Figure 3: United States’ Imports from ASEAN Countries, Yearly Data, 2014–18 (US$ billion)

Figure 4: United States’ Imports from ASEAN Countries, Monthly Data, Jan–May 2019 (in US$ billion).

Insight #1: Vietnam has emerged as the biggest beneficiary of the US-China trade conflict.

The first insight here is that Vietnam has emerged as the biggest beneficiary of the US-China trade conflict as it latched on the opportunity of trade substitution in the short-run and is poised to gain from production relocation in the medium-term.

In the first five months of 2019, Vietnamese exports to the US have surged by 36.4% compared with the same period last year. With $25.8 billion in shipped goods until May 2019, Vietnam has become the eighth biggest source of American imports, up from 12th place a year ago.

As per the statistics released by the General Statistics Office of Vietnam, the country ran a trade surplus with the US (US$17 billion up to 5M19, +25.1% YoY), and a deficit with China (US$16.3 billion, + 48% YoY) and South Korea (US$12.2 billion, -3.6% YoY). This explains Vietnam’s newly acquired position as an assembler in the Global Value Chain with components and inputs being sourced from China and South Korea.

Vietnam’s top export growth to the US in the first five months of 2019 included Mobile Phone: 91.7% (US$3.77 billion), Electronics: 71.6% (US$1.78 billion) and Machinery: 54.6% (US$1.69 billion). Most of these products are those attracting the new 25% duty in the US when shipped from China.

Insight #2: Cambodia, Burma, and Laos have also benefitted from the retreat of Chinese imports to the US market.

The second insight is that besides Vietnam, Cambodia, Burma, and Laos have also benefitted from the retreat of Chinese imports to the US market. Likewise, Thailand and Malaysia on account of their existing ecosystem for electronics and automobile can attract relocating factories.

It is a known fact that Chinese companies have been heavily investing in these economies since last 4-5 years, and there is evidence of trade diversion from Mainland China to the neighboring ASEAN countries.

>> Read Also: Nicolas Michaux: Vietnam is becoming interesting for business.

However, before the onset of the trade war, these countries were attracting Chinese FDI due to rising wages, strict enforcement of environmental laws and the rising cost of production. Some of these macro factors have helped Vietnam make massive strides in the last 10 years for diversifying beyond shoes and apparel to relatively higher-value products by attracting companies such as Samsung, Intel and Canon.

For Vietnam in 1Q 2019, total and new registered FDI into manufacturing increased 66% and 33% YTD YoY, respectively. China, outpaced Vietnam’s other major investment partners, boosting investment 411% YoY. This partly reflects the trade diversion trend that was visible since the beginning of the year, and the trend is likely to continue over the near term – from both Chinese and non-Chinese firms. For example, LG announced in April that it would relocate its premium phone manufacturing to Hai Phong in 2H19, which accounts for 10-20% of LG’s smartphones.

Some other examples of investment relocation and supply chain re-configuration favouring ASEAN economies are mentioned in Figure 5.

Figure 5: Investment Relocation and Supply Chain Re-Configuration.

ASEAN — No cheer without fears.

ASEAN’s cheer might be short-lived, however. The US has taken note of rising trade deficit with Vietnam and has suspected transshipment of Chinese goods with “Made in Vietnam” label to its shores.

This is forcing Vietnam to get stricter in dealing with such trade evasions. Hence the country will eventually get selective about the nature of FDI it wants to attract. Vietnam, being an export-dependent economy, will not want to position itself as a new hub for trade diversion for the US consignments.

ASEAN countries that are being captured by the US’ broadening trade war net include Vietnam (currency manipulation, undervaluation); Singapore (currency manipulation, undervaluation); Thailand (currency undervaluation, Generalized System of Preferences – GSP); Malaysia (currency manipulation); Indonesia (GSP); Philippines (GSP); Cambodia (GSP); and Myanmar (GSP).

The US has also accused several ASEAN countries of undervaluing their currency to manipulate the prices of their goods and has threatened to impose duties.

Five of the ten ASEAN countries are among the top twenty beneficiaries of the Generalized System of Preferences (GSP) privileges. In fact, Thailand (US$4.3 billion) and Indonesia (US$2.1 billion) are the 2nd and 4th largest beneficiary of this scheme.

Most of the ASEAN nations are much smaller in size and availability of labor pools than India, and very soon the available resources to attract new factories will be under stress. India should therefore capitalize on this opportunity by positioning itself as a long term and sustainable production hub.

India could build strategies for targeting opportunities rrising from the US-China Trade War.

India has gained marginally on the trade side due to the US-China trade war so far; however, it is yet to touch its true potential on attracting factories relocating from China or on integrating its manufacturers into the supply chain change process. Here are some of the steps that could help achieve these goals in the short to medium term.

1. India could customize strategies by Product/Industry Type

• Strategies to attract manufacturers for Apparels, Footwear and Toys.
  • Over 35 US retailers for apparel & footwear and discount store operators have been working to diversify their sourcing options beyond China. Export Promotion Councils should work with these retailers, buying agents and other influencers to bring these orders to Indian factories.
  • In-depth advisory on identifying credible suppliers and last-mile support in developing new vendors will help in building large order books for India.
  • India should also focus on promoting Domestic Champions in these sectors and incentivize them to achieve compliance standards to meet the sourcing norms.
• Pushing for special indirect and direct tax-related incentive packages for investors in advanced technology sectors through a competitive bidding system. Priority sectors should include Semi-conductor Fabrication (FAB), Solar Photo Voltaic cells, Lithium storage batteries, Solar electric charging infrastructure, Computer Servers, Laptops, etc.
• Consumer electronics, another one-third of US imports from China, will take more time to move because the supply chain is rooted in China. India should start with attracting front-end assembly over the next three to five years.

2. India could push for Greater Market Access in Key Markets and Product Categories.

• India should negotiate hard with China to open its domestic market for Indian exporters in sectors like Pharmaceuticals, Agri-commodities, Organic Chemicals, Sea Food, Engineering products, etc.
• India should consider substituting Chinese imports to the US where India has a comparative advantage over China and its Southeast Asian counterparts: the Ministry of Commerce & Industry has already identified 350 products where India can emerge as a substitute sourcing location to China such as Rubber, Graphite Electrode, Organic Chemicals, etc.

3. India could turn the “Made in India for the World” label as a Development Theme for New Industries.

• About 300 factories making electronics goods such as smartphones and components, LED and TVs have started to run their operations in India. However, the majority of them are located at Noida-Greater Noida-Gurgaon-Manesar stretch which is approximately 1500 kms away from a major seaport.
• Efforts should therefore be made to locate them in zones that are cost-competitive from an export point of view. Prescribed steps could consist in establishing country-specific industrial parks in PPP mode in coastal states, in incentivizing industrial real estate innovations like Factory on Rent or Built to Suit in coastal states, in finding synergies between national programs like Skill India or Sagarmala to meet the industry’s requirement.
• Similar efforts should be made for attracting investments in Lithium-Ion batteries, Electric Vehicles, robotics, and other advanced sectors. As of now, our domestic demand is not sufficient to attract large scale factories.

4. India could strive to make Domestic Champions, wherever possible.

• India should avoid letting foreign-owned companies tap opportunities in the global trade, by promoting itslef as a base for last-leg assembly. The US-Japan trade war in the 1960-80s resulted in Japan pushing its assembly operations to South East Asia and then to China. Japan continued to run large trade surpluses against the US indirectly through exports of materials to assembly countries. Similar patterns are now visible in China to Vietnam to US trade flows.
• Domestic champions holding new positions in Global Value Chains (GVCs) can help India retain its competitive advantage in times of disruptions. Strategies could include incentivizing such endeavors by offering low-cost capital/tax incentives to Indian businesses willing to diversify into strategic sectors/industries. India might also encourage foreign/Indian OEMs to develop Tier 1 or Tier 2 Indian-owned suppliers by aligning production subsidies to support local vendors.

5. India might offer specialized Incentives to Attract Relocating Factories.

• Strategies could aim at reducing or waiving import duties on new or used machinery (with residual life of 5 years and above) or offer Additional Capital Subsidy on purchasing Made in India Capital goods
• Corporate Income Tax benefits could be considered to attract new factories and develop new industrial zones, especially those well-positioned for exports. E.g. Vietnam reduces corporate income in disadvantaged areas.
• Offering real Plug-n-Play facilities like Shovel-ready land parcels for factory construction, or Ready Built Sheds in good locations or Pre-approved Projects.
• Working on stabilizing production by understanding the key challenges of those industries such as availability of skilled workforce, labour productivity, access to reliable power supply network, water resources or cheaper fuels such as natural gas.