Against the odds – Is Cambodia a weak link to ASEAN’s global supply chain?

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Cambodia hopes to be part of the global food supply chain in future. Post staff

As a new normal in global trade diversification emerges, off-shoring opportunities arise in the region. But Cambodia might lose out in the fight for a larger slice of the investment pie

In past months, the novel coronavirus pandemic has accelerated the need to diversify and strengthen supply chains to ensure security.

This, as trade becomes fragmented on the back of a slowly forming protectionist global economy because of restrictions on trade, investments and technology transfers.

No doubt sombre, this scenario would effectively be an overarching objective of governments and companies, which overtakes cost and efficiency considerations, a recent Moody’s report said.

“High reliance on a single supplier [whether a single producer or a group of producers from the same country] creates the potential risk of supply shortages for companies and economies during pandemics, natural disasters and geopolitical conflicts.

“A major source of concentration risk is reliance on producers from China, which accounted for 20 to 25 per cent of advanced economies’ total imports in 2019,” it said.

Therefore, Asian countries ex-China are likely to benefit from diversification from that country, provided they have sound economic fundamentals, reliable infrastructure, sufficient human capital stock, and local geopolitical and supply security risk.

Although these supply chain shifts would occur in a multi-year process because China would retain some advantage over other economies, as pointed out by Moody’s, relocation by some companies might not occur due to the large Chinese market it serves.

But they could seek to add an additional production base outside China; using the “China plus One” strategy for export. This makes Southeast Asia one of the regions ripe to capitalise on this predicament due to its proximity and sound ecosystem.

This turn of events is good news in the long run for Cambodia whose economy is forecast to recoil to -1.9 per cent this year, no thanks to hived orders from the West where nearly 450 factories were suspended in the first half of 2020, apart from a crippled tourism sector.

The figures for that period are grim, to say the least.

For instance, garment, textile and footwear shipments – among its main exports – dipped 5.4 per cent year-on-year to $3.8 billion in the first half of 2020 while revenue loss from the tourism sector is said to hit $3 billion this year.

Conversely, milled rice exports grew 38.3 per cent to 426,073 tonnes from January to July compared to 308,013 tonnes in the corresponding period last year, owing largely to food security storage because of the pandemic and the contraction of EU’s regressive rice tax this year.

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The 10 member countries of ASEAN are Brunei, Cambodia, Indonesia, Laos, Malaysia,Myanmar, the Philippines, Singapore, Thailand and Vietnam.

With the partial withdrawal of the EU’s preferential scheme which came into force on August 12 this year, Cambodia is in a fix as more pressure is laid on the government, subjecting it to threats of soft economic sanctions unless it puts its house in order as civil rights demonstrations rage on over politically-linked arrests.

This is something Cambodia has to work on, opined Stephen Higgins, co-founder and managing director of investment and advisory firm Mekong Strategic Partners (MSP).

“Cambodia needs to work on its brand which has been somewhat damaged in recent years. It has been getting bad publicity and it needs to start reversing this,” he asserted.

That aside, Covid-19 has shaken up the global economy which has re-drawn trade narratives away from modern-day globalisation, as disputes over tariffs endure between the US and China.

This could result in reduced dependence on China in the global value chain (GVC) as part of risk mitigation efforts, Moody’s wrote.

The silver lining here is that it essentially opens up trade flows between advanced economies and the rest of Asia or offshoring of activities to ASEAN.

Through trade regionalisation, economic integration can heighten as ASEAN is developed further to become a trading bloc in its own right.

When asked, Ministry of Commerce spokesman Penn Sovicheat said global supply chain and value chain objectives are contained in the National Industrial Development Policy 2015-2025.

They are aimed at utilising existing advantages to attract investment to special economic zones where clusters can be formed.

“We stand to benefit from the shift as ASEAN becomes an attractive location as a global production base.

“Cambodia is a relatively new site where cheap labour and agricultural land exist although we are preparing to shift to skilled labour and Industry 4.0 along with other countries in the region,” he said.

The standard reply, which evaded questions on weak competitiveness, mentioned Cambodia’s leverage on its young labour force to accomplish its goal in industrial development while offering generous incentives to investors.

In addition, the trade integration strategy which enables export market and product diversification is expected to help local producers to reach out to global markets by using the `compensation strategy’ rather than a competitive strategy to create niche markets and promote own brand names.

“One of our expectations is to become a food production and supply chain for the global market,” Sovicheat said.

But does all this adequately prepare Cambodia for the global trade reconfiguration?

Slipping into complacency

Anthony Galliano, the group CEO of corporate finance firm Cambodia Investment Management Co Ltd (CIM), said China’s dominant manufacturing role has been challenged by the pandemic and US administration’s protectionist policies.

Its role has also declined due to a continued shift away from low-skilled manufacturing, as well as a location for final assembly.

Tariffs on Chinese imports directly impact manufacturers in the global supply chain, making Chinese goods and materials much more expensive and prompting manufacturers to circumvent tariffs.

“[Because of this] manufacturers will likely seek new suppliers who are not subject to the same tariffs as China and this would benefit Cambodia as an integrated partner in ASEAN, in addition to its key geographic location in the Mekong sub-region.

“More importantly, Cambodia benefits from access to European and US markets for certain goods under the Generalised System of Preferences (GSP) and remaining Everything But Arms (EBA) advantages,” Galliano said.

Unfortunately, observers have said before that these schemes and their assured benefits are the very reason Cambodia slipped into complacency with little effort to drive skills upgrades, technological advancement and robust policy enforcement over the years.

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Source: UN Comtrade, Taiwan Ministry of Finance and Moody’s Investors Service

They put a damper not only on Cambodia becoming a fastidious player in the supply chain shifts, but they might also hinder its progress as an active participant in the global value chain.

Shortcomings eclipse strengths

For nearly two decades, the preferential tariff schemes enabled tax-free exports to the US and EU, boosting Cambodia’s economic growth at an annual average of seven per cent.

Garment and footwear exports surged to over $9.5 billion in 2018 from just $80 million in 1996 – a sector that employed 660,000 people two years ago, said a 2019 World Bank special report.

Footwear production alone put Cambodia among the top 10 producers in the world, with exports valued at $1.04 billion in 2018.

In the 20-year period of meteoric growth, Cambodia participated in backward and forward global value chain (GVC) which saw it expanding faster than Malaysia, Thailand, Vietnam, Bangladesh and Sri Lanka, although it was from a low base.

An example of backward participation in garment value chain involved making t-shirts out of imported textiles from China and exporting the final product to the US.

Forward participation in food and beverage value chain consisted of unprocessed cassava exports to Thailand which were processed into chips and re-exported.

According to the World Bank, measures of backward GVC participation showed that foreign value-added in Cambodia’s export stood at $523 million at the end of 2015 from $5 million in 1990.

But here’s the rub. Cambodia’s move up the value chain has occurred with relatively little diversification or upgrading, the international financial institution said.

Why? Because the nation is challenged by lower productivity, higher electricity and logistics costs, unofficial fees and low backward links.

So, despite its strengths, such as trade openness, and having liberal economic policies and macroeconomic, political and social stability, World Bank said they were eclipsed by the shortcomings.

“The combination of these factors [the challenges] results in high cost of doing business in the sector, which makes Cambodia less competitive and creates a barrier to diversifying into similar productions and producing higher value-added products,” said the World Bank.

In any case, MSP’s Higgins finds that Cambodia is still well-placed to benefit from supply chain shifts but that is subject to several conditions.

“Logistics needs to be dramatically improved, which includes better road and rail infrastructure. Wage increases, which are also closely related to productivity upgrades, have to be sensible.

“Multinational corporations [MNCs] are moving towards carbon neutral. Cambodia needs to shift its energy mix more towards renewable, otherwise MNCs and their supply chain will avoid it,” Higgins said.

In the Moody’s report, Thailand, Vietnam and Malaysia were cited as standing to benefit the most from trade and investment diversion from China.

But it also stated that developing countries such as Indonesia, Cambodia and India would gain from the preferential access to the West.

On the whole though, competition will remain stiff, warned economist Dr Chheng Kimlong of independent think-tank Asian Vision Institute (AVI).

“[Because] Cambodia is not in a position to compete fiercely with other ASEAN member countries as the current industrial base, labour market and private sector are relatively weaker and less competitive,” said the director of AVI’s Centre for Governance Innovation and Democracy.

To gain competitive and comparative advantages coming from emerging trends, Cambodia would need greater participation of the private sector in the promotion of technology and innovation.

“This includes the use of digital technologies in various social and economic platforms to boost domestic productive capacities,” he said.

‘Only a trickle’

Local entrepreneur and advocate of the public-private partnership concept, David Van, submitted that the global supply chain would eventually be broken down to a more regional format post Covid-19.

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Source: Moody’s Investors Service

It is what the new normal dictates, he said, adding that Cambodia needed more `ammunition’ to position itself in such a setting.

This is especially important as the “China plus One” strategy adopted by many investors like Korea and Japan has mostly benefitted Vietnam, Indonesia and Thailand.

“Only a trickle ended up in Cambodia. [This setback is because] of the infrastructure, skilled manpower and tax incentives that have been aggressively offered by [our] competitive neighbours.

“It might help that our overhyped new investment law [which has been on the table] for the last few years is finally launched so that the Council for the Development of Cambodia becomes more proactive in securing such potential [investments],” Van said.

Similarly, CIM’s Galliano said in order to capitalise on shifting production bases, the Kingdom has diversify its export outputs and destinations, increase product categories, reduce electricity costs, improve connectivity in transport and logistics, and raise its labour market and skills.

It is also crucial that the manufacturing sector embrace digitalisation and tech development such as robotics.

‘Cannot replace China’

But all this diversification from China is not new, as it started before Covid-19 as result of rising relative land and labour costs.

Nevertheless, analysts including Moody’s have reported that this phenomenon would only have a negligible effect on China because companies continue to retain a manufacturing presence there to maintain access to its large market.

Yet, investments in other production plants in a lower-wage economy elsewhere in Asia will ensue which is why Kimlong is confident Cambodia’s strategic location in the Mekong subregion can absorb some of the shift.

“However, Cambodia and ASEAN will not be able to replace China as a global production powerhouse in near future due to its fragmented logistics and infrastructure networks despite having lower labour cost advantages,” he said.

There is no denying that but whatever the outcome Cambodia has to first step up its game or lose out to its neighbours, who are already ahead in the race.