World Economy

Coronavirus outbreak in China spurs supply chain shifts that began during trade war

Key Points
  • China's Council for the Promotion of International Trade has issued 1,615 force majeure slips to help companies avoid penalties for not being able to meet contractual obligations amid the COVID-19 outbreak.
  • The new coronavirus outbreak in China has hit global supply chains hard with the impact starting to show as inventories run low amid prolonged citywide shutdowns and factory closures.
An employee works on a truck production line at a factory in Zhangjiakou in China's northern Hebei province on January 13, 2020.
STR | AFP | Getty Images

The new coronavirus outbreak in China has hit global supply chains hard and spurred sourcing away from the world's manufacturing hub — a shift that started amid the U.S.-China tariff fight.

As business activity and transportation has been restricted in many Chinese cities, companies unable to fulfill contractual obligations are applying for force majeure certificates issued by China's Council for the Promotion of International Trade.

Companies that present such certificates to the counterparties of their deals could — depending on the clauses of their contracts — be absolved from paying penalties for being unable to fulfill agreed upon terms due to circumstances beyond their control. China's total trade reached 30.51 trillion Chinese yuan ($4.4 trillion) in 2018.

Since it announced the availability of these slips at the end of January, the council has issued 1,615 of these certificates in just two weeks, Xinhua state news agency reported, citing data from the council. Those certificates cover a total contract value of 109.9 billion Chinese yuan ($15.8 billion) worth of goods that could be cancelled or for which fulfillment could be deferred, Xinhua reported.

Most of the applications for the force majeure certificates had been from Chinese exporters, although there were a few inquiries from importers, Reuters reported, citing an unnamed source.

The demand for these slips — which Xinhua reports stretches over 30 sectors — underscores the impact that extended city shutdowns and factory closures have on international supply chain, trade and shipping in China.

Dun and Bradstreet estimate that there are around 22 million businesses — or 90% of all active businesses in China — within the regions impacted by the new coronavirus, now formally named COVID-19. This in turn, would impact at least 56,000 companies around the world with suppliers either directly or in the first and second tiers, said the commercial data and analytics consultancy.

It's not just manufactured goods but raw materials, such as those used in garment making, that have been hit, said Stanley Szeto, executive chairman at Lever Style, a clothing manufacturer. China is the world's largest cotton producer.

Besides being unable to ship, companies are also unable to take delivery of what they had previously ordered as copper and liquefied natural gas traders.

For instance, "LNG demand has fallen off a cliff since January," commodity consultancy Wood Mackenzie said bluntly in a recent report.

Import pickup is quite slow in Chinese ports amid coronavirus outbreak, says CEO
Import pickup still slow in China's cargo industry over coronavirus outbreak

Rethinking supply chains

As business activity stutters to life after prolonged citywide and factory shutdowns, the supply chain shift that started during the U.S.-China trade war is evolving.

"At the end of the day, the retailers and the consignees at the destination, they still want their products and they are still planning on that with their inventories," said Jeremy Nixon, CEO of Ocean Network Express, a container shipping company. "In some places like North America, the inventories are quite low at the moment, so they do need to replenish," he told CNBC recently.

City-wide lockdowns and quarantines have led to labor shortages that affect logistics such as pick-up and trucking, particularly for refrigerated goods, said Nixon.

Ships carrying refrigerated cargo containers of chicken from the U.S. to China are being diverted to ports in Hong Kong, South Korea, Taiwan and Vietnam as ports are running out of space for refrigerated containers that need to be plugged into electrical sources, Reuters reported.

Retailers are already starting to reconsider their supply chains as they run low on inventories, said Nixon.

So purchasers are moving on, with more interest in booking out of Southeast Asia to compensate for the shortfall from China, said Nixon.

That strategy shift stems from the trade war between the U.S. and China, as well as increasing wages in China.

According to a report by Qima, a Hong Kong-based supply chain inspection company, U.S. buyers had already started moving their sourcing away from China, with inspection demand in 2019 down 14% from 2018. Much of that manufacturing moved to Southeast Asia and Taiwan where inspections and audits from U.S. brands grew 9.7% in 2019 from 2018, and to South Asia where inspection demand grew 37% on-year in the same period.