This post originally appeared on the Western Union Business Solutions Blog.
More than fifteen years on from the SARS epidemic, China again faces a virus outbreak. This time though it’s in the city of Wuhan within the Hubei province – the so-called ‘industrial powerhouse’ of the world’s number two economy.
Wuhan’s connection to the rest of the world, and the rate at which this virus spreads, means that as many as 4,015 lives worldwide (as of March 10th) have been lost, dwarfing the 774 deaths attributed to SARS in 2003. [1] However, coronavirus – or rather COVID-19 – remains significantly less fatal than SARS was, with a mortality rate of 3.4% according to the World Health Organisation (WHO). That’s about three times less than the 9.6% mortality rate under SARS.
With COVID-19 now impacting 110 different countries, what if this escalates further as the WHO updates its global health emergency rating to a ‘global pandemic’? This prospect of further escalation, and thoughts of ‘what if’ is what’s now driving fear across financial markets and forcing economists to quickly reassess potential implications for businesses in 2020.
Quantifying the risks not easy
While it is relatively easy to measure the tragic human impact, it is much more difficult to quantify the economic impact. Historical comparisons to SARS won’t work because in 2003, China’s share of world GDP totalled just 4% compared to its 16% contribution today.[2] Also, the rate of China’s economic growth and the reliance of world demand on its economy is much higher today, while the material integration of China into the supply chain of many international companies like Apple Inc. raises concerns of a ‘double impact’.
If the economic shock that China is delivering now is indeed a double impact – both on the demand-side as well as the supply-side – then the subsequent downside effect on global GDP may be much larger than previously estimated. If we take the OECD’s response in March, it revised its Chinese growth projections for 2020 by -0.8% to 4.9%, versus its 5.7% forecast in November 2019 before the outbreak started. For the global economy, it downgraded its 2020 forecasts from 2.9% to 2.4%. We are entitled to wonder about this estimate which should be revised down further as COVID-19 spreads internationally. I’ll go on to explain later why the US central bank is already front-running this likelihood.
Who is most exposed?
Several groups are working on a vaccine, but updates suggest it will not be ready until next year. In the absence of an effective treatment, the fastest option to stem the virus’ spread is the implementation of a containment policy. However, such a policy means the temporary closure of factories in the manufacturing sector and a sharp reduction in activity across services sectors like travel and leisure. This temporary interruption of activity is already causing a rapid drop in business across major economies, with some countries more vulnerable than others to a prolonged disruption.
Geographic proximity and stronger economic ties with China mean that Asia (mainly Japan, South Korea, Singapore and Thailand) and countries across Oceania (Australia and New Zealand) are among the first to feel the effects of China’s economic shock. However, Europe is vulnerable too. The fragility of Europe’s vast automotive industry was already an issue, with a contraction of growth in Q4 2019 across France and Italy, and zero growth in Germany. China is the number one trade partner (exports and imports) for German manufacturers.[3]
For Germany’s BMW/Daimler and Volkswagen businesses, 30% and 40% of revenues come from China respectively. [4] In the UK, the largest carmaker Jaguar Land Rover has warned that Chinese supply disruption means it will face a major test in March when parts are due to run short, while on the demand side it said car sales in China fell 85% in February. Britain’s manufacturing sector accounts for 10% of total output[5].
The demand and supply side dilemma
In terms of industry sectors likely to be most affected by this health crisis, it is necessary to distinguish between those linked to the demand shock versus the supply shock. From the demand side, we already see the immediate impact on travel and tourism with China and neighbouring countries like South Korea where 7,513 COVID-19 cases have been reported. Japan is also at risk, and now has the issue of the Olympic games to consider. As a result, the International Air Transport Association (IATA) predicts an earnings hit of at least $63bn for the airline industry this year and, in the UK, the already struggling Flybe has fallen victim.
Chinese tourists are also the world’s biggest spenders, contributing $258bn and 17% of total foreign tourism spending globally in 2018[6] – underlining the world’s need for China to travel and spend. The UK welcomed nearly 400,000 Chinese tourists and £657m of spending in 2018[7]. China is also the world’s biggest importer of raw materials such as petroleum, iron and copper so this puts industrial sectors in countries like Australia at risk.
From a supply chain disruption perspective, high tech and electronic sectors may be most exposed and impacted, headlined by Apple Inc. which manufactures its iPhone 11 through its Chinese partner Foxconn, and has already issued virus-related downgrades to earnings. Still, the supply impact extends far beyond Apple and high-tech, given that Beijing shutdown factories and critical hubs and ports that facilitate so much trade across industry, textiles and pharmaceuticals. Indeed, 20% of Active Pharmaceutical Ingredients (API) in the world is produced in China, and approximately 60% of paracetamol[8].
13% fall in stocks spurs emergency response
Across financial sectors, debt repayments will become an issue, and it’s why the US Federal Reserve shocked markets on March 3rd with a 0.5% interest cut – it’s first emergency cut since the Financial Crisis of 2008. In the US, the country faces a number of challenges related to financial markets as more than half of American people own shares.[9] Therefore, the -13% fall in US and European stock markets in the last week of February – the biggest correction since 2008 – and the subsequent impact on consumer spending, is another key factor behind the Fed’s emergency response on interest rates and why we may see further cuts in the coming months.
According to Mckinsey’s research there is still a higher probability of a major global economic slowdown versus an all-out global pandemic and recession. However, should the corrections in US financial markets escalate, and if a US demand shock then adds to what China is already delivering, then more central banks globally will need to respond. Although Australia, Canada the US and the UK have recently cut interest rates, we think that monetary stimulus should be more limited compared to a previous crisis like 2008 as global interest rates are already so low. In Europe, negative interest rates should urge governments to activate fiscal stimulus. Furthermore, among the risks we identified behind the threat of a pandemic, is a major supply shock. This cannot simply be resolved by massive injections of cash into money markets through monetary stimulus.
Foreign exchange implications for companies
The issue of geopolitical uncertainty, and the impact on foreign exchange volatility is what will challenge international companies in the coming months. According to our own global study[10] – a survey of over 4,000 companies worldwide with international payments and FX services needs – 66% of decision makers said geopolitical risks and market volatility are the biggest issues that make effective planning and currency management the most challenging. Geopolitical issues are so much harder to quantify while global events or incidents like COVID-19 have such different effects on currencies dependent on market sentiment at the time.
Japan’s Yen and the Hong Kong Dollar, for example, have performed well this year, despite their economic exposure to China, as these two countries are seen as haven assets or ‘shelters’ in Asia during times of turbulence. The Australian Dollar and Thai Baht however have a higher ‘risk profile’ for investors and therefore both have depreciated markedly. China’s Yuan is so far seeing limited losses, partly thanks to its global reserve currency status as well as numerous support measures quickly announced by Chinese authorities. The currencies of net commodity exporting countries like Norway are paying a heavy price so far, reaching historic lows.
The Euro – and companies with large exposure to the currency’s value – is experiencing a roller-coaster start to the year, first losing 4% of its value against the US Dollar to reach almost 3-year lows below $1.08, but it then erased all losses and appreciated unexpectedly by 5% when global markets collapsed in late February. If this type of turbulence continues in the world’s most traded currencies, there will be consequences for others.
It is this type of market volatility that makes planning forward hard for companies who seek clear longer-term trends but are faced with short-term gyrations in currency rates. Our research also shows that one in four companies, in sectors such as manufacturing, said they would face financial difficulty if faced with a negative currency shift of 10% or more. We don’t want to risk exaggerating COVID-19; however, evidence here suggests that it’s critical for international companies to review quickly the supply, demand, and exchange rate risks they face in this uncertain environment.
How can companies respond?
Western Union Business Solutions supports over 60,000 companies worldwide, and as an expert in financial risk management and international payments, here are some key considerations we’d recommend to help support:
- If you are being impacted by supply chain disruption and need help with geographic diversification, there are government resources as well as public information sites like UN Comtrade that can provide guidance.
- If you are being exposed to volatility, cash flow risks, payment complexity, and need help with developing a counter strategy, or need more guidance on what types of currency products are available for companies with longer-term payment needs and large exposures, then click here to contact one of our solutions experts.
- If you need help keeping up to date on the latest news related to the coronavirus crisis to inform your continuity plans, you can access the World Health Organisation’s resources through its website or ask to join our webinars. For regular updates on the virus’ impact on the market, then click here to register for our daily reports.
For additional information, please visit the Western Union COVID-19 Resource Center.
