Analysis China: rising currency & wages to benefit global LSPs?

Factories in China continued to see disruptions this week to the flow of material to assembly lines following another set of strikes by parts suppliers over low wages. This time the walkouts were in Guangdon province at Denso (Guangzhou Nansha), a subsidiary of Japanese tier supplier Denso–the largest global supplier by revenue in 2009–bringing a halt to a Toyota plant.

 

The strikes, which come after weeks of disruptions for Honda, follow on the heels of the announcement over the weekend by the People’s Bank of China (PBOC) that it would allow some flexibility back to the Chinese renminbi, following its two-year peg to the US dollar. On Monday stocks surged on anticipation that an appreciating RMB would go some way toward rebalancing global trade and drive consumption in China, though markets cooled later in the week as it became more clear that this “flexible” currency policy only means a change of about 0.5% from the PBOC’s daily reference. Most economists are predicting a small appreciation over the next year in the rate despite estimations that the currency is undervalued between 25-40%. Many commentators, including George Magnus, senior economic adviser at UBS, see the move more as a political gesture by Beijing rather than a real effort at reform.

 

But nevertheless the recent strike action and this (mild) loosening of the RMB rate draw into question the implications for manufacturers and logistics providers in China. Despite its prominence as the world’s largest car market, with a staggering growth rate, the Chinese industry clearly has some structural problems that could undermine its competitiveness if government restraints are loosened. However, a global rebalance in which Chinese consumers and producers imported more products built elsewhere–including cars and components–could have positive implications for global logistics providers.

 

China’s problems are apparent to providers operating there. Logistics costs remain high and standards low, while the domestic automotive logistics industry is fragmented and often dominated by logistics companies that are themselves owned by carmakers. This lack of consolidation is often a mirror image of China’s own automotive manufacturers and industrial giants, which are themselves highly fragmented, globally uncompetitive in their product offering and largely supported by state spending.

 

While wage increases have been a reality for a number of years in China, tight government controls and resistance to labour unions have kept them lower. Honda’s recent decision to increase wages is likely to be followed, but inefficiency elsewhere in the supply chain could be a bigger cost than wage increases. An increase in labour costs could lead some manufacturers to pay more attention to this reality. Indeed, Ford’s Rick DeMuro, direct of material planning and logistics for Ford in Asia Pacific and Africa, has pointed out that freight and duty costs often exceed labour costs in the region (read more here).

 

A stronger RMB would in theory also raise costs for manufacturers in China, making imported parts and cars more competitive. Manufacturers in Europe or Japan with significant excess capacity might hope that a stronger RMB would give their factories the chance to sell more into the world’s largest car market, or provide components to China’s factories. “While the Chinese auto sector is well down the route of developing its own supply base, the importation of components is still significant and [the RMB's appreciation] could increase the attraction of imports to a degree,” said Thomas Cullen, chief analyst at Transport Intelligence.

 

Any such rebalancing of automotive as well as other goods into China would also have subsequent implications for containers shipping and ports, which are currently dominated by export out of China, and could benefit global logistics players managing that freight.

 

However, higher local costs in China could also change some sourcing patterns in a global supply chain back to more regional models. Some in the sector have already suggested that there have been small but discernable shifts for sourcing of components from China or other parts of Asia back to markets closer to consumption, such as to Mexico for North America. Dave Andrea, senior vice president, industry analysis and economics for the supplier organisation OESA, told Automotive Logistics News last month that, even before the recent labour increases or the prospect of a stronger RMB, he had encountered tier one suppliers “re-sourcing back from China or low cost countries because of high risk in the supply chain”.

 

 

Cullen points out that the Chinese are unlikely to allow any major shift in currency or labour costs to immediately strike at their current competitiveness. “[The Chinese authorities] are clearly resistant to imports despite the WTO reforms of recent years, fearful that the Japanese and western VMs will destroy their home grown companies,” he told Automotive Logistics News. “Horrifyingly for the Chinese authorities the weaknesses in the Chinese economy may be shown-up [with a rise in the currency], such as in overcapacity, misallocation of capital, real private sector businesses being squeezed out at the expense of state companies, such as most Chinese VMs.”

 

A sudden realignment in currency appears therefore unlikely. Currency controls overall remain strict; also, given the scope of the domestic market in China, even large wage increases will probably not dramatically change the landscape of the Chinese supply chain. The Chinese government, meanwhile, may not be so quick to expose the cracks that Cullen points out in the perceived competitiveness of its domestic industries, such as automotive, for which it continues to prop up with state support and cheap credit. As Magnus writes this week in the FT, “The renminbi regime matters not so much because of any particular degree of undervaluation, but because it sustains an economy wedded to underpriced capital, excessive credit growth and artificially low interest rates.”