The Economy Following COVID-19: The State Advances, Private Sector Retreats
By Edward Hsieh
The impact of broken supply chains has exacerbated an already uncertain economic outlook in China. Its leadership is expected to implement new fiscal and monetary policies to maintain stability. China and other countries must still hope for the best and prepare for the worst.
China’s official case count for the COVID-19 virus now exceeds 70,000, with over 2,000 deaths, exceeding the numbers of the 2003 SARS outbreak. We should not be sanguine about future prospects. As the pandemic impacts China’s economy and finances, the banking industry must increase its alertness to risks as well as possible opportunities.
The Possibility of Supply Chain Failure
As we know, the direct effects of the outbreak included the extension of the Spring Festival holiday across China, the suspension of cross-province passenger transport, and various forms of lockdown. These measures are understandable for a matter of life and death, but they have broken manufacturing chains to various degrees. Even if manufacturers in some cities have re-opened, some employees are still unable to return to work. Meanwhile, due to official demands or protective initiative by freight drivers, local logistics has still not reached its prior levels, delaying delivery of raw materials and semi-finished and finished products, further impacting manufacturing from the logistics side. Although 13 major express delivery companies, including the Five Express Companies and Deppon, have gradually resumed operations, the logistics industry is still facing staffing problems, restrictions by residential communities, and traffic controls in some areas, causing ‘last mile’ challenges.
Overall, production interruptions are still widespread. The resulting fragmentation is certainly helping the pandemic situation, but it is also seriously threatening China’s and Taiwan’s upstream and downstream manufacturing cooperation and management, previously a point of pride.
In addition, some public and private financial institutions have been unable to start operations as scheduled, affecting cash flows. Aside from impacting bank operations in some regions, manufacturers’ operations, investments, and financing cash flows are being affected by the inability of banks, stockholders, and upstream/downstream counterparties to operate on schedule, breaking financial chains. Successive problems have emerged. Financial supervisors have launched a variety of measures including large repos, proactive credit line increases, and continuation for overdue loans, confirming the impact of the pandemic.
The Important Task of Economic Stability
The current situation has added to the risks already present in China’s economic outlook. People are unable to work, capital is unable to earn interest, commodities cannot be used, and logistics are being interrupted, directly affecting manufacturing exports and investment, which in turn feeds back to service consumption. Even if the manufacturers are operating smoothly now, they will face short-term logistics competition for raw materials and semi-finished products. Whoever has access to supplies will profit. Data including industrial output, retail sales, and the Consumer Price Index (CPI) and Producer Price Index (PPI) can reflect the current outlook. Meanwhile, 2020 was also when the Party was expecting to the 13th Five Year Plan, “building a well-off society in an all-around way,” and the two doublings (GDP and per capita GDP) to pay off. China is expected to implement more fiscal and monetary policies, and based on its current leadership’s strong support for state capitalism, the private sector may continue its retreat. Of course, with these expansionary policies, the timetable to resolve the country’s enormous debt problem will be extended further.
Four Major Financial Risks
Regarding Taiwan, a market contagion effect exists in its traditional finance industry. A financial crisis in one place can spread elsewhere through trade or financial flows – a phenomenon that has become more pronounced with deeper globalization. The Investment Commission of the Ministry of Economic Affairs calculated that as of the end of 2019, Taiwan’s cumulative investment in China was US$ 186.512 billion; the Bureau of Foreign Trade calculated that its 2019 trade with China was US$ 149.281 billion, and the Financial Supervisory Commission calculated that as of December 2019, Taiwanese banks had issued NT$ 1.6453 trillion to China in credit, investments, and deposits. Clearly, Taiwan’s and China’s economic and financial systems are inextricably linked. Isolation policies akin to bulkhead isolation in ships can be used to stop the spread of the disease, but the close cross-strait economic, trade, and financial connections cannot be broken this way. At best, securities buyers can temporarily cool market fears through circuit breaker mechanisms. Meanwhile, it is difficult to avoid risk in indirect bank financing.
Based on all of this, the following risk warnings are in order. First, banks previously believed trade financing was lower in risk. Because they focused on the transaction basis and did not collect outside collateral or other credit guarantees, creditors’ upstream and downstream supply chain capital or broken operating chains may now influence cash flows, directly reflected in deteriorating liquidity or creditworthiness. Even if policy-side technologies may delay defaults, it is still necessary to pay attention to customer defaults and liquidity risk. Second, local financial crises may be triggered in decentralized and weaker urban and rural commercial banks, and even in leasing companies due to deterioration in clients’ credit situation or the banks’ own low resistance to credit risks. (See Fig. 2 for non-performing loans in each type of commercial bank.) Notably, the events since 2019 in Baoshang Bank, Jinzhou Bank, HengFeng Bank, and Harbin Bank have been repeated, or even exacerbated. Third, consumer sentiment has impacted industries like tourism, retail, department stores, F&B, and air travel. If the employment market is affected, the real estate industry will also be hit, and will also have impact on corporate and consumer financing. Evergrande Real Estate, for example, announced a series of discounts on February 17, so that 613 properties in China would be sold at a discount of 25%, and 22% during March. Fourth, over a half year of anti-extradition protests, in addition to this pandemic, have further confirmed that Hong Kong cannot extricate itself from the influence of the mainland, shaking international confidence in its status as an independent financial center. Trends in its capital markets and even overall financial industry are unfavorable. The status of several planned IPOs and SEOs will be important to watch.
New Business Opportunities:
Stay-at-home Economy, Health Care
In summary, just as how existing threats like the influenza and the enterovirus, in addition to just COVID-19 itself, cannot be ignored in local public health, the impacts of pre-existing economic and financial risks aside from the pandemic such as gradual deterioration in China’s economic environment, debt, a real estate bubble, and the trade war, may range from individual credit risk to a reshaped global industry chain. Of course, this pandemic brings not only risks and challenges, but also new opportunities. E-commerce and online retail will serve the ‘stay-at-home economy.’ Jingdong (JD.com), for example, may come out ahead due to its supply chain advantages and its large investment in JD Logistics over many years. Healthcare and drone applications may also become future opportunities. Both the public and private sectors are expected to invest heavily, which will be significant for the banking industry.
Finally, recalling the famous words of former British Prime Minister Churchill during World War II: “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” It’s important to keep a close eye on how China's economy responds to the ongoing pandemic. To be sure, there will be a short-term impact, affecting the pillars of consumption, investment, and exports. The author expects this period to include at least the first two quarters of 2020. Further, changes already in progress that will have medium and long term effects can provide a glimpse into global supply chain rebalancing. Some manufacturers have accelerated their migration from China. (The main previous waves of migration were the result of SARS in 2003, the labor contract law in 2008, the social insurance law in 2011, and the trade war since 2018.) China will be hard pressed to grow as quickly as it did in the first four decades after reform and opening up, especially following the years immediately following its 2001 accession to the WTO. With that in mind, banks must change their outlook accordingly. In light of these changes, as well as the fact that existing funds cannot immediately be moved out, to expand business locally, it is important to pay attention to the trend in which “the state advances, the private sector retreats,” and to follow local industry and consumption trends. (The author is Deputy Director of the TABF Publication and Communication Institute)