Editor's Note: This Stratfor analysis examines the potential economic impacts of the ongoing coronavirus outbreak; be on the lookout for further pieces on specific sectors in the days ahead.
The coronavirus outbreak that has thus far killed scores and sickened thousands in China is set to deliver a significant blow to its already-weakening economy. Quarantines and travel bans enacted to limit the spread of the illness have disrupted what is usually the country's busiest travel and spending periods of the year, the Lunar New Year holiday that began Jan. 25. Public transportation, including trains, planes and ferries in and out Hubei province, whose capital, Wuhan, was the epicenter of the outbreak, have been suspended, curtailing the freedom of movement for some 60 million people.
The lockdowns have also created major supply chain disruptions in the province, a major manufacturing center for automobiles, fiber optic cable and machinery and a key Chinese transit hub. The disruptions are not limited to the province, however, and business and industrial activities across the nation, already substantially slowed or even suspended over the past week, will likely continue to suffer until the outbreak is contained. Even if that occurs within a matter of weeks, China could experience the ripple effects of the disruptions for some time.
Chinese authorities have imposed strict measures, including travel bans and quarantines, to try to contain the fast spread of a coronavirus that apparently originated in the strategic central city of Wuhan. The outbreak will inflict substantial, but potentially short-term, costs and supply chain disruptions on the Chinese economy — but the longer the outbreak lasts and the farther it spreads, the more serious the consequences for China and the rest of the world.
Given the virus' relatively long incubation period (up to 14 days), and the fact that as many as 5 million people left Wuhan between the emergence of the initial case of infection and the Jan. 23 lockdown, it will take at least two to three more weeks before the effectiveness of Chinese emergency measures becomes clear. The preventative measures will likely limit the scope of broader global economic disruptions. But even so, many countries will find themselves vulnerable to the outbreak's economic impact, which will include everything from fewer Chinese tourists to supply chain disruptions.
In the short term, the outbreak is expected to cut further into Chinese economic growth, already at its slowest pace in three decades as long-term structural economic transformations and the trade war with the United States unfold. Efforts to manage the coronavirus crisis have already delivered a major blow to China's transportation, retail, restaurant and tourism sectors, which are unlikely to recover before the outbreak is contained. In 2019, consumption reached $149 billion during the seven-day Lunar New Year holiday, roughly 2 percent of the country's annual total. (Domestic travel accounted for $76 billion of that figure.)
Dips in consumption and business activity will create short-term pain at a minimum, compelling officials to use fiscal stimulus and investments to try to arrest the economic slowdown. But past experience suggests that once the outbreak is contained, these sectors could rebound quickly. During the outbreak of severe acute respiratory syndrome in 2003, China's retail sales growth bottomed out at 4.3 percent of economic activity in May, when SARS cases peaked, but rebounded to 9.7 percent in the third quarter after the situation came under control.
Meanwhile, the timing of the current outbreak was fortuitous for the broader economy in that industrial activity already tends to slow down during the weeklong Lunar New Year period as workers take extended vacations. Should the outbreak linger, however, those sectors will be hit harder. In a bid to contain the disease, national authorities have extended the holiday period by three days, with local authorities in some cases extending it even further. For instance, in Shanghai, the holiday will now run until Feb. 9, while some factories in Guangdong province are set to stop production until the end of February.
The extended suspensions will inevitably weigh on China's industrial, manufacturing and commercial output. Some economists calculate that the coronavirus could cut Chinese economic growth by anywhere from 0.5 to as much as 1.5 percent in 2020. By comparison, SARS was estimated to have cut China's GDP by 1.1 percent in 2003, with annual growth at 10 percent, when the Chinese economy was only a quarter of its current size in real terms. But while the broader economic impact of the current outbreak on China cannot yet be assessed, it is clear that the outbreak will deal a major blow both to Wuhan, the seventh-largest city in China and the largest in central China, and to Hubei province, with an economy and population that account for roughly 4.5 percent of the national economy.
Why What Affects Hubei Affects China … and the World
Hubei province sits at China's geographic heart. It is at the intersection of the country's most critical road, rail and water transportation networks and is central to national development strategies, such as the "Yangtze River Economic Belt," designed to promote regional industrial development.
In terms of logistics, the province features the country's fourth-longest expressway, at 6,204 kilometers (3,855 miles) and 10th longest railway (5,200 kilometers). They connect Hubei with its six neighboring provinces and thence to the rest of the nation. It also hosts the longest section of the 6,300-kilometer-long Yangtze. This makes Hubei a key part of the national waterway that connects industrial powerhouses on the upper Yangtze such as Sichuan and Chongqing and central inland provinces including Henan and Hunan with the eastern coast. In 2018, 1 billion passengers and 2 billion tons of goods including manufacturing products, metals, coal and grain moved via Hubei's expressways and waterways, accounting for roughly 7 percent and 4 percent, respectively, of the national total.
And Wuhan itself is the largest water, land and air transportation hub in central China. It also serves as a main freight hub along the China-Europe railway under the Belt and Road Initiative, which regularly sees shipments of electronics, auto parts and food made in China into European markets via Paris, and Hamburg and Duisburg in Germany.
Industrywise, in 2019, Hubei produced the country's fourth-highest number of cars, accounting for 8 percent of national production. The city of Wuhan alone produced 7 percent of the national total and hosts many domestic and multinational manufacturers, such as Dongfeng; the second-largest automaker in China; Geely; Nissan; GM; and Honda, along with roughly 500 auto parts suppliers. The province is also a traditional production base for steel and iron, petrochemicals, and equipment and machinery manufacturing, and in recent years it has emerged as an important tech center.
Wuhan hosts a large high-tech cluster that is home to IT, biotech, artificial intelligence and semiconductor companies, some with global prominence and all benefitting from the large number of universities and scientific research centers in the city. Wuhan's optical fiber cable and optical devices manufacturers accounted for two-thirds of the national total and 25 percent of the global market share. Yangtze Optical Fiber Cable is the world's largest supplier of optical fiber. The city also ranked third in growth in the semiconductor industry in China and 10th in size in the country in 2018, and hosts the headquarters of Yangtze Memory Tech and a number of research institutes for Huawei, MediaTek and Synopsys.
At least in the short term, the extended lockdown of Hubei will directly disrupt the supply chain of a number of industrial sectors. This will affect hundreds of multinationals with operations in the province, including IBM, Microsoft and Siemens. The traffic cutoff will meanwhile increasingly threaten to disrupt shipments of goods and raw materials that transit Hubei, causing costlier diversions to other provinces.
Extended travel restrictions will have ripple effects on many of its neighboring provinces in terms of supply chain disruptions and a labor drain. Because Hubei is home to large numbers of technicians, researchers and low-cost migrant workers with jobs in other provinces, their inability to return to work will likely result in short-term labor shortages in provinces with significant volumes of labor-intensive industries. Foxconn, for example, has already expressed concerns about potential labor shortages in its factories in Guangdong and nearby Henan province that manufacture components for the iPhone.
And even if the outbreak is contained in the coming weeks, the economic costs might endure. As the global supply chain continues to evolve in the face of increasing production costs in China amid the U.S.-China trade war, a sustained lockdown of Hubei for several weeks or months could prompt some multinationals to reduce their business presence in China, adding to the latter's economic woes.
At this point, the economic impact of the coronavirus appears mostly confined to China. The country's firm response seems to have limited disruptions to the broader global economy, though this could change in some countries that experience secondary outbreaks. That said, China's vast share of the global economy means anything that happens there will have an outsized effect elsewhere. During the SARS outbreak 17 years ago, China's share of the global economy stood at 4 percent; now it is 16 percent. The magnitude of outsiders' transportation, trade and supply-chain integration with China are dramatically higher. China's demands for energy and goods from the outside world alone mean the coronavirus outbreak will have major global ripple effects.
The outbreak will continue to unsettle the global market at least in the short term. It has the potential to hit oil demand hard in the first half of the year given that China accounted for about two-thirds of global demand growth in 2019. Countries heavily dependent on Chinese tourism and trade, such as Thailand and South Korea, will particularly suffer. The length and spread of the outbreak, in large part, will ultimately determine how hard a global economy already on edge is hit.