Economic activity is returning in China, but we estimate China’s real GDP growth in the second quarter will remain negative, after reporting -6.8% year-over-year in the first quarter.
It remains unclear how soon other countries in Asia can follow China to relaunch activity, or if China will see a resurgence in COVID-19 cases, as policymakers around the globe assess the often conflicting goals of restoring daily life and containing the spread of the virus.
To be sure, the central banks in the Asia-Pacific region have provided prompt responses by initiating different easing measures that aim to stabilize their economies and support certain badly affected industries, which may help smooth out some of the expected economic slowdown within the region. Looking at the sectors heavily affected by COVID-19, a sharp decline in travel is already hitting retail and services sectors, such as department stores and malls, tourism, gaming and airlines. The global economic slowdown has also weakened industrial production, which is negative for commodities.
The decline in consumer sentiment in China delayed purchases, particularly big-ticket items such as automobiles and property, in Q1 2020. However, since the start of April, sales have begun to improve although it remains uncertain if they are sustainable due to the weaker macroeconomic environment.
Some sectors, however, have benefited and will continue to benefit from the current situation. Online shopping and gaming, pharmaceuticals and food, as well as technology, media and telecommunications (TMT) sectors should see a boost given that people are spending more time at home and becoming more health conscious. In addition, we expect traditionally defensive sectors, such as utilities and infrastructure to be less affected.
Asia credit spreads have widened meaningfully, especially for high yield bonds issued by companies that are directly impacted by COVID-19. From the start of January to May 15, U.S. dollar-denominated bond issuance in Asia amounted to more than USD 110 billion, but it has mostly been issued by investment grade companies or sovereign, or quasi-sovereign entities. We expect this trend to continue with select Asian sovereigns issuing bonds to fund their stimulus programs. We also expect select high yield Chinese property companies to issue new bonds later this year to refinance their maturing bonds for next year. That said, we would also caution that the current fragile economic and financial conditions will accelerate or increase the likelihood of defaults in both the onshore China and offshore U.S. dollar-denominated bond markets. As a result, we remain very cautious and are avoiding issuers that have tight liquidity positions and substantial debt maturing this year or early next year.
In the sections below, we look at some examples of how sectors and countries in the region are being affected by the pandemic and its economic repercussions.
Sectors that have benefited or experienced limited impact from this period of uncertainty
- E-commerce and online services. In China and other Asian countries affected by the virus, the consumer appetite for spending and going out remains much less than before the outbreak of the coronavirus. This has provided a boost to online shopping channels, from food delivery to clothing and household products, with ground delivery now almost back to normal. Transportation costs, however, have increased substantially for overseas delivery given the limited number of international flights. Online gaming and video streaming is also benefiting from the fact that consumers are spending more time at home.
- Utilities. We expect low business and credit risk for state-owned utility companies that provide essential services such as electricity generation and networks, as well as gas distribution. These are large-scale quasi-sovereign companies with strong balance sheets, diverse sources of funding and strong government support. For private sector Indian renewable independent power producers (IPPs), we expect earnings before interest, tax, depreciation and amortization (EBITDA) to be resilient given renewable energy’s “must-run” status in India and fixed tariffs. However, pressure on cash flow and liquidity will emerge given the potential for delayed payments from offtakers. There has been a 25%-30% decline in electricity demand in India during the nationwide lockdown and state-owned distribution companies are collecting less revenue from their commercial and industrial customers. The mitigating factors are that leading Indian renewable IPPs have sufficient liquidity, limited short-term debt and strong shareholders.
Sectors that have been affected but where the negative impact should be manageable
- China property. After being shut down through most of February, almost all property sales offices across the country have gradually re-opened for business, with visitor numbers recovering to around 70% of the pre-crisis level. The recovery is varied across different regions, with the Yangtze River Delta area taking a lead, followed by Southern China (mainly the Pearl River Delta area) and Western China, while Northern China lags behind. With COVID-19 now largely under control in China, property sales mostly normalized in April, after falling by about 25% in Q1 2020. Most developers remain hopeful about growing their contract sales by low double digits as they believe policy is set to ease further and the market will rebound in the second half of the year. While we believe policy and credit easing will support market sentiment, the positive impact could be largely offset by increasing unemployment and much weaker salary growth prospects (or even salary reduction in certain industries like exports or services). Hence we expect developers’ 2020 contract sales to decline by 5%-10% year-over-year.
- Chinese financials. The timely launch of a payment relief campaign by the China Banking and Insurance Regulatory Commission (CBIRC), combined with ample liquidity support and rate cuts from the People’s Bank of China (PBoC), worked to avoid funding disruption for China’s corporate segment. Now the COVID-19 impact is retreating in China and March total social financing is about one-third above market expectations. Assuming the payment relief program lasts until the end of June, problem loans formed since the outbreak began will mostly emerge from Q4 onwards. Meanwhile, an increase in the fiscal deficit and loose liquidity in the onshore credit market has considerably improved the re-financing conditions for broad-based local government funding vehicles. As such, the risk of a surprise default is lower.
Sectors that have been directly affected
- Transportation. The number of travelers to Japan has reduced by 80%-90% year-over-year and airline companies in Japan experienced a 70%-80% reduction in passenger volume on international routes and 50%-60% on domestic routes in March. We expect a further reduction in domestic flights by 65%-75% year-over-year for April/May. While it seems inevitable that airline companies will incur operating losses in the quarter ending March 2020, they are coping with the headwinds via a series of cost reduction and financing efforts. These include using cost-efficient and smaller aircrafts, agreeing on reduced work days with labor unions, retaining eligibility for government wage support for their employees, negotiating delays in new aircraft purchases and working with the government on potential financing needs.
Marine shippers’ earnings largely depend on economic activities and macroeconomic conditions. We expect reduced volumes in many areas of businesses due to COVID-19, including containers, dry bulkers and oil tankers. Marine shippers are exhibiting more resilience than at the time of global financial crisis – since then the sector has improved via consolidation and less oversupply in ships. However, we would expect a more accelerated reduction in volumes which will have a knock-on impact on earnings.
- Transport infrastructure. Demand-based transport infrastructure assets face significant volume risk as a result of the COVID-19 outbreak. Airports are most affected and we expect a sharp decline in airport traffic in India in 2020 as a result of the nationwide lockdown and travel restrictions. Ports across China, India and Indonesia will see mid- to high-single digit decline in the total volume of containers discharged and loaded (container throughput) in 2020 due to supply chain disruption and weak global trade demand. In Q1, Chinese and Indonesian ports’ container throughput declined by around 10% and 7% year-over-year, respectively. Indian public-private partnership (PPP) airports and privately-owned ports are more vulnerable compared with their government-owned peers in China and Indonesia. However, we expect PPP and privately-owned ports to have sufficient liquidity to sustain themselves for a year even though the airports are completely shut down. Besides, since they provide critical national transport infrastructure with a regulated return profile, this should help them access the domestic loan market if needed.
- Auto and related sectors. Auto sales in China were a drag on total retail sales in Q1 due to weaker consumer sentiment and production disruption. This will be negative for auto dealers as well as producers. Although the sector seems to be on a path of recovery with narrowing year-over-year sales decline, the situation is still fluid especially for the second half of the year. We also expect auto sales in other Asian countries to remain slow, particularly in countries more impacted by the virus situation, such as India, Korea and Japan.
- Gaming. A sharp decline in travelling has substantially reduced tourist activities, including gaming in Macau and Australia. Macau’s casino gross gaming revenue (GGR) fell 96.8% year-over-year in April 2020 to around USD 94 million with May GGR looking to be significantly down as well. While daily average visitors in 2019 were about 108,000, recent daily visits totaled less than 300. While the casinos have already reopened, we do not expect visitor numbers to return to normal levels until the virus situation has stabilized and travel restrictions are lifted.
- Non-China financials. Singaporean banks are likely to experience asset quality downside amidst a broad-based domestic and regional economic slowdown. However, given the strong underwriting standards and robust capital and provision buffers already in place, we expect these banks to weather these challenges relatively well in terms of credit fundamentals. We expect meaningful asset quality deterioration at Indian banks. The nationwide lockdown makes lower quality borrowers, particularly micro, small, and medium enterprises, vulnerable to reduced real activities and income. The non-bank financial sector continues to have limited access to liquidity onshore, hampering its role of channeling credit into areas where banks do not have strong underwriting expertise. The mitigating factors are that the Indian government regularly injects equity into its state-owned banks and that the Reserve Bank of India is providing regulatory incentives to banks to support the non-bank financial sector.
Rigorous credit analysis crucial amid current uncertainty
While the situation is still fluid and it is too soon to know the ultimate impact of the coronavirus on Asian credit markets, we remain cautious from a fundamental viewpoint and are mindful of liquidity and market dislocations.
In our view, rigorous analysis, careful credit selection and active portfolio management are crucial to managing risks and seeking returns in this environment.
For more on PIMCO’s outlook for markets and how investors can prepare for volatility, please see our “Investing in Uncertain Markets” page.