China's next virus challenge: stabilizing world's supply chain

President Donald Trump had waged a protracted trade war on the world's second largest economy and had urged American companies to "decouple" from China. His administration was leading an international campaign to shun Chinese national champion Huawei and its 5G technology. And the Chinese economy was undergoing a structural slowdown, growing at the lowest rate in three decades.

Then came the coronavirus, an epidemic whose economic impact is ricocheting around the world like a pinball - with China as the drain.

Leader Xi Jinping may have signaled victory over the virus, but things are still far from normal here. Factories in the "manufacturing hub of the world" are struggling to get up to full speed. Supply chains have been severely disrupted because parts are not being made and transportation networks have ground to a halt.

Consumer demand inside China has plummeted, and international demand for Chinese products could soon follow as the virus spreads across Chinese markets as diverse as Italy, Iran and the United States.

Together, all this raises the prospect that the coronavirus epidemic will do what the trade war did not: prompt American companies to lessen their reliance on China.

"Everybody was thrashing around about decoupling before this happened, trying to decide: 'Should we decouple? How much should we decouple? Is decoupling even possible?" said Shehzad H. Qazi, the managing director of China Beige Book, a publication that collects data on the country's opaque economy.

"And then suddenly we had this almost divine intervention of the virus and everything just started to be decoupled," he said. "That is not only going to change the entire structure of things within China, but also the global fabric connecting China to the rest of the world." 

Trump's hawkish advisers are clearly trying to capitalize on this moment. "On the supply chain issue, for the American people they need to understand that in crises like this we have no allies," Peter Navarro said on Fox Business last month. 

American companies big and small have warned of the virus's impact on its production facilities. Coca Cola hasn't been able to get artificial sweeteners for its diet sodas. Procter & Gamble - whose brands include Pampers, Tide and Pepto-Bismol - has also said its 387 suppliers in China have faced challenges in resuming operations. 

But the electronics and automaker sectors are particularly hard hit. Apple has warned investors not only about supply chain disruptions but also a sudden drop in customers in China, where all of its stores were closed for weeks. 

Two major General Motors factories in the United States are facing production outages as China-made parts at its Michigan and Texas plants run low, the Wall Street Journal reported, citing union officials.

Ford said that its joint ventures in China - Changan Ford and JMC - had started resuming production a month ago but still needed more time to return to normal.

"We are presently working with our supplier partners, some of whom are located in Hubei province to assess and plan for parts supply to support current parts needs for productions," said spokeswoman Wendy Guo.

Chinese companies - especially electronics manufacturers, carmakers and auto parts suppliers - have applied for a record number of force majeure certificates to try to get out of contracts they can't fulfill without having to pay penalties.

The impact is being felt everywhere that China does business, which is to say everywhere.

France's finance minister has said that French industries need to think about "economic and strategic independence," especially in the pharmaceutical industry, which is heavily reliant on China for active ingredients. Sanofi, the French drug giant, has already said it will create its own supply chain.

Global car manufacturers including a Hyundai assembly line in South Korea and a Fiat-Chrysler plant in Serbia have suffered disruptions because of a lack of parts from Chinese suppliers. 

It takes only one broken link to destroy the chain. 

Take the case of Hangzhou-based Huajiang Science & Technology, the largest Chinese maker of polyurethane composites used for car bodies. It makes waterproof roof coatings for famous auto brands from Mercedes-Benz and BMW to China's largest electric carmaker BYD.

It managed to get its workers back and was ready to resume production at full capacity by the end of February. But their work has been hampered by breakdowns elsewhere in the chain.

"We are totally ready to deliver the products, but the problem is that we have to wait for our customers, whose factories have either delayed reopening or remained largely closed," said Mo Kefei, a Huajiang executive.

"The epidemic has not only affected the supplies to Chinese customers, but also disrupted our exports to Japan and South Korea. Up to now, we have only received 30% of our orders compared with any normal month," she said.

There were different challenges for Webasto, a German auto parts company that manufactures car roofs, battery systems, and heating and cooling systems. It had reopened nine of its 11 factories across China - but not its two biggest manufacturing facilities, both in Hubei province.

"Our factories in Shanghai and Changchun were among the first to reopen [on Feb. 10] but struggled to cope with a shortage of material supplies due to logistics delays caused by the widespread travel ban," said William Xu, a spokesman. "We had to take some detours to bypass Hubei and surrounding areas and coordinate delivery of inventory between factories."

The impact of these disruptions can already be clearly seen in the economic data.

The value of China's exports for January and February fell 17.2 % from the first two months of last year because of production bottlenecks caused by the virus, China's customs agency said Saturday.

Two closely watched measures of manufacturing activity - a survey of purchasing managers conducted by the Caixin media group and official government data - both found this month that sentiment in the industry has plunged to record lows. 

Xi, clearly alarmed by the impact this will have on the overall growth rate and particularly on his pledge to double GDP from 2010 levels by this year, has urged companies to get back to work. 

State media have reported that more than 90% of China's state-owned enterprises have resumed production, although the number of small and midsized enterprises back at work was much lower at barely one-third. 

The Agriculture Ministry this week reported that less than half of migrant workers from the rural areas have returned to their jobs at factories along the industrial coasts, even though huge employers like Foxconn, which supplies companies including Apple, have organized special trains to help them return.

The question remains, however, whether this disruption will accelerate a trend toward diversification away from China, one that had begun with its rising labor costs and was spurred on by Trump's trade war.

In many respects, it's too soon to tell. "When a fire is raging in the house, you first have to put out the fire," said Minxin Pei, a China expert at Claremont McKenna College. "Then you can worry about the wiring."

China is trying to make sure the "wiring" is sound. In an effort to limit disruptions to global supply chains, the Ministry of Commerce has said that restart priority should be given to foreign companies and their suppliers, especially in the electronics and automobile fields. 

But other analysts expect the outbreak to accelerate a trend among multinationals to move to a "China plus one" strategy.

For example, Honda auto parts maker F-TECH has decided to temporarily compensate the reduction in brake pedal production in Wuhan by increasing production in their plant in the Philippines, National University of Singapore researchers led by Bert Hofman, a former China director for the World Bank, wrote in a research paper.

Qima, a supply chain inspection company based in Hong Kong, said in a recent report that American companies were already diversifying away from China, saying that demand for inspection services fell by 14% in 2019 from the previous year.

But Trump's hope that American companies would move their manufacturing bases home were not borne out by the report, which said there was a sharp increase in demand in South Asia and a smaller one in Southeast Asia and Taiwan.

Vincent Yu, managing director for China at Llamasoft, a supply-chain analytics firm, said, however, that the spread of the coronavirus across the globe meant that China was no longer at a disadvantage.

"Currently there is no place that is safe in the world," Yu said. "Maybe China is the safest place."