SARS: what will be its impact on business in China and Hong Kong?

Alysha Webb discovers that severe acute respiratory syndrome, or SARS, looks to be an economic problem long after the health issues are resolved

M at the Fringe, a trendy restaurant on the edge of Hong Kong�s Lan Kwai Fong restaurant and bar district, can usually count on being full in the spring with suited convention goers and visiting business people trying to look hip. Not this year though. Visitors to Hong Kong have plummeted since March and so have reservations at M. The cause? Severe acute respiratory syndrome, or SARS.

�Business has dropped 60%-70%,� says Michelle Garnaut, the restaurant�s founder and managing director. And like a bad dream that won�t end, Garnaut is now seeing business dive at M on the Bund, her Shanghai restaurant. �It�s a complete nightmare,� she moans. �You�re in the frontline in the restaurant business. We�re the first people to see the economic downturn.�

Others are sharing her pain. Hotel occupancy in Hong Kong and on the mainland dropped 40% in April and May, and event venues have been hit with a rash of cancellations. Tourism is way down. Retailers are also hurting. And though there are signs of a slow recovery for the Hong Kong economy, with its heavy dependence on the service sector, the outlook is still grim.

China is facing an increasingly pessimistic outlook. The crucial element is time. While Hong Kong�s SARS epidemic seems to have peaked, China�s SARS crisis is just beginning. A full assessment of the damage SARS has inflicted on the Hong Kong and mainland China economies will therefore take months, if not years. Much will depend on Beijing�s ability to stop the spread of the virus to the poorer inland provinces, and on how quickly overseas business people and tourists return.

That makes SARS unique in terms of economic shock. �9/11 was a one time event that put a shock wave into the world,� says Chuck Abbott, general manager of the St Regis Hotel in Shanghai, which has seen occupancy halved to 35%. The SARS epidemic �may have a longer term effect because it�s uncertain when it will be resolved,� he says.

The uncertainty is reflected in economists� growth forecasts for both economies. Credit Suisse First Boston figures China�s 2003 economic growth will be dragged down by 0.5 percentage points, to 6.9%, even if the outbreak was to be controlled by June. �The consumption slowdown has already happened - it is unlikely to be reversed at least until late summer,� argues CSFB economist, Dong Tao. Morgan Stanley also cut 0.5 percentage points off its GDP growth estimate, to 6.5%. Not all are so pessimistic though. ING figures China�s economy can still grow by 7.5% this year, �because of a good first quarter� that recorded 9.9% growth, says analyst Kingston Lee. But ING�s estimate depends on the outbreak being contained in the second quarter.

Even the normally optimistic China Daily has run editorials warning that SARS will hit economic growth. Beijing took the unprecedented move of releasing a monthly GDP growth figure of 8.9% for April, down from the first quarter�s blistering 9.9%. Retail sales growth slowed to 7.7% from 9.2% in March.

Hong Kong growth estimates are also pessimistic. Morgan Stanley has already chopped 0.7 percentage points off its estimate, to 2%, and ratings agency Standard & Poor�s figures SARS will cut 0.6 to 1.5 percentage points off an already low 2.5% GDP growth estimate, assuming the virus is contained in three months. The Hong Kong Chamber of Commerce, normally a Hong Kong booster, predicts 1.5% growth, down from December�s forecast of 2%. That means more hard times ahead for businessmen like Andy Au, who owns the flower shop in the lobby of Hong Kong�s Metropole Hotel, where SARS first appeared in Hong Kong. His sales are down 70%. �I just have to wait,� says Au philosophically. �June will be better - at least I hope so.�

Service sector businesses like Andy�s Flowers make up 34% of Hong Kong�s GDP, and tourism contributes 6.1%. Tourists account for 20% of Hong Kong�s retail sales. �In Hong Kong, everybody depends on the tourist business,� confirms Peter Lau, chairman of Hong Kong based clothing chain Giordano International. Sales at Giordano�s 70 Hong Kong stores are down by two-thirds; sales in stores that depend most heavily on tourists are down 70%, he says.

Services added only 34% to China�s 2002 GDP and tourism accounted for only 1.6%, according to Merrill Lynch. But those figures hide some important facts that mean the impact on China�s economy may be more severe than the estimates reflect. Shanghai is hands down China�s retail powerhouse, and the service sector accounts for 51% of the city�s GDP. China�s week-long May Day holiday is usually a shopping spree for Chinese consumers, but not only was it shortened to five days (including a weekend) this year, but local governments urged residents not to go out. The result? Department stores in Shanghai saw sales plunge 44.6% compared to a year ago.

And while total tourism - including international visitors - may be a small part of China�s GDP, domestic tourism accounts for 4% of GDP, considering its boost to consumption, says CSFB�s Tao. �The May Day holiday is the largest tourism and travelling occasion outside of [the late February] Chinese New Year,� he says. Says Lau, who has more than 500 stores on the mainland: �In China, the domestic travellers are big customers. The [May Day] holiday was basically not here this year. That hurt a lot of people.�

The outbreak

SARS first appeared in China in late 2002, when reports of a pneumonia outbreak in southern China�s Guangdong province began to emerge. In April 2003, nearly 20,000 Beijing residents were in quarantine, though that number is now dropping. In cities like Shanghai, which apparently has a much lower infection rate, the Government is requiring all hotels to take arriving guests� temperatures, and the local health bureau sends representatives to the homes of those returning from trips abroad.

The malaise may continue in China�s economy long after the Government has declared the illness under control. Foreign direct investment accounts for about 5% of China�s GDP, and Morgan Stanley has revised its actual FDI estimates for 2003, down US$10bn to US$50bn. Foreign investors �require a much higher level of comfort before they will come to China,� explains Morgan Stanley economist Andy Xie. �Even if SARS is controlled in three months, people won�t come.� In the first four months of 2003, actual FDI rose 51.03% on-year to US$17.82bn. Contractual FDI rose 50.13% to US$30.53bn.

For those already in China, business travel restrictions based on World Health Organisation (WHO) travel advisories have had an impact. Hewitt Associates Consulting banned all travel in China, although the firm generally prides itself in sending the right specialist to the right job. �The SARS situation has meant that we can�t operate like that,� says Simon Keeley, director of Greater China. That puts smaller Hewitt offices like Guangzhou �at a greater disadvantage,� he says, adding: �South China is a big growth market. There�s no question that this will impact our business.�

Manufacturers are feeling the pinch too. Phone calls and video conferencing are not satisfactory replacements for meeting in person. �From my perspective, doing business in Asia requires more personal contact than doing business in other regions,� says Steve McCoskey, director of Asia manufacturing and operations support for Eastman Chemical, a Tennessee based integrated chemical manufacturing company with five plants in China. �There is a value created with meeting someone face-to-face compared to giving them a telephone call.�

In Hong Kong, economists say the worst may be yet to come. March retail sales fell by less than the expected 6% compared to the previous year. However, �the March number hasn�t really reflected the full impact,� says Merrill Lynch economist Marvin Wong. �We expect the April retail sales number to be quite ugly.� Retail sales also do not reflect the service sector - which includes restaurants like M at the Fringe.

There is some good news. The WHO has lifted its travel advisory for Hong Kong. The Hong Kong Government is pumping HK$11.7bn into an economic stimulus package that includes tax breaks for the middle class and loan guarantees for businesses.

That will push an already ballooning budget deficit from HK$70bn in 2002 - a record 5.5% of GDP - to $100bn, says Hong Kong Chamber of Commerce chief economist, David O�Rear. But he doesn�t see any danger to the Hong Kong dollar-US dollar peg. �Defence of the peg is based on [the Hong Kong Banking Association�s] willingness to raise interest rates,� O�Rear explains. �If that holds, the interest rate shoots up and everybody realises [the peg] will stay put.� Hong Kong has US$120bn in foreign exchange reserves with which to defend the peg, he adds.

A slowdown in China�s economy is a much bigger worry. �We�re the most deeply integrated economy with China in the world,� O�Rear says �It�s critical to us that China�s economy does not take a hit.� But there is little doubt the Chinese economy will take a hit - how big remains to be seen. As Benno Von Canstein, general manager of Shanghai based joint venture Allianz DaZhong Life Insurance Co, says of the impact on his business: �It�s too early for a reliable forecast.�

Alysha Webb is a business journalist based in Shanghai.