As the virus continues to spread and Chinese factories close, the world’s economy is taking the hit.
It has long been clear that the coronavirus would have a huge local impact in China, with factories still shuttered over a wide swath of the country. Now the impacts of the illness—named Covid-19—are rippling across the global economy. Chinese components are critical to supply chains throughout Southeast Asia and Mexico, where such things as Chinese fasteners and circuit boards are added to locally sourced materials before being shipped to factories in the US, Europe, Japan and Korea.
A February report from data firm Dun & Bradstreet (D&B) said 5 million companies around the world, including 938 Fortune 1000 firms, would be affected by the lockdown because they have one or more Tier 2 suppliers in the affected region, which encompassed 19 provinces as of February 5. Tier 2 suppliers are factories, often specialists, that supply the direct-source factories in a company’s supply chain.
Among the worst hit are the auto, electronics and fashion industries. The closures have even impacted the global oil industry, with the International Energy Agency forecasting the first quarterly decline in oil demand in a decade. Wall Street research analysts have trimmed estimates for China’s GDP growth this year from around 6% to closer to 5.5%, with J.P. Morgan warning it could be “below 5%” in the first quarter due to supply shocks. Nathan Resnick, CEO of Sourcify, a company that helps other firms source parts overseas, told CNBC that he expects “trickle-down effects in everyone’s supply chains” for around six months.
To be sure, the true nature of the virus is not fully known; and some expect it to run its course relatively soon. “By all accounts, this appears to be more of a short-term disruption with a long tail of recovery going forward,” says Eric Smith, an analyst at Strategy Analytics. “We expect production to slowly come back to full strength by the March/April timeline. The trick will be in how companies reengage their target customers, to revive that demand once supply recovers.”
In Hubei, the province surrounding Wuhan, the city at the epicenter of the illness, over 50 million people were effectively still under quarantine in mid-February. Authorities ordered factories to remain closed until at least February 23. Similar closures were imposed in Zhejiang, a province on China’s eastern coast so economically important that city and county officials were directed by provincial government not to “overreact” to the epidemic, and to find “balance” between the need to control the outbreak and the need to resume economic activity.
“We are starting to see impacts in other provinces that are definitely hurting businesses’ ability to conduct business as usual,” D&B’s Brian Alster, general manager for third-party risk and compliance, tells Global Finance. “Port cities are not allowing exports to go out; so even if businesses are getting work done, the movement of materials globally has been significantly impacted.”
The authorities’ extreme measures came after Hubei reported a huge surge in the number of Covid-19 cases after the local government began using a new diagnostic method. The Chinese government said a total of 74,185 cases had been reported by February 19, with 2,004 deaths. In contrast, the outbreak in 2002 of severe acute respiratory syndrome, or SARS, killed a total of 774 people worldwide.
“Beijing faces a tricky balancing act between continuing with its efforts to contain the coronavirus and the urgent need to resume business as usual,” says Kaho Yu, senior Asia analyst at risk management firm Verisk Maplecroft. “Disruptions to air travel and production have already played havoc with global supply chains, and companies increasingly have to find alternative suppliers or reduce or stop production.”
Already, South Korean carmaker Hyundai says it was forced to suspend operations at its Ulsan five-factory complex—the largest auto-manufacturing facility in the world—because of a lack of spare parts. Parts shortages forced Nissan to close one of its Japanese auto plants. Likewise, Italian-American carmaker Fiat Chrysler says it will temporarily shutter one of its European car factories.
“The auto industry has a ‘complete set’ problem—you cannot make a car with just 98% of the parts,” says Kristin Dziczek, vice president for research at the Center for Automotive Research (CAR) in Ann Arbor, Michigan. “If [factory reopening] delays much further, then we will start to see a crunch.”
The global fashion industry, which depends heavily on Chinese factories for complete articles of clothing as well as cloth and other components that are assembled elsewhere in Asia, is also reeling. China is the world’s largest textile exporter, accounting for 38% of global turnover, according to World Bank data.
“With respect to factories, we’re continuing to see closures, changing timelines of when they might reopen and trying to assess what it means for production fulfillment, capacity and prioritization of which products to make,” Patrik Frisk, president and CEO of athletic-wear company Under Armour, said on February 11 in an earnings call. “In logistics, we think it’s reasonable to expect industrywide delays in terms of delivery around the world, including potentially missed shipment and service windows, and the need for increased air freight and additional measures at ports that could create unforeseen congestion.”
Another industry reeling from the virus is electronics. Foxconn, which assembles products for Apple, Sony and HP, among others, had expected to get back to work February 10, a week later than originally planned because of the holiday. But the company said it would quarantine workers coming back to its giant factory complex in Zhengzhou from outside the province for at least two more weeks, meaning production is unlikely to resume in February.
The virus prompted Apple CEO Tim Cook to give unusually wide revenue guidance for the second quarter—$4 billion—then later said it did not expect to meet the lower bound due to “a slower return to normal conditions than anticipated.”
On the other hand, Scott Kennedy, a senior adviser on Chinese business and economics at the Center for Strategic and International Studies in Washington, DC, says he believes the virus is likely to be a short-term problem for most companies. “Although there is some uncertainty, most still see this as a problem that will have a defined time to it,” Kennedy says. “Unless the restrictions on returning to work are extended far beyond the middle of February, my expectation is that for most companies this will not be something that on its own leads to a significant adjustment of supply chains.”
Kennedy noted that Chinese supply chains have already been reduced because of increasing labor costs in China and the arrival of automation in other areas, such as Eastern Europe, that offer more-economical alternatives. The trade war with the US has also accelerated movement out of China to factories in other countries, such as Vietnam.
According to the CAR’s Dziczek, this shift has even affected the car parts industry, where China was long the No. 2 supplier to US firms after Mexico. Mexico supplied $53.9 billion in parts to the US industry in 2018, followed by China with $20.1 billion and Canada with $17.5 billion. But she says Canada had overtaken China in 2019 as the No. 2 suppler, as companies struggled with import tariffs on Chinese goods.