Anti-Japanese sentiment puts the brakes on Chinese expansion
Amid escalating anti-Japanese sentiment on the mainland, it was not surprising to hear a key Japanese tyre supplier to Toyota Motors announce that it would be scaling back its China expansion.
While China was a key market for the company, it mentioned it could just as easily supply the market from Malaysia. This must be passing through the minds of many Japanese manufacturers that have invested heavily in China.
Japanese foreign direct investment rose sharply in the past year because of the yen's strength and post-tsunami power disruptions at home.
Japanese investment in China grew 78 per cent last year, roughly in line with overall Japanese investment in Asia. Japanese manufacturing investment in China tends to target the domestic market, where strong domestic consumer growth assures plenty of demand for quality Japanese-branded cars and home appliances. But do Japanese manufacturers need to be in China to supply this market?
A more interesting trend in Japanese overseas investment has emerged in recent years: countries in the Association of Southeast Asian Nations (Asean) have enjoyed a rising share of Japanese investment at the expense of China.
Asean already receives close to half of the Japanese investment in Asia. That is compared with about one-third that goes to China.
But last year, Japan's investment in the four key Asean nations - Thailand, Malaysia, Indonesia and the Philippines - exceeded that in China for the first time.
In contrast to China, Japanese investment to Asean is focused mainly on outsourcing and responds to rising rationalisation of supply chains. This can be cost-driven: rapidly rising wages in China are driving many manufacturers to Vietnam, Indonesia and Thailand, where wages are cheaper. Unstable or unfriendly Sino-Japanese relations will act as a catalyst to this growing flight of Japanese manufacturing to Asean countries.
The sharpest growth of Japanese investment to Asean over the past three years has been to Indonesia, Thailand and Vietnam, with Thailand the recipient of more than half of Japanese investment in the region. Much of this investment is in manufacturing, such as auto parts and electronic components in Thailand and Malaysia.
In Indonesia, Japanese manufacturing increasingly targets domestic auto, motorcycle and appliance markets where, like China, domestic consumer demand is growing rapidly.
But there is another key reason why Japan now favours Asean nations as export bases into China. The China-Asean Free Trade Agreement (Cafta) will go into full effect in 2015, by which time a zero-tariff free-trade zone will probably be in place.
Under this agreement, six Asean members have already cut average tariffs on goods sold to China to 0.1 per cent, while Chinese goods sold to Asean have seen tariffs fall to 0.6 per cent. It makes a lot of sense for Japanese manufacturers to be based in Cafta countries, several of which border China, and allow locally produced goods to enter China free, or nearly free, of tariffs.
Carl Berrisford is an analyst with UBS CIO Wealth Management Research