Asia Soaring Wages Hit Factories Stoking Inflation as Costs Rise
Comment of the Day

April 03 2013

Commentary by Eoin Treacy

Asia Soaring Wages Hit Factories Stoking Inflation as Costs Rise

This article by Shamim Adam and Sharon Chen for Bloomberg may be of interest to subscribers. Here is a section
“Producers are no longer able to absorb rising wage costs and ultimately will have to jack up prices for consumers in the West,” said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong and a former consultant on Asian economics and politics to the World Bank.

“It's the manufacturing hub of the world, and if prices rise here, then inevitably the global price level will have to rise as well.”

The threat of inflation prompted Pacific Investment Management Co., which runs the world's biggest bond fund, to plan Asia's first fund to protect against it. The investment will aim to return at least 2 percentage points more than the average consumer-price gains in Singapore and Hong Kong, Michael Thompson, head of Pimco's wealth-management group for the region excluding Japan, said in a March 7 interview in Singapore. Singapore's inflation quickened to 4.9 percent in February compared with an average 2.6 percent in the past decade, while in Hong Kong, consumer prices rose 4.4 percent, more than double the 1.9 percent 10-year average.

Eoin Treacy's view Increasing labour costs represent a significant challenge for many manufacturers. Some costs will inevitably be passed on to customers but relocation of manufacturing facilities and industrial automation represent equally important alternatives that are likely to shape investment themes over the next decade.

For example this note on Shenzhou International highlights how one of China's largest textile manufacturers is balancing its expansion in China with investment in Cambodian manufacturing capacity.

Capacity release well on track. Shenzhou commenced production in its new garment factory in Ningbo in 4Q12 and ~US$ 60mn revenue contribution is expected in FY13. Besides, for the Phase II of Cambodia plant and Anqing plant, total number of labors has increased to 7,000 and 6,200 as of FY12, and accounting for 9% and 13% of the group's total capacity. We expect a 10-15% capacity growth during
FY13-14 and the optimized production base will well relive pressure from rising labor costs and strengthen comprehensive competitiveness. Managements are also actively seeking for opportunities of building up new plants in Pan-Pacific Area.

Shenzhou International qualifies as an Autonomy since it is one of China's largest textile companies and derives more than 80% of its business internationally. Japan is its largest market representing 30% of revenue.

The share is listed in Hong Kong and has been consolidating mostly above HK$20 since February in what has so far been a relatively steady process of mean reversion. A sustained move below the MA would be required to question medium-term upside potential.

Vietnam has also been a beneficiary of outsourcing while the opening up of Myanmar is likely to make that country increasingly attractive for foreign direct investment. As mentioned previously, a number of African countries have also benefitted from the relocation of low cost manufacturing.

Over the last few years we have mostly talked about how industrial automation has been of benefit to European and North American economies. However, there is nothing to stop Asian companies making the same types of investments. Assuming that the pace of automation increases in Asia, the medium-term question will then turn to whether the premium paid for labour in, for example the USA, can be offset by the competitive advantage in energy, transport costs and proximity to the end customer. As consumer sectors flourish globally, the competitiveness of regional manufacturing hubs is likely to come into sharper focus, not least because Asia is likely to represent a significantly higher proportion of global consumer demand in future.

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