While China is losing its appeal as a destination for Japanese investors as tensions between the two giants rise, the conventional wisdom that Asean is drawing more Japanese investment as a result may be overstated, a new survey suggests.
Part of the reason is that China itself has been integrating its own economy more with that of Asean to tap the region's cheaper and higher-skilled workforce. Japanese businesses that are exiting China because of high costs or political tensions now find themselves competing directly with Chinese peers when they look toward Southeast Asia.
Still, a significant change is under way, according to the latest annual survey by the Japan External Trade Organization (Jetro). For the first time since Jetro began the survey in 1998, the proportion of Japanese businesses in China that intend to expand in the next one or two years fell below 50%. In Asean, approximately 60% of firms said they would expand, a slight decrease from 2013. The highest response rate, above 70%, came from companies in some of the region's poorest countries: Cambodia, India and Bangladesh.
The Jetro report was based on 4,767 responses (out of 10,078 surveys sent out) from Japanese-owned businesses across Asia and Oceania in October and November last year.
China's ranking in terms of investment attractiveness recovered to third place after having fallen to the fourth place in 2013. The decline in 2013 was a major blow as China had been ranked first the year before.
Rising production costs and the slowdown of the economy were among the reasons for the dip in China, said Ryo Ikebe, director of the Asia and Oceania Division of the Overseas Research Department at Jetro.
But one big factor that has had a major influence has been the deteriorating relations between Japan and China, he said in a recent talk with Asean media members.
Despite the problems with China, however, Asean had not gained that much in popularity as an alternative for production locations, he added.
Japan's investments in China declined to $4.3 billion last year from $7.1 billion in 2013 and $7.4 billion in 2012. In 2011 the figure stood at $6.3 billion.
China, like Japan, has been trying to achieve greater integration with the 10-member Asean group.
Ikebe said the trend could be seen in figures showing the dependence of Asean countries on imports of high-value materials as their economies become more industrialised. Those materials are coming from Japan but also from China and South Korea, he said.
Thailand's dependence on China for imports of machinery jumped to 30% in 2013 from 18.7% in 2008; while the figures for Japan decreased to 18.1% from 23.7% over the same period. Indonesian imports of machinery from China's rose to 37.2% from 21.7%, compared with a decline to 10.1% from 14% for Japanese machinery. In Cambodia, Chinese machinery imports rose to 73.3% from 41.2% while Japanese imports fell to 2% from 5.3% over the same period.
The economist noted that Thailand would reap more benefits from the Asean Economic Community than other countries because its well-established automobile industry, dominated by Japanese producers, used a region-wide supply chain and also fed into large domestic consumption, especially motorcycles.
"Despite the AEC, somehow Asean countries do not rely on each other that much. Almost all Asean countries have lower competitiveness to China, except the Philippines," said Mr Ikebe.
On the manufacturing front, Japanese food sector businesses reported the highest interest in expanding business, according to the survey, along with communications and software, finance and insurance, and wholesale and retail.
One country that respondents saw as promising was Myanmar, helped by the fact that the country is building the Thilawa special economic zone with strong Japanese backing.
However, doing business in Myanmar is still not profitable for most. About 68% of Japanese companies operating there estimated they would report operating losses for 2014, 24% expected to break even and only 8% expected profits.
Nonetheless, the survey found that over the next two years 65% of businesses would expand in Myanmar as they could see sales increasing, as well as gains from high growth potential and deregulation. They also have concerns, though, chief among them power shortages, wage increases, restrictions on foreign remittances, time-consuming customs clearance and difficulty in local procurement of raw materials and parts.
The responses were similar to those from Cambodia where 46.2% said they would report losses, 18.4% would break even and 25.6% would make profits. Despite this, about 80% of Japanese companies were thinking of expanding in Cambodia.
Kimihiro Ishikane, director-general of the International Cooperation Bureau at the Ministry of Foreign Affairs, said business and investment prospects in the CLMV economies — Cambodia, Laos, Myanmar and Vietnam — were good because of the East-West economic corridor taking shape with Japanese support through multilateral organisations such as Asian Development Bank, which would improve logistics.
Asked to list their concerns about the AEC, the Japanese businesses ranked the top three countries that needed to resolve the following problems: Indonesia, Laos, and Vietnam on simplified customs clearance; and Myanmar, Vietnam and the Philippines on avoidance of double taxation and correction of irregular withholding tax rates. They also would like to see Indonesia, Malaysia and Vietnam offer more clarity about interpretation and enforcement of rules of origin.
The Japanese companies also expect that Cambodia, Thailand and Myanmar will introduce mutual duty exemptions under CLMV cooperation.
As well, Japanese corporations expected freer movement of skilled labour in Malaysia, Thailand and Myanmar, the report concluded.