The great China shock

November 02, 2021 4:00 AM

The dissipation of China's power crisis is unlikely to fix the global supply-chain immediately. The after-effects Will likely linger & input prices will stay high for a while

Final goods producers have to choose between accepting a squeeze on margins or passing the cost-spikes on to consumers.Final goods producers have to choose between accepting a squeeze on margins or passing the cost-spikes on to consumers.

By Abheek Barua

The problem with assessing the impact of the current slowdown in China on global supply chain is the sheer complexity of its links. It is the mother factory of the world with its products, particularly industrial inputs, feeding a mindbogglingly diverse range of shop floors from across the world. Thus, unless China’s industrial growth problems, particularly its energy shortage, get resolved soon, the impact on global output could be significant. Prolonged global stagflation is a real risk as the shortage of inputs curbs output while, at the same time, pushing up prices of intermediates as demand outstrips supply. Final goods producers have to choose between accepting a squeeze on margins or passing the cost-spikes on to consumers.

China contributes ~17% global GDP. Its share of the world’s total exports rose to 15% in 2020 (as compared to 12% in 2014). Besides, it is the centre of the global value chain, accounting for 19% of global manufacturing exports.
The decade after the Great Financial Crisis saw a trend towards “deglobalisation” of supply chains as countries woke up to the perils of interdependence.

The share of imported inputs (excluding those from China) in total exports and total output declined. Take the case of the global chemicals value-chain, where trade intensity (the share of total exports to total output) declined 5.5% between 2007 and 2017. It had risen by 7.8% between 2000 and 2007. For automotives, the fall was 7.9% compared to a rise of 11% in the two corresponding periods.

However, somewhat curiously, China itself “deglobalised”, in that it reduced its reliance on foreign inputs for exports. China’s import of intermediate goods (as a percentage of its total imports) moderated to 20.3% in 2018 from 24.7% in 2005. However, on the export front, it bucked the trend. China’s export of intermediate goods (as percentage of its total exports) rose to 16.7% in 2018 from ~16% in 2007. The share of China’s intermediate goods in global GDP rose from 0.26% in 2007 to 0.5% in 2018.

While a comprehensive assessment of the “China supply shock” is difficult, the Grubel-Lloyd index published by UNCTAD gives an idea of the vulnerability of different sectors of the global industrial economy. Chinese manufacturing is essential to several supply chains in the precision instruments, machinery, automotive and communication equipment sector.

One can also attempt to get a broad idea of the impact on different economies, based on their principal imports from China. Overall, the most impacted economies will be the EU, the US, Japan and South Korea, due to their heavy reliance on machinery and electrical equipment, transport equipment, intermediate goods, metals and chemicals from China.

In fact, the impact is already visible on global economic activity. For example, Germany’s manufacturing activity (as gauged from the manufacturing PMI) slowed in September 21 amid supply bottlenecks and escalating costs. Japan’s PMI marked its slowest pace of expansion since February.

India too has its share of problems. Its reliance on intermediate goods from China is high. It imported $23.3 bn worth of such goods in 2019, ~15% higher as compared to 2010. Auto, appliance makers, consumer durables producers in India could face shortages of raw materials. Around 40% of India’s electrical machinery and equipment is imported from China. As per industry estimates, 80-85% of the parts used to manufacture TVs and 65-70% of the parts used to manufacture ACs are sourced from China. Anecdotal evidence suggests that the companies typically maintain inventory for 2-3 months. Hence, the impact could be felt from December onwards (should supply disruptions in China persist).

There is the demand side to think of as well. China is India’s one of the biggest market for domestic merchandise goods, accounting for around 7% of India’s exports in 2020. Exports of commodities like organic chemicals, and ores among others are likely to take a hit should China’s slowdown persist.

Moreover, trade is not the only channel that would hurt global supply. The world’s exposure to China on technology and capital also increased while China’s exposure fell. According to the McKinsey Global Institute, the aggregate global index for trade, technology and capital put together rose to 1.2 in 2017 from 0.6 in 2000 while China’s exposure to the world eased to 0.6 in 2017 from 0.9 in 2007.

How long will the supply shock persist? China’s power crisis is expected to continue for the next 3-4 months at the least. It has already made clear that power prices will be allowed to rise by as much as 20% from current base levels for commercial use, barring agriculture-linked industries. However, the dissipation of the power crisis is unlikely to fix the global supply-chain immediately. The after-effects are likely to linger and input prices will take a while to reduce.
The effort to contain the impact of the pandemic has, until now, largely focused on the demand side. Policy making now has to reorient itself to handle the supply front. It is not an easy transition to make.

Chief economist, HDFC Bank
Views are personal

Co-authored with Swati Arora,
economist, HDFC Bank

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