The China Slowdown: Emerging Asia Beckons

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Aug. 29 – The Indian newspaper Daily News and Analysis has been conducting a series of interviews with Asian-based businesses, including those in Hong Kong and on the mainland, to assess the impact of a potential slowdown in China.

In the first article in the series, “Made in China Not So Cheap Now,” the paper noted that both Videocon and Foxxconn are looking at relocating their Guangdong-based operations, with India, Vietnam and Bangladesh all touted as recipients of relating businesses.

A Hong Kong-based garments manufacturer who sources from China for the world markets has already moved some of his supply lines from China to Vietnam and Bangladesh. “Exporters are finding it very difficult,” M. Arunachalam said, “many low-tech industries, squeezed by shrinking margins and severe credit constraints, are closing down.”

The article quotes CIBC World Markets senior economist Benjamin Tal as saying that China is not the cheapest place to do business anymore. He argues that high transport costs, driven by high oil prices, are changing the geography of manufacturing. “We’re seeing a situation where, in the steel industry, for instance, transport costs can make a difference between ‘Made in China’ and ‘Made in the U.S.’. American companies are doing the math and shifting some businesses from China. And if energy prices remain high, as we believe they will, you’ll see more and more industries leaving China,” Tal says.

All this ties in with the Chinese government’s efforts to reposition China higher up the value chain of manufacturing. “China no longer wants to be the manufacturing capital of the world,” says Chris Devonshire-Ellis, senior partner at Dezan Shira & Associates. “It wants to be the added-value production capital of the world.”

Rich Brubaker of All Roads Lead to China, believes it’s hard for manufacturers to leave China because there is no business case to move. “It’s not just that China has superior infrastructure and a huge supply base; increasingly, firms are manufacturing not just for export but for the China market,” he says.

In the second report in the series, “The World is No Longer Flat,” DNA takes a look at the impact of the rising costs of fuel. “High oil prices will reverse globalization and alter the ‘geography of manufacturing,” says Tal. Indeed, a recent CIBC study, co-authored by Tal and “maverick” economist Jeff Rubin argued that rising transport costs would reverse the trend of globalization in favor of “regionalization.”

“Soaring transport costs suggest trade should be both dampened and diverted as markets seek shorter, and hence, less costly supply lines. Instead of finding cheap labor halfway across the world, the key will be to find the cheapest labor force within reasonable shipping distance to your market,” the report says.

More worryingly, Tal also is convinced Oil prices will remain high. “We believe that oil prices will remain elevated, and in fact go higher again,” he says. “It’s not a question of tomorrow. It’s a long-term story. We believe there’s a major disagreement between supply and demand, therefore energy prices will remain elevated and go higher, which in turn means transport prices will become more and important for companies.” For now, he and Rubin are standing by their call that oil prices will touch $225 a barrel by 2012.

The third report in the series, “MNC’s China Plus One Strategy,” follows a similar viewpoint that China Briefing highlighted several months ago. Devonshire-Ellis states that U.S. policy is driving business to competing markets with India, while corporate bean counters are looking as always for the next best sustainable manufacturing deal. Interest in India is very high he says.

“Our existing clients in China (all of whom are foreign-invested companies) are asking us to go to India, not necessarily to shut down their manufacturing operations in China, but to take advantage of the fact that there’s a large market in India,” Devonshire-Ellis says.

China is gradually changing from an export-driven society to a consumer-driven society. “You come to China to do one or two things: one, manufacture here for export—and that’s starting to get a bit expensive, which is why low-end guys are shifting to Vietnam,” he says. “Or you come here to manufacture and sell onto the domestic market, and that’s where the future money is. The same is true of India.”

But does India offer the scale and ease of operations in the way that China does? “A lot of people talk about the bureaucracy in India and its impact on business development,” observes Devonshire-Ellis. “But although politics and bureaucracy does hold up certain processes, you can go to India and establish a business in a relatively short time-scale. In fact, the processes to set up a representative office in India are actually two steps less than it takes in China.”

The Final Report, “Why China is So Hard to Leave” deals with the China development realities of the regional markets: For all the hand-wringing over the rising cost of sourcing from China, the country’s scale of manufacturing operations, the depth of its supply base and its famed infrastructural advantages make it a difficult country for manufacturers to leave for elsewhere, say economists, business consultants and businessmen.

“Where else but in China can you source the huge quantity of goods that Wal-Mart needs, for instance,” says Jing Ulrich, chairman of China equities at JPMorgan Securities. “Countries like Vietnam and Bangladesh may be able to take some market share from China in some industries, but they’re not going to be able to replicate the huge scale of manufacturing that China has built up over the past 30 years.”

Ulrich notes that China remains a competitive producer of many goods, but that it feels the need to exit low-end manufacturing industries such as textiles, garments and shoes, which operate on thin margins. “In low-end manufacturing, which is labor-intensive and materials-intensive, China is not going to be as competitive as it once was,” Ulrich says.

China, she adds, is looking to move up the value chain into machinery manufacturing, including high-end goods and telecommunication equipment. “This is where the bright spots will be.”

Alberto Vettoretti, managing partner for Dezan Shira & Associates, recently returned to Shenzhen from the firm’s Vietnam offices, viewed the region’s economic landscape as one full of opportunities.

“China is clearly shifting its priorities from ‘quantity’ to ‘quality’ and it can be selective over which industries to welcome and which ones to restrict,” Vettoretti says. The shift is especially pronounced in South China, where the policy of “cleaning the cage and changing the birds” is raising concern if not sending away many low-end manufacturers while not yet convincing high-end and high tech manufacturers to set up operations in the country. “The region is taking certain low end manufacturing away from China” he says. “That’s partly Beijing’s policies, partly economic reality. Vietnam is cheaper to manufacture certain goods than Shenzhen or Dongguan is, but if you go to Vietnam, then there are people there telling you it’s cheaper still in Laos and Cambodia.” While 10 years ago China was “the place” where to invest if you were into export-manufacturing, right now it is becoming more of a “moving target” depending on different hard and soft aspects.

“There’s also a regional shift for the global manufacturers looking for new markets,” says Devonshire-Ellis. “Penetration in China to sell to China will continue, however there’s the huge India market to consider also. The smaller countries of Southeast Asia will progressively absorb low cost manufacturing, while India is becoming a domestic market that cannot be ignored.” The issue for multinationals, he says, is to not just have a China strategy, but rather, an Asian one. “Where you want to manufacture and export and where you want to manufacture and sell onto has changed. There are an increasing number of options regionally – which is why we are running around assessing them”.

We are grateful to Daily News and Analysis’ Venkatesan Vembu for his assistance with this article.

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