There is some positive news in China where case numbers have been dropping significantly and factories are anticipating the return of workers and a move back towards full production. However, heavy reliance on the mainland for mass production of consumer goods has left global markets counting the cost of limited supply chain options and the difficulty of maintaining stability in the face of this major shock to the highly globalized economy.
And with full factory production still a work-in-progress in China, there is a potentially greater economic threat looming due to a sudden fall in consumer demand in countries around the world.
Just as it is important to re-balance an investment portfolio in the face of challenging market circumstances as explained here, so is it essential to review an existing supply chain and consider spreading the risk through the diversification of production.
How are global markets responding to Covid-19?
The high transmission rate of Covid-19 has placed a large proportion of the world’s population at risk and governments are now aiming to ‘flatten the curve’ and slow infection rates in order to avoid overwhelming local health services. Stricter regulation has led to widespread ‘social distancing’ with limited interaction as schools’ lessons stop, university campuses close and people increasingly work from home, shunning meetings and any large-scale social activity.
As many global markets have entered a phase of inactivity, opportunities to spend money are significantly restricted. The hospitality and travel industries were first to be hit, but almost all types of economic activity have quickly been impacted. Confidence is heavily affected too, with companies struggling to maintain a regular level of business as revenue drops dramatically. The result is a struggle for survival with staff layoffs almost inevitable. This phase of rapid escalation for Covid-19 means that a return to normal daily life is likely to be postponed and the risk of global recession is growing increasingly real.
Three potential outcomes for the current crisis
There is considerable uncertainty about how the Covid-19 crisis will play out because this virus strain only recently emerged and it is not yet well understood. There are a range of issues that make its progress unpredictable, including seasonality (whether it survives well in the warmer temperatures of a northern hemisphere spring and summer) and the impact of undetected, milder cases (the risk of as asymptomatic transmission). The possibility of re-infection by returning citizens also holds the potential to raise patient numbers once more in markets which are initially considered to be improving (such as China). With a fully tested and approved vaccine unlikely to be available for many months, it is difficult to know the ultimate effect of Covid-19 on global health and economic activity. Below we look at three possible outcomes for the current crisis:
1/ Quick Recovery
According to the COVID-19 Briefing Notes published by McKinsey & Company, this most optimistic scenario accepts that there will be a continuing growth in the number of cases due to the high transmissibility of the virus, which in turn will lead to a strong public reaction and a fall in consumer demand. However, with effective steps taken by governments to achieve control in a manner similar to China, the peak of public concern may come within just a few weeks. Given the low fatality rate among children and working-age adults, it is expected that levels of concern may diminish even while the disease continues to spread, while older people – and especially those with underlying conditions – take extra care to protect their own health. Most citizens are likely to adopt more careful behaviour – including social distancing – and there is an assumption that the virus is likely to be seasonal and will be significantly impacted by the warmer weather of spring and summer.
Under this scenario, global GDP growth will fall from the previous estimate of 2.5 percent to about 2 percent during 2020, with China making the biggest contribution to the fall (down from 6 percent to about 4.7 percent); East Asia falling 1 percent; and other large economies around the world down by around 0.5 percent. China is expected to restart factory output (although customer confidence on the mainland might only recover by end of Q2 2020).
2/ Global Slowdown
This scenario assumes that gradual control of the virus worldwide takes place somewhat slower than was achieved by China, and that high transmission rates occur across Europe and the US, but on a localized basis, because of effective government counter measures and social distancing implemented by individuals and firms. The expectation is for some spread across Africa, India, and into other densely populated territories, but the transmissibility of the virus will decline naturally with the onset of the northern hemisphere spring.
For the United States, there is an assumption of between 100,000 and 500,000 cases in total with one major epicentre that has 40 to 50 percent of all cases, with two or three smaller centres totally a similar amount and the remainder spread more widely. This reaction may last for six to eight weeks in cities with active transmission, and three to four weeks in neighbouring towns. The resulting demand shock can be expected to cut global GDP growth in half during 2020, reducing it to between 1 percent and 1.5 percent. This will put the global economy into a slowdown but not into full recession.
In this scenario, a global slowdown would affect small and midsize companies more acutely than large corporations, while less developed economies would suffer more than advanced markets. Not all sectors would be equally affected: service sectors – such as aviation, travel, and tourism – would likely to be hardest hit, with airlines suffering a steep fall in traffic in the busy summer season leading to bankruptcies and market consolidation.
The steep drop in consumer confidence would likely mean that much market demand is delayed. This has implications for many consumer product companies (and their suppliers) which operate with limited working capital and a narrow margin for profitability. Demand is anticipated to rise in May–June as concerns about the virus diminish. Most other sectors would also be heavily affected due to the drop in national and global GDP, with oil and gas, for example, adversely affected as oil prices stay lower than expected until Q3.
3/ Pandemic and Recession
This scenario is similar to the global slowdown outlined above, except that it assumes that the Covid-19 virus is not seasonal and will not be moderated by spring warming in the northern hemisphere. High levels of reinfection by travellers crossing national borders may also add to the continuing case growth which is expected through Q2 and Q3, potentially overwhelming healthcare systems around the world and delaying the recovery in consumer confidence to Q3 or beyond. The severe economic impact of this most pessimistic scenario is likely to result in a full recession, with global growth in 2020 falling to between –1.5 percent and 0.5 percent.
Reducing the strain of Covid-19 on the supply chain
The wide range of possible outcomes to the current crisis reflects the fact that there are still many unanswered questions about the full effect of the virus.
However, there is little doubt that Covid-19 is a major black swan event impacting healthcare on a global scale and significantly slowing the economy in a way that few crises have achieved in recent history.
This is a major test for the global supply chain at a time when they are already under pressure from the prolonged US-China trade war. While China’s role as the major producer of goods is still unchallenged, the impact of Covid-19 has underlined the risk of depending on a single source for manufactured goods and components – no matter how efficient and cost-effective.
China is likely to see a 0.2% to 0.5% reduction in GDP – equivalent to as much as 500 billion renminbi, according to Bain & Company – the impact of Covid-19 is likely to be as much as five times than the SARS crisis of 2002-3, with many hard hit industries including food and beverage, discretionary consumer products, automobiles, electronics, machinery, electrical equipment and traditional retail businesses.
In view of the above, each importer or brand with a vested interested in mainland production needs to ask some key questions, starting with: ‘How resilient is our supply chain’?
Each business needs an intimate understanding of every one of its suppliers – not just the main factories, but also the second and third tier subcontracted partners. The goal here is to identify problems before they become major issues that impact delivery schedules. For example, lithium ion batteries are key components in many electronic goods that alone can disrupt supply chains for electric vehicles, personal computers, cell phones, power tools and electricity grid storage systems.
With a greater depth of knowledge, the next question to ask is: ‘How can we successfully diversify production?’
Weaknesses in the supply chain highlighted by the current crisis can then be addressed by diversifying the source of production to include other manufacturers at a similar cost level in Asia or even relocating part or all of the manufacturing process closer to home.
Finally – and perhaps the most urgent question: ‘How secure is the financing of our current suppliers?’
It is important to remember that manufacturers sometimes face cash flow issues when handling large scale orders for international clients and at a time of economic uncertainty they may confront challenges that can disrupt business and place important orders at risk.
Customers with strong finances can leverage their banking relationship to help fund supplier invoices and solidify their partner’s position through Invoice Discounting or Factoring via an online platform such as Velotrade.
The ability of Discounting and Factoring platforms to reprice such short-dated assets or to decline to trade ensures that assets presented to investors remain safe and that a thorough risk assessment has been performed.