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Friday, May 29, 2020

As the coronavirus rocks financial markets worldwide, China is not the safe bet investors hope it is

The Chinese stock market has not fallen as steeply as its peers, the yuan has proved resilient and the domestic bond market has attracted strong inflows. However, it is too early to say whether China will be hit by a second wave of infections, and the strain on global supply chains does not bode well for the country

The coronavirus is a fast-moving pathogen. In the space of just a few months, a localised public health issue in China has morphed into a global pandemic that has so far claimed more than 21,000 lives and infected over 468,000 people. China itself now accounts for fewer than 18 per cent of the confirmed cases and fewer than 16 per cent of the fatalities.

In financial markets, Covid-19 has gone from being a non-event in the minds of most investors to the catalyst for a global financial and economic crisis that, over the past two weeks, has looked a lot like the events surrounding the demise of Lehman Brothers in 2008.

Since hitting an all-time high on February 19, the benchmark S&P 500 equity index has plunged 27 per cent, the fastest descent into a bear market on record. Spreads on US high-yield bonds are on the brink of falling into distressed territory, while the dollar index, a gauge of the greenback’s performance against a basket of other currencies, has surged 6.4 per cent since March 9, contributing to a sharp tightening in financial conditions.

Economists have slashed their forecasts for global growth this year. JP Morgan expects the world economy to contract by a shocking 12 per cent this quarter, on a quarter-on-quarter annualised basis, and to continue to shrink, albeit less severely, next quarter, representing one of the sharpest contractions in a century.

While all regions and asset classes have suffered since the disease took hold, China – the country which earlier this year faced a torrent of outrage, domestically and internationally, over its mishandling of the crisis, and whose virus-induced economic collapse was the focal point of market anxiety – has fared significantly better, creating the perception that it has become a safe haven.

There is some evidence to support this view.

First, Chinese stocks, both mainland shares and those listed offshore, have performed markedly better than their Western and emerging market peers over the past month. While the MSCI All-Country World Index, a gauge of developed and developing market stocks, is down 26 per cent since February 19, the CSI 300 Index and the MSCI China Index have fallen 8 per cent and 15 per cent respectively.

What is more, the renminbi has proved resilient since markets came under severe strain in early March, while China’s domestic bond market has attracted hefty inflows over the past two months, underpinned by the country’s higher yields and lack of correlation with US and European debt markets.

Second, and more importantly, China has managed to contain the spread of the virus domestically through a complete lockdown of the Hubei province, the largest mass quarantine in modern history. The number of confirmed cases in the country peaked in late February, prompting Beijing to ease some of the curbs in the hope of restarting economic activity without triggering a wave of new infections.

So far, there has been little sign of a fresh outbreak, while China appears to be in the early stages of an economic rebound, according to an analysis of high-frequency data by Boston Consulting Group. However, as JP Morgan rightly noted in a report published last Friday, “China is the test case for further contagion as the domestic population resumes normal activity. The next few weeks will be critical for assessing this risk scenario.”

This is one of the reasons China’s haven status should be treated with caution.

The perception that China is a refuge is strongly shaped by the fact that Covid-19 is spreading like wildfire across Europe and America, with Italy and Spain now accounting for half the number of confirmed deaths worldwide. What is more, there is increasing concern that advanced economies – in particular the United States and Britain – are succumbing to “lockdown fatigue” as the tensions between aggressive containment measures and economic salvation become more acute.

Even though JP Morgan estimates that China’s economy will contract by a shocking 40 per cent this quarter, investors have more confidence in Beijing’s ability to do what it takes to beat the virus and revive growth.

China looks like a safer bet mainly because the outlook for advanced economies has become so much bleaker. Yet, China is by no means out of the woods.

Not only is it too early to say whether the word’s second-largest economy can bounce back without being hit by a second wave of infections, the prospects for global growth have deteriorated dramatically in the last month, putting further strain on supply chains and boding ill for the swift rebound in Chinese economic activity forecast by many analysts.

While China deserves credit for having kept the spread of the virus under control, its role as a haven is exaggerated.


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