This report represents the analysis of the coronavirus outbreak as of 3 March 2020, and, therefore, may be subject to change as the situation develops.
Concerns about the possibility of the Coronavirus (covid-19) becoming a full-blown global pandemic are widespread as the outbreak has grown outside of China. With the number of cases spiking into the thousands in Italy and rising steadily across more European countries, markets and businesses have become increasingly worried about the potential impact of the outbreak on the global economy.
Although the number of confirmed cases of covid-19 in the UK has been quite limited so far, the impact of efforts to contain the virus in China (and other nations) is already affecting the operations of firms in a number of sectors and economic activity more broadly. This article seeks to outline what we’ve learnt of the main impact channels so far.
What are the major channels through which disruption in China may impact the UK economy?
Supply chain disruption
The rapid spread of covid-19 in China resulted in the closure of many factories as part of containment measures to curtail the outbreak. Although the Chinese government has, subsequently, encouraged factories to restart production, many have been slow to recover to full capacity. The highly integrated manufacturing processes across the globe means that the disruption to Chinese output is likely to affect industrial production across the globe. Furthermore, many retailers that import goods from China may also be significantly affected by delays to deliveries. Currently, the impact appears to be confined largely to non-food goods, but, if the situation elsewhere deteriorates, retailers may see supply issues mount. Additionally, construction and engineering firms have cited concerns about the availability of spare parts in the coming months.
The extent and timing of the impact on supply chains will vary across sectors and will depend on the length of disruption, the number of inventories that companies were holding before the outbreak, and the availability of an alternative supplier. It is worthwhile noting that some companies seem to have a buffer of stocks, due to a combination of a routine build-up of inventories ahead of Chinese New Year and stocks that were built up ahead of Brexit deadlines in 2019. Certain industries that are closely tied to China – such as electronics and motor vehicles – are likely to feel the impact relatively quickly and more acutely. In other industries the impact could take longer. For example, in some “advanced manufacturing” sectors, such as aerospace, the effects could be felt up to six months from now as the disruption ripples through Tier 2 & 3 suppliers. Of course, the risk that activity remains subdued for longer presents a significant downside risk to the UK economy, particularly for SMEs that may not have the resources to continue production if there are significant delays to delivery times of critical goods.
Increased financial market volatility
The spread of covid-19 across the globe has pushed markets to downgrade their view of global activity in the near term. This has resulted in many investors selling off equities and rushing to buy “safe” assets such as bonds. Stock markets have tumbled across the globe, making the week of 24 February the worst one for global equities since the financial crisis. Meanwhile, bond yields have dropped sharply, with the 10-year U.S. Treasuries dropping below 1.2% for the first time on 28 February. It is also worth noting that, as of the week of 24 February, Brent crude oil prices had fallen by more than 20% from their highs in early January as traders worry about the impact of a decrease in global oil demand.
Reduced exports to China
Exports to China made up 1.1% of UK GDP in 2018, which means that a reduction in Chinese demand for UK goods and services could have a noticeable impact on UK output. Consumer spending in China has collapsed following the outbreak, with expenditure on everything from cars to cinema tickets dropping sharply. Meanwhile, business activity has been slow to recover following widespread factory and office shutdowns, and the logistics sector (including shipping, airfreight and onward transport) has been severely affected. This suggests that UK firms that sell to China may see a reduction in sales and/or orders while disruption persists.
It is also worth noting that UK exports will be impacted more generally by the hit to global demand from the outbreak. China makes up around 16% of global GDP, which means that a reduction in Chinese activity will feed through in a significant manner to other countries across the globe. In the case of UK exports, a weakening in global demand will be particularly felt in reduced trade to European countries that are closely tied to China, such as Germany (exports to which made up 2.6% of UK GDP in 2018), and East Asian countries, such as Japan and South Korea (0.6% and 0.4% of UK GDP in 2018, respectively). Additionally, the outbreak in Italy poses a risk in and of itself to UK exports (1% of UK GDP in 2018).
Decreased tourism from China
There has been anecdotal evidence that suggests that the covid-19 outbreak seems to have resulted in a sharp drop in the number of Chinese travelling abroad due mandatory and/or voluntary containment measures. Furthermore, as of 3 March, over 70 countries worldwide had imposed travel restrictions – typically banning travel from mainland China – in order to stem the spread of the virus. While the UK has yet to impose any ban on travel, a reduction in the number of Chinese tourists – who spent around £1,700 on average per visit in 2018 – will likely have a noticeable impact on certain regions and businesses.
What are some other impacts to watch out for?
Reduced business confidence
The bearish turn in financial markets reflects expectations of reduced revenues and profitability in a number of sectors. This will likely be reflected by a downward turn in business confidence globally, particularly if the outbreak continues to show little sign of slowing outside of China. This could pose a downside risk to orders and investment, the extent of which will depend on the length of disruption (which is still uncertain). Furthermore, the uncertainty surrounding the trajectory of the outbreak may cause some firms to put investment or projects on hold.
Decreased travel
Containment measures, alongside fears of potential infection, are likely to lead to decreased business and leisure travel globally. We have already heard many stories of companies restricting travel to countries that have seen a notable outbreak of covid-19, alongside news of conferences, tradeshows, and other events being cancelled. The consequent disruption to sales and marketing operations potentially represents a permanent loss of business. This is not only affecting firms in manufacturing, but also services sectors, such as education. For example, at this time of year, UK universities would normally be attending recruitment fairs in China, but many of these have now been cancelled.
Meanwhile, we are seeing early signs that individuals are beginning to reconsider their holiday plans to some destinations, for fears of either catching the virus or being quarantined in a foreign country. These concerns have been reflected by the sell-off in equity markets, with travel and leisure-related stocks in Europe falling by 19% between the weeks of 17 and 24 February.
What about the spread of covid-19 in Europe?
The recent outbreak in Italy, alongside smaller ones across Europe, present a significant downside risk to economic activity across the continent. This is particularly due to the highly integrated nature of European economies and borders. If the outbreak becomes a full-blown pandemic, it is likely that many countries will respond with containment measures of varying levels of severity. This would likely pose a significant threat to UK economic activity through a variety of channels; for example, a severe scenario could potentially see supply chains being disrupted by border closures. However, as of now, it is too early to tell how widely the covid-19 outbreak will spread and how long any disruption may last. As a result, it would be sensible for UK firms to take reasonable measures to prepare for a variety of scenarios.
What is the estimated impact on economic activity?
Economic forecasters across the globe have already started downgrading their expectations for global and UK GDP growth due to the covid-19 outbreak. On 2 March, the OECD announced that they had revised their forecast for global GDP growth in 2020 to 2.4% (from 2.9% in their November forecast). This downgrade is driven primarily by reduced activity in China due to virus containment measures. Meanwhile, the OECD’s forecast for UK GDP growth in 2020 was pushed down by 0.2pp to 0.8%, marking a slowdown from growth of 1.4% in 2019.
Has the covid-19 outbreak impacted your business/sector? Let us know by emailing Martin Sartorius.
