China’s Choppy Road to Recovery
Author: Regina Chi
May 4, 2020
Westerners looking for signs of hope that their day-to-day lives – and their economies – will return to “normal” sooner rather than later might wish to consider how far China has come. It is largely back to work. The Chinese government began lifting their draconian coronavirus restrictions in March, and parts of the economy have come back to life. According to a recent McKinsey & Co. analysis, almost all of China’s major industrial enterprises had resumed production by the end of March, as had more than 90% of all government-owned firms and about three-quarters of SMEs outside Hubei province, the epicentre of the outbreak. Today, China is operating at an estimated 80% to 90% of economic capacity – a remarkable spring-back from the lockdown situation of only a few weeks ago.
So, yes, China provides some hope to other regions still in the midst of dealing with the COVID-19 pandemic. But that hope should be tempered by the very real potential that its recovery will be bumpier than preliminary indications suggest. The robust March Purchasing Manager’s Index (PMI) data – including a mere 1.1% decline in factory output – could prove to be an anomaly. In fact, we anticipate a weaker than expected recovery in the second quarter, suggesting that what looks like a V-shaped recovery for China could end up as more of a W. Moreover, we see the COVID-19 environment accelerating existing secular trends in globalization and technology, which will have significant long-term implications for China, other emerging markets (EMs) and the global economy.
China will play a central role in the unfolding COVID-19 story, as it has already. Its effective shutdown and corresponding decline in output disrupted global supply chains, but the dynamic is now shifting. Rather than a lack of output, China faces a decline in demand from Western economies that are in their own lockdowns. In effect, China’s production could be all revved up with no place to go.
The same goes for other countries in the global trade region, which could well get hurt over the next several months by the lack of Western demand – a challenge aggravated by continuing disruptions in supply chains. It’s wise to remember that global supply chains don’t flow one way. In many Asian manufacturing centres, critical components – especially those that are high-tech, proprietary and of very high quality, such as sensors and semiconductor equipment – are still often sourced from the United States and the European Union, where manufacturing facilities are largely closed due to the lockdowns.
China’s export sector is better insulated against those shocks than other EMs. According to a study by HSBC, the export economies of Singapore, Taiwan, Malaysia, Vietnam and South Korea are the most exposed to global value chain disruption. Singapore tops the list because about two-thirds of its exports incorporate components from at least two other markets.
Clearly, then, the timing and effectiveness of developed markets’ reopening is critical to the shape of economic recovery in the short term. But what about the longer term? We see several likely trends. One is over-arching: an intensification of the move away from globalization and toward regionalization. The COVID-19 environment has exposed inherent risks in globalized supply chains, and business leaders will be increasingly looking for ways to mitigate. We expect greater diversification in supply chain nodes, particularly away from China – a trend that was occurring already before the pandemic, and could benefit other emerging markets in the long term.
On a more general level, localization will be the new buzz word, as governments and manufacturers strive to reduce their dependence on one another (especially, and most obviously, when it comes to healthcare supplies). Local supply chains will become more robust and more decentralized. One potential upside: a revival of global industrial capex, which has been sluggish for the past couple of years.
The COVID-19 environment and social distancing could also accelerate the secular trend toward automation. The pandemic has exposed new risks to the supply chain of a human labour force, and not just in manufacturing: some service industries (think fast-food restaurants) could also see more automation. Relative to the rest of the world, robotic density in Asia remains low, so there is room to grow.
In short, the recovery from the COVID-19 environment in China and the rest of the world is likely to be choppy, at best. And the outcome is unlikely to be a return to “normal,” but rather a global economy that is less globalized. It might also be less reliant on humans, which could have important ramifications for traditionally low-labour-cost emerging markets.
Obviously, much depends on the pathology of the pandemic itself. Yet if it turns out to be less an acute crisis than a chronic condition, the most pertinent question isn’t whether the global economy will recover, but how it will adapt.
Regina Chi is a Vice-President and Portfolio Manager at AGF Investments Inc. She is a regular contributor to AGF Perspectives.
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