Abstract: The recent spread of the novel coronavirus in China, a typical exogenous shock, has ignited concerns among global investors about China's economy and global growth. When China's financial market reopened after the Spring Festival on February 3, the stocks and Renminbi's exchange rate both tumbled. The stock market is hit the hardest by the epidemic outbreak, although its further slide after the Spring Festival is within expectations based on observations of indicators including the Hong Kong Hang Seng Index, FTSE China A50 Index and iVIX. The major risk at present is time-lagged stock price plunges, and when the risk is resolved, the stock market and the foreign exchange market are expected to stabilize. However, there is still uncertainty about their future development, which mainly depends on whether the epidemic will go beyond market expectations.
Judging from related indexes, the current level of panic is lower than that amid the China-US trade war when it was at its height. However, the economic and financial impacts of the novel coronavirus are perceived to be greater than those of SARS back in 2003 considering the country's different development stages, external environments, economic structures and the different timings of the viruses' outbreaks. In a medium-term view, the Chinese market is expected to resume its normal economic activities once the epidemic is brought under control, and the shocks to the capital market will be gradually eliminated.
I. The stock market was less hit by the epidemic than when the trade war peaked
A typical exogenous shock to the Chinese market, the epidemic has sparked concerns among global investors about China's economic prospects and global growth, which is reflected in the fluctuations that have been seen in the overseas capital markets, exchange rate markets and commodity markets.
During the Spring Festival in 2020 (January 23 to 31), major stock markets worldwide have all been impacted - in the Unites States, the Dow Jones Industrial Average, S&P 500 Index and NASDAQ Index fell by 3.1%, 3.0% and 2.7% respectively; in Europe, Cotation Assistée en Continu 40, DAX Index and FEST 100 Index went down by 2.8%, 3.0% and 3.0%, respectively; while in Asia, the Nikkei 225, KOSPI and the Hong Kong Hang Seng Index dropped by 2.5%, 5.7% and 5.7%, respectively.
The epidemic has triggered widespread concern in the global investor community. However, there is less fear and panic in the financial market currently than during the peak of China-US trade tensions. During the Spring Festival, the iVIX index in the US market rose from 21.6 to 28.9, while it stood at 32.7 in 2018 when President Trump started the trade war and 30.4 in 2019 when trade tensions escalated. Even if we examine the US financial market separately, the S&P 500 Index (VIX) rose during the Spring Festival from 13.0 to 18.8, much lower than in 2018 or 2019 amid the outbreak / escalation of the trade war when it went up to 37.3 and 24.6 respectively. Therefore, the various indexes suggest that the current level of panic is lower than that during the trade war when it was at its height.
In the foreign exchange market, despite that CNH has tumbled to 7 per dollar, the outlook is still better than in early September, 2019 when it was traded at 7.195 to the dollar. If the exchange rate of CNH faithfully reflects the demand-supply relationship in China's foreign exchange market, it indicates concerns of global investors over the negative impact of the epidemic; however, it also shows that things are better than when the trade war was in full swing. To be specific, the exchange rate of CNH to dollar rose by 1.02% from 6.93 to 7.00 during the Spring Festival. The plunge beyond 7 has manifested the prevailing worry about the epidemic among global investors who have channeled their funds out of China for the moment, which has mounted the pressure on Renminbi. But on the brighter side, the exchange rate of Renminbi has not risen as much as in the second quarter of 2019 when the trade war turned white-hot. Back then, CNY and CNH both tumbled past 7 per dollar, and worse still, ended up at a historic level of 7.195 in early September.
In addition, the market has turned more risk-adverse as the epidemic looms large. Bond markets in major countries around the globe have been rather strong since the novel coronavirus outbreak, while the bond yields have decreased. The Chinese bond market is likely to repeat the track. As for the commodity market, we have seen higher gold price, lower crude oil price and slumps in the prices of copper and aluminum.
The further slide in China's stock market when it reopened on February 3 is within expectations. The major risk at present is time-lagged stock price plunges. Since mid-to-late January, investors have been increasingly pessimistic toward the epidemic and its impacts on the stock market as the virus spread and related statistics got disclosed. During the Spring Festival, the Hong Kong Hang Seng Index experienced a cumulative 5.72% decline, and FTSE China A50 Index futures, 7.48%, showing the prevailing pessimism in the investor community. These indicators serve as important references for taking stock of the A-share market's development. After the market reopens, it has seen declines to a similar extent as the indicators suggest, most of which are time-lagged stock price plunges.
During mid-to-late April and early May in 2019, VIX experienced a similar drop as that seen by the Hong Kong Hang Seng Index and FTSE China A50 Index futures during this Spring Festival. Back then, the Shanghai Composite Index declined by about 11%. If we take this as a reference and adopt a relatively static perspective, a fall by up to 6.5% in the Shanghai Composite Index is within expectation since it was 4.5% lower right before the Spring Festival than when it stood high in mid-January. This judgement also dovetails with our previous analysis.
In conclusion, the impacts of the novel coronavirus on China's bond and foreign exchange markets will be relatively limited. As the panic brought by the virus spreads, investors turn more risk-adverse, and real economies are suffering for the time being. As a result, the bond market may witness a short-term boom. As for the foreign exchange market, since China's economic fundamentals have not changed much, the US dollar index remains relatively stable, and the trade tensions between China and the United States are not likely to further escalate, the Renminbi will not be confronted with much pressure of a sharp depreciation despite the negative impacts of the novel coronavirus. The depreciation on February 3 was mostly time-lagged response.
When the time-lagged price plunges are over, the stock market and the foreign exchange market are expected to stabilize in the near future. However, there is still uncertainty about their later development, which mainly depends on whether the epidemic will go beyond market expectations.
II. Current pressure to maintain economic growth and contain financial risks is more intense than in 2003 amid the SARS crisis
Like in the SARS crisis in 2003, the novel coronavirus has brought shocks to China's economy and financial market, though in different ways.
First, they strike the country at its different economic development stages. Back in 2003, China's economic growth was in great momentum, with its heavy and chemical industries thriving and its urbanization drive as well as consumption upgrading in full swing. In contrast, currently China is pushing ahead with its supply-side structural reforms and economic restructuring under mounting downward pressure as its population is increasingly aged, its macro leverage ratio stands high, and it is at a critical moment to enhance regulation of the real estate sector.
Second, China's external environments in 2003 and 17 years later are very different. When China gained accession into the WTO, the global economy was quickly recovering after the Internet bubble burst. The bilateral trade between China and the United States was highly complementary, and the year-on-year growth rate of China's exports surged from 6.8% in 2001 to 34.6% in 2003. But today, given the huge scale of the Chinese economy, export has been contributing much less to its growth, not to mention export growth itself has been way lower than before. Amid sluggish global economic growth and the trade frictions with the United States, China's export grew by as little as 0.47% in 2019.
Third, China's economy has been restructured during 2003 and 2020. The tertiary industry, which is hit the hardest by the epidemics, accounted for 32% of total GDP in 2003; but in 2019, the proportion has gone up to 54%, so the national economy becomes more vulnerable to the novel coronavirus's shocks. Besides, the epidemic will also cause a lot of trouble to the manufacturing industry because it impedes the flow of labor and resources and thus interrupt the normal production of manufacturers.
Fourth, the timings of the two epidemic outbreaks are different. The SARS crisis broke out in April and May, while the novel coronavirus struck the ninth biggest city and a major transportation hub in China, Wuhan, right before the Spring Festival amid the transportation rush. After the Spring Festival, there will be large-scale movement of population again, so it will be more difficult to quarantine infected people and control the disease than in 2003. However, the negative effects of epidemic control measures on economic activities is much less in the first quarter than in the second quarter, because generally speaking, economic activities in the first quarter contributes the least proportion to the year's total GDP.
Past experiences show that economic activities and financial markets may go into a slump under shock from widespread diseases. But once the epidemic is brought under control, the economy will resume back to normal, and the long-term impacts on the capital market will be gradually eliminated, too.
Therefore, the novel coronavirus will not alter the long-term trend of China's economic growth or stop China's rise in the global economy. But considering the multiple structural changes both at home and abroad, China is shouldering greater pressure to maintain economic growth and contain financial risks than in 2003 amid the SARS crisis.
