Destined to be Tested

Stephen Roach informs us that as a result of the SARS epidemic China has just taken it's first exam, and passed with above average marks. I'm sure he's right about industrial activity and exports, and the shock to domestic consumption can easily compensate itself later this year. That's the difference between a 'growth recession' US style, and a growth explosion 'made in China'.

The New China was always destined to be tested. And tested it has been -- first by the Asian financial crisis of 1997-98 and then by the synchronous global recession of 2001. But now China faces what perhaps could be its toughest trial yet. Unlike the external shocks of the past six years, this one is internal -- the outbreak of severe acute respiratory syndrome. SARS not only challenges the stability of China from within but also raises key questions about the nation’s global role. Notwithstanding these risks, my early take on China’s response is quite positive. Barring a major setback in this virulent disease, I see a post-SARS China that has come of age in the depths of crisis. This has enormous strategic significance for Asia and the broader global economy.

The first-order effects of SARS on China are obviously quite serious. That’s true of the economic impacts as well as the damage that has been done to China’s image. The curtailment of economic activity has already prompted us to cut our 2003 estimate of Chinese real GDP growth from 7.0% to 6.5%. Given the extent of the disruptions to commerce, the risks to our revised forecast remain decidedly on the downside. To date, the impacts seem largely confined to China’s services sector. The silver lining is that China is not a services-intensive economy. Services account for “just” 34% of its GDP -- hardly a trivial slice but about half the portion of most rich, developed countries. International tourist receipts, which are the equivalent of nearly 2% of Chinese GDP, have all but dried up for the time being. Moreover, domestic tourism, which amounts to another 3.7% of the economy, has been sharply curtailed. The cessation of domestic travel during the national May holiday is an especially harsh blow; our estimates suggest that this effect, alone, could slice anywhere from 0.2% to 0.4% off annual GDP growth. In addition, the quarantine remedies of accepted public health procedures have had a dramatic impact in constricting most service activities in Beijing -- China’s second largest city (with a population of 11.2 million). Beijing is China’s most service-intensive metropolitan area, with services accounting for an estimated 61% of the city’s economic activity -- nearly double the national norm. With Beijing’s share of overall Chinese GDP about 3.0%, the impacts of services-related economic disruptions in the nation’s capital can hardly be minimized.

Manufacturing is a different story. So far, anecdotal reports -- including surveys of Morgan Stanley’s teams of equity analysts around the world -- tell us that interruptions to Chinese factory sector activity have been limited. That’s good news for this manufacturing-intensive economy, where industry accounts for fully 44% of its GDP (and construction another 7%). It’s also good news for the supply chain that sources production and demand elsewhere in the world. Certainly, if SARS is not contained, there are risks of widespread worker absenteeism and factory shutdowns that would deal a more serious blow to China and the rest of the world. Such a possibility can hardly be ruled out. But the draconian public health measures now being taken in China suggest that it’s probably more appropriate to build an economic forecast based on SARS containment. Right now, that seems like a very heroic assumption. But looking out over the next several months, I do think that’s the best way to model the problem. Under that presumption, the probable output losses of the second and third quarters of 2003 should be seen as temporary, most likely followed by a sharp snapback in late 2003 and early 2004.
Source: Morgan Stanley Global Economic Forum
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