COVID-19 and its implications for businesses

On Monday (Feb 17), Singapore’s Ministry of Trade and Industry (MTI) downgraded its economic growth forecast to between -0.5 and 1.5 per cent, indicating a possible recession as a result of the weakened outlook following the outbreak of the coronavirus.

It is likely that many other countries will start lowering their forecast for the year over the next couple of weeks. The overall impact on each economy will differ, depending on the composition of each economy, the length and severity of the outbreak in China and in each of the respective economies. Countries reliant on tourism (especially Chinese tourists), dependent wholesale trade & logistics, meetings, exhibitions, conventions and exhibitions (MICEs) as well as on China as a final demand destination, will be particularly hard hit. This includes economies such as Singapore, Thailand, Vietnam, and Hong Kong.

Of course, China itself as the epicentre will be the most affected. An analysis by Deutsche Bank estimates that Q1 GDP will be revised downward by as much as 1.5% points in China, to 0.4% points in Japan and other parts of Asia [Exhibit 1].

Exhibit 1: Impact of Coronavirus on GDP

In terms of air travel, China outbound flight bookings took a nosedive. According to the Moodie Davitt Report, China outbound flight to the world (excl Hongkong and Taiwan) reversed from a 7.3% YoY growth on 19 Jan 2020 (before travel restrictions) to a 6.8% YoY contraction as of 26 Jan 2020 (after travel restrictions). Particularly, outbound flight bookings to Asia Pac tumbled -15.1% YoY after 26 Jan compared to a slight -1.3% YoY decline on 19 Jan.

Given its proximity to China and status as an international air hub, it is little surprise that Singapore is the hardest hit, with an estimated 38% loss in international airline capacity from China. This is closely followed by Thailand (34%), Hong Kong SAR (32%) and Taiwan (29%), based on data from 20 Jan to 3 February 2020 [Exhibit 2]. The fallout is likely to be even greater as more countries impose travel restrictions.

Exhibit 2: COVID-19 coronavirus impact on airline capacity from China 2020, by market

In China, businesses are reeling from this outbreak, especially small medium enterprises (SMEs). 85% of enterprises reported not having enough cash balances to last for more than 3 months. One third of enterprises’ cash balances will not last more than a month [Exhibit 3].

Exhibit 3: Share of enterprises having sufficient cash balance for operation during coronavirus COVID-19 outbreak period in China as of January 2020, by time length

Of these enterprises, 63% cited financial pressures stemming from labour cost and social security contributions, 14% loan repayment and another 14% rent [Exhibit 4]. 22% of these companies will be looking towards layoff and salary reductions to ease cash flow shortfalls while another one-fifth will be looking to take up loans to do so.

Exhibit 4: Share of enterprises facing financial pressure during the outbreak of coronavirus COVID-19 in China as of January 2020, by type

China’s central bank has provided 200 billion RMB of one-year medium term loans on Monday (17 Feb) and lowered the interest rates by 10 basis points to 3.15% to help cushion the impact of the epidemic. Since late January when the outbreak worsened, China’s authorities have announced small rate cuts, early bond sales, and other targeted measures to calm markets and is likely to continue doing so.

While growth in new suspected cases have fallen in the past few days following a redefinition, the situation remains fluid with Chinese workers gradually returning to work after the spring break. Despite the evolving situation, some of the key longer-term implications for businesses have emerged.

Core implications for businesses

Diversification from a single country sourcing and demand destination

As the coronavirus epidemic drags further, it is becoming increasingly clear that companies that are heavily exposed to China - both as a sourcing or demand destination, are bearing the brunt of the impact. Case in point, share prices of US firms with high China sales exposure have fallen by 5% on average by 6 Feb compared to a 2% gain in the S&P 500 index. While China is now the largest manufacturer in the world and will eventually become the biggest consumer markets in the world, the COVID-19 crisis exposes the fragility of having all the eggs in one basket. Today, it is China; tomorrow, this may possibly happen in any country.

Businesses will increasingly need to look to diversify from a single source of supply and demand. Companies will have to globalise, diversifying beyond their local shores. From a supply chain perspective, companies may have to relook at locating their productions and/or the entire portion of a value chain in a single location.

While economies of scale, contract manufacturing and just-in-time management brings about huge gains in efficiency and productivity, years of gains may be write-off from just a single event. Companies from Samsung, to Foxconn and Fiat Chrysler all had their productions disrupted to varying degrees. High tech industries, given their relative limited number of alternative sources and lowest number of days of inventory buffer, are most at risk.

Will this reverse some of the entrenched thinking around economies of scale, contract manufacturing and raise the requirements on level of redundancy?

Growing importance of digital economy

While the fallout is still unclear, one thing for sure is that the online share of the economy had been given a big boost from the ongoing epidemic. As people avoids physical interactions to minimise contagion, they are turning online to fulfil their consumption of goods and services. This includes moving from cash to mobile payment, offline to online education, from physical retail to ecommerce, from cinemas to online video streaming. This change in habit which otherwise might have taken years to cultivate, have now converted in a matter of weeks.

Businesses will need to hasten their digitization efforts and be increasingly ready to conduct their operations and sales digitally. On the other hand, online businesses such as ecommerce marketplaces will also need to evaluate their ability to continue operations if the physical portion of their value chain (e.g. manufacturing) takes a hit.

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The original article can also be found on KeyHole Insight's blog @ www.khinsights.com.

Kok How Lee is an Entrepreneur, Consultant, Strategist and Economist. He founded KeyHole Insights - an economic & strategy consulting firm focusing on Asia, in particular China and Southeast Asia, delivering customised advice to help organisations make better decisions, implement those decisions and deliver success.

Kok How graduated from the Tsinghua- INSEAD Executive MBA Programme in July 2019. He also holds a MSc (Financial Engineering) and BSc (Economics) degree from the National University of Singapore.