Another negative shock for Asia

Economic opinion

The novel coronavirus outbreak (Covid-19) that started in December in Wuhan, China, is expected to have a sizable effect on China’s economy in 2020. As noted in an opinion last week, several European countries could be vulnerable to a negative demand shock in China. For Asian economies, the story is even more concerning. Economies in the region are more deeply integrated with China through both value chains and a higher reliance on Chinese final demand. What’s more, the region is coming off of a difficult period, with weaker growth and trade developments in 2019 reflecting the effects of the US-China trade war and a downturn in the high-tech chip industry. Positive signals at the end of 2019 and beginning of 2020, such as improvements in manufacturing sentiment and the start of a recovery in global semiconductor sales, have not disappeared, but they are being overshadowed by the spread of the coronavirus for the moment. Recent reports suggest the virus is spreading more intensively outside of China (particularly in South Korea, Italy and Iran) but the World Health Organization has yet to declare the coronavirus as a pandemic. However, even if the vast majority of cases remain contained to China, the economic impact will be felt further afield in the short term, especially in Asia.

 

Slower growth for China


The spread of Covid-19 continues, with confirmed cases in Mainland China surpassing 78,000 and cases in other countries reaching nearly 3,000 as of 26 February. The Chinese authorities have taken sweeping steps to try and contain the virus, including putting entire cities under lockdown, drastically cutting transportation, and extending the holiday period to keep factories closed and workers at home. Outside of Wuhan, some factories and offices have started to reopen, but reports of staff shortages suggest disruptions are still the norm. Several sectors will see a deterioration in growth, such as tourism, retail trade, transportation, real estate, and general consumer demand. Given factory closings, industrial production is also likely to take a hit. Indeed, vehicle production, which recovered in the second half of 2019, contracted 24.6% yoy in January. Under the assumption that the spread of the virus peaks sometime in the first quarter, we expect Chinese growth to slow considerably in Q1, before partially recovering in Q2 and then returning to its long-term growth path in Q3.


Regional economies will feel it too


This growth disruption will have spillover effects for a number of Asian economies, particularly in the short term. Though over the past decade or so China’s backward participation in global value chains has declined, the country’s importance to global supply chains should not be underestimated. China’s GDP as a share of world GDP increased from 3% in 1998 to 16% in 2019, while its share of world trade similarly expanded from 3% to 14% over the same period. Furthermore, from the perspective of individual economies, especially other Asian economies, China is a key partner for their forward global value chain participation. Figure 1 shows the value-added originating from each country that is found in China’s exports, measured as a share of the originating country’s exports. This figure is particularly high for Taiwan (11%) but also not insubstantial for South Korea (7%), the Philippines (6.4%), Japan (4.8%) and Malaysia (4.5%).


China has also increased its forward participation in global value chains since 2009, which is consistent with China’s aim of focusing on higher value added (high-tech) exports. It also means that China is exporting more intermediate goods to other countries. This is why extended disruptions at Chinese factories could disrupt supply chains and cause problems for businesses that rely on Chinese suppliers. As Figure 2 shows, value added from China accounts for more than 5% of exports for at least seven Asian economies, and over 10% and 14% for Cambodia and Vietnam, respectively. Though there is also supply chain integration between China and the EU or the US, the extent of this integration is smaller than for most Asian economies.


Finally, a number of countries in the region are, to some extent, dependent on final demand from China (Figure 3), which is consistent with China’s growing consumer market and its growing wealth. In Hong Kong, for example, value added embodied in China’s final demand accounts for almost 10% of Hong Kong’s total value added. This can likely be attributed to tourism, as Hong Kong is the top destination for Chinese tourists, but also to financial services. For Taiwan, in contrast, this figure is nearly 14%, and can be attributed to the enormous amount of electronics Taiwan exports to China (Taiwan is China’s third most important import partner).


It therefore becomes clear that the economic disruptions in China will likely have important implications for other economies in the region, at least in the short term. The slowdown in China’s consumer demand will impact those economies that rely heavily on final demand from China, while those with important supply chain linkages may face additional challenges. The positive signals coming out of Asia prior to the outbreak haven’t vanished, of course, and authorities in vulnerable economies are responding with monetary and fiscal stimulus measures. Once the outbreak comes under control, the region should continue to benefit from an improving external environment in which trade tensions have eased and important sectors for the region are experiencing a recovery.

Disclaimer:

Any opinion expressed in this KBC Economic Opinions represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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