The Taiwan Banker

The seemingly unstoppable spread of coronavirus is quickly turning local health emergencies into a global economic calamity. In the world so deeply interlinked, disruption in a major manufacturer and consumer like China has an inevitable drag on the global economy, as the relatively unhindered flow of goods and people across borders – previously taken for granted – has virtually come to a standstill. Governments are now racing against the clock to contain the economic damage as businesses are re-thinking their extensive exposure to China. As the world was bidding farewell to 2019, predictions of a global epidemic would have sounded like a far-fetched science-fiction fantasy. Yet, three months later the novel coronavirus (officially known as COVID-19) has inflicted unprecedented community, business and economic costs across the world. Quarantine measures, which effectively cut off whole regions from the outside world, have not prevented the disease from spreading into other countries. The virus has already disrupted international travel and put supply chains under unprecedented strain and. Global economic growth is expected to crater in the first half of the year. There are no clear signs of how and when the epidemic will be brought under control as so many questions remain unanswered about the virus’s nature and potential. Predicting the extent of economic damage at this stage would be a pure speculation. The coronavirus, however, highlights some fundamental vulnerabilities of our modern economy, which is intensely interconnected as well as deeply reliant on China. The crisis already dwarfs the US-China trade war: Allianz Group, a financial services provider, expects the epidemic and ensuing containment efforts to reduce global trade volumes by US$320 billion per quarter . Globalisation is under scrutiny in the most challenging circumstances since the financial crisis over a decade ago. Eggs In One BasketAs the coronavirus spreads across the world, observers are looking to history to gauge its potential economic damage. Severe Acute Respiratory Syndrome (SARS) outbreak – which started in 2002 infecting over 8,000 people, killing 774 and wreaking economic as well as emotional havoc across the region – does not provide a meaningful comparison. At the time, China was a less significant player in the global economy, which meant that disruption within its borders had smaller external spillovers. In contrast, China is now the world’s second largest economy responsible for over 15% of global GDP (compared to just 4% two decades ago) . China remains a leading manufacturing centre and its citizens are major spenders both within and outside its borders. When China experiences a slowdown, the international community inevitably feels the strain. Southeast Asia is particularly exposed to Chinese factories, businesses and tourists as the region has become increasingly interconnected with China in recent years. ASEAN+3 Macroeconomic Research Office, a policy adviser to the regional economies, estimated that a drop in China’s GPD growth by 0.5% would lead to a deduction of 0.4 percentage points from the aggregate performance across ASEAN, China, Japan and Korea . This will be largely driven by a decrease in regional travel and China’s reduced consumption levels. Australia is another regional economy heavily reliant on China with about a third of the country’s exports heading to China and around 38% of foreign students coming from there . The tourism industry has become all too reliant on Chinese holidaymakers who, according to estimates by McKinsey & Company, a management consultancy, spent over US$250 billion in 2017 on outbound trips . IHS Markit, an information services provider, estimates that China’s international outbound tourism amounted to 150 million travellers in 2018, up from 20 million in 2003. For countries like Thailand and Japan , where Chinese tourists account for 30% of all visitors, closed borders mean significant business and job losses. Airlines are feeling the pain of this reduced demand too. In mid-February, the International Air Transport Association (IATA) estimated that Asia-Pacific airlines could lose up to US$27.8 billion in revenue, with most of the losses related to the Chinese market . In a sign that the contagion is spreading too rapidly, the IATA had to revise its estimates just two weeks later with the global impact expected to run up to US$113 billion at that time . The virus has now spread to every continent but Antarctica. As a result, businesses are freezing non-essential travel and cancelling conferences, trade fairs and other gatherings. Analysts say that, an epidemic in the age of social media will linger in travellers’ minds for months to come, further dashing the hopes of a quick recovery. China is a major investor in other economies through the Belt & Road Initiative (BRI), taking both money and people to its high-profile infrastructure projects. Once the Lunar New Year holiday ended in February, observers started reporting disruptions at some developments as Chinese nationals found their project locations out of reach. China’s state-owned assets supervisor also acknowledged there were ‘difficulties’ . Completion of the Pokhara Regional International Airport in Nepal faced the risk of delay due to a labour shortage . So did projects in Sri Lanka, Pakistan, Bangladesh and Indonesia . In many economies the coronavirus has made bad things worse. Hong Kong’s position has been already severely weakened by political turmoil which rocked the territory throughout last year. A destructive typhoon coupled with a controversial sales tax hike to 10% has weakened Japan’s economy. The region is still reeling from the two-year long trade war between the US and China. And as the virus spreads globally, the economic contagion is quickly intensifying as supply chains get further disrupted and consumers delay their spending.Economic Contagion SpreadsInternational markets started taking notice of the coronavirus when infection rates outside China exceeded those inside the country. McKinsey & Company estimated that countries most affected by the virus as of the end of February represented about 40% of the global economy . At some point, US stocks registered their worst performance since the global financial crisis in 2008. This time, however, policymakers are not dealing with a financial system failure, but with a global health emergency, which affects both the supply and demand sides of the economy. All eyes were on central banks in the expectation of imminent rate cuts, which duly followed. As some observers point out, however, lower borrowing costs will not lift quarantines or restore broken supply chains. In situations where simple everyday activity may increase the risk of infection, individuals will forego all non-essential outings as health considerations generally trump all other factors. Indeed, when the Federal Reserve announced an emergency rate cut in early March, market reaction was somewhat unenthusiastic . A more comprehensive stimulus therefore is required to keep the economy from sliding into stagnation or – worse – recession. In its interim report on economic risks caused by the coronavirus, the OECD estimated that annual global GDP growth could drop to 2.4% this year from the previously expected weak performance of 2.9% . It urged policymakers to take measures to avert inevitable economic pain by supporting vulnerable households and providing assistance to businesses directly affected by the epidemic. Governments are under increasing pressure to abandon their entrenched aversion to public spending and offset the damage caused by containment measures, such as enforced quarantines and travel restrictions. Indeed, some countries have already announced relief packages to reduce the economic fallout. South Korea, a country with one of the highest infection numbers outside China, announced a plan in early March to provide US$9.8 billion in economic aid to facilitate access to funds for businesses and low income families . As Japan’s Prime Minister Shinzo Abe asked all schools across the country to close, the government announced a new subsidy system to support working parents . Italy, a European cluster of the virus, was also planning stimulus measures to support the economy that had already been under significant strain in the previous years. Bloomberg calculated that, by early March, over US$54 billion in budget support was pledged or was under consideration by the governments around the world .As borrowers struggle to repay their loans, the banking industry may be set for a significant downturn. Some consider that temporary lower income is better than a large number of clients going out of business leading to a surge in non-performing loans. The Thai Bankers’ Association has, for example, announced a yearlong grace period on loan repayments aimed at borrowers operating in the most affected industries, such as tourism and retail, or mortgage customers who experience difficulty in making repayments after losing a job . The State Bank of Vietnam was reportedly ordering commercial banks to apply a flexible approach to interest payments on their loans . Some UK banks, including Barclays and the Royal Bank of Scotland, have been reaching out to their customers to provide overdraft facilities or issue emergency loans to those affected by the outbreak . What has been lacking so far is a decisive action at the global level as countries increasingly operate on the ‘all politics is local’ basis. In an emergency call, G7 financial ministers said that they stand ready to act, including taking the necessary fiscal measures, but did not commit to any particular steps . Markets were left unimpressed by the announcement, which they felt was strong on rhetoric but weak on action. The virus now also threatens the very existence of the European Union as members hold different views on financial assistance to countries most affected by the disease.A Missing Link The coronavirus has put a spotlight on China’s major role in the global supply chains as the world relies on the country to produce both finished and intermediate goods. According to IHS Markit, China is the world’s second-largest importer of manufacturing goods with a trade volume of US$1.7 trillion in 2019 and the largest exporter at US$2.5 trillion . Quarantine measures have kept factory workers away from their workplace which in turn had a knock-on effect on production around the world. Hyundai, the fifth largest car manufacturer in the world, had to suspend production lines at its factories in South Korea due to the shortage of certain components manufactured in China . In December 2019, the World Trade Organisation (WTO) reported a drop in its Goods Trade Barometer to 95.5%, where anything below 100 indicates below trend growth . The reading does not yet take account of the coronavirus crisis and the WTO now warns of a ‘substantial’ impact on global trade as the epidemic spreads contagion into global economic activity . With its dependency on China for both manufacturing and consumer demand, Apple now expects to miss its revenue targets for this year’s first quarter . Profit warnings have been issued by firms from the automobile, pharmaceutical, tourism, retail, beverage and other industries. Goldman Sachs, an investment bank, forecasts no earnings growth for S&P 500 firms in 2020 as disrupted supply chains and lower economic activity hit companies’ financial performance across the board . Modern supply chains are incredibly complex involving multiple parties across different jurisdictions and relying on just-in-time deliveries. Their fundamental principle is cost efficiency which relies on process optimisation, often at the expense of operational resilience. This makes them particularly vulnerable to shocks, such as the ongoing coronavirus crisis. Prolonged disruption of supply chains will inevitably trigger a strategic re-think at companies which are particularly exposed to China. To be sure, this has already been happening at some firms that found their operational costs rising over the years as well as the US-China trade war adding a high degree of business uncertainty. But the virus might further accelerate this transformation process. Company boards have their hands full dealing with an unprecedented crisis which has potential to affect all organisational aspects, from customer service to operations to HR. The epidemic is set to become the largest ‘working from home’ experiment in an attempt to contain the virus. Court rooms will be deliberating on the appropriateness of relying on force majeure clauses – as some companies started mitigating financial exposure from their failure to comply with contractual obligations – in the years to come. The role of insurance will come under close scrutiny as businesses attempt to recover their losses from what is a highly rare event. Measures triggered under business continuity plans may well quickly become business as usual for firms and their workers. Some commentators envisage the virus will bring about a fundamental transformation of our world as it adapts to new realities characterised by limited mobility and fractured supply chains. In these desperate times, the Fourth Industrial Revolution with its enthusiastic embrace of new technologies may soon cease to be a far-fetched science-fiction fantasy.