China’s coronavirus challenge

The coronavirus has hit China's services sector hard. Shops are empty and restaurants are suffering, as people stay at home. Worries that the virus could be spread through delivery services has dealt a further blow to the industry.

Some services--such as children’s after-school classes- have stopped completely.

Mass transportation and inbound tourism have taken a hit and outbound tourism has fallen, too. While the drop in Chinese spending abroad will help China's GDP growth, the rest of the world will pay for it.

The manufacturing sector is also feeling the strain. Many factory workers went back to their home towns for the Lunar New Year holiday and have been unable to return to work following the lockdown of Chinese cities. It's unclear when or if they will be able to go back. Local governments are likely to relax travel restrictions only when the virus has been contained.

For now, many workers are concerned that they won't be allowed to return, and even if they do, the factory may not have enough workers to function. That said, workers may struggle to find a job in their home towns. Hence the uncertainty. The situation should be clearer two weeks from now.

There is a high chance that some production lines will be stopped, which will hurt output and exports. The more labour intensive the factory, the more it will be affected. This will delay investment in production lines even if there is demand.

We highlight two points for the loan and credit sector as a result of the coronavirus:

1. Regardless of whether companies are hit by sales or production, they may struggle to repay debt. The non-performing loan ratio could increase from the level of 1.86% recorded in the third quarter of last year. In fact, we expect this to go up to around 2.5%, a level similar to that seen in the fourth quarter of 2008. History tells us that when the NPL increases, bank loan growth falls and so too, does GDP growth.
2. In China, it is common for borrowers to pledge equities as collateral for loans. If the A-share stock market falls, the collateral value will fall as well, and borrowers may need to top this up. However, it will be difficult to top up collateral when asset prices are falling. Though some news reports claim that the Chinese government could install administrative measures to stop A-shares from falling, e.g. by the four state-owned asset management companies buying stocks, this may not prop up every stock that is being used as collateral for loans and credit. Without enough collateral, borrowers may need to wind down their outstanding loans and credit or risk default, which will also hit GDP growth.

We expect that the Chinese government will increase fiscal support to stabilise GDP growth. Before the outbreak of the coronavirus, we predicted 2 trillion yuan of fiscal stimulus, but we now believe this will go up to at least 3.5 trillion yuan in 2020, which is 3.5% of nominal GDP for this year.

Most of the fiscal money will be used in the medical sector to try to combat the virus, to cure patients and to prevent more confirmed cases. This will directly and indirectly support GDP.

Two hospitals have been built, and we expect more to come. With the additional hospitals, there will be a need for more hospital beds, medical equipment and medical vehicles.

Aside from fiscal stimulus, monetary policy will ensure ample liquidity in the market so there is no squeeze in short-term interest rates. This reduces the possibility of market volatility.

We expect one more rate cut of 10 basis points and one more RRR cut of 0.5 percentage point in the second quarter if the coronavirus continues in the coming months.

As activity has slowed down, energy prices have dropped, providing some support to China’s real GDP. However, this is not good news for producers.

We do not expect a speedy recovery for the economy, even in the unlikely event that there are no new confirmed cases. After the coronavirus has been contained, it may still take four quarters to see a full recovery.

Consumers will still be cautious, which will continue to affect both inbound tourism and global tourism. They will avoid crowds and places like the gym room, swimming pools, and cinemas.

Factories should recover faster than the consumer sector, which will help loan growth to recover as well.