Asia | China | Economics & Growth | Emerging Markets | US
A global COVID-19 pandemic would further accelerate the post-financial crisis deglobalization. China’s long-term growth rate could be hit the hardest, the US the least.
Three key factors could drive the long-term impact of a COVID-19 pandemic on global growth:
• Further reversal of globalization as corporations reassessed their supply chains. This would translate into a further decline in global trade and foreign direct investment (FDI) (Chart 1).
• The exposure of underlying financial fragility, which could have a lasting impact on growth (Chart 2).
• Impacted political stability and policymaking capacity.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
A global COVID-19 pandemic would further accelerate the post-financial crisis deglobalization. China’s long-term growth rate could be hit the hardest, the US the least.
Three key factors could drive the long-term impact of a COVID-19 pandemic on global growth:
• Further reversal of globalization as corporations reassessed their supply chains. This would translate into a further decline in global trade and foreign direct investment (FDI) (Chart 1).
• The exposure of underlying financial fragility, which could have a lasting impact on growth (Chart 2).
• Impacted political stability and policymaking capacity.
Chart 1: G20 FDI and Trade Flows
Source: Macro Hive, Haver
Chart 2: Credit to the Non Financial Private Sector
Source: Macro Hive, Haver
China is the Most Exposed
Based on these criteria, China appears the most exposed. China’s persistent, if lower, current account surplus suggests the country remains strongly dependent on external demand and would suffer from a decline in global trade. In addition, due to a combination of loss of competitiveness and trade war, global supply chains were moving away from China prior to the epidemic. COVID-19 could further undermine China’s competitiveness by highlighting a weakness of its governance model: China tends, for cultural reasons, to a be source of zoonotic viruses, and its monitoring and containment capabilities are weakened by a system that penalizes bottom-up reporting of negative news.
The epidemic could make it more difficult for China to deleverage while avoiding a crisis. Before the epidemic, China was trying to rein in credit growth and was cleaning up its banking system, especially its smaller banks where nonperforming loans (NPLs) have been building over the past few years. In addition, Chinese corporates, including state-owned enterprises (SOEs), had been defaulting on their CNY and USD bonds. The government has already injected liquidity and introduced some regulatory forbearance, which suggests a further build-up of NPLs with adverse consequences for long-term growth. Furthermore, corporate defaults could set back China’s plans to internationalize its bond market and currency.
The epidemic could also impact China’s political stability and its policymaking abilities. In China, changes in economic policy typically require changes in political personnel, for instance Deng Xiaoping’ ascent following Mao Zedong’s death allowed China to open up its economy. Until recently, China’s tradition of collegial governance and term limits afforded some political and policy flexibility but those have largely disappeared under Xi Jinping. This creates a risk of policy paralysis – for instance if Xi is viewed as having failed to contain the epidemic and there is no established process to bring about new leadership.
Table 1: Access to Quality Healthcare
Source: Social Progress Institute, Macro Hive
*Average scores weighted by population
Both EMs and Europe Also Exposed
Other emerging markets’ long-term growth prospects would also be hit by a global pandemic. A global comparison of access to quality healthcare (that would be required to handle COVID-19) shows a large gap between advanced economies and emerging markets (EMs), especially in Asia, Africa, and the Middle East (Table 1). This suggests EMs’ healthcare systems could get overwhelmed, which could lead to a sharp decline in growth, financial and political instability, and increased migrations.
Euro area countries’ greatest long-term impact from exposure to COVID-19 could come from two channels:
(1) As shown by the recent surge in anti-Asian sentiment, an epidemic could easily fuel xenophobia. Anti-immigration parties could see their popularity rise and could pressure governments to reject EU policies on open borders, shared policies on asylum seekers, and European integration more broadly. This could lead, for instance, to renewed conflict on fiscal policies between Italy and the European Commission.
(2) The Euro area growth model based on austerity, domestic demand compression, and reliance on external demand would be challenged by a long-term decline in global trade.
The US is More Insulated
US long-term growth could be relatively more sheltered, though the country’s access to quality healthcare is closer to that of Eastern Europe than of other advanced economies. Nevertheless, the US economy is more domestic-driven than either China or the Euro area and would be less impacted by a decline in global trade. In addition, while anti-immigrant sentiment is strong in the US, it is not an existential threat to economic institutions. This contrasts the Euro area – a coalition of sovereign states whose continued existence requires strong political commitment from all members. Of course, a marked US growth slowdown could expose financial fragility, for instance in the corporate sector and with low income households. But the epidemic would have to bring a deep recession for the fragility to turn into a financial crisis, which is not my base case scenario, for now.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)