The ensuing geopolitical dynamic between the U.S. and China has been a one-step forward, two-steps back affair. The disagreements over tariffs are now in the second year, with impacts reverberating into capital markets and making cross-border deal flows vulnerable. While the current thinking in Washington as well as Beijing seems to be precocious, the ambiguity around the future of trade amongst them is expected to remain the principal showground of the ongoing power tussle.
One of the most prominent aftermaths of this uncertainty is for global companies to look at re-evaluating their supply chains to mitigate the impact on cost and earning structures by making them more resilient and agile. Supply chain leaders in sectors like technology, automotive, industrial markets and consumer retail are taking the hardest look at moving pieces of their supply chain out of China.
Sensing an immediate need to relocate, several companies have begun evaluating key imported components by classification and country of origin to exploring course corrective measures like product rerouting or alternative sourcing.
Shifting epicentre – South Asia
The shifting regional trade dynamic, while on the one hand means challenges for a few economies like China who traditionally had the lion’s share of regional trade, it also spells opportunity for many other South Asian nations looking to get in on the action. Issues ranging from compliance to local regulations, supply of human capital and raw resources are key considerations for companies planning on building new plants and expanding their capacities in the region.
The relocation of manufacturing to under penetrated economies such as Vietnam, Thailand, India and Indonesia is perhaps the most notable benefit for the region, which is bracing for a surge in FDI. Take the case of Vietnam - touted to be the ‘next China’ is already making big gains. The country boasts of improved regulatory environment, cost effective workforce and competitive advantage in textile and electronics manufacturing than some other alternative sourcing destinations, such as Bangladesh, Thailand, Indonesia and Cambodia.
Taiwan, too, seems to be profiting from this development, as computer production returns home. While moving production back to Taiwan is expected to increase costs, the industry’s highly automated production lines will more than compensate for the labour shortage issue.
Add to this, the recently concluded Regional Comprehensive Economic Partnership (RCEP) agreement is expected to further accelerate the region’s competitiveness in the global arena. Closer home, while sectors like steel, dairy have expressed their reasons to rejoice from India’s decision to opt out of the RCEP, the question remains whether the non-participation is likely to deny Indian companies from being included in regional and global value chains in the medium to long term.
India – need to gear up for the long haul
The India story remains real and relevant. The reduced tax rates recently announced by the government have brought the country at a relatively competitive position amongst other east Asian countries. That being said, if taxes payable on shareholder profit distributions are included, on an overall basis, India still continues to be a high tax country. For the country to be a prime contender in this ‘alternative investment destination race’, there are four specific areas to be focused on:
Domestic consumption-based growth – The large home market cannot be ignored. While export oriented growth will play its role in helping the country gain global prominence and introduce new skills and efficiencies in the manufacturing ecosystem, building a strong narrative around domestic manufacturing will remain critical. Rural demand is increasing significantly and steadily, at the back of productive jobs and enterprises. This will likely set off a ‘trickle up’ effect, where higher disposable income will lead to more demand thereby making the national market more attractive for foreign companies. We are already seeing some signs of these with many global corporations expanding their rural India footprint.
Shift from labour-intensive to capital and technology-intensive exports: Technology transfer through intermediate goods is expected to improve India's manufactured exports and help Indian manufacturing companies integrate with global supply chains. The technological upgrading will lead to highly internationalised and competitive industries being able to sell their exports to the developed economies.
Infrastructure development – While the country enjoys comparative locational advantage, there is a need to develop sustainable and resilient infrastructure to support economic development. The glaring investment gap needs funding through innovative approaches like hybrid financing models, etc. This will be a key determinant for foreign companies looking to bring down the operational and logistics costs as part of their relocation strategy.
Skill development: Need to focus on upskilling and re-skilling the workforce which can be achieved through partnerships with government, industry and academia. They will be vital to redesigning industry related curriculums, vocational and soft skills trainings.
‘Cautious optimism’ is the key
This expected shift in global sourcing, though initially began at the back of a few key ‘push’ factors, has now interestingly emerged as a combination of both ‘push and pull’ factors that will determine where investors/businesses will place their next big bet. Asian economies are aware that there is a limited time frame available to capitalise on this opportunity. However, the risk of ending up with more demand for manufacturing than their capacity to handle, is real. The key is to focus on securing the supply side, which will eventually take care of the demand and not going the other way around!
(A version of this article appeared in The Business Standard on November 24, 2019)