China's health emergency will disrupt economic activity throughout Asia-Pacific. S&P Global Ratings anticipates the region's GDP will expand by 4.3% in 2020, 0.5 percentage point (ppt) lower than our pre-outbreak forecast. Our forecasts are subject to much more uncertainty than normal. We expect significant growth drags of 1 ppt or more in Hong Kong and Singapore, given their close linkages with, and heavy reliance on mainland China. Australia, Korea, Taiwan, Thailand, and Vietnam will also suffer. At this point, we anticipate a recovery will take a firm hold in the third quarter but risks are tilted to the downside. We expect more policy easing in the most affected economies, especially rate cuts.

It's not yet known how far the new coronavirus (COVID-19) has spread in the region outside China including Hong Kong. Reported cases are clustered in Japan, Korea, Singapore, and Thailand. This could reflect greater capacity in these places to detect and diagnose the virus. Elsewhere in Asia-Pacific, cases may be unreported and could rise, which could change the behavior of consumers and firms and the policy responses of governments. Even if the regional outbreak is contained relative to China's experience, the economic impact will still be felt.

This article focuses more on economic than viral transmission, and we see four channels: People flows, supply chains, goods trade, and commodity prices in order of importance. The financial sector could be an amplifier but so far markets have taken a benign view. Policymakers are set to provide fiscal support, and central banks have already signaled a bias towards easing. Our revised forecasts for the region assume China's economy will expand at a coronavirus-dented 5% in 2020.

Supply And Demand Shocks In China

The new coronavirus outbreak is shocking China's economy in unique ways. Understanding the nature of these shocks helps us trace their effects on Asia-Pacific neighbors. The demand shock is centered mostly on consumers who are either unable or unwilling to venture out in public or travel overseas. The supply shock relates to the inability of firms to resume operations after the lunar new year break in late January. This is a simplification and there are second-order effects. However, these are the shocks most likely to move the macro needle.

Shocks Likely To Be Temporary

We are learning about how big these shocks might be. Still, if we assume that economic activity in China begins to normalize sometime during the second quarter of 2020, both the demand and supply shocks are likely to be temporary (see "Global Credit Conditions: Coronavirus Casts Shadow Over Credit Outlook," Feb. 11, 2020).

There will be economic losses because some activity, such as eating out or taking vacations, will not be compensated in the future. However, the level of activity should return to normal. Overall, we would expect China's economy to be employing as many people and producing as much output as it would have been in the absence of the virus by the end of 2021.

If we assume, based on our understanding of the current specialist opinion, that COVID-19 is contained sometime between February and April of this year, we expect China's economy to grow by between 4.4% and 5.5% in 2020. This is a large range but our baseline is 5.0% compared with our previous forecast of 5.7%. Our new baseline assumes a rebound well above 6% next year. We assume that the official GDP data are not smoothed and that any policy stimulus is restrained.

Duration And Rising Marginal Costs

How long these shocks last matters a lot. Each additional month that policies designed to contain the outbreak remain in place imposes marginal economic costs on China and the region that we think are rising --in other words, each month's delay means a higher cost than the previous month. Quantifying these rising costs is hard but they stem from two sources. First, the cumulative impact on corporate cash flows of weak demand or supply outages, worsening the debt-servicing capacity of indebted firms. Second, supply-chain disruptions which could accelerate as inventories are run down and production halts spread across firms and industries.

Four Main Channels And One Amplifier To Asia-Pacific

If activity begins to normalize through the second quarter, as in our baseline, these duration effects will be limited. Still, regional spillovers would be material and through four channels. These are in order of importance for Asia-Pacific, in our view:

• People flows. Travel, tourism, and education.
• Supply chains. Industries in outbreak hotspots and with specialized production.
• Goods trade. China's imports of discretionary consumer goods, potentially capital goods.
• Commodity prices. Travel hits oil, weaker investment affects iron ore and coal.

We have not added the financial sector as a channel because China's role in the region's financial activity is still small compared to the U.S. (e.g., the role of the renminbi as a funding currency). Instead, we see financial markets as an amplifier. Should risk aversion pick up and financial conditions tighten—higher exchange rate volatility, wider credit spreads, and tighter bank lending standards—the spillovers could intensify quickly. For now, financial conditions remain benign and this should help cushion, rather than amplify, the real economic effects.

Don't Model This As A Normal Business Cycle Shock

This is not a typical business cycle shock. Often we think about a potential China shock mostly in terms of the trade channel, that is demand for exports from the rest of the region. Indeed, in our global model, this is exactly how a China shock scenario plays out. However, this time the usual trade channel is less important compared with people flows and supply chain disruptions. This is harder to model using past experience.

The effects will vary across the region but using our four channels, we expect Hong Kong and Singapore to be hit hardest with a decline in growth of about 1 ppt (see table 1). Australia, Korea, Taiwan, Thailand, and Vietnam will likely see a hit of about 0.5 ppt. We anticipate a smaller impact for India, Malaysia, and Japan but the outlook will depend on hard-to-predict supply chain effects.

More Policy Easing To Come

Policymakers are in a quandary. Higher-than-normal uncertainty makes it difficult to craft the right policy response. The long and variable lags of monetary policy may mean the support arrives to an economy just as the shock is dissipating. The irreversibility of many fiscal measures may make it hard to change course should conditions change. Some central banks are moving early although this may reflect domestic factors rather than the virus (e.g., the Philippines and Thailand).

We expect more easing from the most heavily affected economies, mainly policy rate cuts and targeted liquidity support to affected sectors. Fiscal easing is also likely but may be targeted at affected sectors, such as tourism. Together with exchange rate depreciation this will help offset some of the hit but the economic losses will remain material this year.

Disrupting A China-Centric Supply Chain Model

Prolonged disruption across Asia-Pacific's supply chains into the second quarter could tip the regional into a full-blown regional recession, stress corporate cash flows, and have substantial credit implications. Asia-Pacific economies mostly ship intermediate goods, such as car parts or electronics components, to and from China. Depending on the economy and the industry, China may be upstream or downstream but it is often the hub of regional trade. These goods make up about 55% of Asia-Pacific goods trade with China (imports and exports). These same goods account for about 45% of total Asia-Pacific trade with the rest of the world. China's position in the network, not just the value of its intermediate goods trade, will determine the size of the hit.

World Bank research shows that China is now the hub for Asia-Pacific's supply chains ("Global Value Chain Development Report 2019," World Bank). This means that almost all regional supply chains, from textiles to technology, flow through China at some point. If parts and components do not flow to and from the hub, the chain breaks down, upstream (e.g., Korea and Singapore) and downstream (especially Vietnam).

Chart 1

Five Factors Determine The Supply Chain Damage

How to measure the damage wrought on the broader region? We think the damage will be higher:

• The less a downstream economy can source substitute inputs;
• The less an upstream economy can divert to alternative producers;
• The more an economy adds value to the supply chain;
• The more industries in the supply chain hire local workers; and
• The higher the financial vulnerability of industries in the supply chain.

Korea is an exposed upstream economy. The country will find it hard to identify producers with the required scale and capacity to absorb its technology-rich intermediate goods exports. In turn, this would have a material impact on growth because the economy is open to trade and adds substantial value to its exports (about 70% according to the OECD but somewhat less for electronics according to some estimates) [1]. Manufacturing accounts for about 15% of employment which is high for an OECD economy. To give a sense of the potential hit, if value-added intermediate goods exports to China fall by 10% for 2020 and cannot be re-routed elsewhere, the direct effect on Korea's GDP could be roughly equivalent to a 0.7 ppt decline in growth. For now, we expect a hit of about 0.5 ppt on growth compared to our previous forecast of 2.1% for 2020.

Vietnam is a vulnerable downstream economy although there may be mitigating factors. Vietnam's export machine is fueled, in large part, by inputs from China. For example, about 30% of electronics component imports come from China, a similar proportion as the value coming from Korea. Vietnam is also open to trade but adds less value to its exports than Korea (about 56% according to the OECD but likely much lower in the electronics sector), acting more as an assembler rather than creator. Vietnamese-based producers may also be able to source alternative suppliers if China goes offline in some cases.

We estimate the sensitivity of Vietnam's electronic exports to its electronics imports from both Korea and China using a simple econometric model. The results suggest that a fall in Korean imports is typically associated with a large, significant decline in Vietnam's exports. In contrast, we found a weaker relationship for imports from China, suggesting Vietnam's exports are less dependent on Chinese inputs. Still, we would be careful about drawing too strong a conclusion given the rapid change in China's technological capacity and a short sample period (just 28 quarters) [2].

Will Multinationals Further Diversify Supply Chains?

Multinational corporations (MNCs), including those headquartered in China, may take the experience of the virus and recent trade frictions as motivation to further explore supply-chain diversification. This need not rely on some expectation that viral outbreaks will become more common. Instead, this episode may be emphasizing fragilities in supply chains that result from any type of shock that affects the hub. Extricating the effect of trade tensions versus public health issues will also be hard but the outbreak is surely strengthening, not weakening, the push for diversification.

This inevitably leads to a discussion about "winners and losers." The same economies that could benefit from the supply-chain displacement resulting from U.S.-China trade and technology tension are obvious candidates. These include those with a track record of scaling up supply chain participation such as Malaysia, Thailand, and Vietnam. Other economies with a weaker track record but economies of scale include India and Indonesia. While this is an interesting story to follow, it is unlikely to be important for macro-credit developments until uncertainty recedes.

Table 1

Economies Most Affected--Hong Kong And Singapore

Hong Kong

We estimate Hong Kong's economy will contract this year. That is about 1.2 ppts lower than our forecast before the COVID-19. Hong Kong will be hit via people flows, both tourism and business- related travel. Tourism accounts for almost 10% of GDP and visitors from China account for 80% of arrivals. A mandatory 14-day quarantine upon arrival from the mainland will likely deter almost all potential tourists. Restricted travel to and from Hong Kong will also hamper arrivals from third countries and could drag on the financial and business services sectors, which often revolve around personal interactions such as deal roadshows.

The economy will also suffer from a sharp fall-off in China-related goods trade given Hong Kong's role as a logistics gateway to mainland China. As in China, households are also likely to scale back discretionary consumption as they stay at home to avoid public spaces. Hong Kong has already announced a modest stimulus package and we would expect additional fiscal easing measures in the upcoming budget for the fiscal year that ends March 31, 2021.

Singapore

We estimate Singapore's growth to be about 0.9 ppt lower than our previous forecast of 1.4% for 2020. People flows, mainly tourism but also business-related travel, will weigh hard on the economy in 2020. Travel and tourism account for 5% of GDP and visitors from China account for around 20% of all arrivals. Singapore's Tourism Board now forecasts a fall in tourist arrivals of up to 30% in 2020. Domestic households will also hold back spending, given local virus transmission cases have been reported.

Singapore is an upstream supplier to China with shipments of processed intermediate goods accounting for about 17% of GDP. These exports are mainly highly differentiated electronics components, such as semiconductors, which Singaporean-based producers may find hard to divert elsewhere. While relatively low domestic value-added in gross exports and a low share of employment in manufacturing (less than 15%) mitigates the effect somewhat, the extreme openness of the economy renders Singapore especially vulnerable to supply-chain disruptions.

Policy easing is likely. The Monetary Authority of Singapore (MAS), which conducts monetary policy through the exchange rate, responded to the outbreak by announcing that there was room for the currency to depreciate. We now expect the MAS to ease policy by flattening the rate of crawl of the nominal exchange rate against a basket of currencies at its meeting in April.

Economies Heavily Affected--Australia, Korea, Taiwan, Thailand, and Vietnam

Australia

We estimate that growth will be about 0.5 ppt lower than our previous forecast of 2.2% for 2020. Travel accounts for about 3% of GDP and of that, more than 2% of this is education-related travel, and Chinese students account for about 40% of all enrolments at the tertiary level. In recent years, travel exports have been growing by double-digits in nominal terms, providing an offset to weakness elsewhere in the economy.

The timing of the virus outbreak means that a large number of Chinese students may not be able to start the new academic year and there is some risk that some students may postpone their arrival until a new semester begins. With Chinese visitors of all types accounting directly for about 1% of GDP, a full-year decline in arrivals would exert a material drag on overall growth, compounding the challenges faced by the sector following the recent bushfires (incorporated in this scenario).

The second transmission channel for Australia is lower commodity prices. The fall in iron ore and coal prices since the virus outbreak has been contained, suggesting that markets are pricing in only a temporary shock. If activity in China, especially in the property sector, rebounds later in 2020, prices may rebound and stabilize, blunting the impact on capital expenditure plans of Australian miners. Exchange rate depreciation will help offset some of these effects, and we would expect one additional rate cut from the Reserve Bank of Australia this year (two in total) to bring the cash rate down to 0.25%.

Korea

We anticipate the hit on people flows and supply-chain channels would reduce growth by about 0.5 ppt compared with our previous forecast of 2.1%. This sets back Korea's recovery for another year. Visitors from China account for almost 44% of total tourism spending, but the overall effect is mitigated by tourism's small 1% share of GDP. Much more important are the supply-chain effects we discussed above.

We expect the Bank of Kora to cut its policy rate twice this year (in line with our previous forecasts) to 0.75% with a substantial fiscal easing also helping to offset the external drag.

Taiwan

Growth will be about 0.5 percentage points lower than our previous forecast of 2.4% for 2020. Taiwan is exposed through two channels: supply chains and, to a lesser extent, people flows.

Exports to China make up almost 30% of Taiwan's total exports and many of these products are aligned closely with China's trade sector, evident in a high Export Similarity Index of 61%. Some industries had already begun reshoring in Taiwan from China as a result of U.S.-China trade and technology tension. In July 2019, the Ministry of Economic Affairs (MOEA) launched three incentive programs targeted mainly at Taiwanese firms with operations in China. Since then, almost 350 Taiwanese firms have been approved to make investments of up to US$29 billion in Taiwan. However, reshoring takes time and is unlikely to offset the short-run impact of disruptions.

Travel and tourism channels also play a role, because about 25% of the island's visitors come from mainland China. This means the sector will slow while travel restrictions remain in place before recovering gradually. The mitigating factor is that the tourism sector is not large, with travel exports accounting for just about 2% of GDP. We expect macroeconomic policies to remain broadly unchanged.

Thailand

We estimate COVID-19 will knock about 0.6 ppt off our previous forecast of 2.8% for 2020. Tourism and travel will take the brunt of the impact. Thailand's tourism industry is large--travel exports account for 11% of GDP, the largest share in the region, and Chinese tourists account for nearly 30% of arrivals. This implies that tourism from China by itself accounts for more than 3% of GDP. We assume that visitors from China fall by about 50% in the first half of the year, before recovering towards the latter part of the year. We assume that tourism from the rest of the world neither grows nor shrinks considerably.

Thailand will also feel significant supply-chain impacts. China is a key trading partner although it is less directly exposed to China than some of it neighbors--processed intermediate trade with China accounts for 10%-15% of total trade. The broad product groups that could be vulnerable to disruption are electronics, metals, and chemical products. Manufacturing's share of employment in Thailand, at 25%, is large by international standards which could lead to larger effects than in other countries. Policy easing by the Bank of Thailand (which could cut one more time this year) and exchange rate depreciation will help a little, but will do little to address supply-chain disruptions.

Chart 3

Vietnam

We expect growth to be 0.5 ppt lower in 2020 from our previous forecast of 6.2%. The tourism channel will strike the largest blow to growth, but other channels could also be significant. Travel exports are about 6% of GDP and visitors from China are 32% of the total, implying a total exposure of about 2% of GDP. The economy relies on China for imported goods--at nearly 27% of total imports. In addition, China accounted for 10% of new registered foreign direct investment (FDI) inflows in 2019. Disruption in these flows could stall investment.

Economies Less Affected--Japan, Indonesia, Malaysia, and the Philippines

Japan

Lower revenues from people flows will be large in U.S. dollars but small as a share of the economy. Chinese tourists account for about 40% of tourist revenues and tourism has a 1% share of GDP. Should the Olympic Games this summer be delayed, the effect on tourism revenues could be somewhat larger than normal but this remains a second-order issue.

Trade and supply chains matter most for Japan. At first glance, Japan does not seem to export too much to China except parts and components, suggesting it is a supply chain issue. However, Japanese firms, especially auto producers, operate large facilities in China that directly serve Chinese consumers. This will erode sales and profits for these firms and could affect broad hiring and investment intentions.

Finally, while reported cases in Japan remain very low as a share of the population, the risk of infection could further undermine already-weak consumer confidence and further drag down spending that has slowed as a result of last year's consumption tax hike.

Monetary policy space is limited and fiscal policy has already been eased materially. Further easing, especially by the Bank of Japan, may depend on the yen which has been fairly stable but could appreciate if there are safe haven inflows. Japan, more than other larger economies, remains vulnerable to the global cycle.

Indonesia

The magnitude of impact depends on commodity markets. Agricultural oils, metals, and mineral products together account for about 60% of Indonesia's exports to China. Crude oil prices have fallen more than 15% since the outbreak started. Prices for agricultural oils have sunk by a similar magnitude, while iron ore prices have declined 10%. This will hinder commodity exporters in Indonesia. However, if a recovery in demand in the later part of the year boosts prices, then the impact on the sector will be small. People flows will not matter much as China accounts for about 13% of visitors and travel exports are just 2% of Indonesia's GDP. Policymakers might lean be more open to an accommodative stance given the policy easing widely expected in the rest of the region.

Malaysia

The overall impact is moderate. Visitors from China make up a smaller proportion of arrivals relative to the region, at about 10%. The supply-chain channel is more significant. As discussed, China provides key inputs to Malaysia's electronics sector, and the economy is open and trade-oriented. We would expect an additional policy rate cut from the Bank Negara Malaysia this year, which should lift demand modestly in the wider economy. The exchange rate has weakened modestly relative to trading partners, which will help cushion the impact slightly.

Philippines

People flows are less important than for many neighbors. Tourism-related exports are only 3% of GDP, and less than a fifth of visitors are from China.

More uncertain is the impact on supply chains. The Philippines is both upstream and downstream from China with processed intermediate trade with the country accounting for about 15% of overall trade. This is dominated by electronics components which may experience region-wide disruptions. The OECD estimates that the Philippines domestic value-added in gross exports is over 75% which is high by emerging market standards, although it is likely to be lower in the electronics industry. On the investment side, inward FDI is only 3% of GDP, while the Chinese share of approved FDI is typically less than 3%.

India

We expect India to be relatively spared. The adverse impact will be felt through import links, given imports from China are about 16% of total in India. Barring extended manufacturing disruptions, the trade channel is unlikely to be significant. Tourism from China is also relatively small. As a result, we do not expect policy to be only marginally lower than the previous forecast.

Related Research

• Global Credit Conditions: Coronavirus Casts Shadow Over Credit Outlook, Feb. 11, 2020
• Coronavirus To Inflict A Large, Temporary Blow To China's Economy Feb. 6, 2020s