Vietnam stands to win as “China+1” gains traction

Vietnam is continuing to be an enticing investment destination for multinational corporations

Linda Liu, an economist at Maybank Kim Eng, told VIR that the pandemic is akin to a “wake-up call” for multinational companies about the risks of over-dependence on China. The pandemic will likely reinforce the shift in manufacturing supply chains away from China, as multinational corporations adopt a “China+1” strategy and look for alternative bases to diversify risks.

“Foreign direct investment (FDI) registrations in Vietnam have slowed in the first quarter. It is likely due to multinationals and companies putting business decisions on hold amidst the COVID-19 uncertainties. Vietnam will remain as one of the biggest beneficiaries from this structural shift in supply chains once the situation comes under control and business sentiments revive,” Liu said.

Indeed, there is a wide range of companies indicating plans to diversify productions from China to Vietnam, from both electronics and non-electronics sectors. Samsung has indicated plans to speed up relocation plans from China to Vietnam. Several of Apple’s manufacturing suppliers including Wistron Corporation, Pegatron, and Inventec also revealed plans to diversify production and consider additional manufacturing plants in Vietnam due to the virus outbreak during their recent earnings call with investors.

Google and Microsoft also expressed intentions to begin producing Made-in-Vietnam devices within the year, as reported by Nikkei Asian Review. Google is planning to manufacture its low-cost smartphone Pixel 4A after April in the north of Vietnam. Moreover, its next-generation flagship device named Pixel 5 will be produced in the country from the second half of this year.

Meanwhile, Microsoft forecast that its latest models of Surface laptops and desktop computers will be manufactured in northern Vietnam from the second quarter of this year. Nikkei quoted a Microsoft supply chain executive as saying, “The volume in Vietnam would be small at the beginning, but the output will pick up and this is the direction that Microsoft wants.”

Commenting on this matter, Dean Rolfe, partner, head of Market Entry, KPMG in Vietnam told VIR that the spreading coronavirus may soon affect people’s health in a different way. “The outbreak is now starting to hurt the supply of essential drugs with India announcing in March that the export of a range of generic pharmaceutical products will be temporarily halted,” Rolfe said. “This is because many of the raw ingredients needed for the manufacturing of drugs comes from China and with their factories shut down, supply chains are adversely impacted.”

This highlights the risks associated with non-diversified supply chains, according to Rolfe, and has only reinforced a view that diversification is an essential element of supply chain security. Put another way, the global economy’s reliance on goods made in China has been highlighted once again.

Plus points for Vietnam

While many people have pointed to the trade dispute between China and the United States as the catalyst for a global rethink of China-centric supply chains, many other factors like pollution, complex tax rules, and inconsistent tax administration, as well as ongoing cost escalation issues have all played a part.

Rolfe from KPMG have considered the question of where the FDI ends up if not in China, saying it is clear there is no obvious answer. “Many jurisdictions have advantages in the form of developed regulatory systems, modern infrastructure, cheap and plentiful labour, and low taxes. And individual investors will place a different emphasis on each of these factors, so direct comparisons are always challenging and rarely achievable,” Rolfe added. “That said, Vietnam has many advantages to offer including a large pool of skilled and semi-skilled low-cost labour, a stable political system, connectivity and proximity to China as well as the rest of Southeast Asia.”

More recently, the ratification of the EU-Vietnam Free Trade Agreement as well as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership inked in March 2018 have made it one of the most globally-connected supply chains and arguably the most connected in Southeast Asia. “These agreements in particular will reduce many taxes normally burdening cross-border supply chains,” Rolfe said. “This willingness to embrace international agreements demonstrates Vietnam’s intention to become an open trading economy.”

According to the KPMG expert, an often-overlooked advantage to Vietnam’s economy is its high levels of small- and medium-sized enterprises which exist with no or very little levels of external finance. This lack of leverage makes the domestic economy more resilient to external economic shocks.

One challenge, however, is set to be access to large-scale manufacturing spaces. While land is plentiful, much of it remains undeveloped and this will create a bottleneck to economic growth if not addressed in the short term.

“It is not easy or cost-effective to disrupt existing supply chains for the sake of achieving geographic diversity. The coronavirus outbreak is, however, challenging that thinking and it is increasingly likely that when our global economy comes through this economic shock, our global supply chains will look vastly different with Vietnam playing an increasingly prominent role,” Rolfe stressed.

On the same note, VinaCapital’s chief economist Michael Kokalari and research manager Huyen Tran said that the pandemic will have a negative impact on Vietnam’s economic growth in 2020 due to the blow it has dealt to the tourism sector (circa 12 per cent of GDP), and the manufacturing sector (about 20 per cent). The crisis – much like the US-China trade war – will ultimately be a powerful catalyst for the migration of factories from China to Vietnam, and Moody’s latest report predicts that this will ultimately boost Vietnam’s annual GDP growth by 2 percentage points.

“Once COVID-19 concerns subside (most likely in the second quarter of 2020), it will serve as an even more powerful catalyst than the trade war in prompting companies to move their factories to Vietnam, because of the stronger psychological impact that supply chains will have on corporate executives,” noted Kokalari and Tran.

The economists also quoted a senior fellow at the Milken Institute, an independent economic think tank based in California, as commenting that the crisis will “underscore to all of China’s trading partners the value of diversification away from the country”, and that the pandemic is speeding up the dismantling of US corporations’ sourcing from China even faster than the trade war has.

Japanese strategy

Hirai Shinji, chief representative of the Japan External Trade Organization (JETRO) in Ho Chi Minh City, meanwhile, told VIR that none of the Japanese enterprises operating in China consulted by the JETRO intend to close production activities in China to move to Vietnam. Instead, most Japanese businesses still want to maintain production in China and open more production facilities in Vietnam to disperse risks from reliance on the Chinese market. Indeed, many Japanese investors had adopted the “China+1” strategy before the US-China trade war, with Vietnam being the favourite alternative destination for relocation.

“If China’s export activities to other countries become more difficult, many Japanese businesses may stop producing some items in China and move part of production to Vietnam. On the other hand, the relocation trends among Japanese investors also come from the fact that production costs in China are quite high. With regards to the COVID-19 crisis, I suppose Japanese businesses will now focus on dealing with this difficult situation rather than shifting manufacturing,” Shinji added.

Data from the Foreign Investment Agency under the Ministry of Planning and Investment in Vietnam shows that the country reported $8.55 billion of registered FDI in the first quarter of this year. In terms of investment partners, 87 countries and territories have investment in the country, of which Singapore ranked first with the total registered investment capital of $4.54 billion, accounting for 53.1 per cent of the country’s total FDI. Japan ranked second at $846.7 million, accounting for 9.9 per cent of the total, while China was third at $815.6 million, or 9.3 per cent.