The COVID-19 outbreak and efforts to contain its spread are disrupting economic activity, with implications for the trade credit and surety insurance markets.
Over 80 Chinese cities have been placed under full or partial lockdown, including Beijing, Shanghai, and Shenzhen, hampering business activity. These cities accounted for 48.6% of Chinese GDP in 2018.
The Lunar New Year holiday and its extension further disrupted economic activity, as has the continued closure of many factories. Reduced tourism and halted construction projects have also significantly affected the economy.
Growth estimates for 2020 have been revised down. Even if the disruptions could be confined to Q1 2020, the outbreak could reduce the GDP growth rate by 0.6%.
The Chinese government is expected to ramp up fiscal and monetary stimulus to counteract the economic impact of COVID-19 over the coming weeks – having already cut reverse repo rates by 10bps and injecting US$173 billion into the economy on 3 February, 2020.
The global economy is even more at risk as the number of cases outside of China rises, with outbreaks in South Korea, Italy, and Iran making a pandemic seem more likely. Factory closures and weaker consumer demand are dampening commodity imports, disrupting regional supply chains, and weighing on the travel sector. In February, for example, Hyundai halted car production outside of China as a result of a parts shortage from China. Similarly, Jaguar Land Rover has reported supply issues, while Apple and many other retail and manufacturing companies are indicating they may fail to meet quarterly revenue targets, following store closures in China, temporary halts in production, and delays in shipments.
The lockdown of certain cities has been extended to several Chinese ports, while labor shortages have slowed the movement of goods. Reports suggest that Tianjin, Shanghai, and Ningbo ports are experiencing bottlenecks, with deliveries backing up and ships being rerouted as ports reach capacity.
As supply chains and trade are disrupted, the government is issuing force majeure certificates to shield Chinese firms from liabilities arising from their inability to fully perform contractual obligations in relation to COVID-19. As of February 14, 2020, the China Council for the Promotion of International Trade issued 1,615 force majeure certificates to Chinese firms, covering 30 sectors and a total contract value of US$15.7 billion. Several copper traders have already declared force majeure, cancelling and delaying copper shipments from miners.
In light of ongoing disruptions, Chinese companies across many sectors are likely to experience financial strains, heightening credit risks. If the recovery is slower than anticipated, the impact on earnings and balance sheets is likely to intensify in coming quarters.
In the surety market, underwriters are likely to reduce their support for companies that are unable to sustain themselves through this period of business interruption, particularly if the return to normal economic activity is delayed. Businesses with exposure to Chinese supply chains can also expect extra scrutiny by surety markets.
There has been less immediate impact on the political risk and structured credit (PRSC) market, although some disruption has occurred, particularly in Asia. Reports suggest that deals between banks and potential borrowers are being postponed. As a result, there likely will be a delay in banks disbursing funds in Q1-2 2020, but an uptick in activity Q3-4 2020, as pent up deals enter the PRSC market.
The global impact of the COVID-19 outbreak has immediately affected the trade credit insurance market. In particular, the combination of business interruption and the issuance of force majeure contracts is leading insurers to reduce limits. A minority of insurers have taken dramatic action, with at least one cancelling limits for buyers in Hubei province with little notice for clients. Another has withdrawn completely from multi-buyer whole-turnover risks in Asia, focusing on a single-risk approach to underwriting. However, most insurers are taking a pragmatic approach and monitoring the situation.
Businesses with China-based interests should:
Taking these steps and business continuity risk mitigation actions will help your organization be better prepared for and more resilient to the economic effects of COVID-19, especially if it continues to spread to other countries.