The Four Coronavirus Scenarios: The Bad, The Worse, The Ugly...

The Four Coronavirus Scenarios: The Bad; The Worse; The Ugly; And The Unthinkable

Michael Every of Rabobank

Summary

• The Covid-19 coronavirus could be more disruptive than markets are currently pricing in. Not in the least because the ‘true’ number of infected people remains uncertain, as the recent surge in cases exemplifies
• We outline four scenarios in which the virus increasingly becomes severe: The Bad; The Worse; The Ugly; and The Unthinkable 
• We provide rough estimates for China’s growth trajectory in these scenarios although we stress that these are not our official forecasts since we are still working out the details
• The three main channels through which Covid-19 will affect the global economy are tourism, net exports, and intermediate goods
• In the ‘Bad’ scenario the virus outbreak does not last far beyond Q1. China’s GDP growth for 2020 could drop to below 5%, with production taking the biggest hit and a catch up in Q3 and Q4. This is our base case scenario, although with the recent surge in mind, the second scenario is becoming increasingly likely
• In the ‘Worse’ scenario, the virus outbreak lasts beyond Q1. In that case China’s GDP growth could end up below 4% in 2020
• In this scenario, next to China, Asia will bear the brunt of the prolonged outbreak due to its dependence on Chinas as an export market and intermediate imports as well as for tourism
• In China itself, defaults of non-financial corporates in China could start to rise rapidly
• This will lead to a decline in China’s long-term growth potential as private companies will suffer most, while less efficient SOEs will likely be bailed out. As a result, debt levels will balloon further, leaving China more vulnerable in the future
• There will also be downwards pressure on the Chinese currency as extra CNY liquidity is made available
• In the Ugly scenario, the virus spreads beyond China, and spreads to Asia as well as developed economies. Its effects will likely resemble the Global Financial Crisis of 2008/2009 more than the SARS outbreak in 2003
• The Unthinkable scenario is a far left tail scenario, in which the virus mutates and becomes a truly global pandemic

Financial markets have been on a roller-coaster ride since the Novel coronavirus Covid-19 stole the headlines – albeit mainly on the ascent phase (bar today’s reaction) of the ride so far in terms of equities at least. At this stage, it’s still too early to tell whether or not Covid-19 is ‘under control’ or not. Especially given that the most surge in cases (due to a new counting methodology) shows that we don’t really know the actual number of infected cases (Figure 1).

In a research report published end-January we discussed the ‘most likely’ outcome for the global economy and markets based on what we knew at the time. But the huge uncertainty surrounding the spread of the virus as well as its impact on economic behaviour implies that we are still dealing with a wide range of possibilities from a relatively quick stabilization of the situation to a full-blown pandemic with far far-reaching consequences.

This report will therefore examine what the potential impact of the virus will be on the Chinese, Asian, and global economies under four different scenarios. As shall be seen, none of these are positive, in contra-distinction to the relative optimism shown by equity markets at present. In fact, all of them are negative to varying degrees such that we dub them: The Bad; The Worse; The Ugly; and The Unthinkable.

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