By Tyler Durden
For the past two weeks, even as the market took delight in China’s doctored and fabricated numbers showing the coronavirus spread was “slowing”, we warned again and again that not only was this not the case (which recent data out of South Korea, Japan and now Italy has confirmed), but that for all its assertions to the contrary, China’s workers simply refused to go back to work (even with FoxConn offering its workers extra bonuses just to return to the factory) and as a result the domestic economy had ground to a halt.
China is now fighting against time to reboot its economy, and the longer the paralysis continues, the more dire the outcome for both China’s banks and local companies. And since it is no longer just “scaremongering” by “conspiracy blogs”, but rather conventional wisdom that China may implode, here is a summary of how the narrative that “it will all be over by mid-March” is dramatically changing.
Let’s start with Chinese businesses: while China’s giant state-owned SOEs will likely have enough of a liquidity lifeblood to last them for 2-3 quarters, it is the country’s small businesses that are facing a head on collision with an iceberg, because according to the Nikkei, over 85% of small businesses – which employ 80% of China’s population – expect to run out of cash within three months, and a third expect the cash to be all gone within a month.
Should this happen, not only will China’s economy collapse, but China’s $40 trillion financial system will disintegrate, as it is suddenly flooded with trillions in bad loans.
Take the case of Danny Lau who last week reopened his aluminum facade panel factory in China’s southern city of Dongguan after an extended Lunar New Year break. To his shock, less than a third of its roughly 200 migrant workers showed up.
“They couldn’t make their way back,” the Hong Kong businessman said. Most of his workers hail from central-western China, including 11 from Hubei Province, the epicenter of the coronavirus outbreak that has killed more than 2,000 people. Many said they had been banned from leaving their villages as authorities race to contain the epidemic.
Lau’s business had already been hurt by the 25% tariff on aluminum products the U.S. imposed in its tit-for-tat trade war with China. Now he worries the production constraints will give American customers another reason to cancel orders and switch to Southeast Asian suppliers. The virus is making a bad situation “worse,” he said.
Lau is not alone: this same double blow is hitting small and midsize enterprises across China, prompting a growing chorus of calls for the government to step in and offer lifelines. The stakes could not be higher: These smaller employers account for 99.8% of registered companies in China and employ 79.4% of workers, according to the latest official statistics. They contribute more than 60% of gross domestic product and, for the government, more than 50% of tax revenue. In short: they are the beating heart of China’s economy.
Companies like Lau’s that have resumed some production are the lucky ones. Many factories and other businesses remain completely stalled due to the virus. Many owners have no other choice but pray that things return to normal before they careen off a financial cliff.
And here is the stark reality of China’s T-minus 3 months countdown: 85% of 1,506 SMEs surveyed in early February said they expect to run out of cash within three months, according to a report by Tsinghua University and Peking University. And forget about profits for the foreseeable future: one-third of the respondents said the outbreak is likely to cut into their full-year revenue by more than 50%, according to the Nikkei.
“Most SMEs in China rely on operating revenue and they have fewer sources for funding” than large companies and state-owned enterprises, said Zhu Wuxiang, a professor at Tsinghua University’s School of Economics and Management and a lead author of the report.
The problem with sequential supply chains is that these also apply to the transfer of liquidity: employers need to pay landlords, workers, suppliers and creditors – regardless of whether they can regain full production capacity anytime soon. Any abrupt and lasting delays will wreak havoc on China’s economic ecosystem.
“The longer the epidemic lasts, the larger the cash gap drain will be,” Zhu said, adding that companies affected by the trade war face a greater danger of bankruptcy because many are already heavily indebted. “Self-rescue will not be enough. The government will need to lend help.”
So where are we nearly two months after the epidemic started? Well, as of last Monday, only about 25% of people had returned to work in China’s tier-one cities, according to an estimate by Japanese brokerage Nomura, based on data from China’s Baidu. By the same time last year, 93% were back on the job.
And making matters worse, as we first noted several weeks ago, local governments around the country face a daunting question of whether to focus on staving off the virus or encourage factory reopenings, as the following tweet perfectly captures.
Worse, last Sunday the communist party’s mouthpiece, the Global Times, suggested that instead of waiting for fiscal bailouts, Beijing will have no choice but to cut spending and unleash austerity, a move that would have catastrophic consequences for China. But even if Beijing does ease fiscally, it is unclear just what it can do short of printing money and handing it out to everyone. “A tax reduction doesn’t help if you don’t even have income,” said Zhu, who must somehow scrape together around 700,000 yuan ($100,000) for rent and the salaries of about 40 employees.
Zhu reckons her company will lose about 3 million yuan in profit over the two months. Besides the postponements, couples that were looking at wedding options before the outbreak have put their planning on hold. There is little room, it seems, to think about love in the time of the coronavirus.
“This is the most difficult time I have ever experienced” after 11 years of running the company, Zhu said. The worst part might be the uncertainty: She has no idea when the authorities might lift the ban or whether she can make it that long. “All of this is unknown to us,” Zhu said.
She is not alone: Wu Hai, owner of Mei KTV, a chain of 100 Karaoke bars across China, took to the nation’s premier outlet of discontent, social media platform WeChat, to voice his despair. KTV’s bars have been closed by the government because of the virus, choking off its cash flow. The special loans from the authorities will be of little help and no bank will provide a loan without enough collateral and cash flow, he said on his official WeChat account earlier this month. On WeChat , Wu gave himself two months before he has to shutter his business.
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It’s not just Japan’s flagship financial publication and owner of the Financial Times, the Nikkei, that is dramatically changing the narrative away from “all shall be well.” In its headline article today, Bloomberg writes that “Millions of Chinese Firms Face Collapse If Banks Don’t Act Fast” and described the plight of Brigita, a director at one of China’s largest car dealers, who is also running out of options. Her firm’s 100 outlets have been closed for about a month because of the coronavirus, cash reserves are dwindling and banks are reluctant to extend deadlines on billions of yuan in debt coming due over the next few months. There are also other creditors to think about.
“If we can’t pay back the bonds, it will be very, very bad,” said Brigita, whose company has 10,000 employees and sells mid- to high-end car brands such as BMWs. She asked that only her first name be used and that her firm not be identified because she isn’t authorized to speak to the press. With much of China’s economy still idled as authorities try to contain an epidemic that has infected more than 75,000 people, millions of companies across the country are in a race against the clock to stay afloat.
The irony, of course, is that all this is happening even as China has in fact eased dramatically in recent weeks, from cutting rates, to engaging in a barrage of mini stimulus measures, to injecting massive amounts of liquidity, to cutting taxes, to supporting virus-stricken companies…