The world’s economies are facing one of their most difficult periods since the global financial crisis, and Asia is unlikely to escape the consequences. George W Russell asks legal experts how clients can mitigate the damage from global headwinds impacting their operations
Asia faces not only a cryptocurrency winter, but also the chill of an economic slowdown accelerated by Russia’s war on Ukraine, lingering covid-19 lockdowns in China, and spiralling inflation across much of the world.
US corporations in China have cut their revenue projections, according to the American Chamber of Commerce, while many European companies plan to downsize operations. That sentiment is echoed in a wider global “misery index” says Keith Wade, chief economist and chief strategist at Schroders in London.
“The ‘misery index’, an economic indicator that helps determine how the average citizen is doing economically, is now in the highest 20% of readings across almost 50 years,” says Wade. “We’re effectively at the early stages of an economic slowdown.”
Asia is also facing economic headwinds. In the second quarter of 2022, China’s economy grew at the slowest pace since the start of the pandemic. The world’s second-largest economy expanded just 0.4% year on year between April and June, official data showed.
The new economy has been particularly vulnerable. Singapore-based Sea Group’s e-commerce arm, Shopee, shut its India operations in March and laid off staff in Indonesia, Thailand and Vietnam. The Chinese ride-hailing platform, Caocao Chuxing, has dramatically reduced its headcount by up to 40%, while internet giants such as Alibaba have shed employees, according to official media.
Crypto platforms have been devastated by the slump in the value of digital assets. The Singapore-based crypto hedge fund, Three Arrows Capital, declared bankruptcy, while China’s Huobi Global is weighing layoffs.
“We are undergoing a systemic disruption to international trade and economics that has not let up since we were hit by the coronavirus pandemic,” says Philip Teoh, partner and head of the admiralty and shipping, insurance and international trade practice group at Malaysian law firm Azmi & Associates in Kuala Lumpur.
Even Asia’s much-vaunted manufacturing activity has stalled. June data showed many companies were hit by supply disruptions caused by China’s strict covid-19 lockdowns, while sharp economic slowdown risks in Europe and North America have stoked fears of a wider recession.
China’s factory activity is rebounding, though, as restrictions mostly ease and companies adapt to “closed-loop” working to limit the spread of coronavirus. But output in Japan, South Korea and Taiwan has been crimped by supply disruptions, rising costs, and raw material and component shortages.
For some lawyers, the situation has obviously become untenable. “Clearly lockdowns have deeply impacted the Chinese economy and have damaged economic development,” says Cheng Tai-Heng, global co-head of arbitration and trade, and co-managing partner at Sidley Austin in Singapore. “My instinct is they know this and it’s not positive or sustainable. China will reverse course.”
Looming global recession
As the world’s largest economy, the US is the focus of interest. A recession is indicated by two consecutive quarters of declines in GDP, which is increasingly likely, according to most pundits. “We think that growth worries will gain traction with the monetary authorities,” says Eugene Leow, senior rates strategist at DBS in Singapore.
“In any case, we are somewhat concerned that financial conditions have been moderately stressed for some time. Weak financial conditions tend to foreshadow a slowdown in US economic activity by several months.”
Any US recession would have global repercussions. Economist Chetan Seth and his team at Nomura in Singapore say it is likely to begin in the fourth quarter of 2022, with a risk that it could start even sooner. “Consequently, much of the developed world – the euro area, the UK and Canada – are also likely to see a recession in the next 12 months,” Seth forecasts.
The Asia-Pacific region would not be immune, with Japan, South Korea and Australia affected soon after, he adds. “Australia’s consumer confidence has fallen to levels only seen a handful of times in the past three decades, consistent with a stagnation in consumer spending,” says Marcel Thieliant, Australia and New Zealand economist at Capital Economics in Singapore. “In New Zealand, confidence has fallen to a record low.”
India – the world’s sixth-largest economy, with one of the highest GDP growth rates in the world – has seen its economic expansion forecast cut twice by the World Bank. In April, the lender trimmed its forecast from 8.7% to 8% and, in June, revised that to 7.5% as rising inflation, supply chain disruptions and geopolitical tensions tapered a recovery.
The downturn has hit many countries that have yet to fully recover from the pandemic that began in early 2020, including India.
“One of the biggest challenges of adapting to a disruption like covid-19 was understanding how it will play out,” says Subir Bikas Mitra, legal adviser to GAIL, India’s state-owned natural gas exploration and production group, and president of the Federation of Indian Corporate Counsel. He says many Indian businesses struggled to model the pandemic’s impact and develop an appropriate response.
Meanwhile, most companies failed to foresee a systemic threat to their China operations. Analysts say companies tend to forget the effect of high-impact, low-probability disruption events. “While high impacts may shock in the immediate aftermath of such events, the low probability eventually commands companies’ foci,” notes Angelia Chia, a partner in Mayer Brown’s Singapore office and a member of the firm’s global finance practice group. “The result is, on average, under-diversification [of supply chains].”
Insurers have also been hit by the downturn, says Peter Mansfield, a partner at Reynolds Porter Chamberlain in London. “Policyholders will look to make savings, which may include buying less insurance. Second, policyholders may be subject to more claims. Third, an insurer will not be able to rely upon its investments to make a profit.”
While insurance cannot prevent a crisis, it can mitigate the risks created, Mansfield adds. “The insurance world should be involved in conversations with governments and central banks to ensure that it has a role in the making of political decisions.”
Unscrambling supply chains
Clients are also looking for answers to supply chain disruptions, such as with semiconductors and other vital components. “Businesses reconfiguring their supply chains face a host of legal issues,” says John Choong, a partner at Freshfields Bruckhaus Deringer in Hong Kong. “Exactly which ones apply will depend on the business’s strategy.”
Disruptions to and changes in supply chains also have contractual implications. “The covid-19 pandemic underlined the importance of force majeure, material adverse change, hardship and other clauses that deal with supply chain disruptions, and of ensuring that every link in the supply chain is adequately protected,” adds Choong.
Some companies have been able to replicate and disperse operations across countries, using new technologies like digitalisation and tele-working systems to co-ordinate and manage production from a distance. Others have re-shored or on-shored supply chains back to their home countries. “This makes the supply chain shorter, less fragmented, and may utilise robotics-driven automation to substitute labour with technology,” says Chia, from Mayer Brown.
The third approach is regionalisation, she adds, comprising a reconfiguration of the supply chain to countries within the same region. This is especially relevant to macro-regions like the EU, North America, or members of the Asean, which have established trade arrangements. “Technology would be employed to the same effect, and shorter transport and tighter control over suppliers could aid the client in meeting sustainability requirements,” says Chia.
Meanwhile, rising materials costs and inflation are having widespread effects on suppliers, manufacturers and consumers. “We advise that companies dealing with these issues review their current agreements to see if there is any relief available in their pricing provisions such as, on the buy side, terms relating to fixed pricing or, on the sell side, ways to pass increased costs on to customers,” says Leah Imbrogno, senior counsel at Foley & Lardner in Detroit.
“Companies entering into new agreements should consider including pricing provisions that are tied to indexing, in order to decrease inflationary exposure moving forward, and including provisions requiring the parties to revisit or renegotiate prices at set points throughout the duration of their agreements,” she adds.
Coping with runaway inflation
As with the early stages of covid-19, the seemingly despondent economic outlook has sent companies scrambling for legal solutions to a raft of problems. Rising inflation is a major issue.
“We haven’t seen a squeeze on living standards like this for some time,” says Wade, at Schroders. “Real incomes are falling in a way they haven’t done since the second half of the 1970s, when inflation was very high, or the early 1980s when we had a really big oil shock.”
While inflation risk is a worldwide phenomenon, China has had to shut down a lot of the economy in order to implement the zero-covid policy. Increased demand due to the easing of coronavirus restrictions could contribute to a rise in China’s inflation later this year. The consumer price index (CPI) increased by 2.5% in June from a year earlier.
Supply chain shocks, material shortages and energy prices have all contributed to skyrocketing inflation, and are likely to persist all year. “Given the nature of inflation right now, I don’t believe this is something that [the US] Federal Reserve is going to be able to manage purely through adjustments to interest rates,” says Nazak Nikakhtar, a partner at Wiley Rein in Washington.
“We absolutely need better policy measures that get at the heart of the problem – that address material shortages and lower energy prices,” he adds. “For instance, there’s no reason that the US should be exporting volumes of energy resources like liquefied natural gas to adversary countries when we need to deploy our energy resources at home to help alleviate soaring prices.”
Companies can take steps to mitigate the current inflationary spiral. “Apart from prudent spending, as a lawyer I would advise that they should review their contracts,” says Teoh, from Azmi and Associates. “When shipping costs and costs of purchasing materials increase but they are committed to sell at a pre-inflationary price, this is a recipe for breach of contract.”
He says legal advisers can help build resilience – in effect, insure against the next crisis – by offering to review a client’s business operations, and reviewing contracts to see if there is flexibility to adapt to changes or the pressures brought about by the disruptions since 2020.
But making a business recession-proof is likely to be impossible, says Cheng, at Sidley. “It depends on the nature of the business; I’m not sure it’s wise to be recession-proof because the cost is you limit your growth potential. Using credit in whatever form is a growth strategy but if you maintain a huge balance with no credit you would be left behind in a high-growth environment.”
Making digital progress
Experts say there is no doubt that companies made missteps that have exacerbated the effect of the post-pandemic downturn. “Take semiconductors, especially vehicle chip supply chain disruption, as a case study,” says Jiang Zhaokang, managing partner of GSC Potomac, a trade and supply chain legal service in Washington.
He notes that at the beginning of the pandemic, the vehicle industry forecast lower demand and ordered fewer chips, but when demand rose there was a significant shortage of chips. “Then they started ordering more and more, and now it’s reported that the chips are at the point of significant overproduction. We need smarter business intelligence and decisions,” says Jiang.
Some legal experts believe the crisis will accelerate digital transformation. “Digital technologies can reinvent the way a company does business, to be more productive, agile and responsive in order to deliver higher value to customers at lower cost,” says Mitra, at GAIL. “Few areas of a business can benefit from digitalisation more than the supply chain. The potential value locked up in slow and inefficient processes, compounded across many trading partners, is huge.”
Chia, at Mayer Brown, notes that the pandemic has galvanised some jurisdictions into modernising their supply chain. “Emblematic of the progress towards digitalisation, Singapore has signed agreements with overseas counterparts to enhance trade security and trade facilitation with respect to technology,” she says.
She cites Singapore’s recent memorandum of understanding with China customs for co-operation in a single-window interconnection consortium blockchain. “This enables the transmission and exchange of trade and customs-related information between Singapore and China using blockchain technology. Clients should be advised on future-proofing their supply chains and distribution by embracing change as it occurs, reaping the benefits that digitalisation entails.”
Upbeat about the future
It remains to be seen how the economic downturn will play out globally and regionally. Some analysts are upbeat. “Our business cycle indicators suggest the world economy will expand at a modest 2.9% in 2022,” says Luca Paolini, chief strategist at Pictet Asset Management in London, adding: “Emerging Asia’s recovery looks particularly encouraging, thanks in part to China’s resurgence.”
Imbrogno, at Foley & Lardner, notes that despite all of the obstacles of the past couple of years, the markets have thus far shown “amazing resiliency”, although a recession remains a possibility over the next year. “While the timing and severity of any such recession is very difficult to predict, companies should prepare and strategise in advance so they are not caught by surprise if and when a recession occurs,” she says.
Mitra, at GAIL, says he believes India is on the path to a susained economic recovery thanks to the vigorous countrywide drive to deliver safe and wide-reaching covid-19 vaccinations. “That helped reduce the severity of the third pandemic wave, with minimal disruptions in mobility and economic activity,” he says.
The government of India’s policy to improve logistics infratructure, incentives to facilitate industrial production, and measures to improve farmers’ income will support the country’s accelerated recovery, he adds. “There’s no doubt that the pandemic has tested the ingenuity, resilience and flexibility of supply chain leaders globally.”
Lawyers say many clients are already working to adapt their supply chains and anticipating future regulatory regimes. “For example, we have analysed the climate regimes of various jurisdictions to enable a client to select the optimal jurisdiction, and suppliers for its steel and aluminium needs, in anticipation of future carbon border measures,” says Jeffrey Weiss, a partner at Steptoe in Washington.
The downturn is expected to have far-reaching implications for supply chains, especially in China. “The labour market in China is no longer cheap,” says trade lawyer Dennis Unkovic, a partner at Meyer Unkovic & Scott in Pittsburgh. “China built up its special economic zones and they created enormous infrastructure, but in the past 10 years it has been much more difficult to do business there.”
Others see an eventual reorganisation of Asia’s role in global supply chains, with the rise of alternatives to China, such as Malaysia and Vietnam. “The great decoupling from the China supply chain has already begun,” says Dennis Kwok, a partner at Elliott Kwok Levine & Jaroslaw in New York. “However, it is not easy for international companies to suddenly pull out completely from China.”
Kwok sees legal and political risks emerging from China as continuing to be relevant to many multinational corporations. “General counsel of international companies should conduct an overall risk assessment to stress test their existing operations and legal obligations,” he advises. “In the long term, you will see the economic rise in other Southeast Asian countries as the Chinese economy continues to decline.”
For supply chains, the current problems could bring the most far-reaching reforms in generations. “Building a technology-neutral and globally applicable standards-based platform through an open, transparent, impartial, consensus-based process will unleash new efficiencies and innovations in cargo movement,” says Weiss, from Steptoe, transforming global supply chains in ways unseen since the advent of container shipping in the 1960s.
Another result of the pandemic and the subsequent global realignments, says Mitra, is its testing of corporate values and purpose. “Consumers, investors, governments and communities may ultimately judge companies on how they respond to this period of disruption.”