Economic literature is sparse in quantifying the impact of pandemics on the economy. However, financial market responses are usually predicated on the expectations of a short-term drag on economic activity through lower production and tourism coupled with an impact through the confidence channel.
Unsurprisingly, such reactions also tend to be short-lived and their magnitude depends upon factors like the severity and spread of the disease, its curability or preventability, government efforts to contain them, and the prior state of the economy.
In order to offer a guide on how financial markets could evolve in the current situation, ANZ Research looked at how Asian currencies and equity markets have reacted to past outbreaks in the region.
The data showed pandemics do have an impact on financial markets, while currency markets are generally quicker to react - but the impact is usually short-lived.
Based on past experience, financial markets tend to recover well before the peak in pandemic episodes. For example, during the SARS outbreak of 2003, the currency and equity markets had started to move higher more than a month before the number of infections began to decline.
This also came despite sharp contractions in economic activity seen in affected economies. The FX response during the MERS outbreak in 2015 was brief, with the sell-off largely confined to a month before recovering, though the short timeframe of the outbreak did help.
However, the initial selloff can be severe. Financial markets started to react to the Wuhan coronavirus spread on January 20, two weeks after the WHO identified the new virus and more than a week after the first reported death.
The spread of coronavirus is occurring at a time when there has been an improvement in Asia’s growth indicators. Fourth-quarter GDP data largely beat expectations and indicated the third quarter was the low point in growth.
The de-escalation of the US-China trade tensions and a pick-up in the global tech cycle had pointed to a looming rebound in activity.
But now a weaker first-quarter GDP in the region is a near certainty. Production disruptions in China and the timing of the Lunar New Year mean the drag on January data will be pronounced.
The importance of Chinese tourists in the region and the linkages of China’s production through supply chain networks in Asia mean the drag on GDP growth will be quite apparent in upcoming data.
As a comparison, the impact during the SARS outbreak was severe for the affected economies, with sharp quarterly GDP contractions at the height of the outbreak. But the rebound was swift once the outbreak was under control. The magnitude and duration of the coronavirus impact will be determined by how quickly the spread can be contained.