China unplugged
As the Covid-19 health emergency swiftly turns into an economic crisis, it is not just the supply side disruption that everyone should be worried about
1 Apr 2020 | Daniel Yu
Plenty of sceptics doubted China’s pronouncement on the numbers of infections and mortality – and criticized the way the government had handled initially the emergence of the new virus. But no one questions one fact: shutting down China is creating an economic pandemic not seen since the global financial crisis of 2008.
Covid-19 has made it plain to see what happens when the world’s second largest economy unplugs from the rest of the world. It is also what the fallout must be from a full-blown US-China trade war and the impact to the rest of the world. As Thomas Poullaouec, head of multi-asset solutions, Asia Pacific at T Rowe Price notes, “it is a rare event for the US Federal Reserve to cut rates [by 50bp] outside their normal policy meetings [in early March], but Covid-19 outbreak created conditions for this material change to happen”.
As The Asset went to press, the outbreak crossed 415,000 confirmed cases and the mortality nearing 20,000. It has spread to Europe and North America even as the situation in China is starting to stabilize.
Alarm bells were set off in mid-January and for six weeks the world watched nervously the rapid spread of the novel coronavirus in Wuhan, a city of 11 million residents. Health and safety issues were top-of-mind, especially in the adjacent cities and neighbouring countries. As the scale of the outbreak intensified, attention shifted to the impact on business.
In its World Economic Outlook (WEO), January 2020, the International Monetary Fund (IMF) confidently projected global growth to rise from an estimated 2.9% in 2019 to 3.3% in 2020 and 3.4% for 2021—although a downward revision of 0.1 percentage point for 2019 and 2020 compared to those in the October 2019 WEO. “The downward revision primarily reflects negative surprises to economic activity in a few emerging market economies, notably India, which led to a reassessment of growth prospects over the next two years,” it shared. “In a few cases, this reassessment also reflects the impact of increased social unrest.”
By the following month, Kristalina Georgieva, the managing director of the IMF, trimmed the agency’s global growth forecast by a further 0.1%. And by early March, she no longer was able to share a projection, suggesting “more dire scenarios” when she spoke at a briefing in Washington DC. The Institute of International Finance, the global association of the financial industry, slashed its global growth projection closer to 1% from the expansion of 2.6% in 2019, the weakest since 2008.
As the world’s factory, China’s inability to restart manufacturing after the Lunar New Year break soon affected manufacturing operations from South Korea to India. In a research report by Natixis, economists Alicia Garcia Herrero and Trinh Nguyen explain that apart from finished goods, China is today much more relevant to the global value chain, in particular, exports of intermediate goods. “When SARS hit in 2003, China’s manufacturing export share was only 8% and by 2018 it was 19%.” By moving up the ladder, China has become much more important in exporting intermediate goods than before. Any disruption in China’s production capacity could affect the rest of the world more severely than in the past.
While there were plenty of handwringing with sharp questions proffered on the need to diversify the supply chain to new locations, Covid-19 isn’t the trigger. Indeed, the reconfiguration of the supply chain started five years ago, due to China’s increasing cost of production. The US-China trade war certainly accelerated that process 18 months ago and this health emergency adds to that. A recent survey by a foreign business chamber in China reveals that 90% of the largely export-oriented multinationals have already  identified alternative locations otherwise known as the China+1 strategy.
Pegatron, a Taiwanese electronics manufacturer and supplier to Apple and Samsung, in July last year inaugurated a US$40 million facility in Batamindo Industrial Park in Batam, Indonesia, its first diversification into Southeast Asia from manufacturing sites located in Chinese cities such as Shanghai, Chongqing, Suzhou, and Kunshan. It also plans to open a facility in Haiphong, in the north of Vietnam, to remain close to its supply chain in southern China. Other Apple suppliers such Foxconn and Wistron have also set up manufacturing operations in India.
Drop in demand
Disruption on the supply side, which is reverberating around the globe, is not the only source of concern. On the demand side, China similarly has moved up in the global consumption marketplace. Chinese consumers, as they spend and travel more, are becoming increasingly visible contributors across a range of industries from airlines, to hotels, restaurants, luxury goods, retailers and education globally.
 The number of Chinese tourists and students who have ventured outside the country is also rising, a study published by McKinsey Global Institute (MGI) in July 2019 showed . “China is now the largest source of outbound students (608,400 or 16 times more than in 2000) and tourists (150 million trips taken in 2018, or 14 times more than in 2000).”
 The MGI report in July 2019 pointed out that outbound flows of Chinese students have been highly concentrated. “Only three destinations – Australia, the United Kingdom, and the United States – have accounted for about 60% of the total.” In the US, Chinese students’ economic impact, tuition and other expenditures, is more than US$14.9 billion, based on 2018 data from the Bureau of Economic Analysis, US Department of Commerce. In Australia, Chinese students also topped the total by nationality with 28% of international students enrolled at the end of 2019, which is an increase of 4% from a year ago. Estimate of total tuition paid is about US$1.4 billion for seven universities, a study by the Centre for Independent Studies reveals.
Already, the travel ban as a result of Covid-19 is hitting hard a number of Asian economies, where 29% of the trips overseas by Chinese tourists are destined. IMF’s Georgieva says that for every dollar of tourism revenue globally, Chinese tourists account for 18 cents.
“Tourism business from Chinese visitors, for example, is likely to be severely hampered, where Hong Kong, Thailand, the Philippines, and Vietnam are among the top of the affected,” believes Christiaan Tuntono, senior economist, Asia Pacific, Allianz Global Investors.
For example, Thailand’s dependence on Chinese tourism makes up about 2.7% of GDP, which has been on a steady increase. Already, the Tourism Authority of Thailand reported an 85.3% drop in their arrivals in February 2020. This will put downward pressure on growth, the Natixis report points out. “On top of this, export exposure to China is large at 6%. Thus, the deceleration of Chinese demand and supply chain disruption will be negative. We revise our GDP forecast to 2.2% for 2020.”
In the Philippines, Chinese tourists now rank second behind South Korea and ahead of the United States, with a total of 1.74 million visitors in 2019, a 38.6% increase from a year ago. With tourism establishments contributing 12.7% to the economy, government tourism officials are now scrambling to cover a potential loss of revenue of US$850 million from February to April 2020.
Rebalancing, going local
As China’s  impact on global growth rises, the country is also rebalancing its economy toward domestic consumption. “In 11 of the 16 quarters since 2015, domestic consumption contributed more than 60% of total GDP growth,” the MGI report notes. “In 2017 to 2018, about 76% of GDP growth came from domestic consumption, while net trade made a negative contribution to GDP growth. As recently as 2008, China’s net trade surplus amounted to 8% of GDP; by 2018, that figure was estimated to be only 1.3% - less than either Germany or South Korea where net trade surpluses amount to between 5% and 8% of GDP.”

With Covid-19 affecting the rest of the world, some are using the playbook during SARS in 2003/2004 to predict a sharp V-shape recovery for the global economy. The situation today, however, is not the same. For one, SARS was contained largely in China and Hong Kong. This time, the virus has spread to 191 countries and territories with the number of active cases in Europe and North America.
How the rest of the world recovers is far more of a concern now even as China restarts economic activity in mid-March 2020.
One financier also points out to The Asset that in 2003, China was on a sharp growth trajectory, following its entry into the World Trade Organization. That growth rate has slowed with CICC, a Chinese research house, predicting a 2.6% growth for China in 2020. “The world is worried about China,” he postulates. “But China is worried about the world.” Covid-19 is a health emergency. But it also is reshaping globalization, and has now disrupted the longest bull run in US history. 
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