China (and the world) should brace for economic uncertainty

China (and the world) should brace for economic uncertainty

The rapid spread of COVID-19 threatens to disrupt China’s economic growth and global supply chains.

WHAT’S HAPPENING?

Businesses in China are reopening after a Lunar New Year that was extended to three weeks in an effort to combat the spread of coronavirus.

KEY INSIGHTS

– The short-term economic fallout of the coronavirus outbreak will be extensive given the size of China’s economy and the role it plays in global supply chains
– Using SARS as a basis for predicting expected economic consequences could have major shortcomings
– Global markets, particularly in Southeast Asia, will take a hit due to diminishing levels of global consumption and production

BUSINESS ISN’T BOOMING

Businesses across China that closed for the Lunar New Year in late January are just now reopening, weeks after they expected to resume operations. With factories laying dormant in the major industrial city of Wuhan, many of China’s key industries have taken a hit. In the automobile industry, factory shutdowns led to a 15% dip in global car production in the first quarter. The shutdown has affected universities in Wuhan, which are some of the top schools in the country — the quarantined city is considered one of China’s major educational and scientific centres.

The effects of the shutdown have also been felt outside of Wuhan. Apple and Foxconn closed all stores in mainland China, slowing the production of iPhones and other Apple products. Qualcomm, the world’s biggest manufacturer of smartphone chips, has repeatedly warned that smartphone demand has declined since the onset of the outbreak. Non-tech markets also have felt the flow-on effects — aviation, banking and luxury goods markets have seen suboptimal returns due to the outbreak.

SARS IS A FAULTY FORECAST

Photo: qdjuncheng/Wikimedia Commons

While some analysts have used the 2003 SARS epidemic as a benchmark to assess the economic ramifications of coronavirus, most economists have warned against this approach. The SARS epidemic slashed somewhere between 0.5-1% off Chinese economic growth that year. At the time, China’s economy accounted for 4% of global GDP. Since then, the Chinese economy has evolved considerably; is it now firmly in the heart of global commerce, commodity trade and production.

China now accounts for 16% of global GDP, 20% of global growth on a year-by-year average, and, according to the IMF, 39% of global economic expansion in 2019. Since 2003, China has become the first stop on most global supply chains, such as in the automobile industry, where Chinese vendors provide most of the 20,000 parts that go into the assembly line for a standard car. Furthermore, debt in China has risen tremendously since 2003, with its ratio of debt to GDP — a key indicator of vulnerability — more than doubling to 300%, and 15% of the global total.

During the 2003 SARS epidemic, China had a strong trade relationship with the US, facilitating an annualised growth of around 10% per year. Now, entrenched in a robust — though currently frozen — trade war, China’s annualised growth has slipped to around 6% per year. It has supplanted the US in the commodity market as the number one purchaser of mineral fuels, iron ore, copper, oil and coal, and is now a heavyweight in the export of electrical machinery and equipment. The dichotomy between China then and China now is salient, making SARS an inaccurate starting point for analysis and leaving economists without any prior case studies.

SHOULD WE HIT THE PANIC BUTTON?

Photo: Dipartimento Protezione Civile from Italia / Emergenza coronavirus

China will likely continue to issue debt to kick start consumption and keep small and medium-sized companies afloat, reversing the Communist Party’s goal of reducing bad debt expenditures. Even with business as usual, workers might be slow to return, causing factories to hover around partial capacity in the near term. Exports of high tech equipment will continue to drop even with factories reopening. This is because tech, unlike the automotive or pharmaceutical industries, tends to have lower levels of inventory, leading to ‘just-in-time’ deliveries of goods.

Services currently make up more than 50% of the Chinese economy, which is predicted to take a hit as consumption stagnates. Hong Kong’s economy, which is heavily reliant on tourism and retail, will likely continue to be slow thanks to the virus. Tourists from mainland China account for 78% of arrivals and the tourism sector accounts for 32% of service exports. Due to the halt on travel, passenger numbers have fallen by 55%. This will hurt the tourism and retail industry, which has already dropped off by 24% this quarter. With the coronavirus disrupting many key sectors in China’s economy, expect China’s GDP growth to fall to somewhere between 3.5% and 5%.

Due to the disruption of global supply chains, Southeast Asian economies are going to be negatively impacted in the short term as well. In Korea, major industries, such as the automobile industry, are bracing for a shortage of auto parts from China; this has already disrupted Hyundai’s production. Southeast Asian finance sectors will likely make adjustments to economic fallout, with banks in Sri Lanka, Malaysia, Thailand and the Philippines expected to cut interest rates due to low consumption since the onset of the virus. Tourism to these states, a critical industry, will be severely dented. Since 2014, Chinese citizens have been the greatest source of international tourism expenditure, and travel cancellations will mean these countries will not feel the boon of Chinese spending.

Economists are more relaxed when considering the long-term impact on the global economy. The current trajectory is in line with the common major market disruption: the first quarter takes the greatest hit but the second and third quarters rebound. There is reason, however, to be wary. First, the data economists are using to measure the economic ramifications of the coronavirus is unknown, as Chinese reporting has been somewhat ambiguous. Second, the policy response to this outbreak has been far more aggressive than previous outbreaks — there are few historical examples analysts can utilise that show extensive periods of factory shutdowns. Third, economists must consider the panic effect. In the epoch of globalisation and extensive media coverage, there has been a greater sense of alarm over virus containment. This is exemplified by the cancellations of major events such as the Singapore Air Show and the Mobile World Congress.

The weakening of currencies integrated with Chinese supply chains and the continual drop of commodity prices since the first recorded coronavirus death in early January is exponential. China is the largest importer of commodities like oil, iron and soybeans; the outbreak will see demand for these goods reduce significantly. According to a 2013 report by the World Bank, pandemics usually result to losses equivalent to 5% of global GDP. What has changed since the report is China’s contribution to rising global debt levels, which limits China’s purchasing power during such events.

The silver lining, however, is the US–China trade deal, which has made progress in the last month. The US cut tariffs on $120 billion of Chinese goods, while China cut tariffs on $75 billion of US goods. Furthermore, the Communist Party has ramped up rhetoric of striking a deal. Beijing hopes that the lifting of these tariffs on commodities will increase consumption. While there are doubts that China can commit to purchasing requirements of US farm goods, China has made clear that it is a priority — even at the expense of other trade partners. China’s efforts to re-stabilise consumption might just dictate whether the economics of coronavirus is a one-quarter issue or whether they will linger for the rest of the fiscal year.