The Corona regional epidemic may potentially turn global- Many Chinese cities quarantined; trade, tourism & services hit- Market expecting replay of SARS of 2003

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Commodities-centric sectors with direct exposure to China under watch

The Corona virus outbreak in China has emerged as the biggest global worry at the moment. This virus if not contained in time may turn into a global epidemic with adverse implications for travel, trade and markets alike.

So far, 106 casualties have been reported – all in China – with nearly 4,600 confirmed cases of infected individuals. China has seen travel ban and quarantine measures that could impact local and global trade dynamics.

While previous such crises had hurt global equities, a recovery thereafter has prompted investors to draw parallels. However, the potential damage to an already fragile global economy can be high as the treatment to Corona virus is still not available. Investors, hence, should stay cautious on the cyclical sectors.

What is Corona?

On December 31, 2019, the WHO (World Health Organisation) issued an alert about several cases of pneumonia in Wuhan – the capital of Hubei Province of China. The virus was termed as Corona virus (CoV), which belongs to a family of viruses that causes illness ranging from common cold to SARS (Severe Acute Respiratory Syndrome) and MERS (Middle-East Respiratory Syndrome. The strain has not been previously identified in humans and does not respond to any medical treatment so far.

The Corona virus is understood to have been initially transmitted from animals (possibly snakes and bats) -- just as SARS that spread from civet cats, and MERS from camels. It is contagious and what makes the transmission difficult to contain at the initial stage is the fact that its incubation period i.e. time from exposure to developing symptoms is about 3-10 days. Researchers at Northeastern University and Imperial College London estimate that the number of actual infections may be 10 times more than the reported confirmed cases due to this incubation period.

The immediate impact

The official response started with the lockdown of Wuhan, which has a population of 11 million. As of now, 15 cities of the Hubei province are under similar travel quarantine controls. As the outbreak took place in the run-up to the holiday season, that is Chinese Lunar Year celebrations, the consumption and tourism cycle took a beating.

Except for cities of the Hubei province, the impact on manufacturing is yet to be seen as a good set of businesses is anyway shut due to the Chinese New Year. Officially, Chinese holidays are extended to February 2 nationally and February 9 for Shanghai.

Since a solution to the Corona virus is work in progress, it is anyone’s guess how long this crisis will stay and to what extent it can impact globally. So far, multiple countries have reported confirmed cases and are looking at measures ranging from isolating the infected person to a travel ban to China and other restrictions. According to the WHO, the current outbreak is still a regional crisis.

Financial market impact

Markets have started to price in the flu factor in an alarming way. Chinese equities have fallen by 5-6 percent from their January 20 highs. Oil has slumped by more than 10 percent in the past few days and gold is at its 6-year high.

Looking at the SARS of 2003, the global macroeconomic impact was estimated at $30-100 billion. It was also estimated that the impact on China’s GDP was as high as 1 percent. (Source: The Impacts on Health, Society, and Economy of SARS and H7N9 Outbreaks in China: A Case Comparison Study by Qiu, Chu & Mao).

As far as its impact is concerned, Chinese equities had plunged about 8-10 percent during March-April 2003. Similarly, Mexico stocks during Swine Flu in 2009 and Brazilian equities during Zika in 2016 were moderately impacted by 2-4 percent. In all the cases, however, the equities recovered swiftly post the crises.

The scale of the problem calls for a closer look at Ground Zero –the Hubei province. At $595 billion, the province made up about 4 percent of China’s GDP in 2018. Note that the Hubei province is an important center for industries such as metallurgy, automobiles, chemicals and optical electronics. The city of Wuhan constitutes about 1 percent of China’s global trade dynamics – both exports and imports. Historically, known a major automobile and logistic centre, in last few years the city is also fastly emerging as a hi-tech hub for the optics industry.

Takeaways

In our base case, we believe that the Corona virus epidemic may have an impact limited to China with a likely extended quarantine and travel ban within the country. This stems from the fact that China this time is better equipped to deal with this crisis than earlier occasions. The recent quick steps may just prevent the problem getting global. In the short term, the adverse impact on Chinese GDP could be larger than earlier occasions due to the clampdown. Further, longer restrictions on travel and work will adversely impact Chinese consumption, services and manufacturing in the short run.

Investors should look at this event with abundant caution. The positive trade outlook on account of of the Phase 1 trade deal between the US and China now faces a serious risk.

Investors may turn cautious on sectors and companies with direct exposure to China, particularly on the commodities side. Sectors with links to oil such as chemicals and agrochemicals may have to brace for more volatility and potential high cost inventories. The ones that are dependent on raw materials from China like pharma, agrochemicals may face additional headwinds.

Large export-oriented sectors of China such as metals and chemicals may possibly turn to higher dumping in India, particularly if there is lower domestic consumption of same. The recent correction in metal prices therefore comes as little surprise. Note that prior to this metal price outlook had turned positive on account of the improvement in the US-China trade ties.

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Moneycontrol Research analysts do not hold positions in the companies discussed here