China’s Coronavirus will not lead to recession but to stimulus and even more debt

Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow

The outbreak of coronavirus has struck yet another blow to the Chinese economy after the improvement in business confidence since the Phase One trade deal was announced in mid-December. How severe the coronavirus may be for the Chinese economy will not only depend on the extent and depth of the virus outbreak but also on the government response. The People’s Bank of China immediate and bold reaction to calm markets with the equivalent of USD 170 billion in liquidity injection says it all about the pressure for Chinese policymakers to mitigate the impact of the coronavirus outbreak on financial markets, on sentiment and on the Chinese economy, more generally.

Many take the example of the SARS outbreak in 2003 as a benchmark to estimate the impact of coronavirus on the Chinese economy and beyond. The reality is that China is very different from what it was 17 years ago. First, the service sector, especially service consumption, is China’s key growth engine nowadays, with a contribution to economic growth nearly 40% bigger than it in 2003. Based on the SARS’s experience, the service sector is likely to be more severely affected than the manufacturing sector, especially for transportation, which continues to be an important part of the service economy. The second reason is that investor’s confidence has already been hardly hit by the trade war. The coronavirus is already having a knock-on effect on sentiment which is bound to affect the demand for durable goods, as well as private investment. Beyond this demand shock, we cannot forget that there is a negative supply shock stemming for the large number of companies that have not managed to open their doors in a province, Hubei, which accounts to 10% of total auto production in China and is a key transport nexus for West and East China. Furthermore, the sudden stop of production plants is also extending to other provinces.

Over and above the fact that the large negative demand shock is ,this time around and much more than during SARS, is supply shock as well, the other important difference is that China’s growth was increasing on a structural basis — pushed by the growth of population and urbanization. The…