Asia’s Sick Man and the Domino Effect on the Global Supply Chain


Photo: Courtesy (Nation Media Group)


For a whole generation, perhaps due to the loss of face suffered under the Century of Humiliation, postcolonial China sought to avoid that which it needed most – free and open trade.

During this generation, the predominant global trade paradigm was anchored on classical theories of international trade. Theories that stood foursquare on the orthodoxy of perfect markets, constant returns to scale, trade in final products, and product homogeneity.

Borrowing cue from the Ottoman Empire, the pejorative tag of Asia’s sick man stuck on it like a bad habit. But Chbosky observed that things change, friends leave, and life doesn’t stop for anybody.

Because things change and life doesn’t stop, the assumptions of the classical trade theories became their original sin and eternal damnation their inevitable end. Evidence of product heterogeneity, unbundling/fragmentation of production activities and tasks, and the presence of intermediate goods triggered a paradigm shift away from the classical to the new trade theory whose most visible face was Krugman.

Hand in hand with this, and thanks to the dissolution of trade barriers and the emergence of information, transport, and communication technologies, the process of globalisation spread like a circus parade, giving birth to the global value chains (GVCs).

In the GVC, the primary and support supply-chain activities are unbundled and pharmed out, based on location-specific advantages (LSAs), to multiple workers from multiple firms across multiple countries. Consider the iPhone, whose accelerometers are outsourced to a German firm, audio chips, glass screens, networking chips, and cameras to US firms, batteries to South Korean and Chinese firms, compass, flash memory and LCD screens to Japanese firms, processors to Taiwanese and South Korean firms, and the assembly carried out in Taiwan. Consider these firms have global networks of production facilities to which they may further unbundle this production…

The benefits of exploiting dispersed location-specific advantages aside, a distinct advantage of GVCs is that they open up the prospects for countries to integrate into the global economy in a cost-effective way. Because things change, Rumi might have remarked that yesterday China was clever and so it wanted to change the world, but today it is wise and so it changed itself. In 1979, following the Open Door policy, China embraced that which it needed most – open and free trade. This was followed, in rapid succession by WTO membership, effectively integrating into the GVC.

So complete has this integration, and so comprehensive has its dominance over the global supply chain been that one a half generation later, China manufactures 70% of all the world’s mobile phones, 80% of its conditioners, 60% of its shoes, 30% of its cars, and almost half of the world’s goods.  Cheap labour, extensive clusters of supplier networks and manufacturing ecosystems, and a large pool of sophisticated skills and competencies aside, the other LSA that has made China the world’s factory is its network of port infrastructure (seven of the world’s ten busiest ports are in China).

But one and a half a generations later, the country sits smack at the epicentre of the COVID-19 outbreak, and the tag that it had sought to avoid – the sick man of Asia – once again sticks to it like a bad habit. They say that when China sneezes, the world catches a cough.

Supply chains are subject to uncertainties and managers have to prepare for them. But the nature of the uncertainty posed by the COVID-19 is a structural rather than operational disruption that presents a new challenge to managers, and subjects firms to ripple/domino effects.

Rather than being localised, it is likely to propagate as it cascades downstream, and thus affect performance metrics such as sales. Since its occurrence is at the structural level, firms are likely to take severe hits on their performance (revenues and profits), and recovery may only occur in the mid-long term. For example, forecasts indicate that smartphone shipments in the first quarter of 2020 are likely to drop by 50% compared with 2019, with Foxconn (the world’s largest electronics contract manufacturer) and Apple (whose production is outsourced to Foxconn) forecasting revenue and profit shortfalls.

But with the focus riveted on the human cost of the COVID-19, those paid to ponder and wonder over its disruptive effect on the global supply chain have – so far – limited their focus within the supply chains of specific industries (e.g. the auto and electronic supply chains). With more than 50m people under lockdown, factories shuttered, and Chinese supply chains seizing up; will the virus break free from its host cell, reproduce, and multiply in the bloodstream? How hard is this domino effect likely to hit the global supply chain?

Chase Bank: The Truth that Limps and the Falsehood that Flies


Photo credits: Nation Media


The Falsehood that Flies

Had our paths crossed on April 6th 2016, and had you told me then that Chase Bank was just a single nostril above the water, I would have told you then that until I reached hither my finger, and beheld the hands where the nails had gone through, and reached hither my hand, and thrust it into the side where the blood and water had gushed, I would rather be of little faith.

For as Kenyan banks go, Chase had earned its stripes as one of the most stable, mid-tier banks. Heavy on the affairs of those at the bottom of the pyramid, and high on the hit parade of the SME, its net profit had topped 2.6bn shillings by March 2016, 300m bucks over and above its top line the previous December.

It was Jonathan Swift who, in a moment of sudden realisation, famously remarked that “Falsehood flies, and the Truth comes limping after it.” In April 2016, what had begun as a touch of rumour on some WhatsApp groups – that the bank had dug itself into some spot of trouble – erupted on Twitter; and thereafter spread, within days, like a bad case of measles in a country school. Falsehood flew.

To understand the bank’s narrative at the time, one had to understand what a special purpose vehicle (SPV) is.  This is an orphan company, formed for purposes of raising limited or non-recourse finance for a specific project. With a separate legal entity, the SPV owns assets and liabilities. The project finance is an off-balance sheet transaction, and the entity is regarded as insolvency remote. Therefore, SPVs may be formed for risk isolation purposes.

But to “begin from the beginning”, Chase Bank had earlier on – through the Chase Iman –  diversified into Islamic banking. Islam thumbs up a nose at conventional bonds. One, because they charge interest. Two, because they may be used to finance activities which Sharia law expressly forbids.

To skirt around these two realities, Islam proposes its own version of the conventional bond – the Sukuk. Unlike the conventional bond, the Sukuk’s pay-out to investors assumes the form of profits rather than interest, the profit itself being derived from a tangible asset.

Like a sheet anchor, the SPV sits at the nub and core of the Sukuk. The originator forms an SPV, which then issues a Sukuk. Funds raised through the Sukuk are used to purchase a tangible asset from the originator. Given its bankruptcy remoteness, the SPV shields these assets from creditors should the originator experience distress. The SPV leases those assets back to the originator, who in turn passes the income obtained from the lease to the holders of the Sukuk. At the point of maturity, the originator purchases the assets from the SPV at its nominal price.

But Chase’s diversification into Islamic banking appears to have been more of the beginning of its end, rather than the beginning of the beginning. 2016, which appears to have been the end of its beginning, its auditors demanded that the bank charges its Islamic banking assets. Up to that point, and with the approval and validation of its auditors, the bank had categorised its Islamic banking assets under the ‘other assets and interest receivable’ entry in the balance sheet. In 2015, the assets under this entry were valued at 7.9bn shillings.

The bank protested that doing so would turn them into loans, necessitating an increase in loan provisions. Charging the assets would also incur monthly interest costs, in violation of Islamic banking principles.

Nevertheless, the auditors’ position, which also mirrored that of the CBK, prevailed. Forced to restate its financial statements, the bank’s loan impairment costs rose from 757m to 2.1bn. This had the effect of transforming its earlier reported profit into a Sh743 million loss. In a capsule, the narrative that leaked out on the social graph is that the bank had underreported insider loans of up to 7.9bn shillings, resulting into a weak financial position, as manifested  by an actual loss of Sh743 million.

This triggered panic withdrawals by its customers, leading to a massive bank run. With no reserves to sustain the panic withdrawals, the bank turned to the CBK for emergency liquidity of up to 10bn shillings, but the CBK turned up its nose at that request, and placed it under the care of the Kenya Deposit Insurance Corporation. In doing so, the CBK put out a statement that “Chase Bank Limited experienced liquidity difficulties, following inaccurate social media reports…”