China’s manufacturers continue trends of shifting production capacity to Vietnam

As the largest chunk of foreign direct investment (FDI) year-to-date (24%) to Vietnam has originated from China, Chinese manufacturers are shifting their production capacity to Vietnam, and this trend is expected to continue for much of 2019, HSBC said in its latest report. 

FDI from China has outpaced investments from Japan and South Korea.

China’s FDI to Vietnam has outpaced FDI from Japan and South Korea, which have historically been the largest source of investments into Vietnam, stated the report. 



​FDI has risen substantially since the start of the year, which should support domestic growth despite headwinds from slower global growth. Total registered capital is up 153.2% and newly registered capital is up 75.7% year-to-date year-on-year as of February. 



Over three-quarters (77%) of new FDI has been towards the manufacturing sector, which should continue to boost Vietnam’s manufacturing capacity over the medium-to-long term.



According to the report, Vietnam’s GDP growth slowed to 6.8% y-o-y in 1Q19 from 7.3% in the previous quarter, but it still expanded faster than expectations of 6.4 – 6.5%. 



Manufacturing activity remains robust, growing at 13.1% year-on-year and contributing 2.5 percentage points to GDP growth in the first quarter, marking the sector’s largest contribution to growth in a year. 



Meanwhile, domestic demand continues to outperform as measured by sustained growth in the wholesale, retail, transportation, and accommodation sectors. Indeed, the primary drag on services in the first quarter was mostly due to slower growth in the financial sector. This may be partly attributed to slower credit growth since the second half of 2018, as measured by the State Bank of Vietnam (SBV), to contain inflationary pressures. 



Export growth since the beginning of 2019 has expanded at its slowest pace in nine years. 



And while part of this may be attributed to a higher base from 2018, the composition of exports also appears to be different. The biggest contributor to export growth this year has been shipments of textiles and footwear, whereas shipments of phones and computer electronics have historically been the biggest contributor to export growth at this time of the year. This is largely due to a downturn in both global demand and the electronics trade cycle, which is likely to lead to a slower pace of export growth in 2019. 



This could lead to a moderation in GDP growth overall, which is expected to slow to 6.6% in 2019 from 7.1% in 2018. 



However, fiscal stimulus from China and a stable US economy should lead to a normalization of global growth in the second half of 2019, providing a boost for Vietnam’s manufacturing sector, the report stated. 



Inflation considerations



Meanwhile, inflationary pressures remain benign and are unlikely to be an issue for the SBV. Headline inflation declined 0.2% month-on-month in March as a result of lower food prices following Tet holiday in February. 

This year’s inflation trajectory poses no threat to the SBV’s target.

The sequential decline in prices is likely to be temporary and should normalize in the coming months, but it should not pose a threat to the SBV’s “below 4%” inflation target for the year. 



It is expected headline inflation to average 3.1% in 2019, which should allow the SBV to focus solely on sustaining economic growth than containing price pressures. The government would also be prudent to continue its reforms to liberalize healthcare prices amidst this year’s low inflation environment to help ease any strains on the fiscal budget. 



That said, there is potential upside risks to inflation exist. This year’s El Nino cycle could bring upward pressures on global food prices if it leads to widespread drought in the Asia-Pacific region. It may also cause stronger storms in the second half of the year, potentially raising prices on agricultural products for much of the region. 



But as the impact of El Nino has been largely more moderate this year compared to previous cycles (except in the Philippines), the report suggested a moderate rise in food and agricultural prices in the second and third quarters of this year.