Here's a Contagion That Beijing May Be Able to Stop

(Bloomberg Opinion) -- When a financial crisis erupted in the U.S. a little more than a decade ago, the impact rapidly spread to all corners of the globe and idled factories in far-distant China. 

Today, the Covid-19 outbreak has had a similar impact, with manufacturing brought to a halt from a disaster that started in China and escalated worldwide. One example is Hon Hai Precision Industry Co., the flagship of Taipei-based Foxconn Technology Group. Hurt before, it has been hit again.

This time, though, Beijing may be able to halt the kind of financial contagion that spread through the sector. If Foxconn, the maker of Apple Inc. iPhones, Dell Technologies Inc. computers and Nintendo Co. games consoles, is any guide, then it's possible the industry could make it through with few scars.

The 2008 collapse of America's sub-prime mortgage market hurt manufacturing because sources of cash dried up even in Asia. Beyond the drop in U.S. consumer demand, production in China ground to a halt as supply chain finance, the grease in the wheels of production, dried up when institutions cut back on lending or refused to extend existing funding.

Suppliers who relied on letters of credit couldn't pay for their components, and their customers in turn didn't have cash available to pay for goods that had already been shipped, let alone order more. The well-oiled global industrial machine ground to a halt. 

The impact on Hon Hai was swift and brutal. Its current ratio — a measure of current assets as a proportion of current liabilities — immediately dived to a record low, while its Altman's Z Score, which tracks the likelihood of bankruptcy, plunged into dangerous territory. Within a year, it posted a quarterly revenue drop of 11%, still a record. 

Its revenue decline this quarter is set to be even worse than back then.

Chairman Young Liu refused to rule out the possibility that Hon Hai may not even record a profit for the period.

If companies in the supply chain make it through this crisis relatively intact, it may be largely thanks to the government of China, where Foxconn has the majority of its production. While its initial measures implemented to stop the spread of this coronavirus failed (new cases are being recorded daily, with the scale outside of China climbing rapidly), Beijing may actually be able to halt the financial contagion.

As my colleague Anjani Trivedi wrote last month, Beijing is spewing handouts to get hard-up borrowers through the crisis.

To make it happen, lenders have been allowed to avoid recognizing defaults that result from the coronavirus outbreak while the financial regulator has asked banks to be more lenient on bad loans and to reduce their profit targets. In other words: Forget these loans exist and don't worry about making money.  

Banks have taken Beijing's requests to heart, Bloomberg News reported last week. Efforts to alleviate the pain include rolling over loans that seem may miss payments, allowing debtors to skip interest installments, and refraining from reporting delinquencies so that borrowers credit scores don't get hit.

It may be working. Foxconn's Liu, for example, noted that local governments see economic growth as important as fighting the disease that threatens it. They're prioritizing the reopening of some factories. That's a big reason why the sprawling empire Liu oversees is likely to resume full production by the end of this month, from only 50% at the start and essentially zero output in February. Crucially, Foxconn won't be alone in bearing the extra costs. 

Perhaps the most important assistance, which Liu pointed to, are those measures being taken by Beijing to ensure money keeps flowing. They're sorely needed. A survey last month found that a third of Chinese small and medium-size enterprises had only enough cash to cover fixed expenses for a month, while another third could run out within two months. 

Foxconn is China's largest private employer and largest exporter. It relies on thousands of suppliers to all be up and running, and as many as 1 million workers to turn up at its factories. Despite what's likely to be a record decline in revenue this quarter, the company expects full-year sales to be impacted by as little as 1 percentage point.

Pulling off a comeback like that could be proof that China does have contagion-control policies that work.

To contact the editor responsible for this story: Patrick McDowell at pmcdowell10@bloomberg.net

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Tim Culpan is a Bloomberg Opinion columnist covering technology. He previously covered technology for Bloomberg News.

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