An unprecedented decline in economic activity
All views as at 18 March 2020.
We have quantified the impact of the COVID-19 outbreak, and the associated containment measures on the domestic Chinese economy, as a potential template for what we might see in other parts of the world. This helps to shape our view on whether the future for the global economy be V- or U-shaped?
The scale of the decline in Chinese monthly activity data is unprecedented, limiting the amount of historical evidence to go by (see Figure 1, Figure 2). Therefore, in order to assess the potential impact on Chinese growth, we have undertaken three different methods of analysis:
- Bottom-up sector analysis based on activity data
- Resumption rate to ‘normal’ economic growth profile
- Top-down implied GDP growth
Of course, the numbers produced from each of these analyses carries a high degree of uncertainty, but can serve as a guide.
|Figure 1: Industrial production||Figure 2: Fixed asset investment|
Source: Insight Investment. Data as at 18th March 2020.
In summary: we expect a potentially very significant hit to near-term Chinese GDP.
Our analysis produces estimates ranging from -7.5% to -18% for Q1 GDP growth (year-on-year) in China.
Given the unprecedented falls in activity data, we are placing a slightly higher weight on both the bottom-up and resumption rate methods, relative to the top-down method. Therefore, we would suggest a potential -15% year-on-year decline in economic output in China for Q1 as a sensible midpoint estimate.
Dependent on the scale of the economic rebound in March, while this figure could turn out to be a slight overestimation, it may be a good indication of the scale of the potential peak-to-trough fall in GDP.
This is clearly a very significant near-term hit to GDP and gives us an early indication of what other economies may be looking at across Q1/Q2 given the spread of COVID-19 outside of China.
Some more detail on our approaches
This approach estimates the impact on individual sectors of the economy based on monthly/high-frequency activity data.
The table below segments China’s economy into economic sectors, with Insight’s estimates of how activity in these sectors has been adversely affected and, ultimately, the impact on Chinese Q1 GDP.
Taking this bottom-up approach, we estimate -18% year-on-year GDP growth for Q1.
Our analysis makes no assumption for a rebound in March, and is therefore likely an over-estimate of the hit to growth.
The estimated impact on GDP by sector
|GDP breakdown||Share of GDP||Insight estimate
Insight impact estimate
|Primary||Agriculture, forestry, animal husbandry and fishery||7.3%||-10.0%||-0.7%|
|Tertiary||Wholesale and retail trade||9.7%||-20.5%||-2.0%|
|Transport, Storage & Post||4.4%||-30.0%||-1.3%|
|Hotels & Catering Services||1.8%||-80.0%||-1.4%|
Source: Insight Investment. Data as at 18th March 2020.
2. Resumption rate
Using this approach we apply an estimated resumption rate to the ‘normal’ economic growth profile.
Specifically, we have taken the following steps:
- Assumed a 6% structural growth rate for the Chinese economy for 1 quarter
- Divided this rate by 90 days to get a figure for ‘normal’ daily economic activity
- Multiplied each day’s economic activity by an estimated resumption rate. We have used Nomura’s broad resumption rate as our series of choice, as it was broadly in the middle of resumption rates from a number of sell-side research estimates
Unlike the bottom-up analysis, this approach makes no distinction between sectors, or fixed versus discretionary consumption/investment within the economy. It is most akin to a back-of-the-envelope calculation.
Our resumption rate analysis produces an estimated impact of -14.3% year-on-year on Q1 GDP.
Using this approach we determine implied GDP growth using several data series which have historically been best correlated to GDP.
By simply plotting the data series which have historically correlated best with real GDP growth in China, would indicate a Q1 GDP growth rate of -5% to -10% year-on-year (Figure 3, Figure 4).
|Figure 3: Official manufacturing PMI versus real GDP||Figure 4: Current activity indicator versus real GDP|
Source: Insight Investment. Data as at 18th March 2020
A W-shaped economic recovery in China from second-order effects is a major risk
China has made significant progress on restarting economic activity in March. The resumption rate of economic activity currently appears to be around 80% with new cases of COVID-19 slowing to almost zero.
However, with COVID-19 spreading rapidly around the globe, and many economies putting stringent measures in place to contain the pandemic, China is likely to face second-order effects on the economy. This may constrain growth in Q2, even if domestic activity bounces back reasonably strongly.
The outlook remains very uncertain at this point. We believe that the major risk to a deeper and more prolonged recession in China remains a second wave of cases on shore. Ultimately this could lead to an economic recovery profile that proves to be W-shaped, rather than either V- or U-shaped.
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