How China's Lockdown Will Cause Ripple Effects in the World's Global Supply Chain

Reeling under the pressure of a sudden Covid outbreak, Beijing is planning to impose stricter lockdowns and restrictions to curb the spread of the virus in China.

Shanghai, among other cities, is now at a standstill, with a record high number of cases since the new wave emerged. “Control Management” is the official stage of the Chinese response, where citizens cannot leave the area during testing. The tourism industry is also likely to take a hit as screenings have been upped among tourists.

This kind of response is consistent with China's "zero-Covid" policy, which aims to eliminate Covid spread during an outbreak. However, as it faces its most difficult challenge yet, this policy is struggling to understand its future. Depression and rage are looming among citizens who are unable to access medical care and food as a result of the unplanned lockdowns.

Despite assurances from authorities, citizens are panic buying to avoid a supply-less lockdown in many cities that are undergoing mass testing.

Governments and businesses around the world should be concerned about a supply-short summer, not just Chinese citizens. From disruptions in supply chains to acceleration in inflation, the systemic effects could throw the global markets off the balance if not properly handled.

Chinese Reaction

The most immediate impact appears to be a reduction in consumer spending and disruption in the production and distribution of goods. This situation exacerbates the already sluggish property market caused by negative economic activity. The rise in global commodity prices caused by the Russia-Ukrainian war has also had an impact on Beijing's commodity-importing tendency.

To counteract these negative factors, the People's Bank of China (PBOC) implemented a monetary policy that reduced the Required Reserve Ratio by 25 basis points in order to improve liquidity and spending. However, it is unclear whether banks will be willing to lend money in this economic climate.

To avoid falling into the Keynesian liquidity trap, China has implemented a supportive fiscal policy by increasing infrastructure spending.

Any aggressive implementation of the zero-Covid policy, on the other hand, will cause economic disruption across the country, and it is unclear how China will prepare for an increase in cases and hospitalizations if Omicron spreads nationwide.

Meanwhile, the Federal Reserve is raising interest rates, which may render the PBOC's monetary policy largely ineffective, as the PBOC will be forced to stabilize the exchange rate by selling reserves.

The PBOC is caught in a bind as other central banks tighten monetary policy in response to the US Federal Reserve's decision to reverse asset purchases by raising interest rates.

Supply Chain Disruption

China’s pedantic approach to curb COVID has resulted in jammed ports and highways, deserted workers, and numerous closed factories. These disruptions are rippling throughout the global supply chain, affecting everything from iPhones to automobiles.

Although some companies like Foxconn and Bosch practice the “closed-loop” management by isolating the workers inside, it is becoming increasingly difficult to get raw materials and ship them due to strict curbs. According to some companies, logistical issues only allow them to operate at 60% capacity. However, Pegatron Corp, the iPhone assemblers, has suspended production and expects no sales for the next two months.

EV companies like Nio, have halted production, not because of curbs but because work has stopped from suppliers. Supply chains operate in a systematic manner, the decision is simple. You can continue to make the main parts, but if your suppliers who make the small parts stop showing up to work, you won't be able to make the main parts for much longer. So what do you do?

Trucker’s Dilemma

Truck transportation, which is the primary mode of transporting goods to ports as well as delivering raw materials to factories, is taking a heavy toll as a result of never-ending lines, delays, and price increases. In the span of three weeks, Procurenet has seen truck rates rise 400% across the industry, for a domestic transport that used to cost 7000 yuan ($1,064 USD) now costs 30,000 yuan ($4,561 USD) to deliver. To make matters worse, subcontractors are working at a loss to keep their companies afloat. The stringent requirements requiring a negative PCR test within 48 hours, make it extremely difficult to find operable drivers in cities like Shanghai and Xuzhou.

Jammed Ports

To provide a ray of hope for foreign businesses, the European Chamber of Commerce in China sent a letter to the government requesting that the issue of supply chains be addressed. China alone accounts for 30% of global port backlogs, and the current situation indicates that things are about to get even worse.

Experts believe that the full extent of the impact will be felt only in the coming weeks. If China continues with the lockdown, ports will see more missed shipments. Maersk, the Danish shipping company, has asked its customers not to unload at the congested Shanghai port. The northern port, however, is unable to accept all cargo ships due to capacity constraints. Because Shanghai's port is the largest in the world, most cargo must still be loaded and unloaded there.

Despite China's efforts to mitigate the impact of the restrictions by promoting the closed-loop system, the number of "stuck" vessels in Shanghai has more than doubled in a year to 118. Even if things improve and the lockdowns are lifted, US ports will have to accommodate all of the stored cargo from the reopened factories, resulting in higher freight rates and exacerbating the situation. The bottleneck at the port also creates an economic "domino effect."



Shipping companies have already informed Procurenet that they intend to raise general rates (GRI) from Asia to the United States by $1,000 to $2,000 USD, resulting in a net increase in freight rates of 10-20%.

In the midst of this, ING is one of many banks that now predicts a bleak economic growth for China, recognizing that its projected rate of 5.5 percent is becoming increasingly difficult to achieve.

The market reaction to the supply chain disruption may still take a month to digest, but it will certainly take even longer to stabilize back to normal.

Iris Pang, Chief economist of China warns about the impact of the Chinese COVID crisis on global growth rates. In an increasingly global world, the problems of China are problems of the world.

Global Financial Markets

After a month of falling Chinese markets, foreign investors are bracing for a second month of outflows as a result of the new restrictions. After Russia, China has the worst-performing stock market, with mid-cap and large-cap stocks falling by around 20%.

The Chinese stock regulator continued to be bullish on the Chinese economy, urging institutional investors to invest in equities to smooth out short-term fluctuations. As the country braces itself for a new wave of COVID, the Chinese stock index has dropped by as much as 5% in April alone.

A drop in the Yuan and an increase in US treasury bonds have kept bond investors mostly on the sidelines. More than $17 billion in Chinese bonds were sold, representing the largest outflow in recent memory.

Foreign holdings of Chinese Government Bonds are expected to fall in the coming months as the yield advantage of CGBs erodes and global bonds sell off. Furthermore, the PBOC is not cutting rates as aggressively as expected.

Inflationary Shock

According to analysts, this round of Chinese lockdowns will have a stronger affinity for global inflation. The main reason is the increased global reliance on China since the beginning of the first pandemic, as evidenced by a 15.4% increase in Chinese exports since 2021.

The macro-implications of the lockdown are significant, and neither the markets or any of us have factored them in. Cargo exports are five times higher and air freight are two times higher than before the pandemic. This means that more of the inflationary burden has been shifted to China's corresponding importers, while China's recovery process has been slowed.

Furthermore, as the leading manufacturer of solar modules, rare earth, ships, PCs, mobile phones, and containers, China has infiltrated virtually every economic aspect of a country, causing the entire world to revolve and be dependent on China.

Previously, China was only a final assembly point, but it now manufactures everything from electronics to components such as IC chips and LCD screens. China's consumer price index also increased at a much faster rate than expected in March.

China emerged as a major player in the auto industry, particularly in the EV supply chain, accounting for 74% of global EV battery production. As the world's largest automaker, accounting for 3.7 percent of total vehicle sales, an increase in freight costs will result in a proportionate increase in automobile prices globally.

Chinese corporations are becoming increasingly concerned as consumer demand in mature markets weakens. This is because of rising inflation and a tightening of monetary policy. Demand pressures combined with supply chain issues will result in an increase in the price of nearly all commodities, which will be borne by the global consumer.

Fear-based actions by corporations will also result in price increases for the average consumer. Experts warn that this effect will be severe, and that it is already being seen in some commodities affected by the Ukraine-Russia conflict. Russia is a major exporter of wheat, aluminum, coal, natural gas, and oil. Ukraine, on the other hand, exports primarily oilseeds and wheat. The outbreak of war means that supply chains, which had been on the mend after nearly two years of lockdown, will be disrupted. Inflation has resulted from this disruption, particularly in food and energy prices. Countries such as Egypt are suffering from severe food shortages as a result of the war. In the end, this impedes global progress, as agencies are now lowering global growth forecasts due to rising inflationary costs and commodity prices.

China's current supply chain issues could trigger a new set of inflationary issues, exacerbating the disruption and create a vicious cycle of inflation and inflation-induced disruption.

This is emphasized by a recent report issued by Bank of America, which stated,"this is another adverse supply shock for the global economy that will lead to prolonged periods of inflation and weakened global growth."

It's also worth noting that transportation costs account for 7.7 percent of global GDP, implying that just these port delays will cause global prices to rise this year. It all starts to add up.

Conclusion

As China struggles with its "zero covid policy," it must reconsider how it addresses its underlying elderly vaccination problem, which is preventing it from reopening. Although China's policies appear to have been effective for less infectious variants, they no longer apply to Omicron. Approximately 40% of Chinese people over the age of 80 have not received a single dose of the Covid vaccine, and approximately 50 million citizens over the age of 60 have an inconsistent vaccination schedule. Inadequate vaccination of the elderly indicates a vulnerability, implying that China will not fully open. As a result, in the coming days, weeks, and months, it must first determine its underlying strategy for immunizing this most vulnerable group.

Until then, global reliance on China and supply chains has resulted in a perfectly timed lockdown that has brought global supply chains to a halt. Furthermore, the immediate increases in freight prices will gradually, if not immediately, result in an increase in the global price of goods. China is now at the helm of an economic upheaval that will begin to have a ripple effect throughout the world. As the one-month anniversary of Shanghai's lockdown approaches, the rest of the world will begin to feel the effects of its supply chain woes.

When there is a supply shock and supply cannot be met in an inflationary environment, demand for goods decreases as a result of the supply chain effect, and when it does not return, the world faces an even more serious economic global challenge.

Gurbaksh Chahal