World economy braces for supply hit as China battles Covid again

If China fails to contain Omicron’s spread, further movement restrictions would derail the economy’s promising start to the year, weakening a key pillar of global growth.
Image: Qilai Shen/Bloomberg

The global economy – already struggling with war in Ukraine and the stagflation risks it’s fanning – is bracing for greater disruption as China scrambles to contain its worst outbreak of Covid-19 since the pandemic began.

Since Wuhan two years ago, China has had relative success in minimising disruption by bringing virus cases quickly under control.

Now, the geographic spread of infections and higher transmissibility of the Omicron variant is challenging the country’s hawkish pandemic strategy of aggressive testing and locking down whole cities or provinces.

If China fails to contain Omicron’s spread, further movement restrictions would derail the economy’s promising start to the year, weakening a key pillar of global growth.

As manufacturer to the world, any disruptions to exports resulting in shortages could also drive up inflation internationally, just as central banks begin hiking interest rates, like the Federal Reserve is expected to do on Wednesday.

“You take all these little paper cuts and you start to add them up and you could be looking at a potential significant slowing of the global economy,” said Jay Bryson, chief economist at Wells Fargo & Co.

Much depends on how quickly China can contain the virus. The nation reported more than 5 000 new infections for Monday for the first time since the early days of the pandemic. While a small outbreak by global standards, it’s prompting officials to lock down more cities, with more than 45 million people restricted from leaving their homes.

Shenzhen’s 17.5 million residents we put into lockdown on Sunday for at least a week. The city is located in Guangdong, the manufacturing powerhouse province, which has a gross domestic product of $1.96 trillion, around that of Spain and South Korea, and which accounts for 11% of China’s economy, according to Bloomberg Economics.

Guangdong’s $795 billion worth of exports in 2021 accounted for 23% of China’s shipments that year, the most of any province.

Bloomberg Economics warns that the restrictions in Shenzhen could inflict the heaviest coronavirus-related blow to growth since a nationwide lockdown in 2020, with the additional threat of sending supply shocks rippling around the world. Morgan Stanley cut its growth forecast for the year to 5.1%, below the government’s target of about 5.5%.

What Bloomberg Economics Says…

The forceful action to contain the worst Covid-19 outbreak since early March will deal a direct hit to the production and consumption sides of a province that accounts for 11% of GDP. Previous steps to contain virus flareups left manufacturing unscathed for the most part. This lockdown will hit output in key industries such as tech and machinery that feed into global supply chains

–Chang Shu, chief economist for Asia

On Monday, residents in northeastern Jilin province were asked not to leave or travel. The region of 24 million people is home to Changchun, an industrial hub of some 9 million that accounted for about 11% of China’s total annual car output in 2020.

Beijing has vowed to reduce the impact of virus controls on the economy by making them more targeted and shorter.

Shenzhen — which is aiming to complete its lockdown in a week during which it will test the entire population three times — and the export hub of Dongguan have both said factories outside the highest risk districts can continue operating if they keep staff in a bubble with regular testing.

Factory shutdowns

Still, manufacturers who were already complaining of rising costs on the back of the Ukraine war are beginning to take a hit.

Key Apple Inc. supplier Hon Hai Precision Industry Co. said it was halting production at its sites in Shenzhen, joining global auto-makers Volkswagen AG and Toyota Motor Corp, which have stopped some operations in the northern province of Jilin.

“Given that China is a major global manufacturing hub and one of the most important links in global supply chains, the country’s Covid policy can have notable spillovers to its trading partners’ activity and the global economy,” said Tuuli McCully, head of Asia-Pacific economics at Scotiabank.

Data on Tuesday showed China’s economy had staged a firm rebound in January and February, led by a strong recovery in household spending and investment by state-owned companies.

But economists cautioned those readings are already in the rearview mirror given developments since the end of February. National Bureau of Statistics spokesman Fu Linghui said Tuesday the lockdowns as well as pressure from rising costs and possible disruption could weigh on growth.

Congestion is starting to build at some Chinese ports, which could push up container freight rates again. Worries over renewed supply chain disruption comes just as US West Coast ports are beginning to process some of the pandemic backlog, helped by a lull after the Chinese New Year holidays.

About 20% of the cargo coming into the busiest container gateways in the US is estimated to be from the Shenzhen region, according to a spokesman for the Port of Los Angeles.

The global impact of a Covid-related shutdown in China could be similar to the blockage that roiled supply chains when a container ship blocked the Suez Canal last year, according to Stephanie Loomis, vice president of International Procurement at freight forwarder CargoTrans, Inc.

“If they don’t let any of these guys go to factories and produce goods, then nothing will move,” she said. “It’ll just stop.”

Whether China’s Covid playbook can continue to contain the virus and minimize negative spillovers to the world will soon become evident, said Zhiwei Zhang, chief economist at Pinpoint Asset Management.

“The outbreaks impose downside risk to China’s economy at least in the next few months,” he said. “A China slowdown would exacerbate the risk of stagflation and global supply chain problems.”

© 2022 Bloomberg

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