The Impact of the NCP Epidemic on China’s Economy
February 19, 2020
About the author: Mr. Zhang Jiarui, Fellow of the Taihe Institute, Assistant Professor in Economics, Nottingham University Business School, and Researcher of CEIBS.
At the beginning of 2020, the Novel Coronavirus Pneumonia (NCP) outbreak began in Wuhan, and soon spread to other places within and outside of China. In order to curb the epidemic more effectively, the Chinese government has taken a series of decisive measures, such as sealing off Wuhan (the provincial capital) and other cities and regions of Hubei province, significantly extending the New Year holiday in order to delay the return of staff to their workplaces, cancelling or eliminating as many events where crowds gather as possible (for instance, the postponement of all Spring Festival movies in cinemas), the implementation of a free refund or re-registration policy for journeys by train or plane in a bid to reduce migration, and so on. Thanks to the government’s awareness-raising campaign and fast dissemination of information, the Chinese people have also become very “self-regulated”, greatly reducing their frequency of gathering, going on trips, and dining out. These measures were surely necessary to prevent the epidemic from spreading further but have led to an objective and immediate impact on China’s macro-economy and micro-economy.
In particular, accommodation and catering industries were among the first group of sectors affected by the epidemic. A rough estimation of the loss in these industries in the first quarter of 2020 can be made by comparing with the first quarter of 2019 when the value-added in the accommodation and catering industry reached 423.49 billion yuan. Even if some restaurants are earning some cash flow from takeaway business, the sales are far more inadequate to cover the fixed cost. Tourism is another sector that has been heavily affected. Tourism revenue during the Spring Festival of 2019 was about 500 billion yuan, compared with almost no revenue generated during the same period in 2020. Without exception, the retail sector has also been affected to a large extent, although online procurement, as an important supplementary mechanism of household consumption, has made up for the loss of retail to some degree. From a short-term perspective, and based on a rough estimate, the “first wave” of direct impact from the epidemic on China’s economy may have been around 1 trillion yuan in the first quarter of 2020.
More concerned is about the loss of manufacturing sector. While the resumption of work has been significantly delayed, firms still need to pay labor wages, rental costs, as well as other expenditures. These altogether pose a significant threat to the firms’ cash flow. The cash flow of manufacturing is far lower than that of the catering and tourism sectors. The liquidity crisis could even turn into a bankruptcy crisis in the event of cash flow disruption, especially for manufacturing corporations with already low profit margins. In addition, regarding the long-term impact, the entire manufacturing supply chain will be affected as well, due to disruption in the schedule of production. Companies may need to renegotiate contracts, develop modified production plans, and even develop new product designs, which will significantly affect their costs, and these problems could have an even longer-term impact on China’s economy.
To assess the impact of the outbreak on China’s economy, it is also necessary to evaluate the quality of the economy itself, just as the same virus could have a different medical effect on people with different immunities. For instance, the SARS shock hit China in 2003. However, at that time, China just joined the WTO for 2 years, the dividend of the economic opening-up was still releasing, and an investment was booming, therefore, the short-term impact of SARS was quickly neutralized and the economy rebounded rapidly. However, currently, China’s economic growth is undergoing structural adjustment and gradual slow-down, the overall investment efficiency has not improved significantly, and the structural problems remain the challenges. Many enterprises are even teetering on the brink. They are faced with the problems of high levels of debt and low levels of profits on the one hand, and the tough situation of sluggish transition and tight cash flow on the other. Therefore, the long-term impact of the epidemic should not be underestimated.
In light of these effects, we believe that the government should take decisive economic measures to block the spread and transmission of the “economic epidemic”. However, we do not advocate for massive fiscal spending and monetary easing, because, on the one hand, an aggregate stimulating policy would be difficult to transmit to the enterprises that really need rescuing, and on the other hand, would distort the incentive mechanism of the overall macro economy; it instead risks extending the idiosyncratic shock caused by the epidemic to the overall macro economy, which would in return harm the current development trend of China’s macroeconomic structural transformation. On the contrary, just as assessment is conducted for where medical masks are most needed, we need to carefully analyze the economic and corporate conditions so as to implement specific policies which allocate resources efficiently and reasonably to the places where they are most needed.
First, we need to distinguish between enterprises facing temporary liquidity problems, and those facing the risk of bankruptcy. This is similar to the separation of “suspected” and “confirmed” cases of the NCP. For example, the film industry suffered “heavy losses” during the Spring Festival holiday due to postponed movie release schedules caused by NCP, but this is just a liquidity problem. The film investment companies may experience delays in receiving their return on investments (ROI), but it will not cause solvency problems. If these films are released six months later, the investment company’s loss would simply be the interest of the box offices’ revenues for six months. By contrast, the losses of the catering sector place them at risk of bankruptcy. While the catering sector can barely pay its employees' wages or rents by relying on previous cash flow, it will be unable to recoup revenues lost during the Spring Festival holiday. And if the outbreak persists for too long, the liquidity problems associated with reduced cash flow could become the last straw.
Second, we need to identify which issues are long-term, which are short-term, and which are likely to have after-effects. This is like distinguishing between those infected with NCP who already have a disease or a weak immunity system, and those who, with stronger immunity, can be cured or even heal themselves. Such differentiation would avoid wasting economic resources and avoid policy from overreaching or hitting the wrong target. For example, the impact of the epidemic itself on the catering and tourism industry is temporary, and in the long run enterprises in those industries will have no further problems if they survive the short-term shock. Another example is inflation. The panic caused by the epidemic could lead to a rapid rise in prices in the short term, but with the panic abated, and the increase in the distribution and supply of goods, the inflation issue will not persist in the long term. On the contrary, the problems facing manufacturing might be long-term. On the one hand, the production structures and supply chains of manufacturing enterprises are more complicated and will need time to recover. On the other hand, many enterprises in the manufacturing industry have low efficiency and slim profit margins, and even rely on leverage and borrowing to survive. These enterprises face long-term difficulties and need transformation and upgrading rather than receiving policy support. In this sense, we urge for targeted and timely actions of government policies, but do not recommend aggregate measures to stimulate the economy.
Specifically, for those enterprises that are at risk of bankruptcy due to the liquidity crisis (e.g. catering, tourism, transportation sectors, etc.), we recommend the government to carry out targeted bailout in a timely fashion, such as tax cuts and bank loan interest exemption or extension. On average, taxes and interest account for more than 50% of a company’s financial costs and, if properly waived, would significantly mitigate the liquidity crisis of those companies. In addition, the government could consider temporarily exempting enterprises from contributions to the “five social insurance and one housing fund” and other possible fees, as well as providing certain financial subsidies to enterprises in order to encourage mutual assistance among them (such as rent reduction). The government could appropriately expand the fiscal deficit, or issue special government bonds to support enterprises. Only by doing so could companies truly enjoy the timely rescue, and maintain cash flow and employment.
However, traditional fiscal measures such as massive investment in infrastructure are not recommended. The purpose of economic policy should be to help enterprises overcome short-term difficulties. We do not recommend long-term fiscal intervention if firms are able to weather the liquidity crisis. Massive government spending in infrastructure is not conductive to manufacture industry under the current urgent situation. Moreover, local governments are subject to budget constraints, and do not have enough room to invest in infrastructure. Limited resources and expanded government deficits should be spent on places where they are needed, rather than on infrastructure construction, where investment efficiency is already very low.
In addition, we do not recommend interest rate cut by the central bank. Commercial banks ought to be encouraged to grant interest exemption or debt extension to the above-mentioned enterprises which are in liquidity shortage or even at risk of bankruptcy due to the impact of the epidemic, and appropriate subsidies should be provided to the banks by means of payments transferring and financial discounts. However, we do not recommend an aggregate monetary easing. On the one hand, an aggregate monetary easing is not the best way to deal with transitory shocks because it may cause further distortions. Instead, we can deal with transitory shocks by transitory measures that only have immediate effects. Just like giving special antivirus medicine to the patients, the economy will gradually return to normal after the outbreak comes to an end. However, aggregate monetary easing is like injecting hormones into a patient who will recover with aftereffects. Once interest rates are cut, industries that have not been hit by the outbreak would also be affected, creating a new wave of economic fluctuation. On the other hand, overall interest rate cuts may not be effectively passed on to companies most in need. China’s monetary policy transmission mechanism is still poor, and interest rate cuts may not be effective in reducing the financing costs of enterprises. In addition, an overall interest rate cut cannot solve the problem of enterprises’ targeted demands. In the face of the epidemic, the key is to get masks to where they are most needed. Finally, China’s current achievements in the interest rate liberalization reform process have been hard-earned, and deleveraging, improving efficiency, and clearing out zombie enterprises still remain fundamental state policies. Therefore, we do not recommend an aggregate monetary easing.
Overall, the outbreak has had the greatest and most direct impact on service industries, especially catering, tourism, transportation, entertainment and others, but the difficulties facing these industries are likely to be confined to short-term liquidity problems. If the government puts in place targeted tax cuts and fiscal subsidies, commercial banks is able to roll over the debts of these enterprises or exempt their interest payments, and businesses can offer some mutual assistance (such as rent reduction and exemption), then these enterprises would be able to save a lot of cash flow. In order to prevent the liquidity crisis of these enterprises from slipping into bankruptcy and even financial contagion, relevant rescue measures are necessary, but these must be implemented rapidly and accurately with clear targets. However, the actual long-term impact will be on manufacturing, which is inherently vulnerable to risks and in the meantime is at a critical juncture in its transition and upgrading. The impact of the epidemic will re-shuffle the deck of the manufacturing firms. Although the process will be painful in the short term, as long as there is no systemic risk, in the long run, this is actually a training process that will improve the immunity of the Chinese economy, and is fundamentally beneficial to its sustainable and healthy growth.
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