Japan: rising direct investment in Southeast Asia

18 March 2016

Economics

Japan: rising direct investment in Southeast Asia DBS Group Research

18 March 2016

• Japan’s FDI investment in Southeast Asia is on the rise • The share of ASEAN-6 in Japan’s total FDI in Asia has exceeded 50% • Strong growth prospects and a high degree of market openness are the main factors attracting Japanese investment • Although the costs of doing business remain high in this region, it is not a binding constraint for Japanese investors • The Japan-ASEAN investment ties are expected to further strengthen on the back of the TPP and increased cooperation in the infrastructure field

Japanese investors are allocating more capital to Southeast Asia. FDI flows to the ASEAN-6 countries (SG, TH, MY, ID, PH, VN) have averaged USD 20bn per year for the past five years (except for 2012 when investment in Thailand fell sharply after the floods). This is a big jump compared to the annual flows of USD 7-10bn in 2006-2010 (Chart 1). The share of FDI headed to the ASEAN-6 has increased significantly, exceeding 50% since 2013 (Chart 2). According to the Japan Bank for International Cooperation (JBIC), about 56% of Japanese firms intend to expand business in ASEAN in the coming three years. The interest is especially strong for the markets of Vietnam, Indonesia and Thailand (Chart 3, next page). By contrast, the share of Japanese firms planning to expand in China has fallen to 48% in the latest survey. Initially, the surge of Japan’s FDI in Southeast Asia might be a strategy of diversification, responding to the Japan earthquake disaster in 2011 and the deterioration in Japan-China political relations in 2012. The sustained rise in recent years, however, could reflect broader considerations.

Chart 1: Japan's FDI in ASEAN

Chart 2: FDI in ASEAN / Japan's total invt in Asia

annual flows, USD bn

% share

25

SG

MY

TH

ID

PH

65

VN

60 20

55 50

15

45 10

40 35

5

30 25

0 2005

2007

2009

2011

2013

2015

2005

2007

2009

2011

2013

2015

Ma Tieying • (65) 6878-2408 • [email protected] 1

Japan: rising direct investment in Southeast Asia

18 March 2016

Chart 3: Japanese firms' business plans in ASEAN and China over the next 3 years VN ID TH PH CN MY SG 0%

10%

20%

30%

Strengthen/expand

40%

50%

60%

70%

Maintain present level

80%

90%

100%

Scale back/withdraw

Hungry for returns According to the JBIC survey, future growth potential of the local markets is the paramount factor that entices Japanese firms to expand business in ASEAN (Table 1). For a long time, Japanese firms have been actively searching for growth opportunities in Asia’s emerging markets (1). Japan’s domestic economic growth has been anemic for two decades due to the burst of asset/credit bubbles in 1990s and the deterioration of demographics since 2000s. Notwithstanding the monetary and fiscal policy stimuli introduced under Abenomics in recent years, the economy grew just 0.6% on average in 2013-2015. Lending rates and bond yields have fallen further as the Bank of Japan pursued quantitative and qualitative easing together with negative rates on banks’ excess reserves. Low growth and low interest rates provide strong incentives for Japanese companies and financial institutions to explore opportunities overseas. Table 1: Reasons for Japanese firms to expand in ASEAN & China (% of respondents) ID

TH

VN

PH

CN

8.6

24.1

14.6

Qualified human resources

4.9

Inexpensive source of labor

35

36.7

49.1

47.9

13

8

12.5

7.8

2.1

12.3

Supply base for assemblers

23.9

27.3

14.7

25

25.9

Concentration of industry

12.9

22.7

9.5

8.3

18.5

4.9

3.9

19

20.8

0.6

Inexpensive components/raw materials

Risk diversification to other countries Base of exports to Japan

8.6

4.3

11.7

11.2

4.2

3.1

11.7

24.2

19

12.5

12.3

4.3

6.3

2.6

2.1

11.7

Current size of local market

38.7

35.9

15.5

12.5

67.9

Future growth potential of local market

83.4

55.5

71.6

64.6

59.9

9.8

10.9

10.3

8.3

9.9

Base of exports to third countries Advantage in raw material procurement

Profitability of local market Base for product development

0

2.3

0

0

8.6

Developed local infrastructure

3.7

23.4

6.9

6.3

13.6

Developed local logistics services

0.6

4.7

4.3

0

4.9

Tax incentives

3.1

14.8

1.7

18.8

1.2

Stable policies to attract FDI

1.8

8.6

5.2

6.3

1.2

Social/political situation stable

9.8

7

20.7

16.7

1.9

Sources: JBIC, 2015

2

Japan: rising direct investment in Southeast Asia

Chart 4: GDP growth in selected Asian countries % YoY

18 March 2016

Chart 5: Japanese firms' FTA utilization ratio in ASEAN 50%

8

45%

7

40%

6

35%

5 4

JP VN

3

ID CN

PH

30% Exports

25%

2

20%

1

15%

Imports

10%

0 2013

2014

2015

2016F

2017F

2007

2009

2011

2013

2015

ASEAN markets are attractive from the Japanese perspective. Many economies have great potential to grow, thanks to relatively low per capita incomes and a young population profile. GDP growth in Vietnam and Philippines, which is currently running at about 6%, is almost on par with that of China (Chart 4). Whilst the market size of ASEAN remains small compared to China’s, the growth gap between the two has started to diminish. This might be considered as an important development by Japanese investors who are eagerly searching for return.

Utilizing FTAs Trade and investment liberalization in the ASEAN region is also attracting Japanese investors. According to a survey by Japan External Trade Organization (JETRO), the percentage of Japanese firms utilizing FTAs and other economic partnership agreements in the ASEAN market has reached 47% in 2015. This is a sharp rise compared to 21% in 2008 when the Japan-ASEAN Comprehensive Economic Partnership Agreement was initially established (Chart 5). It is also markedly higher than the FTA utilization ratio of about 30% in the Chinese market in 2015. Thus far, ASEAN has forged FTAs / quasi-FTAs with not only Japan, but other economies including South Korea, China, India, Australia and New Zealand. Free trade reduces tariff and other transaction costs for Japanese firms producing in and exporting from ASEAN. Moreover, free trade also eases the ownership and other restrictions for Japanese firms to tap local demand growth. This boosts investment not just the manufacturing but services as well.

Managing the costs Costs are always an important factor in the FDI calculus. Labor costs in Southeast Asia are lower than in China (Table 1). But wages in Southeast Asia are also growing rapidly nowadays. And the non-wage operation costs in this region are very high, due to the weakness in infrastructure. According to the JBIC survey, rising labor costs, difficulties in securing management-level staffs, unclear legal systems, underdeveloped infrastructures and social instability are the common problems facing the Japanese firms in ASEAN (Table 2, next page). Thankfully, Japanese investors have accumulated much experience in emerging markets. Through a combination of government guide and private sector due diligence, Japanese firms have established a comprehensive information system to monitor economic, social and political trends within the Asia region. They have also learned to respond to changes and adjust business strategies in a timely and flexible manner (2). Business costs shouldn’t deter Japanese firms from investing in SE Asia.

3

Japan: rising direct investment in Southeast Asia

18 March 2016

Table 2: Problems facing Japanese firms in ASEAN and China (% of respondents) ID

TH

VN

PH

CN

Underdeveloped legal system

17.5

3.4

19.1

9.1

10.1

Execution of legal system unclear

40.3

12.7

30.9

29.5

54.1

Complicated tax system

14.9

4.2

7.3

2.3

8.2

Execution of tax system unclear

22.1

5.1

16.4

9.1

22.6

Increased taxation

17.5

9.3

6.4

13.6

27.7

Restrictions on FDI

23.4

12.7

12.7

11.4

22

Complicated procedures for investment permission

17.5

8.5

17.3

15.9

25.8

Insufficient protection for intellectual property rights

9.1

4.2

8.2

2.3

43.4

Restrictions on FX/transfer of money overseas

16.9

3.4

5.5

6.8

28.9

Import restrictions/customs procedures

18.8

6.8

12.7

9.1

22.6

Difficult to secure technical staff

17.5

19.5

16.4

15.9

9.4

Difficult to secure management-level staff

24.7

21.2

20

34.1

22

Rising labor costs

40.9

50.8

39.1

15.9

73

Labor problems

16.9

7.6

12.7

0

19.5

Intense competition with other companies

31.8

42.4

20.9

11.4

52.8

Difficulties in recovering money owed

7.1

3.4

4.5

0

25.8

Difficulties in raising funds

1.9

2.5

1.8

4.5

5.7

Underdeveloped local supporting industries

9.7

7.6

16.4

20.5

2.5

Sense of instability regarding currency/costs

20.1

5.1

11.8

6.8

4.4

Underdeveloped infrastructure

35.1

5.1

20

40.9

6.9

Security/social instability

23.4

28

5.5

22.7

28.9

6.5

5.1

10

9.1

1.3

Lack of information on the country Sources: JBIC, 2015

Further initiatives to follow Further initiatives are expected to drive Japan’s FDI in SE Asia in the years ahead. Japan and several ASEAN countries have joined the Trans-Pacific Partnership (TPP). If the deal is implemented, Japanese manufacturers would strengthen supply chains in TPP member countries, thanks to not only lower tariffs but also common standards in labor, environment, intellectual property and other aspects. The TPP also cuts trade barriers in service sectors, including financial, telecommunication, e-commerce and other new areas, making investment all the more attractive. Meanwhile, the Japanese government intends to further strengthen ties with its Asian neighbors (including Southeast Asia) through aiding of infrastructure development. Following China’s launch of the Asian Infrastructure Investment Bank and the “One Belt One Road” project, Japan has also announced it will provide USD 110bn to fund Asian infrastructure over the next five years. Southeast Asia has strong needs for infrastructures and should be an important recipient. And what goes around, comes around. Infrastructure investment is ‘circular’ in the sense that by reducing business costs it stimulates even higher levels of FDI down the road.

Sources: All data are sourced from CEIC, Bloomberg, JBIC, JETRO. Forecasts and transformations are DBS Group Research.

Notes: 1) Japan: a long-term investor in Asia, February 2014 2) Japan’s “go global” experience (2), July 2015

4

Japan: rising direct investment in Southeast Asia

18 March 2016

Recent Research SG: a winter budget

14 Mar 16

IN: prepared, not immune

16 Dec 15

Qtrly: Economics-Markets-Strategy 2Q16

10 Mar 16

Qtrly: Economics-Markets-Strategy 1Q16

10 Dec 15

IN: fiscal discipline trumps growth

1 Mar 16

Holiday Heresies 2016

7 Dec 15

Rate: G7 bonds - tantrums brewing

1 Mar 16

ID: manufacturing still a drag

3 Dec 15

Global growth: what is potential and where is it going?

25 Feb 16

ID: BI easing bias persists

19 Feb 16

EZ: negative rates not a cure

17 Feb 16

US: how strong is consumption?

12 Feb 16

SG: the next growth driver

4 Feb 16

JP: BOJ into uncharted territory

2 Feb 16

CNH: will capital controls help? FX: Not just about CNY

2 Feb 16

IN: RBI to await budget cues

1 Feb 16

1 Feb 16

Rates: Global rates roundup/ chart-pack

29 Jan 16

CN: when is a trillion not a trillion?

29 Jan 16

IN: fading boost from low oil prices

28 Jan 16

TH: consumption the weak link

25 Jan 16

CN: how to end the vicious cycle

21 Jan 16

Global crude: still spilling onto the floor

20 Jan 16

TW: after the election

19 Jan 16

IN: back at fiscal crossroads

CNH: billion dollar baby

16 Nov 15

EZ: will more QE help?

4 Nov 15

Rates: regional rates rundown

2 Nov 15

FX: monetary policy divergences intact

2 Nov 15

Rates: UST Curve - the next flattening leg

30 Oct 15

JP: deciphering the BOJ

23 Oct 15

ID: no room to cut

12 Oct 15

IN: the lowdown in exports

9 Oct 15

SG: technical recession

6 Oct 15

SGD: a lower policy band

6 Oct 15

CN: resolving the known unknowns

5 Oct 15

G4: who’s winning the currency wars?

25 Sep 15

IN: RBI – another window opens

22 Sep 15

Japan’s “go global” experience (3)

21 Sep 15

SG: mandate for inclusive policy

17 Sep 15

Qtrly: Economics-Markets-Strategy 4Q15

10 Sep 15

Triangulating Asian Angst: the US, China and the 97 question

7 Sep 15

19 Jan 16

CNH: “Taken” – the RMB episode

15 Jan 16

CN: the need for institutional reform

21 Aug 15

Rates: UST curve: belly’s too big

15 Jan 16

SG: when China devalues

20 Aug 15

CN: services and manufacturing are codependent

14 Jan 16

TW: the impact of yuan devaluation

19 Aug 15

Disclaimer: The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.

5