Investment Inflows to China Plunge as Japan “Pivots” to ASEAN

The scale of Japan’s investment shift away from China has seen a dramatic fall in Japanese foreign direct investment (FDI) flows into China, plunging by 48.8 percent in the first half of 2014 compared to the same period a year ago, according to the latest analysis from IHS, a leading global source of critical information and insight.

In his Asia letter titled: Japan’s ASEAN Pivot, Rajiv Biswas, Asia Pacific chief economist at IHS, noted that total Japanese FDI flows into China amounted to $9.3 billion in 2013, whereas total Japanese FDI into ASEAN was $22.9 billion in the same year. Furthermore, total Japanese FDIs into ASEAN for 2011-13 amounted to $56.3 billion, far exceeding total Japanese FDIs into China for 2011-13 of $35 billion.

“Japan’s FDIs into ASEAN was almost two-and-a-half times larger than investments into China in 2013,” Biswas says. “Japan’s pivot to ASEAN partly reflects a number of ‘push factors’ driving Japanese firms away from making new FDIs into China, notably the escalation of bilateral political tensions between the two nations since 2012, and the rapid rise in manufacturing wage costs in coastal China.”

“The most dramatic swing in Japanese FDI flows came after the anti-Japanese riots in China during 2012 forcing Japanese corporate boardrooms to seek alternative locations for new investments,” Biswas says.

Japan’s Pivot to ASEAN

ASEAN has become particularly attractive for Japanese companies facing a mature domestic consumer market and aging demographics at home. This increased impetus to invest outside of their home market also comes on the back of key policy thrusts of “Abenomics” in a strategic effort to support Japanese multinationals to seize new growth opportunities in emerging market regions since Japanese Prime Minister Shinzo Abe took office in December 2012, the Asia letter says.

“ASEAN has many ‘pull factors’ that are attractive to Japanese multinationals, such as the region’s combined GDP reaching $2.4 trillion in 2014, with a total population 635 million people and a rapidly growing middle class, representing one of the fastest-growing market opportunities over the next two decades,” Biswas observes.

These “pull factors,” added Biswas, are creating surging interest in the ASEAN economies from Japanese firms across many manufacturing industries, including energy, electronics, automotive, construction equipment, industrial machinery and food products, as well as companies in service industries such as banking and logistics.

ASEAN’s Changing Investment Landscape

Aside from China’s rapidly eroding competitiveness for low-end manufacturing and the bilateral political tensions, another driver has been significant trade-liberalization initiatives being untaken by a number of ASEAN economies.

These have included the removal of internal tariff barriers to trade in goods through the implementation of the ASEAN Free Trade Area, put into place for the ASEAN-6 nations (Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand) in 2010 with a somewhat longer transition period for the other four ASEAN nations (Vietnam, Myanmar, Cambodia and Laos).

“The next stage of economic integration is already in progress through ASEAN negotiations for the ASEAN Economic Community (AEC), which aims to liberalize trade in services and remove barriers to investment amongst ASEAN countries,” Biswas says. “The aim is for an AEC deal to be agreed upon by the end of 2015 Trade ministers estimate that around 80 percent of the areas being negotiated have already been agreed.”

Biswas adds that ASEAN has also constructed a network of Free Trade Agreements (FTAs) with other key trade partners, including China through the China-ASEAN FTA, as well as FTAs with Australia, India, and New Zealand.

Beyond the regional trade initiatives, there are significant changes at the national level that are helping to boost ASEAN competitiveness, including:

·      Malaysia – Implementation of the Economic Transformation Program to boost FDI inflows and domestic investments since 2011 has catapulted Malaysia to rank sixth globally in the World Banks’ Ease of Doing Business Index for 2014.
·      Singapore – The City State has consistently ranked as first in the world every year since 2007 in the World Bank’s Ease of Doing Business Index, creating a powerful competitive core for ASEAN.
·      Myanmar – Embarked on far-reaching reforms since 2011 that have opened up the economy to FDI inflows and industrial infrastructure development, including critical exchange rate reforms, foreign bank licenses, and new laws to facilitate foreign investments, particularly for Myanmar’s oil and gas sector.
·      Philippines – Undergoing economic renaissance under President Beningo Aquino to boost FDI inflows over the medium term, including the introduction of new rules to allow 100 percent foreign ownership of its local banking sector.
·      Indonesia – ASEAN’s largest economy to encourage substantial new FDI inflows, particularly from Japanese automakers to meet rapid growth in demand for cars and motorcycles for its rapidly growing urban middle class.

“The ASEAN region offers considerable opportunities for Japanese firms, not only as hubs for manufacturing production, but also because of the large population and fast-growing consumer middle classes in some of ASEAN’s largest economies, including Indonesia, Philippines, and Vietnam,” Biswas says.

“Abe’s ASEAN pivot is already well under way, and this will generate substantial new FDIs from Japan to ASEAN over the medium to long term,” he says. “Meanwhile, Japanese multinationals will continue to use ASEAN as an important risk mitigator for their regional manufacturing supply chains, notably to reduce vulnerability of their supply chains to China.”

Tony Fernandes, founder and CEO of AirAsia, told analysts at McKinsey & Company, Inc. that ASEAN’s relevance is becoming clearer for U.S. supply chain managers.

“ASEAN is growing up and feeling a little bit stronger. In strange ways, situations like territorial disputes might bring ASEAN closer together quicker.”

Rosemary Coates, president of Blue Silk Consulting and author of Rules for Sourcing and Manufacturing in China notes that Japan and China have had a strained relationship for hundreds of years and it isn’t getting any better.

“This makes investments in more Japanese-friendly ASEAN nations more attractive,” she agrees. “But beyond just the politics, the ASEAN region is booming with enhanced trade between the partners through the ASEAN Single Window project and the rise of the middle class with millions of potential new consumers. Nations such as Vietnam, Indonesia and Myanmar still offer very attractive labor rates and ample opportunity for building manufacturing in these countries to serve both domestic and export markets.”

Coates cautions again selling China short, however, noting that the world’s manufacturing base and suppliers are still there and will be for years to come.

“As China turns from mostly export to mostly domestic manufacturing, there are still plenty of opportunities for profitable investing,” she says.

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