Transcript
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Speaker: Hello and welcome to Under the Banyan Tree, your weekly one-stop shop for putting Asian markets and economics in context.
Speaker: I'm Fred Newman, Chief Asia Economist here at HSBC.
Speaker: And I'm Harold van der Linde, Head of Asian Equity Strategy also here at HSBC.
Speaker: We're in myth-buster mode today looking at supply chains across the region.
Speaker: We know they're shifting, but what kind of companies are behind this?
Speaker: Where is production moving to?
Speaker: And which economies actually benefit?
Speaker: Plus, the big question on the world's manufacturing giant, is China still the production behemoth it used to be now that Asian supply chains are becoming more spread out?
Speaker: Answers to all those questions and more coming up under the Banyan tree.
Speaker: Fred, over the last two, three years, we've been talking a lot about movements in supply chains in Asia, right?
Speaker: It's a big economic theme.
Speaker: It's a big, to a certain extent, a theme in the equity universe as well.
Speaker: When I passed your desk, I heard you talking with one of your colleagues about the three myths in supply chain movements.
Speaker: What are these three myths?
Speaker: What is the biggest myth?
Speaker: Let's start with that one.
Speaker: When it comes to the understanding of shifts in supply chains across Asia.
Speaker: Well, in the recent years, it's been a big talking point, right?
Speaker: Looking at supply chain diversification, China plus one strategies, this idea that supply chains are coming out of China, moving into other parts of the world.
Speaker: And there's something to that, but the stories are a little bit distorted.
Speaker: So there are kind of three myths that we call it around this.
Speaker: And the first one is
Speaker: It's really that it's a limited scope in terms of geography to where these supply chains are actually being moved to.
Speaker: So in Asia, we have big beneficiaries in Vietnam.
Speaker: That's a very well-known story.
Speaker: Malaysia, for example.
Speaker: And then you have further... Malaysia is a semiconductor.
Speaker: semiconductors, electronics, and then you have Mexico outside of this region.
Speaker: But this is primarily it.
Speaker: There's a little bit going into Bangladesh, there's a little bit going into Thailand, there's a tiny bit going into maybe Indonesia, a bit into India, but that's fairly limited.
Speaker: So the big beneficiaries of this particular move are really just three, four economies.
Speaker: It's not that if
Speaker: all of the rest of the region is really benefiting from this.
Speaker: So that's limited scope.
Speaker: But aren't there quite a few tech companies going to India, for example?
Speaker: Or we've talked about the EV supply chain moving into Indonesia.
Speaker: There's some tech going into India, but part of this is to produce for the domestic market rather than necessarily for global supply chains.
Speaker: And the other thing is that it's not enough in terms of quality
Speaker: quantity to really make a big difference for the Indian economy overall.
Speaker: It's such a large economy.
Speaker: That's the issue, right?
Speaker: You're talking about supply chains, but actually they're a small part of the overall pie.
Speaker: Yeah.
Speaker: And so at the margin, it helps.
Speaker: But really, if you think about forecasting Indian growth, you're looking at what's the service sector doing, what's the agricultural sector doing, what's consumption doing.
Speaker: But not
Speaker: How many supply chains are coming in?
Speaker: Not looking at certain electronics components.
Speaker: Whereas if you look at Vietnam, for example, we have so much investment going in there that that really drives overall investment trends within the economy.
Speaker: So it's a different ballgame.
Speaker: Isn't it like Samsung exports or tech exports are like 80% of...
Speaker: of Vietnamese exports or something?
Speaker: A huge number, yeah.
Speaker: It depends which measures you use, but electronics themselves, certainly a big, big part of Vietnamese exports.
Speaker: Vietnamese exports actually are roughly 100% of GDP.
Speaker: So it shows how important that is.
Speaker: How relevant that is.
Speaker: And so you get a few more factories in there, it immediately makes a big difference for GDP.
Speaker: So limited scope...
Speaker: Yeah, that's the first myth.
Speaker: It's the first myth.
Speaker: It is not as big as we think it is, with the exception of some countries, right?
Speaker: What is then the second myth?
Speaker: What is the second mistake that we make if we think about this?
Speaker: So the second myth is that it's just Western companies that are fleeing China and moving elsewhere.
Speaker: But actually, if you look closely, it's a lot of Chinese companies who are moving investment in China.
Speaker: into other economies and that's a very important message here, partly because many Western firms are staying in China to supply the domestic market, so they're not leaving China.
Speaker: The other thing is that because it's Chinese companies that are moving to Vietnam or Mexico or Malaysia, they often use Chinese components, right?
Speaker: So actually the connectivity therefore between the Chinese economy and these economies is increasing because
Speaker: we're not really cutting out China.
Speaker: We're just adding, we're moving final assembly to these markets rather than kind of getting rid of all Chinese components.
Speaker: And so from that perspective, the fact that Chinese companies are doing that increases the connectivity between these economies and mainland China.
Speaker: And so the second myth is therefore, it is a lot of Chinese companies are doing that.
Speaker: And it's of course in a lot of industries in China, there's oversupply or there's too many producers of, for example, EVs, right, electric vehicles.
Speaker: So you see them moving out and they probably struggle with the US.
Speaker: Europe is maybe difficult to penetrate as well, very established place there.
Speaker: So then, yeah, you look at Asia, I guess Indonesia is a large market, India is a large market, but might also be difficult for them to get in, right?
Speaker: So...
Speaker: ASEAN would be a major sort of focus for them, I guess.
Speaker: ASEAN is huge, right?
Speaker: So the amount of foreign investment, particularly manufacturing investment, going from China into Southeast Asia is off the charts.
Speaker: It's growing very, very rapidly.
Speaker: The internet companies are also quite active, you know, yeah.
Speaker: Yes, yeah.
Speaker: There are actually sort of three drivers if you think about why Chinese companies are investing in Southeast Asia or other emerging markets.
Speaker: One of them clearly is because...
Speaker: Domestic demand is weak.
Speaker: They're trying to get a foothold in other markets.
Speaker: It's what you just described, right?
Speaker: So if the internet companies or the EV companies, for example, want to sell the products into local markets.
Speaker: In ASEAN, for example, 500 million consumers, that's a large market.
Speaker: Latin America fits in there, particularly if the European-US markets are becoming more closed and they're looking into emerging markets.
Speaker: That's why you see that flow of investment.
Speaker: The second one is that you have rising labor costs actually in China relative to these markets, right?
Speaker: And so it makes sense to shift a very low-end part of the production into these economies, but retaining the higher-end stuff in China.
Speaker: And so that's just China using Southeast Asia just as the U.S. used China many years ago as a kind of...
Speaker: Finding a lower wage area, right?
Speaker: So that's a second area.
Speaker: And then there's a third one, and that is that there are increasing distortions in terms of tariffs and trade restrictions in the global economy.
Speaker: And so by moving production to different areas, you can take advantage of different tariff regimes.
Speaker: And so there's a distortive element of trade restrictions that are coming in.
Speaker: Of course, US-China tensions, economic tensions have led to some of these investment flows.
Speaker: But there are other reasons as well.
Speaker: There's tariffs going up across the world, trade restrictions, and that leads multinational companies, including Chinese, to move production around just to optimize the tariff and trade strategy.
Speaker: And that's the third big driver of why Chinese companies are part of this investment surge into Southeast Asia, for example.
Speaker: Good.
Speaker: Now, Fred, we've spoken about the first and the second myths.
Speaker: I propose we take a quick break here, and then we go look at the third myth and maybe the implication for markets as well.
Speaker: Sounds good.
Speaker: So Fred, we're talking about the three key myths that you've identified when it comes to supply chain movements across Asia.
Speaker: So we try to get a better understanding of it.
Speaker: The first myth that you mentioned was it's actually more limited in scope than what most people think it is.
Speaker: It's big for some countries, but for most countries, it's not as big as you think it is.
Speaker: You don't make changes in your GDP forecast necessarily just on the back of this.
Speaker: The second one is that a lot of people think this is global firms, non-Chinese firms, let's put it like that, that say, oh, I don't want to put all my eggs in one basket so I go somewhere else.
Speaker: Actually, it's a lot of Chinese companies that, for example, try to penetrate new consumer markets or find cheaper production facilities, in particular in ASEAN.
Speaker: But there's a third myth.
Speaker: What is that one?
Speaker: The third myth kind of comes really from the first two, and that is that actually this move of moving supply chains out of China, quote unquote, is actually not reducing the importance of China for the global economy.
Speaker: If anything, actually, the centrality of China for the global manufacturing sector is actually increased partly as a result of this move.
Speaker: And the way it works is that, yes, we're moving some of the final assembly to Mexico, to Vietnam, to Malaysia, but these factories are using Chinese components for the production.
Speaker: And so they still rely on China.
Speaker: In fact, on some measures, they rely increasingly on China rather than on other economies for the components.
Speaker: And so
Speaker: We can measure this and say, well, China's exports as a share of global exports may have come down slightly.
Speaker: And then people say, oh, China's losing market share.
Speaker: But if you look qualitatively, actually, the types of goods we buy from China are becoming more central to the manufacturing process.
Speaker: And therefore, China's importance to the global economy keeps on rising because China is no longer a producer of cheap assembly of products.
Speaker: It's not plastic bath ducts anymore, but it's electric vehicles now, right?
Speaker: It's electric vehicles.
Speaker: It's much more sophisticated.
Speaker: And actually, a lot of this is in the industrial sector.
Speaker: It is specific components that go into machinery that the Chinese produce.
Speaker: It's not sort of your plastic toys or plastic bottles, etc.
Speaker: from 10, 15 years ago.
Speaker: And that means that really China is enormously important for manufacturing.
Speaker: global manufacturing supply chains and that centrality is increasing, it's not declining.
Speaker: And so I think that's the third myth.
Speaker: And so putting that together, China is just a behemoth when it comes to manufacturing output.
Speaker: It's the largest manufacturer in the world.
Speaker: That's exactly when I started to look at this as well, maybe five years ago.
Speaker: I went to see some people at a university here in Hong Kong who've done economic geographers, who've done work on movements in supply chains, much more from a theoretical point of view.
Speaker: And that's exactly what they told me.
Speaker: They said it's such a behemoth and people want to sell their product there.
Speaker: And you've got these clustering facts that companies and industries can't just easily move.
Speaker: It's not sometimes we're very simple, right?
Speaker: We think, well, close the factory and build it up in Vietnam and go there.
Speaker: But you need the plastics.
Speaker: You need to...
Speaker: components you need everything else.
Speaker: It's a very slow process.
Speaker: Size matters in manufacturing and that's because you have so many specialized suppliers and the larger your sector is the more specialized suppliers you have that can actually improve their very specific products and so that
Speaker: That makes supply chains much more sticky.
Speaker: It gives you a competitive advantage.
Speaker: And of course, we can overlay this with a fairly weak currency of the past year with the absence of inflation, with excess capacity building up.
Speaker: So both from a cyclical perspective as well as from a structural perspective, China remains extraordinarily competitive as an export machine.
Speaker: It's just that the type of products that exports are disappearing
Speaker: And many negative headlines about China's importance, about relevance in global exports.
Speaker: And yet at the same time, we see also headlines about China seeing a surge in electric vehicle exports and starting to dominate the global economy.
Speaker: I know of robotic companies in China that are exploring markets in, actually in Europe and the US as well.
Speaker: The medical equipment companies that you can throw in there, they're doing the same.
Speaker: The internet companies have gone into ASEAN.
Speaker: I was once in Indonesia, I saw Chinese manufacturing facilities.
Speaker: I just passed them.
Speaker: I didn't want to visit them, but I passed them.
Speaker: That made blood pressure machines and stuff for hospitals in Indonesia.
Speaker: So it's not just EVs, but there's a lot of other products.
Speaker: There's a lot of other products, and that actually leads to one big risk here.
Speaker: And that is, if you think back over the last 20 years, China was a competitor to other emerging markets.
Speaker: It produced similar types of goods that ASEAN produces, or Mexican producers produce, or Eastern European producers produce.
Speaker: But now it's moving up the value chain that is starting to become a big competitor to Western markets.
Speaker: producers.
Speaker: And that is a risk because it could raise protectionist pressures in these economies.
Speaker: And so that's kind of where the risk lies for the global trading system, that we see increasingly protectionist pressures rise in Europe, in Japan, in the U.S. That's right.
Speaker: In response to this.
Speaker: And particularly in those countries that are responding quickly because it means they can't sell to those geographies.
Speaker: So
Speaker: they'll be focusing more on other ones.
Speaker: Yeah, there's some, you know, this is very macro, what we talked about.
Speaker: How do you think about this in terms of a market context?
Speaker: What does the average investor take away from it?
Speaker: Well, it's good that you use the myths, because to a certain extent, in the equity world also, the impact is somewhat limited.
Speaker: And I think the impact is on particular companies.
Speaker: So there are component technology companies, or other component companies listed in Thailand, and
Speaker: chip kind of testing facilities listed in Malaysia.
Speaker: Indonesia got the kind of nickel mines and battery processing materials sort of companies.
Speaker: So there are individual companies who benefit from that.
Speaker: But most of the benefits, I think, actually come more through the macro level.
Speaker: If there are flows of money going from, say, China into Malaysia or maybe Indonesia, it has an impact on the currency and the interest rates that you guys are looking at.
Speaker: These sort of things, development of the consumer markets.
Speaker: And I think the real benefits really lie there.
Speaker: These consumers can then buy other products and companies moving inland and retailers benefiting from it and these sort of things.
Speaker: It's really secondary sort of.
Speaker: Yeah, you're talking about very indirect.
Speaker: Is it fair to say that some of these big supply chain movements are almost the benefits are internalized by a lot of companies?
Speaker: They're hard to capture for an outside investor.
Speaker: So if you think about the Malaysian stock market, it's probably not dominated by companies that directly benefit.
Speaker: No, no, no.
Speaker: In particular, if you are an investor that just looks at markets and you buy just, for example, an ETF for a market, then that gets further diluted.
Speaker: There are companies who've led this particular process.
Speaker: Samsung and LG in Korea have been very early moves to Vietnam.
Speaker: I think they went there in the early 2000s even.
Speaker: And in India, we talked a lot about the Indian stock market, for example.
Speaker: Is there a sense that as an equity investor, the supply chain diversification really matters?
Speaker: Because from a macro perspective, it doesn't seem to be as big for the Indian economy that one would...
Speaker: No, but it adds to that Indian story that you have multiple drivers of growth.
Speaker: You have a consumer cycle, you have a domestic investment cycle, you've got a foreign investment cycle coming in.
Speaker: So that just allows for an additional kind of growth driver that just creates more visibility, I would say, to good earnings growth in India.
Speaker: So that's the way, I think, to a large extent, these things are being filtered into the equity market.
Speaker: But directly, you mentioned the stickiness of supply chains and production networks.
Speaker: That reminds me of the tulip industry in the Netherlands.
Speaker: You guys have been cornering the tulip market for hundreds of years.
Speaker: Yeah, exactly.
Speaker: I mean, the Netherlands should not be a place to make tulips, right?
Speaker: It's small.
Speaker: It's expensive.
Speaker: The land is expensive.
Speaker: It's on the water, so the risks are really high.
Speaker: And last but not least, there's hardly any sunshine, right?
Speaker: It's as sunny as Britain is.
Speaker: So, yeah.
Speaker: You wouldn't have a tulip industry there, but that industry started there in the 1600s.
Speaker: Of course, a lot of that low cost has moved to Spain and places like, I think, in parts of Africa, Kenya, if I'm not mistaken.
Speaker: There's tulip fields there.
Speaker: But the high-end, expensive tulips that are being sold in major locations… Be honest with me.
Speaker: Are the best tulips still grown today in the Netherlands worldwide?
Speaker: If I want the…
Speaker: you know, the Ferrari of tulips.
Speaker: Do I go to the Netherlands?
Speaker: To be honest, I have no idea.
Speaker: But my answer as a Dutchman would be absolutely yes.
Speaker: But I haven't looked at any, I can't see, I can't notice the difference.
Speaker: But I've heard of tulips that if you put them on a plane and they arrive, that they start to bloom.
Speaker: So they're made in such a way that after a travel, that they start to bloom and look at their best when they're in their shop.
Speaker: So maybe that's the high-end stuff in tulip technology.
Speaker: I will take your word for it, Harold.
Speaker: Thank you very much.
Speaker: Well, there you have it, folks.
Speaker: Supply chains demystified and a bit of sprinkling of the Dutch tulip industry on top of that.
Speaker: Indeed, that's a wrap for another episode of Under the Banyan Tree.
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