Outbreak of Disease Forces Steep Plunge in Chinese Economy

UANGZHOU, China, April 27 — The outbreak of a new respiratory disease has inflicted the greatest blow to the Chinese economy since the Tiananmen Square killings in 1989, causing a plunge in retail sales, a slump in demand for some Chinese exports and a near-collapse in domestic and foreign tourism.

J. P. Morgan Chase, which does investment banking in China, estimates that after expanding at a torrid annual rate of 9.9 percent in the first quarter, the Chinese economy is actually shrinking at an annual rate of 2 percent in the second quarter.

Some government policies adopted to slow the spread of the severe acute respiratory syndrome, or SARS, are increasing the economic damage.

The municipal government in Beijing ordered the closing of all movie theaters, Internet cafes, discos and other places of entertainment today. The government of Guangdong Province said today that tour groups may not enter or leave. The national government has already shortened what was to be a weeklong holiday starting Monday, further discouraging retail spending and tourism.

"The economy has come to a standstill," said Andy Xie, an economist with Morgan Stanley, adding that if China does not get the epidemic under control soon, "it's going to be very, very difficult and we cannot underestimate the downside risk."

In trying to preserve its political legitimacy, the Communist Party has relied heavily on China's position over the last two decades as the world's fastest-growing major economy. If the current economic downturn proves prolonged, that could damage the party's claim to be the best way to offer greater prosperity to 1.3 billion Chinese.

The initial economic impact has fallen most heavily on businesses that provide services, which are most dependent on consumer spending and make up a third of the Chinese economy. But there are signs that the enormous manufacturing sector, which accounts for half of economic output, could begin to feel indirect effects soon, too.

Taiwan, whose companies own and manage much of China's huge electronics industry, said today that nobody except Taiwan citizens may enter from China, Hong Kong, Singapore or Canada because of SARS. People coming home to Taiwan from these places will be required to spend 10 days in quarantine regardless of their health.

The announcement came as Taiwan, which has had 55 cases of SARS, reported its first fatality.

There are many signs of the slowdown here in Guangzhou, the largest city in southern China, with 10 million inhabitants, and the center of an outbreak of SARS over the winter that China carefully hid from the outside world.

The long-distance bus station should be mobbed at this time of year because of the coming May Day celebration, which customarily lasts all week. Instead, there are few riders for drivers like Fu Jian, a long-haul bus driver who ate fried rice with chopsticks from a plastic container in the front of his bus here this afternoon as he waited for passengers for the overnight trip to Yizhou in Guangxi Province.

The national government already trimmed May Day to a three-day holiday, just Wednesday, Thursday and Friday, in the hope of discouraging travel. Many intercity bus services have been canceled and the drivers laid off, and the remaining buses are less than half full, Mr. Fu said.

Travel between cities has become more difficult, he said, with the police setting up roadblocks staffed by nurses who check the temperatures of drivers and passengers and disinfect buses in the hope of containing the disease.

Glancing back warily at the half-dozen passengers who had already trickled aboard his bus, Mr. Fu added that he would not mind being laid off himself. "I can take a rest, and there's much less risk" of infection, he said.

At Guang Xiao, a series of red-roofed Buddhist temples with elaborately carved and painted statues here, the usual throngs had disappeared and even the fortune tellers had gone home for lack of business. At the Huang Zhi Qiang Cold Tea Shop, which sells herbal elixirs across the street from the temples, a sales clerk complained that business had dropped by half.

"It's worse than it used to be, because people simply don't go out of their homes," she said.

What remains unclear, however, is how long the economic slump in China will last. That will depend on how long the disease persists and how long people's fears of it will last, two variables that are impossible for economists or anybody else to predict.

For now, Western banks are predicting a sharp but short drop for the Chinese economy if the Chinese government can bring the outbreak under control quickly. Assuming that happens by the end of June, said Joan Zheng, an economist at J. P. Morgan, China will resume growing at an annual rate of nearly 8 percent in the last three months of this year. She said, however, that the third quarter, July through August, could still see growth at half that level as companies will need to sell the supplies of goods they are now accumulating before they order more from factories.

The economic consequences of the outbreak would be more severe if China were more developed and had more businesses providing services, as such businesses, including the nearly empty restaurants and department stores here, are most susceptible to the kind of steep decline in consumer confidence that fears of SARS create.

Service businesses represent close to two-thirds of the economies of developed countries like the United States and five-sixths of the economy of Hong Kong, which exists as a trading center and has been economically devastated by its SARS epidemic.

By contrast, China's manufacturing sector is enormous because of heavy foreign investment and soaring exports.

Exports to the United States do not appear to have been affected, said Craig Pepples, chief operating officer and president of Global Sources, a company in Hong Kong that helps put foreign buyers in touch with Chinese factories of all sizes, using the Internet and local employees in this and other Chinese cities so that buyers do not have to make the trip themselves.

"As long as people in the States are going to Wal-Mart and Home Depot, the buyers are going to have to get the stuff for the shelves," Mr. Pepples said.

Global Sources works with many factories across China and has not seen any sign that SARS is disrupting production. In interviews at two factories in mid-April, workers said that they were not aware of any cases.

The reality is that China may have considerable extra manufacturing capacity and labor as well. "If they get infected, there are so many other places in China that will clamor to get into the breach," Mr. Pepples said.

But Michael Lee, a self-employed broker of electronic goods in Singapore, said SARS fears had hurt sales throughout east Asia at many department store chains, which had responded by cutting back their orders to him by a third.

Mr. Lee said he had been afraid to travel to China lately and this had been a problem because he was not able to check shipments at the factory before they were exported.

For one recent order, the factory did not silk-screen "Made in China" on each of a large order of stereo speakers, so the customer in South Korea had it done and billed Mr. Lee a substantial sum for the work.

Economists predict that many multinational corporations may reconsider further investments here if SARS persists, but no projects appear to have been canceled yet. David Bodkin, a spokesman for Delphi, the world's largest manufacturer of auto parts, said that the company had restricted corporate travel into and out of China but that no consideration had been given to moving operations.

China's agricultural sector makes up another one-sixth of the output here, but economists doubt that farm production will be disrupted.

While dozens of SARS cases have been reported in rural areas, and more may not have been reported, rural unemployment is one of China's biggest problems. Surplus labor has been estimated as high as 150 million adults, a population greater than the entire work force of the United States.

Some investment banks have waxed enthusiastic about the ability of a repressive country like China to bring SARS under control. Singapore and Vietnam have also had some success in limiting the spread of the disease through stringent quarantines and other measures, while Hong Kong was initially leery of trampling on civil liberties and has had far more cases.

"Once China's leaders focus on problems and are determined to take action, they usually manage to resolve them — sometimes with brutal efficiency," a Goldman Sachs report concluded. "You may call that a virtue of authoritarian government."

Here's the readers digest on my professional opinion on SARS and China. Yes, you're right in that it has yet to cause many deaths. Here are the main three points about SARS.

1. SARS causes panic, because it spreads easily, it has VERY common symptoms, and it is already overloading China's health care system.

2. SARS is a joke now, but if it gets totally out of hand, China itself could wind up quarantined.

3. Much of the problem lies at the feet of the Chinese government. They were duplicitous and incompetent in dealing with the disease.

Now, for why the Chinese government is in mortal danger.

1. The above three issues will shatter their economy. People inside the country won't move, ride the trains, or go to crowded areas (which is everywhere). Foriegners won't go to China, for business or tourism.

2. China was able to forestall revolution in Tiananmen by promising economic growth. Most people didn't think they could do it, but they've been very effective in getting China to appear open and modernizing, and the growth rate has given people a taste of economic freedom. The government knows that the more prosperous the average person becomes, the weaker their grasp will become, but they don't care, because it buys them time.

And the kicker.

1. SARS exposes the Chinese government as helpless, untrustworthy and inept. The people, and especially the beauracrats, businessmen and local military commanders, won't stand for the economy to be decimated. The panic caused by the mere potential of SARS could be enough to tear the government apart, into regional factions looking after their own saftey and interest.

Anyone who thinks that couldn't happen needs to crack open a book on Chinese history. The PRC could be having a 'Soviet' moment in the forseeable future.

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