Michael Kokalari, Chief Economist at VinaCapital, reports that there is still cause for optimism amid fears of Foreign Direct Investment (FDI) competition from India.
Vietnam’s economic growth has gotten off to a slow start this year, with GDP growth of just 3.3% in Q1 versus 8% in 2022. The steep decline stems from a drop in the demand for “Made in Vietnam” products by consumers in the US, which is Vietnam’s largest export market. Vietnam’s exports to the US plunged 20% year-on-year in the first quarter of 2023 after growing by 13% YOY in the first quarter of 2022.
That abrupt drop, coupled with ongoing issues in the Vietnamese real estate sector that are unlikely to be resolved until next year, has weighed on the confidence of many local businesspeople for months. In recent weeks, confidence was further hurt by concerns about the possibility that India could steal some of Vietnam’s share of FDI inflows following Apple CEO Tim Cook’s visit to India last month.
Cook announced that Apple has ambitious plans to expand its iPhone production in India, which spawned a plethora of articles in recent weeks. But it is important to note that multinational firms are currently investing in India primarily to manufacture products that are sold to Indian consumers, which is very different from their motivation for investing in Vietnam.
Vietnam is pursuing the so-called “East Asian Development Model,” which is the same approach that the “Asian Tiger” economies used to become wealthy quickly. This economic growth strategy is focused on manufacturing products that are exported to the US and other developed countries, and multinational firms that invest in Vietnam are contributing to that endeavor.
In contrast, India is pursuing a more domestic-oriented growth strategy, and multinational firms investing in that country are seeking to profit from its rapidly growing middle class rather than as a production base from which to export. For example, Apple iPhone sales in India have exploded, as can be seen in the table below, but Apple only manufactured 6.5m of the 7m iPhones that it sold in India last year, which illustrates why Apple’s immediate motivation is to address surging local demand.
Other reasons why FDI companies are not aggressively investing in India to produce products for export stem from issues with the country’s workforce (especially literacy) and the country’s strict labor laws.
Further to that last point, factories in India with more than 100 employees require government approval before laying off any employees, and India’s “Make in India” program, which was launched in 2015 to attract manufacturing FDI (partly with tax incentives), is widely recognized as having failed to attract foreign investment, partly for the reasons outlined above.
That said, while FDI companies in India do not currently manufacture many products for export to developed markets, this could change in the future as Apple and others have been pressuring India to improve its attractiveness as an FDI destination because of their desire to diversify production out of China for geopolitical and other reasons.
Last year, Vietnam’s “Ease of Doing Business” ranking in the Economist Intelligence Unit (EIU) rating of countries around the world leapt by 12 places, which was the largest improvement in any of the 82 countries the EIU assesses. Meanwhile, India’s ease of doing business ranking also increased by six places. In contrast, China’s ranking fell by 11 places, and the country now has an ease-of-doing- business ranking that is below both Vietnam and India, according to the EIU.
We do not see India threatening Vietnam’s FDI inflows. Vietnam will need to continue focusing on improving its “ease of doing business” rankings and upgrading its physical infrastructure to remain an attractive investment destination in the future, but factory wages in Vietnam are about half those in China, while the quality of the workforce is comparable. Furthermore, Vietnam has close geographic proximity to the supply chains of the high-tech electronics industry in China.
In summary, we believe FDI is likely to remain one of Vietnam’s key growth drivers for years to come. While the current wave of new FDI announcements into India may generate headlines, it should not be viewed as stealing share away from Vietnam. But that could change in the future if Vietnam does not remain competitive. [C]
