(Yicai Global) Feb. 7 -- Recent volatility in the global capital market is unsurprising. The Chinese central bank's clear signal that the government is going to step in has reassured market participants to some extent, so the next few days or a couple of weeks will be crucial, Eswar Prasad, the International Monetary Fund's former China head, told Yicai Global in a recent exclusive interview.
Extracts from the interview with Prasad, who is now Tolani senior professor of trade policy at Cornell University and a senior fellow at the Brookings Institution, appear below.
Yicai Global: What would you judge to be the impact of the 2019-nCoV virus and its prevention and control on first-quarter and full-year economic growth?
Eswar Prasad: It is going to be a significant hit to growth in the first quarter at least, and this will come from the effects on the industrial sector, because production has been disrupted by limits on the movement of labor and other factors of production within the country. But there will also be a hit to the services sector, especially given that during the Spring Festival [Chinese New Year holiday], travel, tourism activity and restaurants tend to increase.
If the outbreak can be contained reasonably quickly, then it is likely that the economic damage will be limited to the first quarter.
The other factor that is crucial is what sort of policy response we see from both fiscal and monetary authorities, so if there is a combination of a relatively quick containment of the outbreak and a strong policy response, even the short-term negative output effects, I think, can be softened to a significant extent.
It's going to be a challenge getting to the objective of about 6 percent growth for the year, and undoubtedly the fact that most of China, including the major metropolises, is effectively on lockdown right now will pose a significant challenge to break.
YG: What will be the effect on the global economy?
Prasad: On the impact for the overall global economy, given how important China is as a major economic power, as a major driver of global economic growth, and given its importance to supply chains, especially within Asia, there will almost certainly be significant disruptive effects across Asia in terms of travel, tourism and supply chain disruption.
The broader effects on the global economy, again, might be muted if we see this outbreak proving to be relatively short-lived, and if there are significant macroeconomic policy responses from other governments.
YG: What is your view on the reaction of global capital markets?
Prasad: I think financial market participants are still trying to get a handle on whether this outbreak is going to have a very persistent and large effect on corporate earnings, and it's a little hard to tell. I think at a time when markets are still trying to get a handle on it, it is not surprising that we see significant volatility.
We've received a very clear signal, I think, from the PBOC [People's Bank of China] that the Chinese government is going to step in, and if there is very significant volatility in the stock market, especially if there is a very substantial fall in stock prices.
So I think that has reassured market participants to some extent, and it's likely to lead to a smoother ride, so the next few days, a couple of weeks, I think are going to be very crucial in terms of figuring out how widespread this outbreak is going to become and how damaging an effect it'll have on corporate earnings.
YG: What kinds of impact will the epidemic have on the bond and crude oil markets in the short term and over the long haul?
Prasad: We will see at least a moderate withdrawal of funds from emerging market economies, including China, at least in the short run, and that money going into safer havens, and in terms of commodity prices, given how important China is in terms of global commodity demand, especially at the margin, and even how this outbreak is affecting not just industrial activity, but travel and tourism, it is hardly surprising that it is putting a significant downward pressure on prices, despite other factors such as continuing tensions in the Middle East that might have given an upward bump to prices.
But at least in the last couple of weeks, even those other factors such as the Middle East tensions have eased, at least marginally, relative to last month, so I think that is a combination of factors now putting downward pressure on commodity prices, but certainly economic activity in China and the potential spillover effects of this outbreak are crucial determinants at this stage.
YG: Do you think China has the policy tools to lessen the risks to the economy posed by the coronavirus?
Prasad: In the short term the Chinese government has quite sufficient policy space in terms of both fiscal and monetary policies to support growth. But I think the government is appropriately being cautious in terms of using these policies.
First of all, they're waiting to see how this plays out and how much support may actually be needed. Second, they continue to be very cognizant of the macroeconomic risks, especially to the financial system that could be caused by an infusion of credit into the economy.
So far, the government has shown, I think, the right kind of restraint in not using policies very aggressively, but signaling that they are steadily using policies as needed to support growth.
But for China, there is always this very difficult balance about how large the medium-term risks are if one uses monetary policy, in particular, to support growth in the short term.
Editors: Dou Shicong, Ben Armour