Trading places: Why southeast Asia could benefit from US-China spat

Trade wars have disrupted supply chains and weighed on stock performance in emerging markets. But as manufacturing companies shift production away from China to evade tariffs, some of its neighbours have spotted an opportunity.

US President Donald Trump’s protectionist policies have drawn criticism from government officials, investors and corporate executives across the world. But they are winning support in some unlikely places. As Indonesian Vice-President Jusuf Kalla told Bloomberg in early 2019: “Ongoing trade war is quite good.”1

Higher tariffs have disrupted supply chains and threatened the economic resilience of China 

Trade tensions might seem like bad news for the open economies of southeast Asia, which have benefited from improved global trade flows over the past few decades. Higher tariffs have disrupted supply chains and threatened the economic resilience of China, the major trading partner of many countries in the region.

But the trade conflict has also brought some benefits. As Trump’s tariffs hit Chinese exports to the US, companies in the engineering, textiles and technology industries have been busy bringing forward plans to move production out of China to neighbouring countries to avoid getting caught in the crossfire. Echoing Indonesia’s government, Vietnamese Prime Minister Nguyen Xuan Phuc called on his nation to “grab the opportunity” to win more foreign investment.2

The shift of manufacturing operations from China to southeast Asia is hastening a longer-term trend. Foreign companies and investors are increasingly drawn to the region’s favourable geographic position and demographic profile – and this is likely to continue whatever the outcome of trade negotiations between Washington and Beijing.

“There has been a diversion of capital and investment to the countries of south and southeast Asia, reflecting the wider growth story,” says Parag Khanna, an expert on geopolitical strategy and author of the book The Future is Asian. “That process was already underway, but the trade war is certainly going to accelerate the process.”

Trade war effects

Southeast Asian economies posted mixed economic performance last year amid the one-two punch from trade disputes and the Federal Reserve tightening cycle. According to data from the Asian Development Bank, weighted average GDP growth across the region’s five major economies – Indonesia, Malaysia, the Philippines, Singapore and Thailand – was 4.8 per cent in 2018, slower than the 5.1 per cent rate in 2017.3

Higher US interest rates and a strengthening dollar tend to prompt outflows of investment from emerging markets, which can expose economies dependent on foreign capital flows. But the impact of such factors was less pronounced in 2018 than during the ‘taper tantrum’ of 2013, partly because the region’s economies are now more resilient than they were six years ago.

“Many southeast Asian markets were adversely affected by higher US rates and a stronger dollar,” says Maulshree Saroliya, macro strategist at Aviva Investors. “The experience was not too dissimilar to the taper tantrum, when higher US rates, amid a repricing of US monetary policy, led to portfolio outflows from emerging markets. But these markets had much larger external deficits and lower real interest rates during the taper tantrum, which led to a very sharp sell-off in EM purely on the back of higher US rates.

the US Federal Reserve has taken a strong dovish turn and China has decided to stimulate its economy more decisively

“Recently, however, the US Federal Reserve has taken a strong dovish turn and China has decided to stimulate its economy more decisively, both of which are sources of significant relief to Asia and wider EM,” Saroliya adds.

Stuart Ritson, emerging market debt fund manager at Aviva Investors in Singapore, also points to improved economic resilience across southeast Asia. With the US dollar unlikely to continue strengthening to the degree it did in 2018, Ritson argues local currency government debt could present an opportunity for fixed income investors.

“Asian local markets are relatively well placed given their decent fundamentals; lower oil prices compared with the second half of 2018; and a more benign US dollar backdrop, which is providing support to the regional high-yielders such as Indonesia,” Ritson says.

“Rupiah valuations are attractive and real yields offer good compensation relative to Indonesian fundamentals. Policymakers were proactive amid the increased macroeconomic volatility last year, and we anticipate a narrowing of the current account deficit, which will reduce pressure on the currency at a time when cross-border demand for Indonesian assets is picking up,” he adds.

Competitive advantage

Trade wars remain a threat, but southeast Asian economies could yet benefit if they can ride out the short-term hit.

Trade wars remain a threat, but southeast Asian economies could yet benefit if they can ride out the short-term hit. Large overseas electronics companies are among the firms expediting plans to relocate their manufacturing bases away from China to avoid tariffs, with Thailand, Indonesia, Malaysia and Vietnam the chief beneficiaries. Although many of these countries export goods to China, including intermediate parts in electronics production chains, they have plenty of scope to export more to the US.

“With the trade dispute and associated geopolitical tensions, companies are concerned about the risk of having too much exposure to China, so they are moving their operations elsewhere in Asia and taking advantage of the labour-market arbitrage,” says Alistair Way, head of emerging market equities at Aviva Investors. “This is an interesting trend from an investment perspective, as companies that can flexibly move their production bases will have a competitive advantage.”

According to figures from the United Nations Conference on Trade and Development (UNCTAD), southeast Asia was the world’s “main FDI growth engine” last year; inflows increased 11 per cent to a record $145 billion, higher than both Europe and China.4 According to a recent survey, more than 70 per cent of US companies operating in southern China said they were considering delaying investment or moving their manufacturing to other countries, with southeast Asia the most likely destination.5

Japanese companies that had been building production in China in order to re-export to the West are already on the move. Announcing its decision to shift production of its in-car stereos from China to Thailand and Malaysia – as well as Mexico – in October 2018, Panasonic said Trump’s threat of additional tariffs on China could hit its annual profits by 10 billion yen ($89 million). Other firms such as Yokowo, Sumitomo and Daikin Industries have also begun to move some manufacturing operations to southeast Asia.

Not all southeast Asian economies are benefiting equally from this trend, however, and political factors can play a role. While foreign investment in Thailand was strong in 2018 – the country attracted $11 billion in FDI, four times more than in 2017 – business confidence has waned recently amid the uncertainty surrounding the country’s general election later this month.6 Ritson says the potential for political gridlock following the vote is high, although Thailand’s healthy current account surplus of six per cent of GDP should support the Thai baht, protecting asset prices. 

Vietnam is increasingly in favour among foreign investors and businesses

Vietnam is increasingly in favour among foreign investors and businesses, having received a record $19 billion in FDI in 2018. The country has many qualities prized by manufacturing companies: political stability, proximity to major supply chains, robust infrastructure and a workforce skilled in high-tech manufacturing, thanks to the government’s targeted investments in education and training.

Long before US-China trade tensions, companies such as Foxconn, Intel and Samsung had begun to shift production bases from China to Vietnam. Fears of a full-blown trade war have simply sped up the process, with manufacturing inflows rising 18 per cent over the first nine months of 2018.7 Such is Samsung’s enthusiasm for the Vietnamese market, it is now the country’s biggest foreign employer.

Flexible supply chains

Vietnam’s success in attracting manufacturing business could bring problems of its own, however. As more companies arrive and start to export to the US, Trump may start to turn his protectionist ire on Hanoi. Vietnam has a $40 billion trade surplus with the US and was hit by tariffs in 2016, when Chinese companies rerouted steel exports through the country to evade China-focused levies. Wary of this danger, Nguyen Xuan Phuc has been careful to stress his government will not take sides in the dispute.

not all companies will be able to move their operations without incurring significant costs, which could wipe out the benefits from circumventing tariffs

Those hoping to play the rise of southeast Asian FDI as an investment theme should also be aware that not all companies will be able to move their operations without incurring significant costs, which could wipe out the benefits from circumventing tariffs. This is especially the case with companies embedded in intricate regional supply chains: The Economist estimates the combined cost to Apple’s suppliers of shifting iPhone production out of China would be anywhere between $25 billion and $90 billion.8

But companies that can shift their operations flexibly will gain an advantage – not only will they avoid swingeing tariffs on exports, they can gain from lower labour costs too. Larger companies agile enough to quickly shift production bases across borders without building entirely new factories will be well-positioned, as will manufacturing solutions firms such as Taiwan’s New Kinpo, which has existing production networks across Southeast Asia.

“Domestic manufacturing firms in Vietnam, Malaysia and Thailand could win new business,” says Way. “There could be a greater disparity in performance between those firms that are sufficiently flexible to be able to cope with the potentially more problematic new world trade order and those that can’t.”

Shifting perceptions

It may take some time for companies moving their operations to southeast Asia to see the effects in their bottom line, and for the host countries to reap the economic benefits of higher investment. But those will come over the medium term, Way argues.

Since the beginning of 2019 there have been signs of a thawing in tensions between the US and China. But even if the two superpowers strike an agreement on trade, as expected, southeast Asia should continue to attract foreign investment. Over the longer term, the region has many characteristics that should help boost growth.

Southeast Asian economies are working together as a bloc through the Association of Southeast Asian Nations (ASEAN) organisation, facilitating greater intra-regional migration and investment. Southeast Asia is also home to a large cohort of young, increasingly affluent citizens whose spending power should help propel more domestic growth over the coming years.

large global companies are likely to see the region as a lucrative consumer market, not simply a source of cheap labour

As this trend develops, large global companies are likely to see the region as a lucrative consumer market, not simply a source of cheap labour. Chinese technology companies such as Alibaba and JD.com and their Western rivals, including Google and Amazon, are already vying for customers in Indonesia, Thailand and Vietnam, whether through partnerships with local firms or by directly offering their own services. China’s tech giants spent $6 billion on acquisitions of southeast Asian companies in 2017.9

Parag Khanna argues southeast Asia, along with south Asia, will be the source of the continent’s next growth wave, shifting perceptions of the region’s status vis-à-vis both China and the West. “It has been well established for some time Asia has the fastest growing middle class in the world, driven at first by Japan and South Korea and now of course China. India is catching up gradually. Once you add in the demographic clusters in southeast Asia, with their teeming megacities and financial centres, this dynamic will only continue,” he explains.

“It shifts the consumer gravity for luxury brands or retail companies. Asia used to make for the West and now the West makes for Asia. That’s how things are playing out in sector after sector. This trend enhances Asia’s leverage quite significantly, in terms of its ability to conduct its industrial policy, to continue to attract foreign investment and to rewrite the rules of global trade and FDI,” Khanna adds.

References

  1. ‘Trade war is a good thing for Indonesia, vice president says,’ Bloomberg, January 2019. https://www.bloomberg.com/news/articles/2019-01-08/trade-war-is-a-good-thing-for-indonesia-vice-president-says
  2. ‘US-China trade war boosts fast-growing southeast Asia,’ Forbes, February 2019. https://www.forbes.com/sites/vinnielauria/2019/02/19/u-s-china-trade-war-boosts-fast-growing-southeast-asia-2/#4e2ef2c76f5e
  3. ‘Trade war hits SE Asia, growth down for first time in three years,’ Nikkei, February 2019. https://asia.nikkei.com/Economy/Trade-war-hits-SE-Asia-growth-down-for-first-time-in-3-years
  4. ‘Southeast Asia bucks trend of sinking global foreign investment,’ Nikkei, February 2019. https://asia.nikkei.com/Economy/Southeast-Asia-bucks-trend-of-sinking-global-foreign-investment
  5. ‘Many US firms in China eyeing relocation as trade war bites,’ Reuters, October 2018. https://www.nbcnews.com/business/business-news/many-u-s-firms-china-eyeing-relocation-trade-war-bites-n925526
  6. See note 4.
  7. ‘Thanks to the trade war, southeast Asia has an investment boom,’ Bloomberg, October 2018. https://www.bloomberg.com/news/articles/2018-10-22/thanks-to-the-trade-war-southeast-asia-has-an-investment-boom
  8. ‘Globalisation has faltered,’ The Economist, January 2019. https://www.economist.com/briefing/2019/01/24/globalisation-has-faltered
  9. ‘Chinese and US tech giants go at it in emerging markets,’ The Economist, July 2018. https://www.economist.com/business/2018/07/07/chinese-and-us-tech-giants-go-at-it-in-emerging-markets

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