How Does Risk Propagate along Supply Chains?

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The spread of COVID-19 caused extraordinary disruption to global supply chains, as governments around the world battled to contain the virus and protect citizens, obtain medical supplies urgently, access millions of vaccines, and maintain the flow of essential goods. Amid the ensuing turmoil, some countries took steps aimed at moving supply chains out of mainland China, following the intermittent closure of Chinese factories during the nationwide drive to stamp out the virus.

Our results demonstrate that disruption in global supply chains during COVID-19 significantly affected the credit risk of U.S. companies.

Prof. Jing Wu

The pandemic provides a unique opportunity to examine the effects of disruption on the resilience of global supply chains. One critical question in assessing such resilience is whether supply chain links to other regions of the world expose firms to increased risk or provide a valuable buffer against local disruption. The study The Impact of COVID-19 on Supply Chain Credit Risk explored this question by examining how disruptions caused by COVID-19 impacted the credit risk of U.S. firms through their supply chain linkages with China. The study used spreads on credit default swaps (CDS), a type of derivative that is used to hedge against credit risk, to examine how vulnerabilities were transmitted up and down supply chains during the pandemic. It is based on our seminal work of Credit Risk Propagation along Supply Chains: Evidence from the CDS Market, which shows that credit shocks are propagated along supply chains as far as three tiers away, amplified by the industry competition and financial linkages between supply chain partners.

The fact that China went through different phases of the pandemic, such as the introduction of lockdown measures and economic reopening, earlier than the U.S., provided an opportunity to examine these effects in detail. We reviewed CDS data in two phases of the pandemic: in February 2020, when the Chinese economy shut down, but the U.S. economy remained open, and from March 2020 to early-April 2020, when the Chinese economy reopened, while the U.S. was substantially affected by stay-at-home measures and economic slowdowns.

The study finds that disruption in global supply chains during COVID-19 significantly affected the credit risk of U.S. companies.

The study found that CDS spreads went up by about 8 percent to 9 percent – suggesting an increase in credit risk –  during the first period for U.S. firms that had supply chain partners in China, regardless of whether the latter were suppliers or customers, and went down by 12 percent to 20 percent during the second period – suggesting a drop in credit risk. The results demonstrate that disruption in global supply chains during COVID-19 significantly affected the credit risk of U.S. companies.

To obtain a more detailed picture, we also examined the impact of household demand on supply chain risk and which industries are most vulnerable to disruption. In sectors that are closely linked to household demand, such as consumer goods and electronics, supply chain disruptions in China during the first phase were mitigated by continuing consumer demand in the U.S. However, in the second phase, the resumption of supply chain links with China was not enough to reduce the credit risk for such firms because household demand in the U.S. had plummeted as pandemic control measures took hold there.

For the manufacturing industry and sectors such as oil and gas, the restoration of supply chain activity in the second phase was more effective in reducing CDS spreads. In addition, among U.S. consumer goods firms with customers in China, CDS spreads were significantly lower in the second period, indicating that they were able to substitute lower demand in the domestic economy with sales to Chinese consumers.

To find out more about a specific topic, click on the links below to navigate to the relevant chapter:

INTRODUCTION – Managing Supply Chains in the Post-pandemic New Normal

PART I – How Does Risk Propagate along Supply Chains?

PART II – Where Will Global Supply Chains Go?

PART III – How is Political Economy Intertwined with the Global Supply Chain?

CONCLUSION – The Future of Supply Chains