This article first appeared in Forum, The Edge Malaysia Weekly on June 6, 2022 - June 12, 2022

Even as the Covid-19 pandemic recedes, the world remains awash with threats to peace and economic vitality due to Russia’s war in Ukraine, the stepped-up pace of monetary tightening by global central banks and the slowdown in China. 

Yet — so far at least — the economies of Southeast Asia have held up relatively well in this downbeat environment. Economic growth has not plunged as in other parts of the world and the surge in inflation has also been less intense. 

Whether such resilience can be sustained depends on the region’s fundamentals. It is encouraging, therefore, to see foreign investors give a vote of confidence in the Asean region: we believe that this faith is a product of improving fundamentals and that foreign direct investment (FDI) will continue to grow and contribute to an acceleration of economic transformation in Southeast Asia.

Data from the United Nations Conference on Trade and Development (UNCTAD) show that FDI flows into developing economies expanded by 30% to nearly US$870 billion in 2021 over 2020. While China enjoyed a record US$179 billion of FDI inflows, this represented only a 20% increase, meaning its share of FDI flows to developing economies fell. India performed even worse, with FDI inflows plunging 26% compared with 2020. It was the Asean region which performed much better, registering growth in FDI inflows of 35% and with the increase spread across most countries in the region. The share of FDI flows to Southeast Asia is now at a record high and exceeded that of China in 2021.

The rising Asean share of total developing country inflows suggests to us that we are at an important inflexion point: could this region be poised to regain its position of the late 1980s and early 1990s, when Asean had been the premier destination for FDI flows to developing regions? At that time, Asean was hit hard by two shocks which threw it off its pedestal. One was the Asian financial crisis, which saw Indonesia, Thailand and Malaysia, once the darlings of foreign investors, devastated by political and economic crises of unprecedented magnitude.

The shock was all the greater because the crisis appeared to be at least partly self-inflicted, arising out of poorly judged policies and compounded by deep political weaknesses. As the region stumbled out of that crisis, it was hit by another shock — China’s entry into the World Trade Organization, which gave it greater market access and required it to undertake reforms which made China more competitive. With Asean floundering and China’s appeal enhanced, there was a massive reallocation of capital to China by global corporations with regions like Asean losing out.

We believe the world is at another turning point where China’s relative advantages are diminishing to some extent and Asean’s are growing more appealing. If nothing goes wrong, this could produce another reallocation of capital — this time, one favouring Asean. We believe that there are many powerful factors that could bring this about.

(A) A more appealing investment ecosystem

Foreign investors’ confidence in Asean has perked up as a result of improvements in their business environments. Take Indonesia under President Joko Widodo as an example. Since assuming office, the reforming president has overseen a substantial improvement in macro-economic management — better control of inflation, a steadier rupiah, a stronger fiscal position and low public sector debt. Investors therefore feel more assured that Indonesia is less likely to endure the currency or other crises that beset other emerging economies.

In addition, the president has courageously pushed through parliament the passage of an Omnibus Law which combined major reforms in one single package. The most important of these were better labour market regulations which brought down the costs of hiring and firing workers: this addressed a major deterrent to foreign investors. When Indonesia’s Constitutional Court declared it “conditionally unconstitutional” last November, the government quickly acted to pass constitutional amendments to allow the new laws to stand. Foreign investors could see that the government respected the rule of law and was able to deal with challenges in a rational and legal manner.

It is not just in Indonesia that the business ecosystem is improving. Vietnam has also made extensive efforts to eliminate bureaucratic red tape where, according to a government committee on administrative reforms, 1,101 business regulations were either eliminated or simplified in 2021.

(B) Supply chain reconfiguration could speed up relocation of production to Asean

Prior to the Covid-19 pandemic, there had been some signs supply chains were being relocated from China to areas such as Southeast Asia. This was a result of rising costs in China and growing protectionism directed at China by the then Trump administration in the US. The dislocations caused by the pandemic led to this process being suspended but recent developments have given it new impetus:

•     China’s relentless pursuit of zero-Covid has visibly shaken foreign investor confidence in China. While the lockdowns imposed by the authorities disrupted production activities, what really upset investors was the extremes to which the officials were prepared to go — even separating parents from children in quarantine and imposing prolonged quarantines that did not seem medically necessary. The American Chamber of Commerce in Shanghai observed that the country’s pandemic control measures “are throttling US business confidence in China”. A flash survey conducted by the European Union (EU) Chamber of Commerce in China in May 2022 found that 23% of EU companies in China were considering shifting current or planned investments out of the country, up from 9% in 2021.

•     Moreover, a more hostile relationship between the US and China will have implications for global supply chains as well. Frictions between the two powers had been growing in recent years but China’s apparent backing for Russia’s actions in Ukraine have hardened American attitudes towards China. In a speech to the Atlantic Council in April, US Treasury Secretary Janet Yellen spoke of the US seeking “friend-­shoring”, that is production relocation out of China to friendly nations. Most nations in Southeast Asia would certainly count as “friendly”. Should the Biden administration include incentives for such relocation as part of its just-­announced Indo-Pacific Economic Framework, even more companies could be moving to Southeast Asia from China. Japan has already instituted such a policy though it is still too early to say how effective it is.

Of course, such relocation could be immensely disruptive and costly given that firms benefit from China’s super-­efficient ecosystem of world-class suppliers and component makers. Still, these additional factors above are likely to lead to a speeding up of the gradual shifting of production in some key areas out of China to places such as Southeast Asia. An example is Apple’s production of iPads. Nikkei Asia has just reported that Apple is moving part of its iPad production out of China and shifting it to Vietnam.

(C) Synergies from trade integration

The Regional Comprehensive Economic Partnership (RCEP) agreement is now in effect, now that the requisite number of countries have ratified it. The RCEP rationalises Asean’s many and separate free trade agreements with China, Japan, South Korea, Australia and New Zealand. Streamlined and standardised regulations governing trade make for smoother exporting and importing in the region, which will boost growth and make the region more attractive. 

The RCEP also directly boosts FDI in the region by liberalising cross-­border investment within the economic grouping. The expanded trade market access enabled by the RCEP also adds to the benefits of operating out of Asia and therefore acts as a significant draw of FDI. The expanded market access that the RCEP offers is significant when RCEP economies make up half of the world’s manufacturing output and automotive production and as much as 70% of global electronics production.

Additionally, some Asean members — Brunei, Malaysia, Singapore and Vietnam — are also members of the Comprehensive and Progressive Trans-Pacific Partnership agreement, which is also boosting trade and investment flows in the region. Vietnam and Singapore have aggressively expanded the number of trade agreements they have negotiated — this gives them extraordinary trade access and enhances their appeal to foreign investors.

In contrast, there are beginning to be nagging doubts about China’s openness. Although China’s policymakers still believe in trade openness, there are some signs that concerns over geopolitical risks are making them more inclined to emphasise domestic self-sufficiency in some key areas such as semiconductors.

(D) Government infrastructure spending plans also boost FDI inflows

Massive government infrastructure spending programmes in various Southeast Asian economies will also increase the flow of FDI into the region in the medium term. These programmes lead to an increase in FDI because they often involve private-sector investment through public-private partnerships (PPP). FDI that comes through this channel will be large in amount based on the sheer sizes of the infrastructure spending programmes. Indonesia, for example, plans to spend US$430 billion in the period 2020–2024 on infrastructure. Thailand’s “PPP Delivery Plan” for 2020–2027 involves 92 PPP infrastructure investment projects worth US$33 billion.

Southeast Asia has made good progress but there is still much work to be done if the region is to realise its potential.

•     First, while the business ecosystem in Asean has been upgraded, there is still room for improvement. The Milken Institute’s 2022 Global Opportunity Index (GOI) shows that emerging Southeast Asian economies still rank relatively poorly out of 126 countries on the factors important to investors when choosing FDI destinations. Further reform efforts will bolster the region’s position as an attractive destination for FDI.

•     Second, the region’s reputation for political stability and leaderships which pursue rational policies has improved, but there are uncertainties and brewing political pressures in many countries. If forthcoming elections in Malaysia and Thailand, for example, produce less coherent coalition governments, then some of the hard-won gains may be lost.

Assuming these risks can be contained, expanded flows of FDI into Asean will not only increase the headline GDP growth rate and create jobs in the near term, they can also facilitate long-term structural improvements.

First, FDI will flow increasingly into high-tech economic sectors in manufacturing and services and thereby help the region move up the value chain.

Second, we see growing FDI related to the secular trends of climate change and the digital economy. For example, Indonesia has been experiencing an influx of FDI from Chinese investors in its electric vehicle supply chain. Global mergers and acquisitions deals in the infocomm sector grew more than 50% in 2021. These types of FDI have an impact on economic restructuring as well. The former will see environmentally sustainable industries come increasingly to the fore, while the latter will see manufacturing and services sectors becoming increasingly intertwined through digital technologies.

Overall, our view is that, not only will FDI play a crucial role in transforming Asian economies for the future, it will also provide Asian economies with a crucial source of growth amid challenging global economic conditions.

Manu Bhaskaran is the CEO of Centennial Asia Advisors

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