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Last Updated : Feb 22, 2020 11:27 AM IST | Source:

Moneycontrol Pro Weekender: The sick man of Asia

China's Emerging Industries PMI (EPMI) slumped to a historic low of 29.9 for February, a huge fall from 50.1 for January

Dear Reader,

Preliminary data on the impact of the coronavirus (COVID-19) on economies this month are out. Japan’s flash Composite Purchasing Managers Index (PMI) for February has come in at 47, much below January’s 50.1. A reading below 50 indicates contraction from the previous month. The fall is at least in part due to COVID-19, with tourism hit particularly hard.

Similarly, Australia’s flash composite PMI for February shows activity shrank to 48.3, down from 50.2 in January, with bushfires and the virus contributing to the decline.


The silver lining is the Flash PMI for the Eurozone came in at a six-month high, indicating that the region has so far remained immune to the effects of the virus.

As for China, its Emerging Industries PMI (EPMI), a gauge of momentum in high-tech industries, slumped to a historic low of 29.9 for February, a huge fall from 50.1 for January. A Nomura research report said, "By adjusting for seasonality and expected progress in business resumption in the coming week, we estimate the official manufacturing PMI could drop to a range of 30-40 in February. We believe markets might underestimate the scale of the current growth slump."

The question is: will the recovery be V-shaped? Chinese authorities say there has been a resumption of 80 per cent of work in key foreign enterprises in many regions. The credibility of the pronouncements of Chinese authorities is even less than its normal dismal level at the moment, but Foxconn has said it will ‘cautiously’ resume production, while Apple issued a revenue warning for the quarter.

The virus has spread to Beijing, with a report saying that infection density in Xicheng district, which houses the headquarters of the Chinese Communist Party and government offices, is only slightly lower than in Wuhan, the centre of the epidemic. Talk about ironic twists of fate!

Nevertheless, a torrent of cash continues to flood into markets around the globe. Indeed, as on 20th February, the MSCI China index was up 1.8 percent year to date. Virus? What virus? That’s what Chinese equities seem to be saying. Other markets in the region have fared far worse, with MSCI Japan, Taiwan, Korea, Thailand, Indonesia, Malaysia and the Philippines all in the red compared to the beginning of the year. The Chinese government has been doing a good job of making stock markets defy gravity.

No wonder the Wall Street Journal printed an article headlined ‘China is the Real Sick Man of Asia’ with the strapline ‘Its financial markets may be even more dangerous than its wildlife markets.’ The nub of the article: ‘Given the accumulated costs of decades of state-driven lending, massive malfeasance by local officials in cahoots with local banks, a towering property bubble, and vast industrial overcapacity, China is as ripe as a country can be for a massive economic correction. Even a small initial shock could lead to a massive bonfire of the vanities as all the false values, inflated expectations and misallocated assets implode.’ China expelled three WSJ journalists for that report.

There are signs that some investors are seeking safe havens. The United States 10-year government bond yield has dropped below 1.5 percent, while gold prices have rebounded. The US dollar has moved sharply higher, which is usually bad news for emerging market equities.

To be sure, the Chinese authorities will throw everything at the virus. They have cut monetary policy lending rates modestly, keeping their firepower in reserve. They too know that monetary policy can do little to get people out of their homes into their workplaces. That is why they’re offering subsidised transport and rewards for migrant workers to return to work.

The Chinese people have a Faustian pact with the Communist Party to deliver economic growth in exchange for putting up with its one-party rule and the government will pull out all stops to keep the economy going.

Elsewhere, central banks in the Philippines, Malaysia, Thailand and Indonesia have cut interest rates while some countries are planning a fiscal stimulus. In the US, the markets now expect a rate cut by the US Fed in June or July. And as the Bank of America survey of global fund managers for February said, we now have full capitulation into a ‘QE-forever’ theme. No wonder asset markets have remained buoyant.

The Bank of America survey found that emerging markets are the most favoured destination for global fund managers and India continues to benefit from that trend. Nevertheless, the Indian markets have been cautious recently. The macro situation has not improved much and there’s now the uncertainty over the telecom dues to be paid to the government.

Loan growth will, at best, see a dead cat bounce. Power sector stress has spread to new areas. Recoveries at the bankruptcy courts have fallen. Corporate India’s December quarter results were poor and the current quarter could be worse. The Reserve Bank of India Monetary Policy Committee’s Ravindra Dholakia, a noted dove, said that ‘the long-term growth revival depends critically on the fiscal policy and structural reforms.

When the long run revival is not seriously attempted, any substantial recovery in the short run is also likely to be elusive and the monetary policy stimulus that works only indirectly and with lags is also likely to be less effective.’ And if that isn’t enough, India’s ex-chief economic advisor just threw a bucket of cold water on the long-term India growth story.

The rare bit of good news is that all analyses indicate that India will be one of the least affected countries from the coronavirus, provided of course it doesn’t show up here.

It’s difficult to keep your chin up against all that negativity, but our independent research analysts nevertheless made a heroic attempt. We explored what makes a stock a winner despite encountering adverse situations here and here. We looked for nuggets available at attractive valuations in a beaten down sector. We recommended stocks with superior earnings quality and pointed out an exception in a tough sector.

We also did an examination of which sectors in India are at risk of being affected by the virus epidemic and how, if played right, relocating production to India could become the industrial world’s Plan B.

And, for next week, here’s a heads up about what to expect from President Trump’s visit to India.


Manas Chakravarty

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First Published on Feb 22, 2020 11:27 am
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