The phase one impact of the coronavirus outbreak on economic growth—to borrow a term from U.S.-China trade negotiations—is a decline in demand.Phase two, which we daresay has a higher probability of materialising than phase two of the U.S.-China trade deal, is a significant disruption in supply.It’s our view that the negative impact to economic growth is likely to exceed that from Severe Acute Respiratory Syndrome (SARS) in 2003.This is due in part to today’s much moreinterconnected, just-in-time global supply chain, where disruption toproduction extends beyond China, especially in the Asian region, which has a high dependence on Chinese intermediate goods. The auto and electronics industries are the most vulnerable,in our estimation, and to a lesser extent the electrical machinery industry. Even if Chinese production does restart in earnest, low capacity utilisation from labour shortages, the cancelation of commercial flights, extended screening at borders, and quarantining will result in long delays for parts.
Why the SARS episode is not a good benchmark
There are a number of reasons why a comparison with SARS may underestimate the potential impact of the current outbreak. From a global supply chain perspective, most factories and offices in China remained open in 2002/2003. The exception was in Guangdong, where SARS was relatively confined. As a result, the impact on Chinese industrial production and exports was minimal. Today, with the coronavirus episode, many factories are operating below capacity, and some remain shuttered.1
Vertical specialisation in trade—the use of imports to produce exports—was also much more limited in 2003. China’s share of world gross value added (the output of a country less its intermediate consumption) was less than 4%. Data on gross value added (GVA) only began in 2005, reflecting a limited need to understand global value chains until then.2
Fast-forward 17 years and significant structural change has occurred. The emergence of global supply chains has led to much more complex trading relationships. An increasing portion of exports to China are intermediate products assembled before either being consumed in China or exported elsewhere in the world. At the same time, an increasing share of China’s exports are assembled in third countries before being exported elsewhere. There are supply chains within supply chains, and China owns much more of the supply chain than it did back in 2003. Its share of global valued added had more than tripled to ~15% as of 2015.
Vulnerability to a disruption in Chinese supply varies
If the downturn in the productive capacity of Chinese factories were to lengthen in duration, many economies may struggle to source goods for their final consumption demand. Vietnam and Cambodia are most vulnerable in this category, with 9% to 11% of their final demand coming from Chinese domestic value added. Hong Kong and Thailand follow with 7% to 8%, then Malaysia, Chile and Taiwan at 5% to 6%.3
What’s more, trade activities with China accounts for a significant share of many economies’ GDP. For example, Taiwan, Vietnam, and Malaysia have total exposures in excess of 20% of GDP. South Korea, Thailand, Singapore, and Hong Kong follow in the 14% to 17% of GDP range.4 This suggests many Asian economies would be exposed to any short-term disruption in the supply chain.
There is also high variation in exposure by sector. Taiwan is heavily exposed to a disruption in Chinese computer and electronics supply (15.4% of GDP). Malaysia (8.9%), South Korea (7.5%), and the Philippines (4.2%) are also mostly exposed in this sector, albeit to varying degrees. Hong Kong is mainly exposed through business services (8.1%), while Chile, Australia, and New Zealand are exposed in other sectors, such as primary commodities to the tune of 4.0% to 7.0% of GDP.5
Of the developed economies, the fact that Hong Kong, Australia, and New Zealand are the most exposed may come as no surprise given their well-known integration with the Chinese economy. Perhaps less well known is Japan’s integration. At 3.9% of GDP, Japan’s intermediate goods trade with China is the largest of the major advanced economies. Exports of intermediate goods to China account for 3.5% of Japan’s GDP, and imports of intermediate goods from China are 0.4% of GDP.6
Low inventories add to the supply chain chaos
Inventories in the more exposed industries—autos, electronics, and machinery—are managed on a just-in-time manufacturing and inventory fulfilment basis. This means there is a limited buffer against suspension or long delays in receiving Chinese-supplied parts and components, and therefore a relatively immediate impact on partner supply chain facilities.
Hyundai and Renault have already announced factory closures outside of China (in South Korea) due to a shortage of parts from China, and Fiat Chrysler warned it may need to halt production in one of its European plants.7 And for South Korean and Taiwanese semiconductor exporters, a pickup in shipments had already resulted in declining inventory ratios prior to the outbreak and a relatively weaker starting position on this front. More recently, there have been reports of companies hoarding parts to see them through, but this will only exacerbate input shortages.8
A silver lining of sorts
One potentially mediating influence in all this is that supply chains have been in the process of adjusting for some time as a result of tensions between the United States and China. The virus-induced supply chain chaos will likely accelerate the trend of companies looking to diversify their supplier concentration risk. For instance, Taiwan and selected ASEAN exporters have been well positioned to adjust to the change in U.S. demand since the start of the U.S.-China trade war and enjoyed strong export gains. While this may help take some of the sting out of Coronavirus’ supply chain disruption and provide some upside potential in select markets, we believe the risks to the downside outweigh the positives for the time being.
1 “Coronavirus: Much of ‘the world’s factory’ still shut,” BBC News, 10 February 2020. 2 OECD, Manulife Investment Management, as of 13 February 2020. 3 OECD, Macrobond, Manulife Investment Management, as of 12 February 2020. 4 Ibid. 5 Ibid. 6 Ibid. 7 “Virus Exposes Cracks in Carmakers’ Chinese Supply Chains,” “Fiat Chrysler warns Coronavirus may force European plant to close,” New York Times, Financial Times, 4 February and 6 February 2020, respectively. 8 “Coronavirus and Your Global Supply Chain, Rising Panic – Part 2,” Logistics Management, 11 February 2020.
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