Global recession: Will virus scare trigger a global recession? Rob Subbaraman explains

It is an interesting report that you have come out with and the first line talks about how the depth and breadth as well as the length remains very uncertain. But I think the question on everybody’s mind is that given the world economy’s prospects due to coronavirus, could this trigger some sort of a global recession?

It is still extremely uncertain. There are good and bad cases at the moment but the positive signs are that the coronavirus in China seems to be easing off; the number of daily infections has fallen quite significantly. So it looks like the draconian policies in China are starting to work. On the other hand, those draconian policies have led to a massive supply disruptions; so China’s GDP growth is going to be at least a halving between Q4 and Q1 this current quarter. So, it is looking like this quarter will be 3% year-on-year and to put that into perspective, if you are trying to look at for instance how the US calculates GDP growth on a quarter-on-quarter annualised basis, it is more like -6% quarter-on-quarter annualised for China this quarter. So China will be in quite a deep recession; the damage has already been done. But the good news is that it looks like the virus is easing off. The other concern is outside China; there have been a number of clusters from South Korea and Japan, Italy and Iran, and it spreading to more countries; so the risk is rising that this could become a global pandemic. A lot of these kinds of public fear factors were playing out in China. As a result, tough government controls could start getting replicated in other countries. If that starts to happen, what you talked about in terms of a global recession could be on the cards.

Recession means more loose monetary policy, which means more liquidity, and that means more money moving into perhaps performing assets like gold and US equities?
It is not clear at this stage whether the major central banks are going to cut interest rates. At this stage, it is still quite possible that this coronavirus shock is going to be V-shaped; it is going to lead to a very bad Q1 but then we could get the virus easing off as it has in China already, and then you get pent up demand production coming through. In that case, it is quite possible that the Fed and the ECB will look through the temporary damage. At this stage, it is looking more like a fiscal response particularly trying to help obviously the health sectors but in addition, there could be efforts to help particularly small companies that are struggling with lost activity; so you could see cash flow problems. For instance, some tax rebates or subsidies for small companies is what China has very much focussed on. They have cut rates a little bit but it has been much more of a fiscal response at this stage. So I think it is too early to really talk about big interest rate cuts outside Asia. Even in Asia, the market was expecting Bank of Korea to cut rates, but they chose not to.

How would you assess the data that is coming from the Chinese government? I am saying this in the right spirit but I am also aware of the fact that sometimes Chinese data does not tell you the true story.
The first principle is to realise that this has been a devastating demand and supply shock simultaneously. By demand I mean the fear factor; people are not spending, and by supply, I mean that all the government controls stopping people from going back to work. So it is going to have a huge impact and when actually activities stall, the impact on GDP growth is huge. So this Saturday is going to be very interesting; we are getting the manufacturing PMI data. Services and manufacturing was 50 in January; we reckon it is going to drop to probably around 35 or so in February. So we are talking about a 15 point drop. Services could be a similar scale drop; so I think that is going to be the first real indication of how much this is really hurting China’s economy. We expect China’s growth, the way it is reported year-on-year, to be around 3% in Q1 versus 6% in Q4. The risk is it could be even lower than that. China is much bigger than it was during SARS; it is about four times bigger as a share of world GDP; so there is going to be a sizable spillover effect on other economies. As I mentioned earlier, if this turns out to be a global pandemic in addition to spillover effect from China on other countries, these other countries have got their own direct effects from coronavirus. So we are still not out of the woods by any means.

Within the emerging market basket and of course, from India-specific point of view, how vulnerable do you think the economy is or the outlook is currently for us on the back of these developments?
So we have done quite a bit of work at Nomura looking at score cards of which countries are most likely to be infected or face contagion from this virus, who could be next to see a big increase in coronavirus cases and also the economic impact. On both those scores, what we find is that Asia is by far the region most exposed to contracting the virus and also the economic impact. But interestingly within Asia, India is the least exposed. In part, it is because India does not have strong links with China in terms of visitor arrivals. Also, the economic spillovers from China to India are not severe. So, in a way there has been a lot of concern. In the past years, India has been slow to get involved in Asia’s very sophisticated supply chain for production across countries where China is the epicentre. In a way that is now to India’s favour that it has not been as involved in the supply chain; hence, it is not going to be affected as much as China, which faces much weaker growth and less production and less exports and imports in the coming months.

Which asset class has overreacted in relation to the coronavirus? Is it crude, which has gone down or is it gold which has gone up?
I do not think there has been an overreaction to be honest. The moves have been fair. I would say, at this point, maybe equities still have not reacted enough, if I look where they are compared to what has happened in say the treasury markets. So I think it is fair and you raised a very good point. For India, the drop in oil prices is a bigger relief than it is for most other economies. India is very dependent on oil. The challenge for India though is going into this coronavirus; India’s domestic economy was already struggling, particularly because of all the financial sector problems. So when you have a financial sector problem, which is the life and blood of an economy, it is very hard when you have a crisis there and get growth picking up again. That is what India has been struggling with. And now there has been this global shock; so from our perspective, we already thought that the recovery in India was going to be very long and it is going to be drawn out. We did not expect India to get back to around 5% growth or so until the second quarter of this calendar year. So for India, there is going to have to be more policy responses and given that fiscal is constrained, we do think RBI is going to have to cut rates further.