China’s Bond Markets Can Weather Coronavirus

As China’s leaders scramble to contain the coronavirus epidemic, the global community braces for impact to China’s people, equity and bond markets, and economy—the world’s second largest.

Already, COVID-19 has been the biggest source of volatility for China’s equity markets and has shaken economies around the world. Investors have even raised concerns about Chinese banks’ ability to withstand a possible wave of defaults.

We think fears about market impact and a default wave are overblown. Here’s why.

Turning Point Fast Approaching

We agree that the coronavirus outbreak represents one of the biggest risks to China’s economic growth in 2020. But we believe China’s economy will prove resilient, especially if the epidemic is curbed within the first half of the year. And that seems increasingly likely. The recent exponential jump in the number of confirmed cases conforms with our expectations of a peak—and turning point—in early March.

If the epidemic is indeed controlled before June, we expect China will suffer a one percentage point hit to GDP growth. If we’re wrong, and the contagion persists throughout 2020, that penalty increases to 1.9%.

We believe that the Chinese government still wants to achieve a growth rate of between 5.6% and 6% for real GDP in 2020, in order to double the per capita GDP from the 2010 level. To achieve this rate, we expect China to go beyond aggressively easing monetary policy. We expect to see the fiscal deficit increase in 2020 by 0.5% from the 2019 level, and special local government bond issuance may double to 3.5–4.0 trillion RMB as well.

Lastly, China’s economy tends to have a seasonal pattern, with output lowest in the first quarter and highest in the fourth. It’s therefore likely that China will catch up later in the year, following a sizable hit to first-quarter growth.