Many companies are moving their supply chains away from China. The world’s smaller emerging markets could be a key beneficiary, says Emily Fletcher, manager of the BlackRock Frontiers Investment trust.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
The pandemic and its aftermath have brought a renewed focus on where companies source parts and materials, and manufacture goods. Rather than relying on lengthy and fragile supply chains to source products at the lowest possible cost, companies have looked to find products closer to home and raise inventory levels. This has been characterised as deglobalization, a move away from the trend to trade freely across the globe.
Yet, the reality is more nuanced. Some manufacturing is returning to the US or Europe or the UK. Countries have become very sensitive about having home-grown capability in mission-critical industries such as semiconductors. However, companies are still outsourcing manufacturing – the costs of not doing so at a time when inflation is raising prices across the world would be prohibitive. Businesses are diversifying their supply chains across the globe, recognising that this is the key to long-term security of supply. It is not deglobalization, but globalization with a different flavour.
Beyond China
It is clear that companies are moving away from China. A recent report by the European Union Chamber of Commerce says one in 10 companies have shifted investments out of China, while another one in five are delaying or considering shifting investments.1 There are concerns over transparency, market access restrictions, rising costs and a weakening economy.
Frontier markets have been a major beneficiary of these moves away from China. Many of them have been able to occupy a neutral position between the warring factions of East and West, trading with and trusted by both sides.
Vietnam is perhaps the clearest example. A natural alternative to China, with a well-educated workforce, strong global links and a business-friendly government, it saw foreign direct investment hit a decade high in 2022,2 at $22.4bn. The country attracted 962 new Foreign Direct Investment (FDI) projects in the first five months of the year, according to the Financial Times, up from 578 in the same period last year.
Apple has moved AirPod production from China to Vietnam, Samsung has also shifted production from China to Vietnam.3 Xiaomi confirmed production at a factory in Thai Nguyen, one of number of electronics firms using Vietnam as a regional production centre.4 The US State Department has recently announced a partnership with the Government of Vietnam to explore opportunities to build semiconductors there, using funds created by the 2022 Chips Act.5
There are limitations. Vietnam does not have the capacity of China and needs to build out its infrastructure to accommodate demand from companies across the globe. However, in the meantime, this investment continues to contribute to long-term economic growth and diversification.
While Vietnam may have been the most high profile example, a similar trend can be seen in Thailand. Sony moved its camera production to Thailand in 2022.6 Nikon had already shifted its operations there in 2020. Thailand's investment applications between January and June rose 70% from a year earlier, focused on the electronics, food, and auto sectors. Foreign direct investment rose 141% on-year to 304 billion baht.7 Thailand is already establishing regional dominance in auto manufacturing, with ambitions to become an electric vehicle hub.
Commodity diversification
There are other reasons why global trade routes are diversifying. Geopolitical tensions and Western sanctions imposed on Russia over the Ukraine invasion have forced companies to find alternative supplies of major commodities, such as oil, gas, wheat or fertilisers. Many of these are to be found in Latin America, which has come to be seen as a reliable trading partner.
At the same time, the energy transition is creating demand for a new range of materials, many of which are held in smaller emerging markets. Indonesia, for example, has established itself as an important supplier of nickel, a key component in electric vehicle batteries. 2023 is the third consecutive year of excess supply and the surplus will be the largest yet.8 The largest lithium reserves are found in smaller emerging markets – Chile, Argentina and Bolivia.9 Lithium is a key component in rechargeable lithium batteries used in electric-vehicle manufacturing, as well as larger-scale electricity battery storage.10
We would argue that the world is not necessarily deglobalising, but instead, new trade links are being established as global companies look to diversify where they source and manufacture their products. This should provide a major support for the economies of smaller emerging markets over the next decade and could bring new opportunities for active fund managers.
Sources:
1AP News – Foreign companies invest out of China – 21/06/23
2FT – Vietnam vital in supply chain – 03/07/23
3Bloomberg – Apple increases investment in Vietnam – 10/11/23
4Reuters - Xiaomi produces first smartphone in Vietnam – 07/07/22
5US State Department – New US partnership with Vietnam – 11/09/23
6Tech Times – Sony shifts production to Thailand – 29/01/23
7Reuters – Thailand investment pledges jump – 10/07/23
8Reuters - Battery makers response to demand from EV’s – 06/10/23
9Yahoo - Lithium Reserves by Country – 24/06/23
10Yahoo - Lithium Reserves by Country – 24/06/23
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