It’s Time to rethink your China sourcing strategy

One of the company’s I’ve invested in has relocated machinery production to China, recently, from Europe.

I suggested they look at Thailand, or Malaysia as a potential base, but China won out.  I think their decision may not be so insightful as they thought.

Chinese GDP growth hit its lowest level since 1999 last year. Part of the slowdown is being driven by Beijing’s efforts to re-balance the economy away from exports and investment-led growth to domestic demand driven growth.

In a new report, Henry McVey, head of Global Macro & Asset Allocation at KKR, writes “China must now appreciate that it ‘cannot go on indefinitely’ as the world’s low-cost manufacturer of low value-added goods.”

Two key reasons are suggested for this

First is wage inflation, which folds into Beijing’s efforts to boost consumption. This has caused China to price itself out of an increasing number of traditional low-end manufacturing and export mandate. Meanwhile, countries like Indonesia, Vietnam, Cambodia and Laos have gained competitive advantage when it comes to manufacturing.

And here’s a simple graph plotting this

20140225-075105.jpg

Moreover, researchers have also seen a steady appreciation in the yuan against the USD in recent years, and this has also hurt China’s manufacturing competitiveness. Furthermore, this has come at a time when other emerging market currencies have been depreciating again against the USD.

20140225-075116.jpg
UBS expects the impact of CNY appreciation in the past year to be felt this coming year, limiting the strength of China’s export recovery in 2014. As such, the era of steady CNY appreciation may be drawing to a close. This is from UBS’ Wang Tao noted in a Bloomberg address and in a note to clients. There has been more yuan volatility in the last week and Tao thinks this could signal a change in China’s exchange rate policy.

So if your long term strategy is to use Chinese manufacturing as the sole basis for cost-competitiveness, think again, and maybe consider sourcing from China and ASEAN for a better total result.