Is the worst over?

EcoPerspectives // 2nd quarter 2020  
Is the worst over?  
China’s population and its economy were the first to be struck by the coronavirus epidemic. Activity contracted abruptly during the  
month of February before rebounding thereafter at a very gradual pace. Although the situation on the supply side is expected to  
return to normal in Q2, the demand shock will persist. Domestic investment and consumption will suffer from the effects of lost  
household and corporate revenues while world demand is falling. The authorities still have substantial resources to intervene to help  
restart the economy. Central government finances are not threatened. However, after the shock to GDP growth, the expected upsurge  
in domestic debt ratios will once again aggravate vulnerabilities in the financial sector.  
Completed on 7 April 2020 Forecasts: last update on 17 April 2020  
China, the first country to be hit by the coronavirus outbreak,  
reported a very sharp drop in activity after the population was put in  
lockdown, from the Chinese New Year celebrations at the end of  
January through the end of March or early April (rules and dates  
vary from region to region). The brutal shock was transmitted  
through numerous channels, ranging from a supply-side shock to a  
shock on domestic demand and exports, a revenue shock and a  
confidence shock. Activity has begun to rebound in the past few  
days, and the authorities have launched stimulus measures that  
should help bolster the recovery. Major downside risks persist  
however. Lost corporate revenues, a deteriorated labour market and  
uncertainty over the pandemic’s future course will hamper domestic  
demand. At the same time, the export sector is bound to be hit by  
the repercussions of the sanitary and economic crisis that is  
currently spreading worldwide. We expect to see an unprecedented  
contraction in real GDP in Q1 2020 (-8% year-on-year), followed by  
a slow normalisation of economic growth starting in Q2.  
- Growth and inflation  
(Y/Y, %)  
GDP Growth  
Source: BNP Paribas Global Markets  
- Collapse  
An unprecedented shock  
y/y % nominal change, year-to-date  
After the authorities imposed drastic measures to contain the  
epidemic, consumption of goods and services collapsed (graph 2).  
Retail sales volumes declined by 23% year-on-year (y/y) in the first  
two months of 2020, with automobile sales entering a free fall (-78%  
y/y in February). Online retail sales were more resilient, but  
nonetheless contracted by 3% y/y in January-February due to the  
decline in sales of services and non-essential goods. Transport  
networks were paralysed (with passenger traffic down 84% y/y in  
February). Construction and the real estate sector were also hard hit  
Goods exports  
2016 2017  
Retail sales  
2018 2019  
property sales were down 40% in the first two months of the year) .  
The supply-side shock was just as severe since factories were  
forced to remain shuttered after Chinese New Year and the work  
force was put in lockdown. Industrial output plunged 13.5% y/y in  
real terms in the first two months of 2020 (vs. +5.8% in 2019). The  
shutdown of production lines and transport blockages contributed to  
the decline in merchandise exports (-17% y/y in January-February).  
Lastly, falling revenues and uncertainty over future growth prospects  
led corporates to drastically scale back investment in all major  
economic sectors. Total fixed-asset investment declined by 25% y/y  
in the first two months of the year.  
Source: NBS  
For the moment, the epidemic’s spread in China is contained and  
the economy is recovering. Restrictions have been lifted on  
domestic passenger traffic and merchandise transport (albeit only  
partially in Hubei) and export activity has started up again. At the  
end of March, the official work resumption rate was 98% for large  
industrial enterprises (and 85% in the province of Hubei) and more  
than 70% for small and medium-sized enterprises (SMEs). Yet  
production capacity utilisation rates are still far below pre-crisis  
levels (it was 77% in the industry in Q4 2019). Production facilities  
are expected to return to normal by the end of April for industry and  
by the end of Q2 for services (with the exception of tourism).  
Services account for 54% of GDP, including retail trade (10%), transport  
Yet just as the supply-side shock is winding down, a new demand  
shock is taking shape. The collapse in world demand will rapidly  
(4%) and real estate (7%). The industrial sector accounts for 39% of GDP,  
including construction (7%).  
EcoPerspectives // 2nd quarter 2020  
undermine China’s exports. Therefore, their contraction could  
worsen in Q2 2020, severely threatening the recovery in the  
manufacturing sector (which also continues to be affected by US  
tariffs). This should drive export corporates to reduce inventories  
and scale back investment. In addition, both households and  
corporates have been hit by a revenue shock, which will continue to  
squeeze domestic demand in the short term. Finally, there has been  
a severe erosion in confidence due to the pandemic and uncertainty  
over its future course.  
- Lower interest rates  
Weighted average lending rate  
Medium-term lending facility (MLF) rate (1Y)  
Loan Prime Rate (1Y)  
Repo rate (7D)  
The financial situation of many corporates has weakened and their  
capacity to invest and repay loans has deteriorated (profits of  
industrial enterprises declined by 38% y/y in the first two months of  
020, and eight SMEs out of ten reported cash-flow problems in  
early March). Total domestic debt of the corporate sector is  
excessively high, at 150% of GDP at year-end 2019 (more than two  
thirds of which are bank loans). The debt burden reduces  
corporates resilience to shocks, and the increasing risk of default  
on bank loans and in the local bond markets could weaken the  
financial sector. In contrast, corporates’ external debt in foreign  
currency is small (estimated at 7% of GDP) and is not a source of  
instability for China’s external accounts, even if payment difficulties  
and refinancing risk increase.  
Source: Central Bank  
In mid-March, reserve requirement ratios were lowered by between  
0 bp and 200 bp (depending on the bank) in order to free up  
RMB 550 bn for targeted loans. Banks have also been sent  
directives instructing them to cover the financing needs of  
corporates hit by the epidemic, refinance loans and reschedule loan  
repayments of clients facing difficulties. Prudential standards have  
been (moderately) eased for commercial banks, as well as the rules  
for issuing corporate equity and bonds.  
Chinese consumers are expected to remain both constrained by  
their income loss and very cautious. Job market conditions  
deteriorated rapidly during the confinement period: the  
unemployment rate surged to 6.2% in February from 3.6% in  
December 2019. The shock will also be amplified by household  
indebtedness. Their debt-to-GDP ratio was 55% of GDP at the end  
of 2019, which is not excessively high yet. However, it has  
increased significantly over the past ten years. More importantly, the  
debt burden is much higher for low-income households, which are  
also more vulnerable to income shocks. Consequently, there is  
likely to be an even sharper downward adjustment in private  
consumption in the short term.  
On the fiscal front, the central government has opted for a relatively  
measured response until now. It has increased spending (notably on  
healthcare: +RMB 110 bn), exonerated companies from some social  
welfare contributions (RMB 500 bn) and taxes, reduced electricity  
rates for corporates by 5%, and announced fiscal incentives to  
stimulate domestic demand. Local governments also participate  
actively in stimulus efforts, notably by increasing investment in  
infrastructure projects (a traditional policy tool in China) and through  
direct aid for enterprises and households (such as reduced rent for  
land leases and the distribution of coupons). Beijing has  
substantially increased the local government bond issuance  
programme to finance infrastructure projects (RMB 850 bn in  
addition to the initial quota of RMB 1 trn for 2020).  
Actions on all fronts  
Since February, the government and the central bank have  
launched a series of measures that aim: 1) to support corporates  
that have been hard hit by the coronavirus outbreak, help prevent  
defaults and bankruptcies, limit the risk of financial-sector instability  
and facilitate the economic recovery, and 2) to offset the decline in  
revenues and to stimulate investment and consumption. As the  
external environment deteriorates, Beijing is expected to bolster its  
stimulus measures in the weeks ahead.  
 Public finances can absorb the shock  
The authorities’ actions will play a key role in restoring economic  
growth. The central government has comfortable fiscal manoeuvring  
room and the central bank has ample liquidity cushions to ensure  
the stabilisation of the financial system. In contrast, the debt excess  
of the economy is constraining monetary policy as well as the  
investment capacity of local governments (their total debt already  
represents about 50% of GDP). Consequently, while it is highly  
likely that the central bank will continue to ease monetary conditions  
in the short term and that local governments will further increase  
investment, the central government will have to give priority to fiscal  
stimulus measures. Fiscal deficits will rise to historically high levels,  
but the central government’s financing needs will be easily covered  
and its debt will remain moderate: it represented 16% of GDP at  
year-end 2019; it is almost entirely in local currency, and more than  
90% of which is held by local investors.  
Monetary conditions have been eased gradually since the beginning  
of the epidemic. The central bank has injected liquidity in the  
financial sector in order to meet demand (RMB 3 trn in the first two  
weeks of February). It initially opted for a moderate reduction in  
policy rates (the rate on medium-term lending facilities was lowered  
from 3.25% to 3.15% in February and then left unchanged in March),  
but recently stepped up the easing in interest rates. Special credit  
programmes have been introduced, such as an expansion of  
relending facilities (RMB 700 bn) and a special loan program by  
policy banks to help small firms (RMB 350 bn).  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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