Germs or GDP? China’s Coronavirus Dilemma

COVID-19, the coronavirus whose first case was recorded last December, has quickly become the most serious epidemic since the SARS outbreak in 2003. The World Health Organisation (WHO) has declared the outbreak a global health emergency, with the number of people infected worldwide rising to over 72,000, the death toll exceeding 1,800. While the virus originated in the city of Wuhan in China, it has since become a global epidemic, with cases in over 26 different countries.

The Chinese government has used various measures in an attempt to contain the spread: quarantining 16 major Chinese cities, extending the Lunar New Year holiday, and restricting key regional transport links. But despite these measures, the virus has taken its toll not only on lives and health, but also on the already-slowing Chinese economy. The Economist Intelligence Unit (EIU) has forecasted a baseline scenario of the epidemic being under control by March, with China’s 2020 Q1 growth dropping to 4.1% (well below the 6.4% of Q1 2019), and at least two government-linked think-tanks have similarly projected a 1 percentage point decline for this quarter.

On the supply side, business production has been significantly stunted. Many companies have suspended Chinese business operations and closed outlets, like Starbucks, which closed more than half its 4,300 stores in China. City quarantines have also meant that many migrant workers will not or cannot return to work from their hometowns. Leading car manufacturers like Honda and Nissan have had to halt production at their Wuhan factories as a result, and employers in neighbouring countries have also taken a blow to their workforce. On a larger scale, many international supply chains which rely on Chinese exports are likely to be disrupted, dampening the economic growth of China’s trade partners as well.

To make matters worse, disruption is likely to be worse than expected or currently experienced, because the epidemic has coincided with the relative economic inactivity that occurs anyway during the Lunar New Year break. Harvard Business School’s Willy Shih argues that people haven’t fully appreciated the impact, because many companies with operations in China already plan for the annual break in production, stocking up inventory each year in anticipation. Chinese company re-openings have already been patchy; now that the Lunar holiday can no longer mask the disruption caused by the virus, the post-holiday economic restart will need to be monitored closely to gauge how serious the supply-side shocks will really be.

As well as supply, the coronavirus will inevitably cause significant demand shock, as Chinese visitors - the staple of many countries’ tourism sectors - are forced to stay at home. The selfie stick-wielding Chinese tourist has become a worldwide stereotype, but hotel chains, restaurant owners and tour operators now find they have lost one of their highest-spending customer groups. According to Corinne Menegaux, Director of Paris’ Convention and Visitor’s Bureau, the number of Chinese tourists shopping for luxury goods in Paris has plummeted, with some duty-free businesses losing up to 80% of their clientele. And this seems to be a global trend: London’s Chinatown was reported being near-deserted during the holiday, Macau has temporarily closed all casinos, and Russia’s tourism industry group expects the country to lose $100m from government measures to keep Chinese citizens out.

But despite the virus continuing to cause damage to the Chinese economy, businesses and global trade, if Beijing wants to improve the situation, it may risk making the outbreak worse. Factory conditions create an ideal breeding ground for the virus, with thousands of workers working in enclosed, often cramped spaces for long shifts at a time. Epidemiologists have warned that returning to normal production levels would significantly increase the risk of virus transmission, inundating already overwhelmed local hospitals. While Chinese President Xi Jinping is reportedly concerned over the damage that restrictive measures are doing to the country’s economy, at the moment at least, local governments and Beijing seem unwilling to take that risk.

But slowing production has forced Beijing’s hand already, prompting a wave of bad bond issuances (dubbed ‘virus bonds’) to keep struggling businesses afloat. Many small and medium enterprises (SMEs) already operate on very thin margins, and many have taken on considerable debt - as Willy Shih notes, ‘even a few weeks of not having any business [and] not having any cash flows will potentially bankrupt these companies’.

The central government has appeared to step in, providing capital to make up for businesses’ lacklustre revenue. Li Junfeng, an official from the China Banking and Insurance Regulatory Commission, has said the latest ‘virus bonds’ created during the outbreak would not be counted as non-performing, and lenders can increase their tolerance for bad debt, particularly in sectors hit hard by the outbreak.

This decision goes against a more than 2-year campaign led by China’s top banking regulator Guo Shuqing, who has pushed for a reduction in bad debt levels and better control of financial risks. According to S&P Global Ratings, a continued freeze in economic activity could see banks hit with over RMB5.6tn ($800bn) worth of new bad debt, trebling the volume of non-performing loans in the Chinese economy.

While many of these bonds are directed towards producing resources in short supply (such as facial masks, protective suits and medicines), there are concerns that other SMEs are taking advantage of cheap capital to refinance themselves. This would reduce the amount of capital banks have available to stave off a crisis, and could significantly destabilise a Chinese system which has been striving for financial prudence in recent years.

It seems as if Beijing is fighting a war on two fronts: trying to contain the country’s worst epidemic in 17 years, while preventing the economy from suffering a painful slowdown. As companies seek to restart operations after the extended Lunar New Year break to make up for already lost production, factory conditions are likely to allow the virus to spread faster. At the moment, it seems as if containment is the priority until the virus is no longer a substantial threat. But as weak production and flailing companies plague the economy, the Chinese authorities will soon have to make a choice: when and how they can afford to step in, to help cure its struggling economy.