a bit closer to the middle. One point to stress, though, is that a lot of large emerging markets – the ones on the right – are net commodity importers. So they will benefit from lower prices.

Chart 10: Net Commodity Exports (% of GDP, 2018)

Sources: Refinitiv, WTO, Capital Economics

4. Deterioration in risk appetite

The final channel through which the coronavirus could have an impact other emerging markets is via a deterioration in risk appetite.

So far, the financial market fallout doesn’t seem to have been very large. And risk aversion has not increased significantly. Chart 11 shows, from left to right, moves in EM dollar bond spreads, EM equities and exchange rates against the dollar. The black bars show the period from 20th January when fears about the coronavirus outbreak flared up.

These moves look pretty small compared with other periods when concerns about China’s economy emerged. For comparison, the blue bars show moves in the two weeks after China’s botched devaluation of the renminbi in August 2015, which sparked fears of a hard landing.

Chart 11: Financial Market Moves

Sources: Refinitiv, Bloomberg, Capital Economics

This suggests markets may be pricing in a pretty benign outcome for China’s economy. Risk aversion could worsen and asset prices could fall much further if the downturn there is steeper.

In that case, those EMs with weak balance sheets are likely to find themselves in the firing line. Chart 12 shows our preferred measure of external vulnerability – the gross external financing requirement. This the total capital flows a country requires over the coming year to roll over maturing external debt and to finance the current account deficit. This is measured this as a share of central banks’ foreign exchange reserves. A higher number indicates larger vulnerabilities.

Chart 12: Gross External Financing Requirement
(% of FX Reserves, Latest)

Sources: Refinitiv, Bloomberg, Capital Economics

We’ve highlighted three countries that stand out – and they probably won’t come as great surprise – Argentina, Turkey and South Africa. A bit further towards the right are countries with relatively large vulnerabilities like Indonesia and Chile.

The heat map in Chart 13 tries to bring together all these different channels. It shows a range of large emerging economies on the left-hand side. The first column shows their exposure to lower Chinese tourist arrivals – the hit has been largest in Thailand (shaded in red) and other parts of Asia (in yellow and orange), but small elsewhere.

The next column shows exposure via supply chains. The risks again are largest in Asia, although a bit more widespread than the effects via tourism. Lower commodity prices are a risk for the countries at the top – Brazil, Russia and South Africa, although these will also provide an offsetting boost for many of the manufacturing-based economies, shown by the green shading. Finally, a deterioration in risk appetite would be particularly bad news for Turkey, but could also cause strains in South Africa and Indonesia.

One final point that emerges from this is that, for a few countries like India, Poland and Mexico, vulnerabilities are generally low.

Chart 13: Vulnerability to Economics Effects of Coronavirus
(Red = More Vulnerable, Green = Benefit, Grey = Little Impact)

Source: Capital Economics

Policy easing likely to be stepped up

Regardless of how severe this economic damage proves to be, concerns about the growth outlook are likely to move governments and central banks to ease policy further.

There has already been a significant shift towards monetary loosening in the emerging world which started in the middle of last year. To illustrate this, Chart 14 shows our EM interest rate diffusion index. A number above the zero line means more central banks are hiking than cutting rates. A number below means more are cutting. And we have also put our forecasts on the right-hand side.

Chart 14: EM Interest Rate Diffusion Index

Sources: Bloomberg, Capital Economics

We think policy will continue to be loosened this year. Some central banks in Asia – such as Thailand and the Philippines – have cited the coronavirus as a reason behind recent interest rate cuts and it may spur others, such as Korea and Taiwan, to act too.

Even so, easing is unlikely to be on the same scale as in 2019. Interest rates are already very low in most countries to start with, EM inflation has risen, and we don’t expect any further easing in the US.

But while most of the monetary loosening in EMs has already happened, fiscal support is in the process of being stepped up.

Chart 15 is similar to the previous one, except it shows our estimate of the net number of emerging economies tightening or loosening fiscal policy in the year. By our estimates, on a net basis, more EMs will loosen fiscal policy this year than at any point since the global financial crisis.

Chart 15: EM Fiscal Policy Diffusion Index

Sources: Refinitiv, IMF, Capital Economics

In Chart 16, we’ve tried to show the likely changes in policy settings from now until year-end across a range of large economies. The horizontal line represents monetary policy – to the right is tighter policy, to the left is looser policy. The vertical axis shows fiscal policy, with those tightening towards the top, and those loosening towards the bottom.

A large number of countries sit towards the bottom left – they will be loosening both monetary and fiscal policy. If the impact coronavirus gets worse, some countries – such as Indonesia and Malaysia, which are in the top left – will probably abandon plans to tighten fiscal policy.

That said, there are a few EMs where these is less scope for a policy response. We would highlight Brazil and South Africa, which sit towards the top left. Although monetary policy has been or is being loosened, the public finances are weak and fiscal policy will tighten. We also have India and Turkey in the bottom right. In both cases, governments are loosening the purse strings. But that is likely to cause inflation to rise, leading to monetary tightening later in the year. Most analysts, in contrast, expect further rate cuts or no change in policy.

What does this mean for GDP growth?

Prior to the outbreak of the coronavirus, we had anticipated that this broad shift towards policy loosening would drive a modest recovery in EM growth this year.

As we discussed earlier in this Focus, the coronavirus may have caused Chinese GDP to fall by around 10% in quarterly annualised terms in Q1. Combining that with our estimates of the impact so far on other EMs implies that aggregate EM GDP has contracted something like 2.5% q/q annualised. That compares with an expansion of 3.5-4.0% in previous quarters.

Chart 16: EM Monetary & Fiscal Policy (Now to End 2020)

Source: Capital Economics

Assuming that the virus is quickly contained, we expect most lost output to be recovered later in the year. Accordingly, we think that EM GDP will grow by a little under 4% over the year as a whole.

However, if the virus continues to spread or supply chain disruptions become more severe, there would be a much sharper slowdown in the rest of the emerging world. We have tried to put some illustrative numbers on what might happen to GDP growth this year if the effects of the coronavirus linger into Q2 and China’s growth is about 2%-pt weaker over 2020. (See Chart 17.)

Chart 17: Impact on 2020 GDP Growth if Virus
Effects are Prolonged (%-pts)

Sources: Refinitiv, Bloomberg, Capital Economics

We’ve shown the countries where the impact would probably be largest. We have left India on the right, where we wouldn’t expect a significant impact, and the same would apply to many other EMs, including Mexico and much of Eastern Europe. The hit would be largest in parts of East Asia. The effects on these economies could be larger even than that on China itself. Commodity producers like Saudi Arabia, Russia, Brazil and South Africa would also suffer.

In terms of our aggregate forecasts, before the outbreak, we expected a steady recovery in EM GDP growth this year. In our central view now, GDP growth falls to less than 3% in Q1, but then recovers from Q2 onwards.

But if the economic disruptions continue into Q2 and start to have an effect on more economies, aggregate EM growth could plausibly weaken to a trough of just 2% y/y. EM GDP would probably expand by around 3% over the year as a whole. That’s about a percentage point lower than in our central view. The slowdown would be even sharper than the one which occurred in 2015 when the devaluation of the renminbi triggered fears about the health of China’s economy. (See Chart 18.)

Chart 18: Emerging Market GDP (% y/y)

Sources: Refinitiv, Bloomberg, Capital Economics

Conclusions

To bring this all together, if the outbreak is brought under control quickly, the disruptions outside China are likely to be limited to parts of Asia. And most lost output should be recovered quickly. So EM growth will slow sharply in Q1, before recovering later in the year. Our central forecast is that aggregate EM GDP growth will average 3.8% over 2020 as a whole (compared with our estimate of 3.7% in 2019).

But there are clearly risks to this view, particularly if factory closures in China cause problems in global supply chains. That could lead to a much larger hit to Asian economies and commodity producers. In that situation, the coronavirus could plausibly knock a full percentage point off EM growth, taking it to around 3%. Over the past 30 years, EM growth would only have been slower during the global financial crisis and the Asian financial crisis.

Financial markets seem to be pricing in a pretty benign outcome for China’s economy. So there’s certainly a risk of larger falls in EM equities and currencies, and a further widening of bond spreads.


William Jackson, Chief Emerging Markets Economist, +44 20 7808 4054, william.jackson@capitaleconomics.com