PRD's pain, China and ASEAN's gain - Special Report

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PRD's pain, China and ASEAN's gain - Special Report
l Global Research l

Special Report

PRD’s pain, China and ASEAN’s gain

Highlights
 Companies in the Pearl River Delta (PRD) – China’s leading              Kelvin Lau +852 3983 8565
                                                                          Kelvin.KH.Lau@sc.com
  manufacturing hub – still face plenty of challenges, according to our   Macro Research
                                                                          Standard Chartered Bank (HK) Limited
  sixth annual survey of manufacturers in the region. A labour
                                                                          Chidu Narayanan +852 3983 8568
  shortage persists, and wages are likely to rise 8.4% this year.         Chidambarathanu.Narayanan@sc.com
                                                                          Macro Research
                                                                          Standard Chartered Bank (HK) Limited
 The PRD’s short-term pain is part of China’s longer-term pursuit of a
                                                                          Betty Rui Wang +852 3983 8564
  more sustainable growth model, in our view. Rising wages reflect        Betty-Rui.Wang@sc.com
                                                                          Macro Research
  China’s improving productivity and the increasing complexity of the     Standard Chartered Bank (HK) Limited

  goods it produces as it moves up the value chain. Rising FDI flows      Jeff Ng +65 6596 8075
                                                                          Jeff.Ng@sc.com
  into the services sector reflect this shift.                            Macro Research
                                                                          Standard Chartered Bank, Singapore Branch

 Investing more in automation and streamlining processes is the
  most common response to labour shortages and rising wages for
  PRD manufacturers. Among those planning to relocate factories, the
  preferred offshore destinations are Vietnam and Cambodia.

 ASEAN – with its lower wages, abundant labour supply and rising
  household affluence – is well positioned to benefit from the PRD’s
  shift towards high-end manufacturing and services. Infrastructure
  development would allow it to become Asia’s next PRD, in our view.

Important disclosures can be found in the Disclosures Appendix
All rights reserved. Standard Chartered Bank 2015                                         research.standardchartered.com
PRD's pain, China and ASEAN's gain - Special Report
Special Report: PRD’s pain, China and ASEAN’s gain

Contents
Overview                                                                      3

Infographics                                                                  4

Feeling the PRD pulse                                                         6
Good news for the economy, less so for manufacturers                          7
Tackling labour challenges – Invest or relocate?                             11
Beyond wages                                                                 13

China through the PRD lens                                                   15
Slowing growth is a headwind to the labour market                            16
Transforming China’s manufacturing machine                                   18
Corporates face higher CNY volatility                                        21

ASEAN – The next PRD?                                                        23
Opportunities for ASEAN                                                      24
Vietnam: Emerging alternative for low-cost manufacturing                     28

Global Research Team                                                         32

Acknowledgements
We would like to acknowledge the contribution of Karcy Chan to this report

5 May 2015                                                                    2
Special Report: PRD’s pain, China and ASEAN’s gain

                                        Overview
         The PRD has driven China’s     The Pearl River Delta (PRD) region consists of nine cities in Guangdong Province:
              success as the world’s    Guangzhou, Shenzhen, Zhuhai, Foshan, Huizhou, Dongguan, Zhongshan,
         manufacturing powerhouse       Jiangmen, and Zhaoqing. Given its pioneering role in China’s Open Door Policy and
                                        its success as a manufacturing powerhouse, the region has been the ‘poster child’ for
                                        China’s spectacular economic ascent of recent decades. Endowed with only 0.6% of
                                        China’s land area and 4.2% of the national population, it accounts for 27% of the
                                        country’s exports and receives almost 20% of inward foreign direct investment (FDI)
                                        – particularly from Hong Kong, given close economic linkages between the two.

                                        The PRD epitomises China in many ways, exemplifying both the qualities that drive
                                        the country’s economic engine and the emerging challenges as the economy
                                        transitions towards a more sustainable growth model. At the centre of these
                                        challenges are labour shortages and the relentless rise in wages, which are eroding
                                        the region’s and the nation’s competitiveness. It is against this backdrop that we
                                        conducted our sixth annual PRD manufacturing survey, which provides unique
                                        insights into what is happening on the ground in China.

     Our survey allows us to feel the   The first section of this Special Report (‘Feeling the PRD pulse’) highlights the results
        pulse of the PRD, helping us    of our latest survey, conducted between late February and late March 2015.
     understand more about China’s      Respondents reported little let-up in the labour shortage, despite the slowing
           current labour conditions
                                        economy. Over 85% said that labour shortages are at least as bad as last year.
                                        Migrant worker wages are expected to rise 8.4% on average this year, versus 8.1%
                                        in 2014. Our CPI inflation forecast of 1.6% this year translates into real wage growth
                                        of 6.8%. This should continue to provide important support to otherwise slowing
                                        consumption. Minimum wage hikes are also putting upward pressure on wages. In
                                        response, most companies plan to invest in automation or in streamlining processes.
                                        For those considering moving capacity outside of China, Vietnam and Cambodia are
                                        the top choices. For those considering moving inland, the outer areas of Guangdong,
                                        Guangxi and Hunan are the favoured destinations.

  The PRD exemplifies China’s shift     In the next section (‘China through the PRD lens’), we extend our analysis from the
   towards high-end manufacturing       PRD to the whole of China. Maintaining a stable labour market and healthy income
      and a more services-oriented      growth are top priorities for Beijing. While our survey shows that the labour market
                         economy
                                        has stayed tight so far, a challenging macro backdrop could create headwinds.

                                        While they pose challenges to manufacturers, China’s rising labour costs and wages
                                        also reflect the country’s improving productivity and the increasing complexity of the
                                        products it makes. We believe automation and robotics will help to drive China’s
                                        move up the manufacturing value chain. Recent FDI trends also confirm that China is
                                        transforming into a more services-oriented economy.

ASEAN, the favoured destination for     In ‘ASEAN – The next PRD?’, we focus on ASEAN as an attractive alternative for
   factory relocation from China, is    factory relocation from the PRD. ASEAN is poised to become Asia’s next PRD, in our
 well positioned to be the next PRD     view, benefiting from lower wage costs and abundant labour supply over the next 20
                                        years. The region’s high growth and rising middle class mean that manufacturers
                                        moving production to ASEAN from the PRD can also capture a share of a large and
                                        growing consumer market. Vietnam, ASEAN’s emerging manufacturing powerhouse,
                                        is the prime example of how these fundamental advantages are converging to attract
                                        investment and drive growth.

5 May 2015                                                                                                                     3
Special Report: PRD’s pain, China and ASEAN’s gain

               Infographics
               Figure 1: The PRD is a magnet for global FDI into China
               Map of the PRD, rest of China and selected Asian economies weighted by inward FDI, 2013
                                     FDI
                                  (USD mn)
               Rest of China         241,734
               PRD                   106,114
               Hong Kong              74,286
               Singapore              63,772
               India
               Indonesia
                                      28,153
                                      23,287                                          REST OF
               Thailand               12,650
               South Korea
               Malaysia
                                      12,221
                                      11,583
                                                                                       CHINA
Infographics

               Macau                   9,875
               Vietnam                 8,900
               Japan                   3,715

                                                                                                                           JAPAN

                        = USD 1bn                                                                            SOUTH KOREA

                                                                                                         PEARL
                                                                                                         RIVER
                                          INDIA                                                          DELTA

                                                               THAILAND

                                                                                      VIETNAM

                      SINGAPORE                                            MALAYSIA

                                                                                                         HONG KONG
                                                                                                M ACAU

                                                                          INDONESIA

               Source: World Bank, CEIC, Standard Chartered Research

               5 May 2015                                                                                                          4
Special Report: PRD’s pain, China and ASEAN’s gain

Figure 2: The PRD drives China’s export engine
Map of the PRD, rest of China and selected Asian economies weighted by exports, 2013
                    Exports
                   (USD mn)
Rest of China       1,426,323
Japan                 754,968
South Korea           635,890
PRD                   607,093
Hong Kong             459,228
Singapore             434,498
India                 352,473
Thailand              189,394
Malaysia              186,226
Indonesia
Vietnam
                      160,972
                       80,770
                                              REST OF                           SOUTH KOREA
                                               CHINA

                                                                                                          Infographics
    = USD 5bn

                                                                                              JAPAN

        INDIA
                                            VIETNAM
                                                                        PEARL
                                                                        RIVER
                                                                        DELTA
                    THAILAND

                                                                    HONG KONG

                                               MALAYSIA
          SINGAPORE

                                                        INDONESIA
Source: World Bank, CEIC, Standard Chartered Research

5 May 2015                                                                                            5
Feeling the PRD pulse
Special Report: PRD’s pain, China and ASEAN’s gain

                                                            Feeling the PRD pulse
                                                            Good news for the economy, less so for manufacturers
                           Kelvin Lau +852 3983 8565        Our sixth annual survey of PRD manufacturers was conducted between late
                                Kelvin.KH.Lau@sc.com
                                       Macro Research       February and late March 2015, with more than 290 responses from Hong Kong- and
                   Standard Chartered Bank (HK) Limited
                                                            Taiwan-based manufacturers operating in the PRD. The results suggest that at the
                   Chidu Narayanan +852 3983 8568           macro level, China is still creating jobs and maintaining income growth for now. At
                   Chidambarathanu.Narayanan@sc.com
                                       Macro Research       the company level, however, persistent labour shortages mean more cost challenges
                   Standard Chartered Bank (HK) Limited
                                                            ahead for PRD manufacturers. Respondents also expressed continuing concerns
                                                            about narrowing margins, tight credit conditions, the still-cautious outlook for orders,
 We surveyed more than 290 Hong                             and an increasingly volatile Chinese yuan (CNY). But for those willing to adapt, there
          Kong- and Taiwan-based                            are also opportunities. Increased capital investment, process automation and factory
manufacturers operating in the PRD                          relocation are possible responses to challenging conditions in the PRD.

                                                            As our infographics (pages 4-5) show, the PRD has not just been a key contributor to
                                                            China’s growth in recent decade; it is also an economic powerhouse in its own right,
                                                            comparable in size to most ASEAN economies. Given that the PRD receives a
                                                            material share of China’s inward FDI, our sample of Hong Kong- and Taiwan-based
                                                            manufacturers operating in the region provides a clear picture of what drives China’s
                                                            manufacturing machine. Our clients are likely to be among the more successful firms

                                                                                                                                                            Feeling the PRD pulse
                                                            operating in the region, which may skew the results somewhat. However, given the
                                                            paucity of reliable official data on wage and employment trends – and our large
                                                            sample size – we think the survey provides an important on-the-ground picture of
                                                            China’s economy.

Figure 1: Wages set to rise 8.4% in 2015, vs. 8.1% in 2014                          Figure 2: Is labour shortage better or worse than in 2014?
Actual and expected wage increase, % of respondents                                 % of respondents

     Others
                                                                                     More difficult
    Up 20%

    Up 15%
                                                                                            Same
    Up 10%                                                                   2015
                                                                      2014

     Up 5%
                                                                                     Less difficult
 No change

              0%      5%      10%     15%      20%        25%   30%   35%    40%                      0%     10%          20%   30%   40%   50%   60%
Source: Standard Chartered Research                                                 Source: Standard Chartered Research

5 May 2015                                                                                                                                              7
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                     Persistent labour shortage, steady wage pressure
                          Rising real wages should support           Higher wages – and the resulting higher income growth – are part of China’s
                               consumption – a positive for          structural shift towards a consumption-driven, services-oriented growth model. Higher
                        China’s otherwise slowing economy            wages are partly policy-driven (we will come back to this later), but demand and
                                                   this year
                                                                     supply factors also play major roles. While the current rapid rise in migrant workers’
                                                                     wages may hurt manufacturers, a broader concern is that labour demand may
                                                                     eventually slow in line with the economy, delaying China’s transformation.

                                                                     In this sense, the fact that our respondents are raising (or plan to raise) wages more
                                                                     this year than in 2014 is good news. Compared with last year’s survey, a larger share
                                                                     of respondents expect wages to rise by 10-15% (Figure 1). The average expected
                                                                     wage increase is 8.4% in 2015, up from 8.1% last year. However, the difference
                                                                     between current-year wage expectations and the prior year’s actual increase is the
                                                                     smallest in recent years (Figure 3), possibly reflecting more cautious sentiment
                                                                     among employers and more benign inflation expectations. Using the official CPI as a
                                                                     deflator, expected real wage growth is around 6.4% in 2015, up from 6.1% in 2014
                                                                     and 5.8% in 2013. This continued rise in real wage growth should provide important
                                                                     support for household consumption – an overlooked positive story for China’s
                                                                     otherwise slowing economy this year, facilitating the structural shift towards more
                                                                     consumption-driven growth.
Feeling the PRD pulse

                                                                     More than 70% of our respondents said they had already raised wages this year
                                                                     ahead of the Lunar New Year, by an average of 8.5%. On a same-company basis,
                                                                     26% of respondents plan to raise wages more than they did last year, while 18%
                                                                     expect to raise them less (Figure 4). The remaining majority expects 2015 wage
                                                                     growth to be in line with 2014, indicating steady underlying momentum driven by a
                                                                     structural labour shortage. The PRD as a whole may be facing a deficit of more than
                                                                     1mn migrant workers, according to media reports.

                                                                     29% of our respondents said labour shortages have worsened over the past 12
                                                                     months, similar to last year’s 30% (Figure 2). That said, a growing minority reported
                                                                     less labour-market tightness compared with a year ago (15% of respondents, versus
                                                                     11% last year); this matches the softer macro backdrop. 84% of respondents
                                                                     reported operating with 80% or more of their full workforce (Figure 5) – marginally
                                                                     down from last year’s 87% utilisation level, but still high. However, 66% of
                                                                     respondents say their factory workers’ average hours have increased in the past 12
                                                                     months, up from 64% prior (Figure 6).

                        Figure 3: Respondents expect milder wage growth                     Figure 4: Wage growth, 2014 actual vs. 2015 expectations
                        acceleration than in past surveys                                   % of respondents; blue shading indicates faster expected
                        Actual and expected wage increase, this and past surveys            wage growth this year versus 2014
                        9.5      Current year
                                                                                                                                          2015
                                 expectation
                        9.0                                                                                              No
                                                                                                                                  Up 5% Up 10% Up 15% Up 20%
                                                                                                                       change
                        8.5
                                                                                                     No change          4.8%      3.1%    1.4%    1.0%
                        8.0                  Prior year
                                              actual
                                                                                                        Up 5%           2.0%      22.1%   11.9%   1.7%
                        7.5
                                                                                              2014

                        7.0                                                                            Up 10%           2.7%      6.5%    19.4%   5.1%   0.3%

                        6.5                                                                            Up 15%           0.7%      0.3%    3.4%    5.4%   1.0%

                        6.0
                                                                                                       Up 20%                     1.0%    1.0%    0.7%   2.7%
                                        2013                  2014          2015
                        Source: Standard Chartered Research                                 Source: Standard Chartered Research

                        5 May 2015                                                                                                                              8
Special Report: PRD’s pain, China and ASEAN’s gain

                                                Minimum wage hikes and other push factors
                                                                                                                                               th
                                                Policy is also playing a key role in driving wages higher. The government’s 12 Five
                                                Year Plan (2011-15) targets minimum wage increases of “at least 13% a year on
                                                average”. So far this year, 11 provinces/cities have hiked their regulatory minimum
                                                wages, led by Shenzhen’s 12% increase to CNY 2,030 (Figure 9). The average
                                                increase in minimum wages fell to 13% in 2014 from 22% in 2011, reflecting the
                                                higher base as well as slowing growth and lower inflation (Figure 10). We estimate
                                                that minimum wage hikes will average around 10-11% in 2015, higher than the 8.4%
                                                wage increase estimated by our survey respondents.

                                                This gap reflects the fact that officially mandated minimum wage levels have
                                                generally lagged the market rate, with many clients already paying more than the
                                                minimum wage to begin with. Only 7% of our respondents (versus 6% last year) said
                                                that minimum wage increases have had a “huge” impact on wage levels (Figure 7).
                                                Even so, 63% (versus 52% last year) said that regulatory wage hikes have forced
                                                them to raise wages more than they had planned. 30% (down from 42% last year)
                                                said they would have hiked wages anyway, regardless of minimum wage changes.
                                                We conclude that minimum wage hikes do have some impact on actual wages,
                                                especially for the least skilled part of the workforce.

                                                                                                                                                             Feeling the PRD pulse
Figure 5: Workforce utilisation level                                          Figure 6: Have the average working hours of your factory
% of respondents, this and previous surveys                                    workers increased in the past 12 months?
                                                                               % of respondents

  100%                                                                                Up 20%             3%

   90%                                                                                Up 15%                         11%

   80%
                                                                                      Up 10%                                    23%

   70%                            2015
                               2014
                                                                                       Up 5%                                           30%

   60%
                                                                                 Did not go up                                               33%
         0%              10%             20%         30%                 40%

Source: Standard Chartered Research                                            Source: Standard Chartered Research

Figure 7: The impact of minimum wage hikes                                     Figure 8: Have you negotiated wages in past six months?
% of respondents, this and previous surveys                                    % of respondents, from this and previous surveys

  Huge impact, would not have                                                                           Yes
        hiked wages otherwise

                                                                  2015                 No, but I think I will          2015
   Some impact, raised wages
    more than initially planned                                                  probably have to this year           2014
                                                           2014

    No impact, will raise wages                                                       No , and I don’t think
            the same anyway                                                                  I will this year

                                  0%     20%   40%         60%           80%                                    0%     20%    40%     60%          80%

Source: Standard Chartered Research                                            Source: Standard Chartered Research

5 May 2015                                                                                                                                               9
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                                  Pressure from collective wage bargaining has not let up this year. 23% of
                                                                                  respondents say they have had formal wage negotiations with worker representatives
                                                                                  in the past six months (Figure 8). This is similar to 24% in 2014, and up from 19% in
                                                                                  2013 and only 9% in 2012. Another 14% of respondents say they will likely have to
                                                                                  negotiate wages sometime this year. Of the companies that have negotiated wages
                                                                                  in the past six months, 55% were asked to hike wages by 5-10%, 41% by 10-20%,
                                                                                  and the rest by more than 20%. We believe the authorities remain committed to
                                                                                  promoting collective wage bargaining as a way to improve worker protection and
                                                                                  calm labour tensions amid a slowing economy.

                                                                                  Stricter worker-related social insurance requirements imposed by local governments
                                                                                  continue to create an additional cost burden for manufacturers. 71% of our survey
                                                                                  respondents said stricter worker insurance schemes had been put in place, similar to
                                                                                  prior years’ readings (Figure 11). Payments to the ‘five insurances’ (health, pension,
                                                                                  worker safety, maternity and housing) are equivalent to 40-50% of the wage bill if
                                                                                  fully implemented, adding significant upward pressure in an already challenging cost
                                                                                  environment. This is especially true given that wages account for a material 22% of
                                                                                  respondents’ total cost base on average (Figure 12).
Feeling the PRD pulse

                        Figure 9: Minimum wages in selected provinces/cities                            Figure 10: Pace of minimum wage hikes has slowed
                        Top-tier minimum wage levels, CNY                                               Fewer provinces saw minimum wage hikes (%)
                                                                                                         30
                        2,500                                                                                         Number of provinces that
                                                                                                                      adjusted minimum wage
                                        2015                                                             25
                        2,000
                                 2014                                                                                                            Average minimum
                                                                                                         20
                                                                                                                                                  wage increase
                        1,500
                                                                                                         15
                        1,000
                                                                                                         10

                          500                                                                             5

                             0                                                                            0
                                 Shenzhen Shanghai            Tianjin   Beijing      Hunan    Hainan                  2011               2012         2013         2014
                        Source: Standard Chartered Research                                             Source: Standard Chartered Research

                        Figure 11: Did the local government impose stricter social                      Figure 12: What share of your total costs are wages?
                        insurance requirements last year?                                               % of respondents
                        % of respondents

                        80                     2014
                                     2013             2015
                        70                                                                                    >50%       1%

                        60
                                                                                                          40-50%                       11%
                        50

                        40
                                                                                                          20-30%                                                    43%
                        30

                        20                                                                                10-20%                                             33%

                        10
                                                                                                              0-10%                     12%
                         0
                                               Yes                                  No
                        Source: Standard Chartered Research                                             Source: Standard Chartered Research

                        5 May 2015                                                                                                                                        10
Special Report: PRD’s pain, China and ASEAN’s gain

                                                    Productivity growth versus wage inflation
                                                    Wages are clearly rising, but this does not necessarily have an inflationary impact on
                                                    the economy if productivity growth matches wage growth. Only if wage growth
                                                    significantly exceeds per-worker output does ‘wage inflation’ become a problem.
                                                    Productivity growth justifies an equal rate of increase in wages to reward workers for
                                                    the improvement in efficiency.

                                                    Productivity growth appears to be rising and outpacing wage growth. In the absence
                                                    of reliable official numbers, we gauge labour productivity growth by asking our
                                                    respondents whether their per-worker output has increased more than wages (Figure
                                                    13). 67% of respondents agreed with this statement, up from 61% last year. While a
                                                    still-material minority of respondents said productivity growth lagged wage growth,
                                                    we expect any spillover from wage costs to prices of final goods to be limited and
                                                    manageable. This adds conviction to our view that inflation is not a concern for China
                                                    this year. We forecast 2015 CPI inflation at 1.6%, down from 2.0% in 2014. If
                                                    anything, we see further downside risk to inflation in H1, creating room for further
                                                    policy easing to support growth.

                                                    Tackling labour challenges – Invest or relocate?
 Larger companies are more willing                  Labour shortages and wage pressures can be positive for an economy if they force

                                                                                                                                               Feeling the PRD pulse
to invest in automation and relocate                the right behavioural changes at the micro level. Companies that are willing to invest
                  factories overseas                in improving their cost structure and competitiveness can benefit from new
                                                    opportunities. Investing more in automation and streamlining process is the preferred
                                                    response to the labour shortage and wage pressures, cited by 45% of our PRD
                                                    respondents. (Figure 14). This percentage increases to almost 70% for bigger
                                                    companies, reflecting their greater ability to invest in process changes and benefit
                                                    from economies of scale. Only 30% of our smallest respondents chose this option,
                                                    preferring to “invest in more capital equipment” (36%, versus 24% for all
                                                    respondents).

                                                    Plans to relocate factories show a similar divergence across companies of different
                                                    sizes. 20% of this year’s respondents said they plan to move capacity inland, down
                                                    from 28% last year. Bigger companies generally favour this option more than smaller
                                                    ones. Separately, 11% of respondents plan to move factories overseas (versus 13%
                                                    last year), mostly larger companies.

Figure 13: Has per-worker output risen more than wages?                   Figure 14: How do you respond to labour shortages?
% of respondents                                                          % of respondents

                                      2015                                   Invest more in automation/
   Yes, a lot                                                                   streamlining processes
                                2014
                                                                                         Invest more in
                                                                                      capital equipment
   Yes, a bit
                                                                                         Move capacity               2015
                                                                                                                            2014
                                                                                                inland                       2013

         No                                                                              Move capacity
                                                                                          out of China

                0%     10%        20%        30%   40%    50%     60%                                     0%    10% 20% 30% 40% 50% 60% 70%
Source: Standard Chartered Research                                       Source: Standard Chartered Research

5 May 2015                                                                                                                                11
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                Vietnam and Cambodia are the top two choices for those considering moving
                                                                capacity overseas to cut costs (Figure 15), followed by Indonesia, Bangladesh and
                                                                Sri Lanka. We believe these choices indicate that companies considering relocating
                                                                from China are mostly low-end producers in the textiles and garments sector. For
                                                                those preferring to move within China, the outer parts of Guangdong province, Hunan
                                                                and Guangxi – all relatively close to the PRD – are the preferred destinations (Figure
                                                                16). This suggests that geographical familiarity and proximity to existing suppliers are
                                                                key considerations, in addition to lower wages. The availability of infrastructure and
                                                                skilled labour is also important.

                                                                45% of our respondents see material cost savings of 10-20% from initiatives to tackle
                                                                labour shortages; 20% see savings of more than 20%. (For further analysis, see
                                                                ‘ASEAN – The next PRD?’.)

                                                                Figure 15: If you plan to move capacity out of China, to where?
                                                                Number of respondents
Feeling the PRD pulse

                              Vietnam and Cambodia are the
                                                                25
                             favoured overseas destinations

                                                                20

                                                                15

                                                                10

                                                                  5

                                                                  0
                                                                        Vietnam      Cambodia     Indonesia Bangladesh Sri Lanka   Thailand   India   Philippines
                                                                Source: Standard Chartered Research

                                                                Figure 16: If you plan to move capacity elsewhere in China, to where?
                                                                Number of respondents
                           Those planning to relocate within
                                                                                    Yunnan, Guizhou
                            China prefer to stay close to the
                                                        PRD        Shaanxi, Gansu, Qinghai, Ningxia

                                                                                       Henan, Hubei

                                                                                  Chongqing, Sichuan

                                                                         Liaoning, Jilin, Heilongjiang

                                                                               Anhui, Fujian, Jiangxi

                                                                       Jiangsu, Zhejiang, Shandong

                                                                                     Hunan, Guangxi

                                                                                    Outer Guangdong

                                                                                                         0           5             10            15             20
                                                                Source: Standard Chartered Research

                        5 May 2015                                                                                                                                   12
Special Report: PRD’s pain, China and ASEAN’s gain

                                            Beyond wages
                                            Margins set to narrow less in 2015
       Rising wages are not the only        The outlook for margins is slightly less challenging this year than in 2014, according
  challenge facing companies in the         to our survey. Respondents expect margins to fall by an average of 0.4% this year,
                                PRD         versus -1.9% last year. On a same-company basis, 24% of respondents expect
                                            margins to improve this year, while 19% expect them to worsen (Figure 17).

                                            Utilisation ratio remains high
                                            Capacity utilisation still looks healthy. Close to 20% of respondents are operating at
                                            full capacity (down from 22% last year), while 63% are running at 80-90% (Figure
                                            18). Only a dozen or so companies look more vulnerable on this measure, operating
                                            at 60% capacity – consistent with prior surveys’ findings.

                                            Credit conditions have gotten worse
                                            35% of respondents reported that it is more difficult to borrow money now than at the
                                            same time in 2014, while only 7% said it has gotten easier (Figure 19). Conditions
                                            may have improved since our survey: Our proprietary Small and Medium Enterprise
                                            Confidence Index for China showed that credit availability improved in April following
                                            recent monetary policy easing. That said, real interest rates remain high relative to

                                                                                                                                                         Feeling the PRD pulse
                                            historical levels, and deflationary pressure has also lifted real funding costs.

                                            Figure 17: Margin change, 2014 actual vs. 2015 estimate
                                            % of respondents; blue shading indicates those expecting positive margin changes
                                            this year than last year
                                                                                                                 2015
                                                                          Down           Down         Down        No
                                                                                                                         Up 10% Up 20% Up 30%
                                                                          30%            20%          10%       change
                                                       Down 30%           1.4%                        0.3%       0.7%     1.7%               0.3%
                                                       Down 20%           0.3%           4.4%         2.7%       0.7%              0.3%
                                                       Down 10%                          1.4%     10.5%          4.4%     6.1%     0.7%
                                               2014

                                                       No change                         0.3%         6.1%      25.5%     4.8%
                                                         Up 10%                          0.3%         2.7%       4.1%    14.6%     0.3%
                                                         Up 20%                                       0.3%       1.4%     0.7%     0.3%      0.7%
                                                         Up 30%                                       0.3%                0.7%     0.3%      0.3%
                                            Source: Standard Chartered Research

Figure 18: Capacity utilisation levels                                    Figure 19: How easy is it to borrow money, now vs. 2014?
% of respondents                                                          % of respondents

  100%
                                                                              Harder

    90%

    80%                                                                           Same

    70%
                                                                              Easier
    60%

                                                                                         0%     10%     20%       30%    40%     50%   60%    70%
          0%              10%         20%     30%               40%
Source: Standard Chartered Research                                       Source: Standard Chartered Research

5 May 2015                                                                                                                                          13
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                             Orders appear to be improving
                                                                             While orders have been weak over the past three months (38% of respondents said
                                                                             they had declined, versus 27% reporting an increase), an improvement is expected.
                                                                             More than 40% of respondents see better orders in the next three months, versus
                                                                             25% expecting a decline (Figure 22). Orders fell 3% on average in the past three
                                                                             months, and are expected to improve by 1.6% over the next three months.

                                                                             Mixed outlook for key markets
                                                                             The US and Europe are the main overseas markets for the companies we surveyed
                                                                             (Figure 23). Sentiment towards key overseas markets is mixed (Figure 20), with 22%
                                                                             of respondents holding a positive view and 27% negative. Views on China are more
                                                                             cautious (18% positive, 37% negative – see Figure 21).

                                                                             Clients are turning bearish on the CNY
                                                                             Only 16% of respondents expect the Chinese yuan (CNY) to appreciate in 2015,
                                                                             down more than 97% in last year’s survey. The majority now expect the currency to
                                                                             depreciate. We present a detailed analysis of respondents’ views on the currency in
                                                                             ‘China through the PRD lens’.
Feeling the PRD pulse

                        Figure 20: What is your view on partner markets in 2015?                       Figure 21: What is your view on China in 2015?
                        % of respondents                                                               % of respondents
                        60%                                                                            50%

                        50%
                                                                                                       40%

                        40%
                                                                                                       30%
                        30%
                                                                                                       20%
                        20%

                                                                                                       10%
                        10%

                         0%                                                                             0%
                                  Negative       Moderately       Neutral   Moderately    Positive               Negative       Moderately   Neutral    Moderately            Positive
                                                  negative                   positive                                            negative                positive
                        Source: Standard Chartered Research                                            Source: Standard Chartered Research

                        Figure 22: How is your orders situation?                                       Figure 23: Where are your main business partners from?
                        % of respondents                                                               % of respondents
                                                                                                       45%
                               +40%
                                                                                                       40%
                               +30%
                                                                                                       35%
                               +20%
                                                                                 Next 3 months         30%
                               +10%
                                                                                                       25%
                          No change
                                -10%                                                                   20%

                                -20%                                                                   15%
                                                           Past 3 months
                                -30%                                                                   10%
                                -40%                                                                    5%
                              Others                                                                    0%
                                                                                                                USA      Europe Emerging Latin Middle    Japan       Africa      Others
                                       0%            10%             20%        30%              40%                              Asia America East
                        Source: Standard Chartered Research                                            Source: Standard Chartered Research

                        5 May 2015                                                                                                                                                       14
China through the PRD lens
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                                        China through the PRD lens
                                                                                        Slowing growth is a headwind to the labour market
                                                      Lan Shen +86 10 5918 8261         Maintaining a stable labour market and healthy income growth are priorities for
                                                                Lan.Shen@sc.com
                                                                   Macro Research       Beijing. Through the lens of our PRD survey, we get a glimpse of the broader picture
                                            Standard Chartered Bank (China) Limited
                                                                                        for China as a whole. The survey results suggest that the labour market remains
                                                Betty Rui Wang +852 3983 8564           resilient – the majority of respondents indicated that it is almost as difficult to find
                                                          Betty-Rui.Wang@sc.com
                                                                  Macro Research        workers now as it was a year ago. This means there are unfilled jobs, supporting the
                                              Standard Chartered Bank (HK) Limited
                                                                                        underlying trend of rising wages. Yet if growth stays weak for longer, the risk is that
                                                    Tony Phoo +886 2 6603 2640
                                                               Tony.Phoo@sc.com
                                                                                        the labour market will start to soften, pulling wages and consumption lower. This
                                                                   Macro Research       adds conviction to our call that more policy easing is on the horizon. Also, short-term
                                           Standard Chartered Bank (Taiwan) Limited
                                                                                        pain is a necessary part of China’s longer-term transformation as companies strive to
                                                  Eddie Cheung +852 3983 8566
                                                           Eddie.Cheung@sc.com          operate more efficiently and move up the value chain (more on this to follow).
                                                                   FICC Research
                                              Standard Chartered Bank (HK) Limited
                                                                                        At the National People’s Congress (NPC) meeting in March 2015, Premier Li
                                                                                        Keqiang set a GDP growth target of about 7% for 2015. He pledged action if growth
                             Maintaining a healthy labour market                        risks falling below the target, cutting into jobs and income. The latest macroeconomic
                                  is a key policy priority for 2015                     data suggests still-soft growth in H1-2015, with household consumption and
                                                                                        investment data continuing to disappoint. GDP growth slowed further to 7.0% y/y in
                                                                                        Q1-2015; this is likely to dent investment and consumer confidence, worsening the
                                                                                        employment outlook.

                                                                                        Slower economic growth is already having a negative effect on household income
                                                                                        and consumption. According to official nationwide data, growth in urban households’
                                                                                        disposable income moderated to 6.3% y/y in real terms in Q4-2014 from 6.5% in Q3,
                                                                                        and retail sales growth weakened to 11.7% y/y from 11.9%. Echoing this, average
                                                                                        wage growth for urban and migrant workers moderated to about 10% in 2014 from
                                                                                        12% in 2012-13 (Figure 2) as slower growth eroded profit margins. Our survey also
                                                                                        finds that profit margins are narrowing.

                                                                                        The labour market still appears resilient for now, with the demand-to-supply ratio in
China through the PRD lens

                                                                                        the nationwide job market still above 1. However, this may not last for the following
                                                                                        reasons: (1) services jobs started to decline in mid-2014, following the three-year
                                                                                        contraction in manufacturing jobs, as reflected in the employment sub-index of the
                                                                                        official PMI (Figure 1); and (2) our household confidence indicator, which is
                                                                                        calculated as the ratio of demand to term deposits and tends to lead consumption
                                                                                        and CPI inflation by about six to nine months, continues to decline.

                             Figure 1: Labour market under pressure across the board                           Figure 2: Average wage growth has moderated
                             Employment sub-index in manufacturing and service PMIs                            Average wages of urban and migrant workers, % y/y
                                56                                                                              25%
                                                                             Services
                                                                                                                                                                 Migrant workers
                                54                                                                                                           Urban workers
                                                                                                                20%
                                52

                                50                                                                              15%

                                48                                                                              10%
                                46                                                Manufacturing
                                                                                                                 5%
                                44

                                42                                                                               0%
                                 Jan-05        Jan-07        Jan-09        Jan-11        Jan-13    Jan-15         Mar-02      Mar-04     Mar-06     Mar-08   Mar-10   Mar-12       Mar-14
                             Source: CEIC, Standard Chartered Research                                         Source: CEIC, Standard Chartered Research

                             5 May 2015                                                                                                                                                     16
Special Report: PRD’s pain, China and ASEAN’s gain

     Our SMEI echoes concerns about                 Our proprietary Small and Medium Enterprise Confidence Index (SMEI) for China
     emerging labour-market softness                adds more colour to the picture of China’s labour market (see Economic Alert, 30
                                                    April 2015, ‘China – SME index moderates as expectations soften’). We surveyed
                                                    more than 600 SMEs across regions of China about their production, sales, credit,
                                                    investment and employment conditions, and measured the responses with diffusion
                                                    indices.

                                                    The latest SMEI survey shows that labour-market conditions continued to improve
                                                    marginally in April after the employment sub-index fell to a record low of 50 in
                                                    February (Figure 4). This suggests that hiring has picked up after the holiday season.
                                                    The salary sub-index remained flat at 63.8 in April, reflecting still-high labour costs for
                                                    SMEs. The employment expectations sub-index fell in April, indicating a slower pace
                                                    of growth in hiring demand in the near future.

                                                    By region, the performance of SMEs in southern and central-western China picked
                                                    up strongly in April after bottoming in February (Figure 3), driven by accelerating
                                                    production and investment; those in eastern and northern China lagged, possibly
                                                    reflecting greater sensitivity to sluggish external demand and the reduction of
                                                    overcapacity.

                                                    We still see the risk of a possible slowdown in consumption along with the broader
                                                    economic slowdown. The first wave of China’s economic slowdown was driven
                                                    primarily by manufacturing and housing investment; we see a potential second wave
                                                    driven by falling consumption if the labour market weakens further. Given Beijing’s
                                                    low tolerance for a deteriorating labour market, we believe monetary policy – the
                                                    most effective tool to boost short-term growth – will have to be eased further. We
                                                    maintain our call that Beijing will cut the 1Y benchmark policy rate by another 25bps
                                                    by end-June, and possibly cut the reserve requirement ratio (RRR) by another 50bps
                                                    in H2-2015.

                                                                                                                                                                  China through the PRD lens

Figure 3: SMEs in southern and central-western China                           Figure 4: Labour market recovers after bottoming in
saw a rebound in April                                                         February, but outlook softens
SMEI reading by region                                                         SME current performance sub-indices
65                                                                             68    Employment
                                                                                      (current)      Employment
                                                                               64                    (forward)
                                                                South                         Salary

               Central-west                                                    60
60
                                                                     East      56

                                                                               52
                                                                 North
55                                                                             48

                                                                               44

                                                                               40
50                                                                                   Sep-14    Oct-14    Nov-14 Dec-14   Jan-15   Feb-15   Mar-15   Apr-15
      Sep-14    Oct-14    Nov-14 Dec-14   Jan-15   Feb-15   Mar-15    Apr-15
Source: Standard Chartered Research                                            Source: Standard Chartered Research

5 May 2015                                                                                                                                                   17
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                                       Transforming China’s manufacturing machine
                                                                                       From manual to automation
                                         Rising operating costs are                    Both domestic and foreign manufacturers have long known that China’s low-wage
                                   consistent with China’s move up                     growth model was coming to an end. The results of our wage survey in the PRD –
                                  the value chain, and might reflect                   which can be seen as a microcosm of China – are consistent with this trend. Many
                                     the shrinking labour force and
                                                                                       have argued that rising costs will put China at a disadvantage given its position as a
                                             improving productivity
                                                                                       global manufacturing hub. We disagree. We see China undergoing a positive
                                                                                       transition as it moves up the manufacturing value chain. The country’s shrinking
                                                                                       labour force and other labour challenges can be seen as catalysts for improving
                                                                                       labour productivity.

                                45% of our respondents say they                        Underlining China’s transition, manufacturers in the PRD are responding to labour
                                         will investment more in                       shortages by investing in automation and streamlining processes. This was cited as
                              automation/streamlining process in                       the preferred response by 45% of our survey respondents, topping the list. The next
                                 response to the labour shortage
                                                                                       most popular option, investing more in capital equipment, was chosen by only 24%,
                                                                                       down from almost 60% in our 2013 and 2014 surveys. (The shift in preferences may
                                                                                       be partly explained by the fact that ‘invest more in automation/streamlining
                                                                                       processes’ was included as an option for the first time in this year’s survey.)

                                                                                       The percentage of respondents preferring to move capacity inland or out of China
                                                                                       declined and remained at a low level. We see the shift towards
                                                                                       automation/streamlining processes as a positive response to the labour shortage. It
                                                                                       may reflect the fact that companies in China are starting to produce more
                                                                                       sophisticated and higher-end products. An important role of automation is to achieve
                                                                                       accuracy and complexity in high-volume output at affordable cost (for example, in
                                                                                       electrical and electronics production). It also reduces worker stress caused by
                                                                                       repetitive, high-pressure work, and can replace humans with machines where
                                                                                       working conditions are unsatisfactory. China is set to overtake the EU and North
                                                                                       America by 2017 as the world’s biggest user of industrial robots, according to
                                                                                       estimates from the International Federation of Robotics.
China through the PRD lens

                             Figure 5: China’s productivity still looks strong within                        Figure 6: China to become the biggest user of industrial
                             Asia                                                                            robots by 2017, overtaking the EU and North America
                             Average annual ppt contribution to GDP growth from                              Estimated operational stock of industrial robots, ’000 units
                             productivity (TFP), by decade
                              5              CN       IN    HK      TW       US       KR   SG    JP           450                  2017
                              4                                                                               400
                                                                                                              350
                              3
                                                                                                              300
                              2
                                                                                                              250
                              1                                                                                           2014
                                                                                                              200
                              0                                                                               150
                             -1                                                                               100

                             -2                                                                                50
                                                                                                                0
                             -3
                                                                                                                              China                     EU_5                North America
                                          1981-1990                  1991-2000               2001-2013
                             Source: Penn World Tables, Standard Chartered Research                          Source: IFR World Robotics 2014, Standard Chartered Research

                             5 May 2015                                                                                                                                                     18
Special Report: PRD’s pain, China and ASEAN’s gain

    We see high potential for China’s                    Automation can also boost labour productivity and may partly explain China’s rising
    services sector and think this will                  wage trend. 67% of our survey respondents said their per-worker output has risen
              lead to healthier growth                   faster than wages, providing solid anecdotal proof of how productivity boosts wages.
                                                         This trend, if it continues, will accelerate China’s income growth and sustain the
                                                         consumption cycle.

                                                         From lower-end to high-tech products
     China’s high-tech exports have                      One gauge of China’s move up the value chain is its share of high-tech exports.
  outpaced lower-end exports in the                      According to the World Bank, high-tech products are those with high R&D intensity,
                        past decade                      including aerospace, computers, pharmaceuticals, scientific instruments, and
                                                         electrical machinery. China’s high-tech exports have grown rapidly since 2004. They
                                                         now account for 28-30% of China’s total exports, exceeding lower-end exports (for
                                                         which we use garments, footwear and toys as a proxy) but still below the high-tech
                                                         shares for Taiwan and Singapore. The y/y growth rate of value-added in China’s
                                                         high-tech manufacturing industry has also started to rise in the past couple of years.

                                                         The government has introduced a ‘made in China 2025’ campagin to encourage
                                                         growth in sectors such as railways, machinery and communication equipment,
                                                         aircraft and electronics. We expect China’s previous labour-intensive growth model to
                                                         be gradually replaced by a new model in which creativity and technology will play a
                                                         more important role. We are therefore not overly concerned about the potential shift
                                                         of lower-end manufacturing from China to other regions.

                                                         China’s rising labour costs are a result of improving productivity and the increasing
                                                         complexity of the goods it produces, in our view. This reflects the country’s potential
                                                         to move up the value chain, tackle industrial overcapacity, apply more rigid
                                                         environmental standards, and transform its growth model from labour-intensive to
                                                         technology-intensive.

                                                         From manufacturing to services
China has embarked on a shift from                       As China’s manufacturing industry moves up the value chain, its broad economic
investment-driven growth to growth                       structure is also undergoing a transformation. China has started to shift from heavily

                                                                                                                                                                   China through the PRD lens
   driven by services and domestic                       investment-driven growth to a more balanced and sustainable growth model. To this
                           demand
                                                         end, developing the services sector is a priority for policy makers. Services’ share of
                                                         China’s GDP has increased (48.2% as of 2014) and surpassed industry’s share in
                                                         the past few years. However, it still lags the US and Japan, where services account
                                                         for more than 70% of GDP.

Figure 7: High-tech exports have a larger share than                                Figure 8: Value-added created in high-tech manufacturing
lower-end exports                                                                   industry is rising after fluctuating for years
Share of total exports, %                                                           Value-added of industry, % y/y
 40                                                                                 25

 35                                                                     High-tech
                                                                                    20                       Special equipt
 30

 25                                                                                                                                  Pharmaceutical
                                                                                    15
 20                                                             Garment,
                                                              footwear and                                                                            Computer
 15                                                                toy              10
                                                                                                                                                         Food
                                                                                                                       Textile
 10
                                                                                     5
  5

  0                                                                                  0
  Jan-00     Feb-02   Mar-04     Apr-06     May-08   Jun-10    Jul-12     Aug-14      2008         2009        2010        2011   2012     2013        2014
Source: CEIC, Standard Chartered Research                                           Source: CEIC, Standard Chartered Research

5 May 2015                                                                                                                                                    19
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                                               We see a high possibility for the services sector to reach its potential and facilitate
                                                                                               China’s economic rebalancing. The financial services sector is a key example of such
                                                                                               potential. China’s population is the most unbanked in the world after India’s. China’s
                                                                                               57mn micro and SME companies contribute 60% of GDP, 50% of tax revenue and
                                                                                               80% of urban job opportunities – yet only 35% of them were financed by banks,
                                                                                               according to a 2011 survey. China’s urbanisation progress will also create growth
                                                                                               opportunities for services sectors. China targets increasing the ratio of urban
                                                                                               residents to 60% by 2020 from 53.7% in 2013, according to the 2014-20 urbanisation
                                                                                               plan released by the State Council. The government aims to improve the social
                                                                                               service coverage ratio by 2020, covering the areas of education, job services,
                                                                                               pension coverage and health care.

                                                                                               Trends in FDI flows to China indicate a growing interest in the country’s services
                                                                                               sector, which was previously more closed to private and foreign investors than the
                                                                                               manufacturing sector. FDI in real estate, leasing and commercial services; wholesale
                                                                                               and retail trade; and banking and insurance has risen as a share of total FDI inflows,
                                                                                               while the share of manufacturing FDI inflows has declined. In 2013 and 2014, utilised
                                                                                               FDI in these four service sectors grew 11% y/y on average, while headline FDI
                                                                                               contracted. The services sector continues to attract new interest from foreign
                                                                                               investors, even as some manufacturers exit the country. This supports our view that
                                                                                               the slowdown in FDI into China’s manufacturing industry is natural for an economy
                                                                                               that is rebalancing its growth model.
China through the PRD lens

                             Figure 9: Tertiary industry* has gradually surpassed                                      Figure 10: Annual FDI utilised in China
                             secondary industry as a major GDP component                                               Share of total FDI, %
                             Share of nominal GDP, %
                             50                                                                                        35                                                                                    60
                                                                                                          Tertiary
                                                                                                          Industry                                                                             Real estate
                                                                                                                       30                                       Manufacturing                                50
                             45
                                                                                                                                                                   (RHS)
                                                                                                                       25
                             40                                                                                                                                                                              40
                                                                                                                       20
                             35                                                                         Secondary                                                                                            30
                                                                                                         Industry      15
                                                                                                                                                  Leasing and                   Whole and
                             30                                                                                                                                                 retail trade                 20
                                                                                                                       10                         commercial
                                                                                                                                                    services
                             25                                                                                         5                                                                                    10
                                                                                                                                                                    Banking and
                                                                                                                                                                     insurance
                             20                                                                                         0                                                                                    0
                               1988       1991      1994      1997     2000      2003      2006      2009      2012      2006     2007     2008    2009     2010      2011      2012    2013       2014
                             * China’s tertiary industry covers 14 sectors, including wholesale and retail services,   Source: CEIC, Standard Chartered Research
                             transport, storage and postal services, financial services, real estate services, etc.
                             Source: CEIC, Standard Chartered Research

                             5 May 2015                                                                                                                                                                      20
Special Report: PRD’s pain, China and ASEAN’s gain

                                       Corporates face higher CNY volatility
Our respondents generally see mild     Our 2015 PRD survey results indicate a turn in client sentiment towards the Chinese
   CNY weakness against the USD,       yuan (CNY) in 2015. A year ago, more than 97% of clients surveyed expected the
which should positively impact their   CNY to appreciate against the USD; now, only 16% expect appreciation, and the
                          business
                                       majority expect depreciation. Only about 6% of respondents predict a major move (of
                                       more than 5%) in the CNY. The majority (just over 30%) of our 2015 respondents see
                                       the CNY weakening mildly by 0-3% by year-end. Perhaps not surprisingly, our clients
                                       see CNY depreciation in a positive light. More than 60% of respondents see CNY
                                       depreciation as having a positive impact on their business, likely reflecting the export-
                                       oriented nature of their businesses.

                                       Client conviction on the CNY has likely been shaken by the pick-up in CNY volatility
                                       since H2-2014. China’s subdued growth-inflation mix and prospective Fed tightening
                                       are also less supportive of CNY appreciation. Additionally, with the authorities now
                                       saying that the currency is at equilibrium value, a reduction in CNY appreciation
                                       expectations is natural. We have also observed a shift in corporate hedging behavior
                                       as a result of CNY volatility. Exporter hedging ratios have collapsed to multi-year
                                       lows, while importer hedging ratios have rebounded strongly, according to data from
                                       the State Administration for Foreign Exchange (SAFE) and merchandise trade flows.
                                       Based on a three-month observation window, importer hedging ratios now
                                       comfortably exceed those of exporters for the first time since late 2008/early 2009.
                                       This shift is likely to underpin support for USD-CNY until CNY appreciation
                                       expectations resume.

                                       We still expect the CNY to appreciate over the medium term, but at a much slower
                                       pace as the authorities shift to a trade-weighted index (TWI) focus in response to
                                       narrowing external balances, the stronger USD and more balanced FX flows
                                       onshore. China’s balance of payments is likely shifting to a ‘new normal’ in which
                                       financial account outflows offset current account surpluses. We see a very low
                                       probability of CNY devaluation against the USD, given the low marginal contribution
                                       of exports to China’s growth and the likely detrimental impact such a move would

                                                                                                                                   China through the PRD lens
                                       have on investor sentiment and CNY internationalisation. We forecast USD-CNY at
                                       6.19 by end-2015.

5 May 2015                                                                                                                   21
Special Report: PRD’s pain, China and ASEAN’s gain

                             Figure 11: What is your outlook for the CNY against the          Figure 12: What is your outlook for the CNY against the
                             USD until the end of the year?                                   USD until end-2015?
                             % of respondents                                                 % of respondents
                             120%                                                             35%

                                                                                              30%
                             100%
                                                                                              25%
                              80%
                                                                                              20%

                              60%                                                             15%

                                                                                              10%
                              40%
                                                    2015
                                                                                               5%
                              20%
                                                                                               0%
                                           2014
                                                                                                          5%
                                0%                                                                                                         material
                                        No material change         Depreciate    Appreciate                                                change
                             Source: Standard Chartered Research                              Source: Standard Chartered Research

                             Figure 13: How would CNY depreciation affect your                Figure 14: Importer hedge ratios comfortably exceed
                             business?                                                        those for exporters for first time since 2008-09
                             % of respondents                                                 Rolling 3M ratio
                             70.00%                                                                                                                               Export-R
                                                                                               0.80
                             60.00%                                                            0.75
                                                                                               0.70
                             50.00%
                                                                                               0.65
                             40.00%                                                            0.60
                                                                                               0.55
                             30.00%
                                                                                               0.50
                             20.00%                                                            0.45                                                                       Import-R
                                                                                               0.40
                             10.00%
                                                                                               0.35
China through the PRD lens

                              0.00%                                                            0.30
                                               It is bad            It is good   No change         2001          2003     2005      2007       2009      2011      2013       2015
                             Source: Standard Chartered Research                              Source: Standard Chartered Research

                             5 May 2015                                                                                                                                              22
Special Report: PRD’s pain, China and ASEAN’s gain

ASEAN – The next PRD?

                                                          ASEAN – The next PRD?

5 May 2015                                           23
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                                ASEAN – The next PRD?
                                                                                Opportunities for ASEAN
                                         Chidu Narayanan +852 3983 8568         The PRD’s transformation is part of a broader change in growth dynamics in
                                         Chidambarathanu.Narayanan@sc.com
                                                             Macro Research     emerging Asia. As China’s manufacturing sector becomes saturated, ASEAN’s is
                                         Standard Chartered Bank (HK) Limited
                                                                                likely to grow. The 10 ASEAN countries have a combined GDP of over USD 2.4tn;
                                                 Edward Lee +65 6596 8252       considered as a single bloc, it is the world’s eighth-largest economy and third-most
                                                        Lee.Wee-Kok@sc.com
                                                              Macro Research    populous market (after China and India). ASEAN is likely to benefit from
                                    Standard Chartered Bank, Singapore Branch
                                                                                comparatively low wage costs and abundant labour supply over the next 20 years.
                                                      Jeff Ng +65 6596 8075
                                                              Jeff.Ng@sc.com
                                                              Macro Research    Manufacturers shifting production to ASEAN are also positioning themselves to
                                    Standard Chartered Bank, Singapore Branch
                                                                                capture a share of the region’s growing consumer market, driven by high economic
                                                                                growth and a rising middle class. In addition, several ASEAN countries perform well
                                                                                in international rankings on business conditions. Given these advantages, we expect
                                                                                ASEAN to become a more important global exporter in the coming years. Vietnam is
                                                                                poised to be among the biggest beneficiaries of China’s move up the manufacturing
                                                                                value chain, in our view, as it combines these attributes with geographical proximity
                                                                                to China. Further infrastructure development across ASEAN is crucial to removing
                                                                                bottlenecks and attracting more FDI, in our view.

                                                                                ASEAN has natural advantages over the next 20 years
                         ASEAN’s favourable demographics                        ASEAN is poised to benefit from the shift in investment from China as the latter loses
                        will help to attract investment in the                  cost competitiveness and its labour supply tightens (see Figures 1 and 2). Most
                        region’s new manufacturing centres                      ASEAN countries (with the exceptions of Singapore and Malaysia) have significantly
                                                                                lower manufacturing wages than China. While wage costs may still be competitive in
                                                                                some parts of China, particularly in the west, the shrinking labour force means that
                                                                                wages are likely to catch up quickly with those in eastern China.

                                                                                ASEAN also has a demographic edge. Its median age was about 27 years as of
                                                                                2013, much younger than China’s estimated 32 years. ASEAN’s labour force will also
                                                                                continue to grow over the next few decades, expanding by 70mn workers between
                                                                                2010 and 2030, according to UN projections. China’s labour force, in contrast, is
                                                                                expected to contract by almost 70mn.

                                                                                Within ASEAN, Indonesia and the Philippines are best positioned to reap the
                                                                                demographic dividend; this should help these economies achieve faster and more

                        Figure 1: ASEAN has cost advantages                                           Figure 2: ASEAN benefits from labour-force growth
                        Monthly manufacturing wages, USD                                              Average annual labour contributions to GDP growth vs. trend
                                                                                                      growth, ppt
                        1,600                                                                               2001-05     2006-10      2011-15P       2016-20P        2021-25P   2026-30P
ASEAN – The next PRD?

                        1,400                                                                          8
                                                                                                       7
                        1,200
                                                                                                       6                             Trend growth
                        1,000                                                                          5
                          800                                                                          4
                                                                                                       3
                          600                                                                          2
                          400                                                                          1
                                                                                                       0
                          200
                                                                                                       -1
                            0                                                                          -2
                                  SG     CN      MY      TH      PH      ID     VN   LA   KH   MM               ID           PH           MY            TH             SG        CN
                        Source: JETRO, Standard Chartered Research                                    Source: IMF, Penn World Tables, Standard Chartered Research

                        5 May 2015                                                                                                                                                    24
Special Report: PRD’s pain, China and ASEAN’s gain

                                                          resilient growth. They also enjoy low levels of household leverage, rising urbanisation
                                                          and a potential increase in productivity – positioning them to become regional
                                                          economic powerhouses in the next few decades. Thailand and Singapore have less
                                                          favourable demographics, with their median ages forecast at over 45 by
                                                          2045. Thailand’s labour force is expected to shrink by almost 5mn between 2010 and
                                                          2030 (source: UN data).

       ASEAN attracted more FDI than                      In addition to low costs and abundant labour supply, ASEAN boasts high growth and
                       China in 2013                      an attractive investment climate. Some ASEAN economies (particularly Singapore,
                                                          Malaysia and Thailand) perform well in international rankings such as the World
                                                          Bank’s Ease of Doing Business and the World Economic Forum’s Global
                                                          Competitiveness Index (see Figure 3). The rest have potential to improve.

                                                          ASEAN overtook China in terms of inward FDI in 2013. While this is mostly
                                                          concentrated in Singapore, other ASEAN economies will likely command a bigger
                                                          share of FDI in the coming years (see Figure 4). Most FDI goes into the
                                                          manufacturing sector, reflecting the region’s positive attributes for investment in
                                                          manufacturing facilities.

Figure 3: World Bank Doing Business ranking, 2015
Table shows world rankings (1-189) in main index and selected sub-indices
                              Ease of doing                                        Dealing with                                          Trading across
                                                       Starting a business                                    Getting electricity
                                business                                        construction permits                                        barriers
Singapore                           1                               6                    2                            11                       1
Malaysia                            18                             13                   28                            27                      11
Thailand                            26                             75                    6                            12                      36
Vietnam                             78                             125                  122                          135                      75
China                               90                             128                  179                          124                      98
The Philippines                     95                             161                  124                           16                      65
Brunei                             101                             179                  53                            42                      46
Indonesia                          114                             155                  153                           78                      62
Cambodia                           135                             184                  183                          139                      124
Laos                               148                             154                  107                          128                      156
Myanmar                            177                             189                  130                          121                      103
Source: Doing Business (World Bank), Standard Chartered Research

Figure 4: ASEAN is attracting more investment
% of total FDI in ASEAN

                      Laos                                               2013             Average (2005-12)
                    Brunei
                Cambodia
                                                                                                                                                               ASEAN – The next PRD?

                 Myanmar
                Philippines
                  Vietnam
                  Malaysia
                  Thailand
                 Indonesia
                                                                                                                                               51%
                Singapore
   ASEAN (% of Asia FDI)                                                                                                                       48%

 ASEAN (% of global FDI)

                              0                 5                  10            15             20                  25              30               35
Source: UNCTAD, Standard Chartered Research

5 May 2015                                                                                                                                                25
Special Report: PRD’s pain, China and ASEAN’s gain

                                                            ASEAN will likely become a more important global exporter
                        ASEAN has the potential to become   Manufacturing capabilities vary across ASEAN. The CLMV region (Cambodia, Laos,
                             an important global exporter   Myanmar and Vietnam) and Indonesia provide low-cost production. The Philippines,
                                                            Malaysia and Thailand have expertise in mixed manufacturing and electronics.
                                                            Singapore has high value-added manufacturing expertise and strong intellectual
                                                            property rights protection. To capitalise on its manufacturing capabilities, ASEAN
                                                            needs to achieve better integration. In addition to infrastructure links, a common
                                                            regional framework for investment regulations would make it much easier for
                                                            companies to adopt a pan-ASEAN strategy with operations located across the region

                                                            As FDI shifts towards ASEAN from China, ASEAN may catch up with China’s current
                                                            status as the world’s top exporter (see Figure 5). ASEAN accounted for close to 7%
                                                            of global exports in 2013, and this share has remained broadly stable for some time.
                                                            China became the top global exporter in 2008-09 and currently accounts for close to
                                                            12% of global exports. Other major exporters – including the US, Germany and
                                                            Japan – have seen their shares of global exports gradually decline in recent years.

                                                            China’s experience demonstrates the importance of external trade in improving
                                                            economic structure and propelling growth. While many factors have contributed to
                                                            China’s outperformance in global trade, its strong openness to trade and investment
                                                            is key, in our view. China created Special Economic Zones (SEZs) in Shenzhen and
                                                            other regions as early as the 1980s. These were designated areas where foreign
                                                            (and later domestic) companies could invest, benefiting from lower taxes, limited
                                                            trade barriers and a supportive bureaucracy.

                                                            Figure 5: ASEAN exporters may gain market share from China in the future
                                                            % of global exports
                                                             14%

                                                             12%                                                                                                  CN
ASEAN – The next PRD?

                                                             10%

                                                                                                                                                                  US
                                                              8%                                                                                                  DE

                                                              6%                                                                                               ASEAN

                                                              4%
                                                                                                                                                                 JP
                                                              2%

                                                              0%
                                                                2000     2001   2002    2003    2004   2005   2006   2007   2008   2009   2010   2011   2012    2013
                                                            Source: WTO, Standard Chartered Research

                        5 May 2015                                                                                                                                    26
Special Report: PRD’s pain, China and ASEAN’s gain

                                                        Infrastructure development is critical
                                                        Without improving their infrastructure, ASEAN economies will have difficulty
                                                        achieving their potential as an economic bloc comparable to China, in our view. The
                                                        long-term shift in manufacturing requires both hard and soft infrastructure to succeed
                                                        (see Figure 6).

     Infrastructure spending across                     Building hard infrastructure, removing bottlenecks and creating the right conditions to
  ASEAN has slowed in recent years                      encourage FDI are key, particularly for less developed economies. The Asian
                                                        Development Bank estimates that ASEAN countries spend only 4% of GDP on
                                                        infrastructure, down from an average of 6% from 1980-2009. Although there is no
                                                        specific optimal level of infrastructure spending, we think 5-10% of GDP is conducive
                                                        to higher long-term growth.

                                                        Seamless transport infrastructure across ASEAN is needed in the longer term,
                                                        although the important question of who will pay for infrastructure development
                                                        remains. Plenty of improvement is needed at the country level before more
                                                        complicated cross-border issues are addressed. Many countries in the region have
                                                        room to raise their capital stock per worker to boost incomes. In all cases,
                                                        infrastructure development is critical to future development.

Figure 6: Infrastructure development attracts more FDI
Value of FDI inflows (2011-13), USD bn, ranked by 3-year average
 70

 60
                                                                                                                                                  ASEAN – The next PRD?

 50

 40

 30
                                                 3YA
 20

                                                           2012 2013
 10
                                                       2011
  0
             SG              ID             MY                TH       VN          PH           MM          KH          BN           LA
Source: UNCTAD World Investment Report, Standard Chartered Research

5 May 2015                                                                                                                                  27
Special Report: PRD’s pain, China and ASEAN’s gain

                                                                              Vietnam: Emerging alternative for low-cost manufacturing
                                                                              China is shifting away from a growth model based on low manufacturing wages, and is
                                                                              increasing automation as it moves up the value chain. This opens up opportunities for
                                                                              low-cost manufacturing regions like ASEAN, particularly the Mekong delta region.
                                                                              Several ASEAN countries have the right mix of a cheap and educated labour force, a
                                                                              large and growing working-age population, and an increasingly affluent middle class. We
                                                                              estimate that a Chinese manufacturing worker in the PRD region earns around USD 700
                                                                              a month, while a similar worker in Vietnam earns only about USD 250 a month. We
                                                                              believe that Vietnam is poised to be among the biggest beneficiaries of China’s move up
                                                                              the manufacturing value chain. It combines all of these attributes with geographical
                                                                              proximity to China, allowing it to support and benefit from the transfer of trade routes.

                           Over one-third of our respondents                  Vietnam is the most preferred destination for clients planning to move manufacturing out
                            cited Vietnam as the top offshore                 of China, cited by more than one-third of these respondents (Figure 7). Lower wages, a
                            destination for factory relocation                young and educated workforce, and geographical proximity to China make Vietnam an
                                                                              attractive destination, particularly for more labour-intensive manufacturing segments. In
                                                                              addition, Vietnam’s fast-growing middle class and increasingly affluent population make
                                                                              it an attractive consumer market. In a survey we conducted last year, foreign companies
                                                                              located in Vietnam noted that the large size of the domestic market was a key reason for
                                                                              their decision to invest in the country (Figure 9).

                        Figure 7: If you plan to move capacity out of China, to                      Figure 8: What are your cost savings from these actions?
                        where?                                                                       % of respondents
                        % of respondents

                                Vietnam                                                      36%
                                                                                                             Move to Cambodia                                                    20%
                              Cambodia                                          25%

                            Bangladesh                            10%                                          Move to Vietnam                                                  19%

                              Indonesia                           10%
                                                                                                        Move capacity inland                                              17%
                                   India                5%

                               Thailand                 5%                                                          More capex                                      14%
                              Sri Lanka                 5%
                                                                                                            Invest in automation                              12%
                             Philippines          3%

                        Source: Standard Chartered Research                                          Source: Standard Chartered Research

                        Figure 9: Why did you invest in Vietnam?                                     Figure 10: Wages in Vietnam are much lower than in
                        % of respondents, survey of foreign firms in Vietnam, 2014                   Shenzhen (labour costs in various cities, USD per month)
                                                                                                      700
ASEAN – The next PRD?

                                                                                                                  Shenzhen         Bangkok         Ho Chi Minh
                             Large domestic market                                           44%
                                                                                                      600         Vientiane        Phnom Penh      Yangon
                                Low operational cost                             29%                  500

                                Ample labour supply                     18%                           400

                                                                                                      300
                          Good operating conditions           2%
                                                                                                      200
                                      Policy benefits        0%
                                                                                                      100

                                              Others               7%                                   0
                                                                                                                   Minimum wage              Factory worker          Clerical worker
                        Source: Standard Chartered Research                                          Source: JETRO, Standard Chartered Research

                        5 May 2015                                                                                                                                                     28
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