The imposition of US sanctions, and responses from Beijing, have prompted many western companies to consider shifting operations away from the People’s Republic of China (“PRC”), towards Southeast Asia.
However, this process of “decoupling” is neither straightforward, nor in some cases even feasible, given Chinese components’ inclusion in other products, and the PRC’s central role in regional trade and investment flows. Moreover, any shift out of China will likely expose companies to new risks in the countries concerned.
Executives should explore these realities when deciding on how to respond – but they should not over-react. Such threats can be mitigated.
SVA is in a position to assist companies in navigating this confusing landscape, by providing accurate and timely business intelligence, and sophisticated due diligence services.
In recent years, the US government has imposed a host range of restrictive measures on China. The most overt have included the imposition of tariffs on Chinese goods, limits on access for certain products, and outright bans on the sharing of key technology with Chinese partners, often through use of sanctions or export controls.
Beijing has responded with its own actions, such as by preparing a list of “unreliable entities”, adopting laws that prohibit compliance with US sanctions, and encouraging a scepticism towards American (or other foreign) investors. Certain rules, such as data laws, and raids on consultancies, throw more “sand in the wheels” of commercial dealings.
It is true that, of late, the US has sought to diminish the combative tone in bilateral relations, with talk of “derisking”, not of “decoupling”. However, US legislators of all stripes still speak of the need to dismantle intimate trading and financial ties with, or even of confronting, China – meaning that the visits of US officials generally do little more than temporarily tamp down frictions.
These political pressures are also only adding to trends that had already eroded China’s appeal, such as rising labour costs, an ageing population, and more erratic (and security-orientated) policymaking. China’s growing technological capability also presents many foreign companies with competitive challenges; the PRC is now amongst the leading producers of electric vehicles, for instance.
A moveable feast
Accordingly, investment is reportedly shifting more towards alternative destinations across Asia, such as Vietnam, Malaysia, Thailand, India, Bangladesh and Indonesia. Some companies have implemented a “China-plus-one” strategy, scaling back spending in the PRC, but ramping it up elsewhere.
There is some merit to this approach, of course. The potential for economic expansion across Asia is vast; China’s industrial capacity is ten times that of India, and 50 times that of Vietnam. Moreover, many Asian states, such as Thailand, already have proven records of effective integration into supply chains.
And this shift is becoming visible in trading figures. The US is now sourcing only 50% of its Asian imports from China, down from well over 60% five years ago. Chinese trade with Brazil, Russia, India, South Africa, and other “non-aligned” states exceeded that with the US, Japan and the European Union (“EU”) for the first time in March 2023 (at about USD1.6 trillion a year).
But is decoupling really happening?
The impact of decoupling appears to be overstated, though. After all, China is not only the largest trading partner of its neighbours in East and Southeast Asia, but also of the European Union, Russia, Brazil, Kenya and South Africa, amongst many other states.
Indeed, in 2000, some 80% of states traded more with the US than with China. Now, only 30% do so. China has also established itself as a key manufacturer for an extremely wide range of products, from high- to low- value. Its trading prowess is not diminished.
Even the US remains heavily reliant on Chinese imports. Bilateral goods trade between the US and China reached USD690 billion in 2022, with US exports to China worth USD153.8 billion and imports worth USD538.8 billion. Sino-American trade has expanded despite tariffs and export controls on technology – albeit at a slower pace than hitherto.
Unravelling the knot
A further issue relates to the nature of supply chains. A shift of production to Thailand or Vietnam may just disguise continued reliance on the PRC, given that many Chinese-made components go into more complex products assembled elsewhere. PRC inputs into Vietnamese goods, for instance, doubled from 2017 to 2021.
Chinese companies have also responded to US restrictions by investing in Southeast Asia themselves, in an effort to circumvent controls. Perhaps 40% of foreign direct investment into Southeast Asia is now from China; a huge upsurge followed the US imposing of tariffs on China – of USD128 billion in 2020, for instance.
Identifying what is local, and what is Chinese, then, is becoming harder. As such, what is seemingly happening is that the “world’s factory” is restructuring to operate on a regional basis, not an outright “decoupling” from China.
Ironically, this regionalisation is also in line with China’s policy of “dual circulation”, which seeks to use external trade to drive domestic economic growth. “Decoupling” may yet enhance Chinese pre-eminence across the region.
Risks in Southeast Asia
A separate concern for investors relates to their exposure to new threats in relatively unknown jurisdictions. After all, many of the Southeast and South Asian states have bureaucracies that are substantially less efficient and more corrupt than those in China.
Investors in Vietnam, for instance, may enjoy cheaper labour, but face manifold regulatory and corruption issues impinging on operations, and relatively weak labour and infrastructure capacity – at least compared to China. Moreover, the Communist Party of Vietnam’s “blazing furnace” anti-corruption campaign, associated arrests, and a pending leadership transition, have all injected uncertainty into policymaking.
Indonesia, for its part, has a history of protectionism and erratic decision making. To be sure, the Joko Widodo government has proven friendly to business, but Prabowo Subianto – current defence minister, former President Suharto’s son-in-law, and a general linked to the killing of students in the 1990s – is a possible prospect as Widodo’s successor; and Prabowo espouses mercantilism. The decentralisation of administration also means that investors must navigate many layers of bureaucracy.
Production in Cambodia poses separate, geopolitical concerns, related to close ties to China, and the recent construction of a naval base at Ream. The US could respond to Phnom Penh’s close association with China by imposing trade restrictions, or sanctions, posing challenges to those operating there.
Thailand remains roiled by political instability, facing continued tests of strength between the royal and military establishment and opposition politicians, some linked to Thaksin Shinawatra. Of course, political contests have troubled Thailand for decades, with limited consequences for business thus far, but corruption and regulatory uncertainty remain concerns.
Moreover, none of these states have straightforward relations with either the US or China. Washington, for instance, has claimed that Vietnam kept its currency artificially low, prior to a settlement in 2021.
Perhaps most importantly, though, all of the Southeast Asian states are exposed to pressure from one or both of the great powers – as the US provides a regional security framework, and China is their main trading partner.
A regional conflict, even if confined to the Taiwan Straits, would seriously affect them all.
How to square the circle
A thoroughgoing decoupling, then, is easier to speak of, than to put into practice. A shift out of China may alleviate some risks, or at least increase deniability, but will expose investors to other threats.
Similarly, economic integration may mean that companies inadvertently breach US sanctions or Chinese restrictions – perhaps by incorporating electronics components into goods produced in Vietnam, or by buying textiles from Thailand that contain cotton grown in Xinjiang.
Finally, executives should recognise that such risks are not unique to any one sector. Rather, all companies are vulnerable. Financial services businesses, and particularly portfolio investors, will need to look beyond the “faddish” narrative to identify new opportunities; and manufacturers may have to adjust expectations as to what is possible, and perhaps restructure operations accordingly. After all, political risk is the main driver behind these significant shifts.
What to do?
“Decoupling” is apparently under way, but it is by no means a straightforward process. Rather, trade and investment flows in Asia are coming to operate on a more regional basis than hitherto, integrated all the same with both China and the US. This messy (and even contradictory) prospect poses new threats to investors,
Of course, risks can be mitigated. Careful due diligence and oversight should alleviate some risks, as can detailed supply chain analysis, going beyond that of standard market entry research. SVA is in a position to provide deeper appraisals of the threats in each separate jurisdiction in question.
Looking forward, key steps to take would include:
• SVA can assist by providing robust due diligence. Professional standards are as important as ever.