China’s hard-line COVID-zero response to Omicron could trigger supply-chain chaos

January 13, 2022, 12:36 PM UTC

On Thursday, China’s northeastern city of Dalian reported its first case of Omicron, becoming the second major Chinese port struck by the highly contagious variant after Tianjin, a port neighboring Beijing, recorded China’s first local Omicron case last week.

Omicron’s spread to Dalian has raised fears that a fresh outbreak of COVID-19—coupled with Beijing’s heavy-handed “COVID-zero” response—could snarl already strained global supply chains. 

The world could face the “mother of all supply-chain stumbles” this year, Frederic Neumann, co-head of Asian economics research at HSBC, warned clients earlier this week, citing the growing epidemic in China.  

The U.S. government is concerned that the outbreaks could lead to more chaos in global supply chains, too. On Tuesday, U.S. Federal Reserve chairman Jerome Powell told U.S. lawmakers that “if China sticks to a no-COVID policy, Omicron can really disturb the supply chains again.”

However, after Chinese suppliers faced a pressure-filled Christmas season, China’s new Omicron outbreaks may not pose as much of a threat to global supply chains as they would have a few months ago. Factories and suppliers are already preparing for a seasonal slowdown as China enters the Lunar New Year holiday, and China’s zero-tolerance lockdowns have proved adept at stymieing what would be a far greater disruption: rampant COVID infections.

Factory shutdown

With COVID outbreaks now spread across the country, from Dalian in the northeast to Shenzhen in the south, China’s hard-line COVID response is testing global supply lines on multiple fronts.

In northern Xi’an, where residents have endured a bruising three-week lockdown that began in December, Samsung has suspended operations at its semiconductor factory since staff are unable to get to work. The group said it plans to “[leverage] our global manufacturing network, to ensure that our customers are not affected.”

In southern Zhengzhou, the home of major iPhone assembler Foxconn, the government discovered dozens of local cases this week after launching an effort to test all 12.6 million city residents last Friday. Foxconn told Chinese media this week that the cases in Zhengzhou have “not affected production capacity thus far,” even as authorities in Anyang, a city 100 miles from Foxconn’s campus, announced stay-at-home orders for all 5 million residents earlier this week.

A police officer examines a truck at an immigration inspection checkpoint at Dongxing port in China’s Guangxi Zhuang autonomous region, Dec. 30, 2021.
Cao Yiming—Xinhua/Getty Images

Meanwhile in Tianjin, where authorities ordered residents into semi-lockdown so that health officials can test all 14 million residents, Japan’s Toyota and Germany’s Volkswagen have both suspended factory output.

Bo Zhuang, China economist at Loomis Sayles, says that car manufacturing may be among the most vulnerable industries to Omicron outbreaks in China and continued supply-chain disruptions since “car components are quite time sensitive and of high value.”

Toyota did not say how the closure might hurt its manufacturing targets. But in a statement to Fortune, the company said it will “resume operations as soon as the government’s instructions and the safety and security of the local community and suppliers are confirmed and assured.”

But Tianjin is also home to the world’s ninth busiest port, and a citywide lockdown, if it’s implemented, could stall operations for many companies besides those with manufacturing plants in the city. 

Port closure

When ports in Shenzhen and Ningbo reported minor COVID outbreaks last year, authorities quickly closed shipping terminals, causing traffic jams of huge container ships and a backlog that eventually caused congestion elsewhere as ships rerouted to China’s other harbors.

But the outbreak in Tianjin has yet to prompt any port closures.

On Wednesday, when local authorities ordered workers in the city to take a day off to facilitate another round of testing, the Tianjin Port Authority announced it had tested 4,920 of its employees as of Sunday and that “all of the wharf companies are operating normally.”

In an email to Fortune on Monday, shipping giant Maersk said the company had experienced zero disruption from the current outbreak in Tianjin. However, Maersk noted that a concurrent outbreak in Ningbo—a port just south of Shanghai—had snarled operations.

Border inspection officers patrol alongside containers for freight trains at Qingdao Qianwan Container Terminal in east China’s Shandong province, Nov. 24, 2021.
Yu Fangping—Costfoto/Barcroft Media/Getty Images

“One Maersk warehouse in the area has ceased operations as requested. Impacted customers have been notified directly. We’re closely monitoring the situation and will have contingency plans ready when necessary,” the company said.

With outbreaks now recorded in other ports—including the southern tech hub of Shenzhen and the northern manufacturing hub Dalian—there’s an increased risk of China denying ships berth. Plus, with cities like Tianjin on lockdown, truck drivers are unable to haul cargo from factories to ships and vice versa, increasing friction in the supply chain.

“With interprovincial transport restrictions in play, companies affected by port closures might have limited contingency options,” says Nick Marro, lead analyst on global trade at the Economist Intelligence Unit (EIU). But Marro notes that unless all the major ports shut down simultaneously, the macro effects of current restrictions “should be painful, but controllable.”

COVID zero

A lot of the painful macro effects of China’s lockdowns will likely be felt within China itself, but China has given no signs it will deviate from its COVID-zero resolve, even as its pursuit of COVID perfection poses risks to its own economy.

On Wednesday, Brian Deese, director of the U.S. National Economic Council, said at a White House press briefing that China’s lockdowns “are most likely to have the effect isolated in China, because the production facilities in those geographies are principally suppliers to the Chinese market.” 

In fact, China’s COVID-zero stance may harden in the lead-up to a number of important events on the national calendar, including the Winter Olympics on Feb. 4 and the annual Two Sessions political meeting set to begin on March 4. 

“Any serious outbreaks from easing restrictions could damage the legitimacy of [the Chinese Communist Party’s] governance,” says Bruce Pang, head of macro and strategy research at China Renaissance Securities, adding that it is “highly unlikely China will abandon their zero-tolerance approach [this spring].”

Pang said that China’s COVID-zero policy has also had its advantages for manufacturing. It’s meant that China avoided COVID surges last year that forced factories to close across southeast Asia. And if China eased its COVID-zero policy, China might struggle to staff its factories with healthy workers.

“I don’t think this lockdown is that counterproductive. On the contrary, I think if they didn’t do preliminary lockdowns then you’d have millions of cases in China, and then you’d have a worse supply-chain crisis,” says Chen Long, founder and economist at Plenum analysts.

Local authorities are already signaling that residents should prepare to hunker down through the rest of winter, urging people to maintain “heightened vigilance” in the lead-up to the Chinese New Year. 

The holiday typically marks the largest annual movement of people in the world, but China’s transport ministry expects roughly half the number of citizens to travel for the holidays compared with pre-pandemic years owing to the outbreak. Zhuang says that employers may take advantage of those inter-China travel restrictions to actually keep factories open, instead of closing for the break, as is usually the case.

“Chinese firms are encouraging migrant workers or workers to stay where they work, which means that even with limited closures, factories can still operate through Chinese New Year,” Zhuang says. “That will ease some of the severe [supply-chain] disruptions.” 

But with the pandemic now entering its third year and exacerbated by the more transmissible Omicron variant, analysts are unsure whether China can, or should, maintain its zero-tolerance approach for much longer.

“Imposing lockdowns and strict restrictions more frequently and widespread would carry significant economic cost,” says Tommy Wu, an economist at Oxford Economics. With the pandemic now the norm in the Western world, too, China would be unable to rely on an export-driven post-lockdown recovery as it did during the pandemic’s initial stages.

On Wednesday, U.S. investment bank Goldman Sachs cited Omicron and the lockdowns as it cut its forecast for China GDP growth to 4.3% from 4.8% .

But China seems far from ready to abandon its COVID-zero approach. 

In a note last week Morgan Stanley said China will only consider shifting away from COVID zero when two conditions are met: COVID-19 appears less deadly globally, and Chinese citizens gain access to mRNA vaccines, which are not yet approved for the Chinese market.

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