(Bloomberg) -- An interconnected global economy is feeling the strain of China’s viral outbreak -- and the potential $160 billion hit in lost growth that may be on the way.
In New Zealand, a bath furnishings seller told a customer that the German-designed shower head he ordered is unavailable -- because the factory in Shanghai is closed. Out in California executives of REC Group organized a supply chain war room to plan around an anticipated trucking shortage and port logjam in China. In the Middle East, Saudi Arabia is rallying support for an emergency OPEC meeting on concern oil demand will falter.
Since China’s last health crisis, the SARS outbreak of 2003, its share of global economic output has quadrupled to about 17%. It’s now the biggest market for new cars and semiconductors, the largest spender on international tourism, the leading exporter of clothing and textiles, and the land where many PCs and virtually all iPhones are made. The global hit from this new outbreak could be three to four times larger than the $40 billion blow from SARS, estimates Warwick McKibbin, a professor of economics at Australian National University.
Thus far, China has absorbed most of the economic shock from the coronavirus known as 2019-nCoV, which has killed more than 210 within its borders and infected over 9,950 globally. Wuhan, the city with 11 million residents where the virus came to light, remains closed off from the world. Under a government-mandated extension of the Lunar New Year holiday, provinces generating at least two-thirds of economic output will be shuttered through next week, including Shanghai and key eastern manufacturing hubs.
All the while, the virus’s toll continues to rise -- and with it the worry. China’s essential role in the global supply chain means business owners and executives around the world are being forced to contemplate what will happen in a prolonged crisis.
“Everyone is waiting to see how this evolves,” said Miguel Patricio, the chief executive officer of Kraft Heinz (NASDAQ:KHC) Co. The food giant has a couple thousand employees in China, including a small sales team in Wuhan. “The danger, of course, is that if this continues and people have to stay home, you start having problems in terms of distribution, production.”
Closed Doors
Four months ago, Levi Strauss (NYSE:LEVI) & Co. opened the doors to a flashy new flagship store in Wuhan, a booming manufacturing powerhouse that alternately gets called the Chicago or Detroit of China. The location features three levels of premium collections and a massive tailor shop. At just over 7,500 square feet (697 square meters), the location is twice as big as any other Levi franchises in China. The mega-store was heralded by top executives as a symbol of a new era of growth for the brand in the country.
Today, like almost everything else in town, the store is shut. A major component of Levi’s growth strategy in the region is temporarily stalled, joining thousands of international corporations, Chinese conglomerates and small businesses in the first wave of economic impact from the virus.
“Our priority is employees, and if the situation doesn’t correct itself quickly, we will probably remain closed for a while.” Levi Chief Financial Officer Harmit J Singh said in a phone interview.
International companies have poured into China, opening up Estée Lauder counters, Canada Goose stores and Rolls-Royce (LON:RR) showrooms in Beijing and Shanghai. In more recent years, they moved into the second- and third-tier cities whose populations have ballooned during the nation’s mass urbanization.
Companies with big exposure to China, from Starbucks Corp (NASDAQ:SBUX). to Tesla (NASDAQ:TSLA) Inc., refrained from predicting this week how the virus would affect demand, saying simply that they’d update their forecasts when they know more. Apple Inc (NASDAQ:AAPL). and Microsoft Corp (NASDAQ:MSFT). gave wider-than-usual forecast ranges for the quarter amid uncertainty about the virus impact.
The hope, of course, is that health officials are able to contain the spread of the virus enough to let people get back to the normal rhythms of life in a matter of weeks. A vaccine could be months or even years away, but some viruses can burn themselves out within the season. Others take longer. SARS was declared a global health emergency in March 2003 and was considered contained by that July.
The fear is that because 2019-nCoV has a stealthy quality -- symptoms can appear as late as two weeks after infection -- it will have staying power. Worst case, it could frustrate the best efforts of the world’s public health authorities and wreak havoc along trade routes and in boardrooms for months to come.
The first wave of economic impact from the virus comes at a delicate moment. Western companies have helped convert late January’s Lunar New Year festivities into a shopping bonanza, to the point where it’s become a key period for economic growth in China. This year, it’s been so subdued that consumption growth in the first quarter will slow by more than half in China from the 5.5% growth rate recorded in the final months of 2019, according to Bloomberg Economics.
It’s easy to see how. Starbucks has closed more than 2,000 outlets across China -- half of its total -- and can’t get some menu items for those that remain open. McDonald’s Corp. has shut hundreds of restaurants. Some Walmart (NYSE:WMT) Inc. stores are running out of products. Walt Disney (NYSE:DIS) Co.’s theme parks in Shanghai and Hong Kong have gone dark. Even before the U.S. and Japan advised their citizens to avoid traveling to China, airlines had curtailed flights to the country -- not because of fear of contagion, but due to lack of passengers.
Many of those coffee purchases, vacation getaways and impulse buys are lost forever, in terms of GDP -- it’s not as if consumers will buy two lattes in March to make up for the one they meant to purchase in January. Manufacturing is different. Although factories that were supposed to be reopening now will remain closed, many have some wiggle room to make up for lost time, pay employees some overtime and finish off their orders.
But with every passing day, there’s less room to maneuver. Construction activity that was paused over the winter, especially in the colder northern parts of China, should be starting up by now. Capital spending is likely to be reined in as companies delay decisions until they know more about the virus’s impact.
The many companies that rely on Chinese manufacturing need to place orders soon to have products ready for peak shopping times.
Take Anne Harper, founder of OMG Accessories, a New York-based company that sells bags and backpacks to Macy’s Inc., Nordstrom Inc (NYSE:JWN)., Dillard’s Inc., TJ Maxx and Burlington Stores Inc. Even before the Lunar New Year, she works to lock in orders with her supplier near Guangzhou to ensure she gets priority after the holiday. Customers want the product by May or June for back-to-school season, when some customers will sell 80,000 backpacks in a single week. That means OMG tries to fill its warehouse by April.
“Making those deliveries is just so important for the life cycle of our product,” Harper said. “If you miss delivery, everyone has already bought their school bags.”
The outbreak will also have a wide-ranging impact on the technology industry, with China accounting for about 21% of global IT hardware spending, Bloomberg Intelligence analysts wrote Jan. 29. Some of the biggest PC makers and parts suppliers are based in China, and if there’s a slowdown in sales, that would constrain demand for Microsoft’s Windows operating system software.
Apple, Tech
More than 50% of the more than $470 billion of chips that are sold each year are either used in devices sold in China or go there to be put into gear sold around the world.
Apple has roughly 10,000 direct employees in China, and its supply chain has a few million workers manufacturing products like the iPad, iPhone and Apple Watch. The Cupertino, California-based company prepares for extreme scenarios like the coronavirus by mandating that major components be dual-sourced -- both in terms of vendors and geography -- and a major immediate impact to its production plans is unlikely for now, a person familiar with its operations said this week. Even so, most of its assembly work is done in China, and so a shortage of workers for assembly lines will have a direct impact on shipment numbers.
On the other side of the equation are small manufacturers in China whose livelihood depends on the confidence of their customers. Any hesitance from clients can cause disarray for people like Cash Liu, a sales director at hot-tub maker Shenzhen Kingston Sanitary Ware.
“Some of our clients choose to wait and see and hold off from placing orders, due to concerns over the coronavirus,” Liu said via a messaging app. “Thus we are likely to miss the peak season of sales to Europe in March.”
Add up the effects of lower consumption, investment and a pause in manufacturing, and the impact from the virus could knock China’s first-quarter gross domestic product growth down to 4.5% -- the lowest since the quarterly data begins in 1992 -- from 6% in the final three months of 2019, estimated Chang Shu, chief Asia economist for Bloomberg Economics. The biggest knock-on effects would be felt by Hong Kong, followed by South Korea and Japan, she wrote. Germany and Japan might take a 0.2% hit to GDP, while the U.S. and U.K. would absorb a 0.1% blow.
It’s survivable, and fiscal stimulus from Beijing could even lessen the blow. On the other hand, the estimate assumes the outbreak is contained to China. And “the longer factory output is affected, the bigger the risk China’s dominant position in global supply chains disrupts activity elsewhere,” the economist wrote.
Shell (LON:RDSa) Shock
Within and outside China’s borders, the virus is bringing up flashbacks to the height of last year’s trade war with the U.S., when global companies raced to find alternatives to their Chinese suppliers and avoid tariffs.
The outbreak could spur more businesses to move manufacturing to the U.S. and Mexico, U.S. Commerce Secretary Wilbur Ross told Fox Business this week. What’s clear is that the virus is adding another layer of complexity for businesses that were just beginning to breathe a sigh of relief over trade tensions.
“This virus outbreak may be even a bigger hit to us than the U.S.-China trade war,” said Melissa Shu, export manager at E.D. Opto Electrical Lighting Co.’s auto-parts factory in Zhenjiang City.
Decades of globalization have made leaders at large corporations comfortable with the logistical challenge of moving resources from place to place and responding nimbly to geopolitical shifts. But 2019 was a lot for anyone to handle, and the thought of contending with a potentially lethal virus in 2020 is giving even the most hardened executives pause.
“Between the virus and the tariffs and the protests in Hong Kong -- I’m waiting for the locusts,” said Emanuel Chirico, CEO of Calvin Klein and Tommy Hilfiger owner PVH Corp (NYSE:PVH). He said it’s too early to determine the impact the virus will have on the apparel industry.
“The honest answer is nobody really knows yet.”