Lagarde’s $186bn coronavirus fear

An infection typically hits the vulnerable hardest — and in the new coronavirus outbreak this might apply economically too. For all the geographical distance between Europe and China, the euro zone has much to fear from its spread.
The disease is another challenge to the export-driven model of the monetary union, which was already struggling with the global lurch towards protectionism. It could be the first big test for Christine Lagarde, the European Central Bank’s (ECB) new president, who has been a tad too optimistic about the euro area’s prospects.
Coronavirus will affect Europe’s economy in three ways. First, there’s demand: China is the third-largest importer of goods and services from the euro zone, after the US and the UK. The bloc’s exports to China nearly trebled between 2007 and 2018 to $185.8 billion. Over the same period, sales to the US increased by about 63%. These figures matter because Europe relies extensively on global demand to drive its prosperity, as shown by its large external surplus. A slowdown in China sales will cause trouble in a number of industries such as luxury.
Then there’s supply. Europe’s manufacturing supply chains are less exposed to China than is the case for other regions of the world, according to a report by Oxford Economics, a consultancy. However, it notes that some industries might be more exposed: The Wuhan area, where the virus originated, is a major automobile hub and home to production sites of carmakers including Peugeot SA and Renault SA.
Finally, there’s the effect of the outbreak on confidence. Europe’s financial markets have been resilient so far: The Stoxx Europe 600 index is still marginally up since the start of the year. It’s possible some companies will benefit from the disruptions, as producers have to look for alternative suppliers. However, coronavirus could weigh on investment decisions in
eurozone. An investment slowdown would create long-term economic damage, even if supply and demand in China rebounded quickly.
These factors matter for every economy in the world, not just the euro zone. But the monetary union’s economy is already very weak. Growth slowed to just 0.1% in the last three months of 2019, the worst quarterly performance since 2013. From Germany to Italy, the industrial sector had a terrible end to the year. Unemployment continues to fall and wage growth remains solid, which should support internal demand. However, the euro area has been exposed to a succession of external shocks. The longer the coronavirus episode lasts, the higher the risk it spills into the domestic economy.
Unfortunately, this time around ECB has already used several of its weapons to combat deflation. The balance sheet of the Eurosystem hit nearly 4.7 trillion euros.
It’s still possible that the economic threat from the coronavirus will fade. A strong policy response in China could create additional demand, which would help foreign companies. But the euro zone’s poor state doesn’t leave room for error. After a quiet start for Lagarde, the difficult decisions could be fast-approaching.
—Bloomberg

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times