is india ready for modi? - markitcdn.ihs.com/ihs_quarterly_economics_q3_2014.pdfis india ready for...

IS INDIA READY FOR MODI?The people have cast their votes and set in motion the potential transformation of the largest democracy in the world. But reforming India’s economy will be a tough task for the new Prime Minister.P12

IHS QUARTERLY Q3-2014

EconoMIcs

NUMBERS THAT MATTER Six figures of substance

P22

KENYA WOWS EUROPE Eurobond is good news

P5

ASIAN LABOR RATES RISING Is it time to relocate?

P6

CAN THAILAND REBOUND? Coups, floods, and hard times

P7

TROUBLE IN CHINA Housing bubble, overcapacity

P17

Your source for comprehensive insight, information and expertise on key topics shaping today’s global business landscape.

We invite you to continue the conversation...

Your source for comprehensive insight, information and expertise on key topics shaping today’s global business landscape.

We invite you to continue the conversation...

IHS QUARTERLY Q3-2014

Economics

main red

PMS 1795CC0 M96 Y90 K2

YOUTUBE LOGO SPECS

PRINTgradient bottom

PMS 1815CC13 M96 Y81 K54

on dark backgroundson light backgrounds

standard

no gradients

watermark

stacked logo (for sharing only)

standard

no gradients

watermark

stacked logo (for sharing only)

white

WHITEC0 M0 Y0 K0

black

BLACKC100 M100 Y100 K100

Visit and subscribe: ihs.com/QE13

Contact: [email protected]

Join the conversation: @IHS

Engage: #IHSQuarterly

http://www.ihs.com/QE13

mailto:[email protected]

IHS Quarterly/Economics | Q3-2014 | 3

VISION

Balancing short-term and long-term expectations for AsiaLong-term competitiveness matters. While this may seem obvious, all too often it’s ignored by decision makers focused on next quarter’s earnings and the race to expand into new, promising high-growth markets. Rapid growth in incomes and consumer spending, attractive labor costs, and seemingly stable regulatory environments in emerging markets lure companies seeking a quick return on investments. However, the most recent slowdown in many emerging markets has taught us all that the continuation of high growth rates should not be taken for granted. The ultimate measure of success in the emerging world is typically the governments’ ability to implement deep, and often unpopular, structural reforms to ensure stable long-term growth.

This issue of IHS Quarterly/Economics features a collection of articles that examine the competitive advantages of economies in Asia and what they mean for business investments—and performances—over the long haul.

In Can India be Modi-fied? Hanna Luchnikava examines the outlook of the post-election economic policies of the new BJP government. As India’s first government in recent history to enjoy an absolute majority in the lower house of parliament, Prime Minister Narendra Modi and his cabinet have to deal with high expectations on the part of the population and investors alike to rapidly implement far-reaching reforms and reverse the policy mistakes of the past. While Hanna views such opportunities positively, she argues that changes and reforms will be implemented slowly and gradually.

In her article on Thailand’s troubled manufacturing sector, Simona Mocuta describes an economy that is falling out of favor with investors and losing ground to its neighbors. Production output is still down compared to pre-2011 flood levels and the regulatory environment and labor market conditions have also deteriorated. The prognosis: even with much-needed structural changes, it will take Thailand years to recoup the advantages it once enjoyed.

Finally, the largest economy in the region, China, is struggling to shift its development model from one driven by exports and investments to one driven by domestic consumption and services. Before the adjustment takes hold, Brian Jackson argues that the Chinese government needs to reform key vestiges of the old system. Among these are industrial overcapacity and an overreliance on construction and real estate.

At IHS we are committed to providing business leaders with unrivaled insight based on data, research, and analytics so the decisions they make will provide competitive advantages not just for today, but over the long term. That’s the number one job of our analysts and economists based in Asia and all major economic and financial centers around the globe.

Zbyszko Tabernacki Vice President IHS Economics and Country Risk

bit.ly/ZTabernacki

https://www.linkedin.com/pub/zbyszko-tabernacki-cfa/1/a83/343

4 | IHS Quarterly/Economics | Q3-2014

#IHSQuarterly

IHS QUARTERLY

COPYRIGHT NOTICE AND LEGAL DISCLAIMER© 2014 IHS No portion of this publication may be reproduced, reused, or otherwise distributed in any form without prior written consent of IHS. Content reproduced or redistributed with IHS permission must display IHS legal notices and attributions of authorship. The information contained herein is from sources considered reliable but its accuracy and completeness are not warranted, nor are the opinions and analyses which are based upon it, and to the extent permitted by law, IHS shall not be liable for any errors or omissions or any loss, damage or expense incurred by reliance on information or any statement contained herein. For more information, contact IHS at [email protected], +1 800 IHS CARE (from North American locations), or +44 (0) 1344 328 300 (from outside North America). TRADEMARKSIHS Quarterly & the IHS logo are trademarks of IHS. Other trademarks appearing in this publication are the property of IHS or their respective owners.

IHS Inc.Scott KeyPresident & Chief Executive Officer

Jonathan GearSenior Vice President – Industrials

Anurag GuptaExecutive Vice President – Strategy, Products & Operations

Sean MenkeExecutive Vice President – Resources

IHS QuarterlySheri RhodineVice President, Integrated Marketing

John WardSenior Director, Thought Leadership

Bruce RaynerEditorial Director, IHS Quarterly/Economics

David EdwardsDirector, Solution MarketingIHS Economics & Country Risk

John SimpsonSenior Manager, Thought Leadership

Peter BeddowCreative Director, IHS Quarterly/Economics

IHS Global Editing, Design and Production Team

IHS Quarterly/Economics Editorial CouncilNariman BehraveshChief Economist, IHS

Zbyszko TabernackiVice President, IHS Economics & Country Risk

Mack BrothersVice President, Industry Services & ConsultingIHS Economics & Country Risk

Rajiv BiswasChief Economist, Asia PacificIHS Economics & Country Risk

Doug HandlerChief Economist, North AmericaIHS Economics & Country Risk

Elisabeth Waelbroeck-RochaChief Economist, InternationalIHS Economics & Country Risk

Farid AbolfathiSenior Director, IHS Risk CenterIHS Economics & Country Risk

Jim DiffleySenior Director, US Regional Forecasting IHS Economics & Country Risk

Sara JohnsonSenior Director, Global EconomicsIHS Economics & Country Risk

Todd LeeSenior Director, Global EconomicsIHS Economics & Country Risk

CONTENTS

VISION Balancing short-term and long-term expectations for AsiaBy Zbyszko Tabernacki

P3

INSIGHTS Eurobond debut opens door to international markets for Kenyan borrowersBy Mark Bohlund

P5

Emerging Asia challenged by labor market dynamicsBy Laura Hodges

P6

FEATURES IS THAILAND STILL COMPETITIVE? Many multinational corporations have long considered Thailand an important sourcing and manufacturing hub for their global operations. However, the 2011 floods, recent political unrest, and a lack of much-needed structural reform could threaten the country’s regional competitiveness.By Simona Mocuta

P7

CAN INDIA’S ECONOMY BE ‘MODI-FIED’? The decisive BJP win in the May elections is seen as a catalyst for India’s growth revival. However, it needs major economic reforms, and given its complex political landscape, these will be difficult to deliver even by a strong government.By Hanna Luchnikava

P12

CHINA’S OVERCAPACITY MEETS THE HOUSING BUBBLE For years, China has been struggling to resolve its industrial overcapacity problems. Now, as the housing market softens and construction growth slows, the situation will likely get worse before it gets better, especially for steel and related industries.By Brian Jackson

P17

NUMBERS Metrics that matterSource: IHS

P22

IHS QUARTERLY/Economics Q3-2014


Eurobond debut opens door to international markets for Kenyan borrowersSeventeen years after first considering selling a sovereign bond, Kenya launched its debut Eurobond for international investors in late June, with strong demand for the issue contrasting with news coverage of renewed terror attacks on the Kenyan coast. The issue’s large size—which at US$2 billion is over five times Rwanda’s debut bond offering in April 2013—had raised fears as to whether the market would be able to digest it. However, these fears were dispelled with total bids of US$8.8 billion for the bond, divided into a US$500 million 5-year tranche, pricing at 5.875%, and a US$1.5 billion 10-year tranche, pricing at 6.875%, allowing investors with differing maturity preferences to invest.

Like the majority of its sub-Saharan African predecessors, Kenya’s bond issue served two main purposes: to raise funds for planned infrastructure investment and to provide channels for domestic corporations to access international financial markets by using the prevailing yield on the bonds as a benchmark for pricing loans and other lending. The latter point is considerably more salient in Kenya’s case than for the majority of its sub-Saharan African peers, as it has a wide range of domestic corporations familiar to foreign investors.

Telecom operator Safaricom and Equity Bank, which together have pioneered mobile money transfers through their M-Pesa and M-Kesho schemes, are among the most favored by foreign investors of the more than 60 companies listed on the Nairobi Stock Exchange. Electricity distributor Kenya Power Ltd and ARM Cement have already stated their plans to raise funds through issuing Eurobonds in international markets, and we believe other companies will also seek to circumvent the double-digit interest rates offered by domestic banks and take advantage of the ample liquidity available in global financial markets.

Domestic banks are normally among the first to follow the sovereigns in issuing in international markets, and we expect this to be the case for Kenya even with abundant evidence of risks in banks borrowing externally to finance expansions of domestic lending.

Kenyan banks currently enjoy double-digit net interest margins, which have underpinned strong profitability. However, increasing competition for deposits and the Central Bank of Kenya’s recent effort to reduce the gap between deposit and lending rates could prompt local banks to look to international markets to finance increased lending and their continued regional expansion.

Kenyan banks are more profitable and better governed than their Nigerian peers, which have been frequent issuers of Eurobonds over the past year. However, the majority of their borrowers lack the ready access to foreign-exchange earnings enjoyed by Nigerian oil and gas companies, which are the recipients of more than 20% of Nigerian bank lending. IHS believes Kenyan banks remain committed to their regional expansion plans, but they may need to seek external financing to fund these plans.

By Mark Bohlund, senior economist, sub-Saharan Africa,

IHS Economics

bit.ly/MarkBohlund

For more information on this topic, visit ihs.com/QE13Kenya

InsIghts

Source: IHS

0

1

2

3

4

5

6

7

8

2020(f)

2019(f)

2018(f)

2017(f)

2016(f)

2015(f)

2014(f)

2013(e)

20122011

2010

Kenya’s Eurobond issue will generate funding for infrastructure to help drive economic growth

Annual real GDP growth, 2010–2020 (% y/y)

http://www.ihs.com/QE13Kenya

https://www.linkedin.com/pub/mark-bohlund/1/514/72b

InsIghts

While much attention has been paid to China’s rising labor costs recently, wages have been climbing at above-average rates in most emerging Asian markets as demand for labor accelerates. Businesses across the region face tough decisions as they struggle to pay higher wages while competing for skilled workers.

In 2000, the average Chinese manufacturing wage was 2.5% that of the US. Currently that ratio is 10% and will approach 25% by 2023, according to IHS. At US$3.50 per hour, Chinese wages remain relatively low, but their growth has changed the cost calculation for many companies manufacturing, outsourcing, or sourcing their goods in China. Global companies are now turning to India, Indonesia, the Philippines, Thailand and Vietnam, but higher minimum wages, limited skilled availability, and strong labor demand are pushing these countries’ wages higher, decreasing their cost advantages over China.

Many Asian countries have raised minimum wages recently. In 2013, Indonesia instituted a 40% minimum wage increase in and around Jakarta; Malaysia introduced a minimum standard; and Thailand set a national minimum wage of 300 baht (US$9.20) per day.

Adding to the concerns of employers in emerging Asia is the difficulty of filling skilled and professional positions, owing to the lack of access to quality educational resources. While education is improving in the region, tertiary enrollment rates still fall well shy of those in the developed world. The result is lower productivity, reduced competitiveness, and higher staff turnover.

Over the past decade, manufacturing output has more than doubled in most ASEAN economies, further

Robust wage increases across Asia are not expected to hinder growth in manufacturing

Annual percentage increase in average manufacturing wages for 2010–2015 and average hourly wage rates in US$ for 2014

Country 2010 2011 2012 2013 2014* 2015* Rates in US$, 2014

China 9.9 17.9 14.3 7.8 10.4 10.1 3.24

India 14.9 12.9 11.1 11.4 10.2 10.3 2.17

Indonesia 10.2 5.6 20.4 4.2 6.7 8.2 1.26

Philippines 4.5 2.9 4.7 3.3 4.9 5.0 2.04

Thailand 2.1 4.7 20.0 9.7 9.2 9.4 2.09

Vietnam 16.3 20.3 13.8 7.6 8.0 9.2 1.57

*Forecast

straining the labor force and fueling wage growth. The Chinese manufacturing sector is now over seven times larger than in 2000 and represents over 40% of its economy. Since its 2007 World Trade Organization accession, Vietnam’s manufacturing sector has quadrupled and now comprises 24% of its economy.

Looking ahead, Asia (excluding Japan) is expected to overtake North America as the largest region, as measured by real GDP, within five years. The region’s growth rates will outpace all others through 2020 and provide leverage, particularly to skilled workers, for wage gains. IHS predicts that wages in emerging Asia will increase robustly in the next few years, but pay levels, particularly in Indonesia and Vietnam, will remain relatively low, helping attract manufacturing (see table below).

Chinese workers have enjoyed strong wage growth since 2000, shifting lower-valued manufacturing to countries such as Indonesia and Vietnam. However, wages are rising in most emerging Asian markets. While labor cost is a key input for manufacturers, infrastructure, political stability, availability of high-quality materials, and worker productivity must also be considered when choosing sourcing or manufacturing locations.

By Laura Hodges, director, pricing and purchasing service, IHS

Operational Excellence & Risk Management

bit.ly/LauraHodges

For more information on this topic, visit ihs.com/QE13AsianLabor

Emerging Asia challenged by labor market dynamics


Source: IHS

http://www.ihs.com/QE13AsianLabor

https://www.linkedin.com/pub/laura-hodges/2b/96a/a51


competitive?Many multinational corporations have long considered Thailand

an important sourcing and manufacturing hub for their global

operations. However, the 2011 floods, recent political unrest,

and a lack of much-needed structural reform could

threaten the country’s regional competitiveness.

By Simona Mocuta

Is Thailand still


Three years on, Thailand’s manufacturing sector has yet to fully recover from the devastation caused by the 2011 floods.

Seasonally adjusted industrial production as of April 2014 was 15.5% lower than in September 2011, the month before record-setting floods hit Bangkok. Thailand’s underperformance is particularly striking when compared to regional competitors such as the Philippines, China, and Vietnam, which have seen industrial output rise by 32%, 26% and 17%, respectively, over the same period. Even India managed a 5% gain despite a pronounced economic slowdown. Japan took just six months to get back to pre-tsunami levels of industrial production, although output has been essentially flat since then (see chart below).

A detailed analysis of Thailand’s manufacturing sector suggests the country’s post-2011 sluggishness is the result of more than just flood-related losses (see table on page 11). Comparing the performance of Thailand’s 21 manufacturing sectors over a 14-year period reveals four significant trends:

• Performance varies widely across manufacturing sub-sectors, distinguished broadly between low value-added and high value-added industries

• Low value-added industries are shrinking, suggesting Thailand is no longer competitive in this space

• The high value-added sectors of automotive and computing machinery (mainly hard disk drives) have been the top performers since 2000

• Much of the growth in the high value-added “success” industries occurred prior to 2005, while much of the shrinkage in “losing” low value-added industries occurred recently.

Five out of 21 sectors analyzed diminished in size between 2000 and early 2014. Of these, four shrank by close to, or even more than, 50%. Furniture, textiles, footwear, straw articles, and wearing apparel all appear to be on a steady death march. All are low value-added, labor-intensive industries, a commonality that suggests Thailand is no longer competitive in this arena.

Comparing performance today against periods just prior to specific events, such as the 2006 coup and the 2011 floods, yields further insight. The magnitude of the 2000–14 declines is roughly similar to, and in some sectors larger than, the 2005–14 ones, indicating that the erosion occurred primarily after 2005. Declines also broadened during 2005–14 to include other sectors such as radio, television, and communication equipment; paper products; basic metals; and coke, refined petroleum products, and nuclear fuel.

Finally, the extent of post-2011 contraction in output of radio, television and communications equipment, footwear, and apparel is striking. These industries appear to be downsizing at an accelerated pace.

Given the global recession of 2008–09, coupled with the 2011 floods, it is tempting to explain Thailand’s current period of manufacturing weakness as a cyclical phenomenon. However, IHS believes that structural forces such as rising labor costs and increasing competition from previously frontier or closed economies, such as Cambodia and Vietnam, have just as much bearing on Thailand’s current predicament and potentially even larger implications for the future of its manufacturing sector in the coming years.

The reasons for the declineConsider Thailand’s labor costs. Two rounds of large minimum wage increases—the first in April 2012 and

Recurrent episodes of political unrest may hurt Thailand’s high value-added sectors more than low value-added ones since capital commitments are larger and investors are more cautious when committing capital over the long run.

Source: Country sources

-20 -15 -10 -5 0 5 10 15 20 25 30 35

Thailand

Japan

India

Taiwan

Singapore

Australia

Indonesia

Malaysia

Vietnam

China

Philippines

Percent change in industrial production, September 2011 to April 2014

Thailand stands out for the wrong reasons


the second in January 2013—sharply raised Thailand’s labor costs, especially at the low end of the spectrum. In April 2012, the government increased minimum wages by 40% and nine months later it mandated a uniform minimum wage of 300 baht (about US$9.20) a day nationwide. Depending on each province’s prior minimum wages, increases ranged from 40% to nearly 90%. About two-thirds of Thai provinces and regions saw minimum wages go up by 70% or more between 2011 and 2013, putting Thailand squarely in the upper echelons of mandated minimum wages within ASEAN (see chart on right).

Higher minimum wages pushed overall wage rates up across the board, particularly in 2012, when the manufacturing hubs of Bangkok and surrounding provinces were most vulnerable to the effects of the flooding. Average private sector manufacturing wages surged 21.8% in 2012 and a further 9.2% in 2013.

The problem of rising labor costs is further exacerbated by shifting demographics and an underperforming educational system. Thailand has the second-fastest-aging population in ASEAN (see chart on right). By 2025, 16% of the population will be above 65, up from 10% today. This will be roughly three times higher than Laos and the Philippines, and twice as high as Malaysia, Indonesia, and Cambodia. Thailand’s working-age population will peak in 2017.

Not only will the country’s labor pool shrink, but the available skill set is poorly matched to the needs of the business community. According to the 2013–14 Global Competitiveness Report by the World Economic Forum, Thailand scored 78th out of 148 countries surveyed in terms of its educational system’s ability to meet the needs of a competitive economy. This was lower than Cambodia (76th), the Philippines (40th), Indonesia (36th), Brunei (32nd), Malaysia (19th), and Singapore (3rd). Low research and development spending—estimated at just 0.2% of Thailand’s gross domestic product in 2012—also hampers innovation.

The labor skill mismatch is reflected in the broadly static employment distribution across the major industry sectors (see top left chart page 10). In 2013, agriculture accounted for 40% of total employment in Thailand, which is not only high by international standards, but has remained virtually unchanged for 15 years. Agriculture still employs as many people as the manufacturing, wholesale and retail trade,

Source: Country sources

Mandated minimum wage rates (in light blue) and ranges (in dark blue, where applicable) by country in US$ per day

Recent wage hikes have reduced Thailand’s regional competitiveness

0

2

4

6

8

10

12

PhilippinesThailand

MalaysiaIndonesia

VietnamLaos

CambodiaMyanmar

Source: 2013–14 Global Competitiveness Report, World Economic Forum

0 5 10 15 20

Laos

Philippines

Cambodia

Indonesia

Malaysia

Myanmar

Brunei

Vietnam

Thailand

Singapore

Percent of population over 65 years old by 2025

Thailand has the second-fastest-aging population in ASEAN


construction, and hospitality sectors combined. Tellingly, manufacturing’s share of total employment declined by roughly two percentage points between 2005 and last year, to 14%, while agriculture’s share rose by 1% to 40%.

High value-added sectors challenged tooOf course, not everything has been doom and gloom in Thailand’s manufacturing sector. After all, the country has won recognition for establishing a first-class automotive industry. Automotive production increased more than fourfold between 2000 and early 2014 (see table on page 11). Production recovered quickly and reached short-lived record highs following the 2011 floods.

This revival was partly driven by surging domestic demand following Thailand’s first-time car buyer incentive program that ran through early 2013. Its expiration and the subsequent drop in demand largely explain the auto sector’s recent deceleration. Office and computing machinery—primarily hard disk drives—has been the top performer, with output rising more than fivefold between 2000 and early 2014. However, its recent performance has been lackluster and production has yet to see a full recovery following the flood-induced plunge in late 2011 (see chart on right).

Rising labor costs are not quite as serious a problem for these two sectors since Thai wages are still much lower than in other key automotive and technology centers in the region such as Japan, Korea, Taiwan, and Singapore. But the sectors struggle against heightened international competition, changing global consumer

preferences, and deteriorating domestic politics. In fact, recurrent episodes of political unrest may hurt these sectors more than the low value-added ones since capital commitments by firms are much larger and investors are more cautious when committing over the long run.

Where’s the competiton?The automotive sector, in particular, is vulnerable to the ascent of new manufacturing centers in Asia, specifically Indonesia, the Philippines, and Vietnam. In 2013, these three countries accounted for 24.5% of Thailand’s total vehicle exports, up sharply from about 13% a decade earlier, and essentially zero in 2000. However, as macroeconomic conditions in those markets improve, each passing year raises the likelihood that major car manufacturers will build production capacities in those countries, especially since all three of these countries have greater long-term vehicle sales potential than Thailand.

Even if such a shift does not imply a relocation of manufacturing capacity out of Thailand, but rather redirection of new incremental investment away from Thailand into other economies, the impact on Thailand’s automotive sector will be significant. This is essentially a double whammy: not only a loss of investment, but also a loss of final demand.

The technology sector faces its own challenges. The impact of a shortage of disk drives on global supply chains in the aftermath of the 2011 floods was extreme. The sector’s inability to return to pre-flood production levels may well result in decisions by producers to diversify production facilities to

Source: Bank of Thailand

Employment by sector as a percent of total

No change: Agriculture remains Thailand's top employer

19981999

20002001

20022003

20042005

20062007

20082009

20102011

20122013

0

20

40

60

80

100

OtherHospitalityConstruction

Wholesale/retail tradeManufacturingAgriculture

Industrial production index, January 2008 to April 2014, base year 2000 = 100

Source: Thailand Office of Industrial Economics

Thailand’s setbacks impacted even the best- performing sectors

Motor vehicles, trailers, and semi-trailersOffice and computing machinery

0

200

400

600

800

1000

1200

Jan-14Jan-13Jan-12Jan-11Jan-10Jan-09Jan-08

minimize the impact of future shocks. Even if Thailand is still cost competitive in this area, it may simply not be able to affect the trend.

The other challenge is more subtle but perhaps more significant: the emergence and rapid global adoption of new technologies—such as smartphones and tablets—is cannibalizing demand for traditional desktop-type computers that require hard drives. Thailand’s focus on hard drive manufacturing


Thailand’s low value-added industries wane as growth slows in high value-added industries

Percent change in industrial output by sector between the first four months of 2014 and (a) the average output for the 12 months of 2000, the months prior to the high-tech bubble bursting; (b) the average output for the 12 months of 2005, the months prior to the 2006 coup; and (c) the average output for January–September 2011, the months prior to the floods.

2000–14 2005–14 2011–14

Furniture and manufacturing NEC -59.0 -42.4 -18.1

Articles of straw and painting material

-52.5 -39.2 15.8

Footwear -48.6 -52.6 -45.2

Textiles -47.0 -42.5 -18.3

Wearing apparel, except fur apparel

-1.5 -33.1 -20.2

Radio, television and communication equipment

10.7 -18.1 -28.9

Paper and paper products 21.3 -1.3 0.2

Basic metals 27.3 -8.7 -2.1

Coke, refined petroleum products and nuclear fuel

34.0 -7.5 -2.3

Electrical machinery and apparatus NEC, accumulators

34.3 24.8 2.6

Rubber and plastics products 37.5 5.7 2.4

Machinery and equipment, domestic appliances NEC

61.1 20.7 -16.5

Food and beverages 62.1 24.6 7.0

Other non-metallic mineral products

77.3 5.7 5.6

Chemicals and chemical products 85.2 30.5 4.6

Medical, precision and optical instruments; watches and clocks

129.2 19.1 -8.5

Machinery and equipment 141.7 53.5 1.6

Other transport equipment: motorcycles, bicycles and invalid carriages

142.7 -21.9 -23.0

Machinery and equipment: other general purpose machinery

253.8 85.3 17.8

Motor vehicles, trailers and semi-trailers

318.1 59.3 19.1

Office, accounting and computing machinery

414.2 44.4 -38.6

Source: Thailand Office of Industrial Economics and IHS

Note: NEC = Not elsewhere classified

may hinder its ability to shift into these newer technologies. One striking comparison is Vietnam, where telephones and spare parts became the country’s top export earner in 2013, with export volumes increasing ninefold in just three years.

While there are some bright spots in Thailand’s manufacturing sector, namely automotive and technology, it faces serious headwinds from rising labor costs, shifting demographics, a domestic skills mismatch, changing consumer preferences, and shifting global sourcing patterns. Recurrent political crises are also proving increasingly costly to Thailand’s reputation as a stable manufacturing location within ASEAN.

Aside from fiscal incentives to lure foreign investors, successive recent governments have done little to address these challenges. The lack of structural reforms threatens to leave Thailand’s industrial sector in limbo, unable to compete in low value-added industries due to rising costs, but also incapable of moving up the value chain due to a failing educational system and a lack of innovation.

Simona Mocuta is director for Asia Pacific, IHS Economics

bit.ly/SimonaMocuta

For more information on this topic, visit ihs.com/QE13Thailand

http://www.ihs.com/QE13Thailand

https://www.linkedin.com/pub/simona-mocuta/1/a41/a9


Can India’s economybe ‘Modi-fied’?

i-S

tock

Following impressive growth in the mid-to-late 2000s, India was seized by policy paralysis, high inflation, and underinvestment. The decisive BJP win in the May elections is seen as a catalyst for India’s growth revival. However, it needs major economic reforms, and given its complex political landscape, these are difficult to deliver even by a strong government.

By Hanna Luchnikava

Given broad-based disillusionment with Congress’ performance in office, a change in government had been widely anticipated. Indeed, the

Bharatiya Janata Party (BJP) achieved the most decisive electoral win in 30 years, securing 282 of 543 seats in the lower house. From an “ease of governing” standpoint, this was the best outcome India could have hoped for, as it allowed incoming Prime Minister Narendra Modi to independently form a government with sufficient political weight to push through tough economic reforms.

BJP’s economic philosophy and Modi’s personal track record also bode well for the economy. The BJP has

strong support among the urban middle and upper class, predominantly aligned with the industry and services sectors. The new government is therefore likely to favor the industrial sector and business community. By contrast, some of the Congress-led United Progressive Alliance (UPA) agricultural policies, such as subsidies and minimum support prices for agricultural goods, are more likely to be abandoned.

Modi’s performance as chief minister of Gujarat since 2001 indicates a hands-on style that former Prime Minister Manmohan Singh largely lacked. Although Gujarat’s social indicators such as education and healthcare are not particularly impressive when


compared with other Indian states, Gujarat does stand out for its infrastructure and manufacturing base expansion (see table at right). Coincidentally, these two areas are exactly what India as a whole needs to focus on at a time when investment and manufacturing are shrinking.

Modi’s “Gujarat model” has focused on upgrading the road, electricity and water infrastructure, and attracting domestic and foreign investors into these sectors. As a result, the state’s transportation network far exceeds national averages. Gujarat is also one of very few power-surplus states in India. Installed power capacity increased 165% over the past decade and distribution losses were cut from 35% to 15%. Reliable electricity supply has helped turn the state into India’s industrial powerhouse, hosting 257 industrial estates, 18 operational (and 50 approved) special economic zones (SEZs) and upcoming infrastructure on the Delhi–Mumbai Industrial Corridor (DMIC). Gujarat is the only state in India where the state government has framed consistent, incentive-based policies in almost all key sectors—industry, power, ports, roads, agriculture, and minerals—targeted at attracting investment.

Markets appear confident that Modi’s government will be able to turn India’s economy around. The S&P Bombay Stock Exchange Sensitive Index (BSE SENSEX) has gained 15% since early May and the rupee has strengthened to a year high. However, the key to sustaining these gains lies in the actual delivery of reforms. IHS believes that the reform timeline and economic impact will vary, with investment-focused reforms likely to see faster implementation and more immediate growth dividends. More contentious measures, such as subsidy and labor reforms, will take longer and have a more diluted impact on growth, once they have been fully vetted through India’s complex political system.

First policy priority: revive investmentModi’s first parliamentary address emphasized that changing India’s investment reputation from “scam India to skill India” is a top priority. Indeed, boosting credibility among domestic and foreign investors is critical to reviving investment and industrial-sector growth, which IHS believes will be the government’s two main focus areas over the next 12–18 months.

India certainly needs more investment. Its investment stock relative to GDP is low compared to other

economies and there are chronic supply deficiencies, particularly in infrastructure. The World Economic Forum Global Competitiveness Report 2013–14 ranks India 85th out of 148 countries on the quality of overall infrastructure, well behind China (ranked 74th), Malaysia (25th), Thailand (61st), and Indonesia (82nd), with India’s notoriously poor quality of power supply ranked 111th (out of 148). The Indian business community repeatedly cites infrastructure as the single biggest hindrance to doing business, ahead of corruption and cumbersome bureaucracy.

Between 2000 and 2008, the country made substantial progress in boosting investment, with real fixed investment’s share of GDP rising from 23% to 33%. However, investment slowed considerably thereafter, bringing its share of GDP to 29% in FY2013 (April 1, 2012 to March 31, 2013). Fixed investment in manufacturing fell from 14.5% of GDP in FY2008 to under 10% in FY2013. Real fixed investment and manufacturing output fell 0.1% and 0.7%, respectively. Declines have been partly driven by pre-election uncertainty; new investment announcements in January–March 2014 were down almost 50% from the previous year’s quarterly average, while completion of existing

Can Prime Minister Modi replicate the ‘Gujarat model’ across India?

Economic comparison of the state of Gujarat vs. India

Gujarat India

GDP per capita, 2012–13 (US$, current prices)

2,040 1,531

Average real GDP growth, 2005–12 (Indian Rupee [INR], constant prices)

10.10% 7.79%

Manufacturing output per capita, 2012–13 (INR, constant prices)

18,694 7,138

Outstanding investments, US$ billions (Apr 2000–Oct 2013)

255 2,658

# of PPP projects 74 881

# of SEZs 61 392

Gujarat’s share in all India

Population 5% –

Geographical area 6% –

National GDP, 2012–13 (INR, current price)

7.14% –

Industrial output, 2012–13 11.20% –

Fixed capital formation, 2011–12 16.90% –

Exports (state produced), 2010–11 24.60% –

Source: Centre for Monitoring Indian Economy, Central Statistical Organization (Government of India), Planning Commission (Government of India), India Brand Equity Foundation, IHS


industrial projects was down 56% from a year earlier.

Massive infrastructure plansTo resume the flow of investment, the government looks to de-clog the project pipeline and allow private-sector participation in areas previously under partial or full state monopoly. It also hopes to regain investor confidence by ensuring policy predictability in areas such as taxes, especially since the predecessor government’s retroactive taxation practices have been a major frustration to foreign investors.

The speed and decisiveness with which the new government has expedited stalled projects is impressive. Since the election, India’s Road Ministry has already reviewed over 250 projects worth over US$10 billion and approved over US$6 billion worth of projects to be started in the next three months. The Ministry has pledged to boost road construction to 30 km per day, 10 times more than the FY2013 average. Future efforts will focus on accelerating the DMIC project and other freight routes, and setting up a national high-

speed train network.

More broadly, these efforts build on the 12th Five Year Development Plan for 2012–17, which puts India’s infrastructure investment needs above US$1 trillion. About half of these are to be financed by the private sector and another half through private-public partnerships (PPPs). In FY2014 alone, the plan envisions infrastructure investment of nearly US$178 billion (see figure above).

Apart from directly contributing to growth, accelerated infrastructure spending will have a spillover effect on the rest of the economy. Manufacturing will benefit from stronger demand for construction materials and equipment, while added power generation capacity will also help manufacturing growth. As a result, IHS expects India’s industrial production growth to recover to 4.2% in 2014 and 6% in 2015. Meanwhile, new jobs in the infrastructure sector and manufacturing will bolster consumer demand.

Financing limitations are, however, a significant risk to the

government’s infrastructure plans. Public infrastructure spending is constrained by fiscal consolidation needs, while high leverage among India’s companies will hinder private expenditures. There has been a significant buildup in corporate leverage among Indian firms in recent years: India’s 10 largest firms alone hold net debt of almost US$100 billion (around 7% of the stock market’s value). India’s non-financial sector debt-to-equity ratio is the highest among emerging market peers, with infrastructure companies particularly overleveraged. The recent revival of India’s capital markets will be used by companies to sell assets but deleveraging will be gradual, suggesting that fresh capital spending from domestic firms will only pick up from 2015 (see top right chart page 15).

FDI reform should go beyond the new budget announcementsGiven limited contributions from India’s domestic private sector to the tremendous infrastructure investment required, the government will look to expand foreign investment. Net foreign direct investment (FDI) inflows into India fell 34% in 2012 to US$24 billion and recovered only slightly in 2013; their share of GDP fell from 3.4% in 2008 to 1.5% in 2013 (see bottom chart page 15). Bureaucracy, numerous corruption scandals, and tax disputes between the Indian government and foreign companies (including high-profile scandals with Nokia, Vodafone, and Royal Dutch Shell) have undermined FDI inflows.

The BJP’s first FY2014 budget, released in July, signaled the government’s investor-friendly

India's projected infrastructure spending, 2012-2017 (US$ billions)

Private investment will be tapped to help ‘un-clog’ the infrastructure project pipeline

0 50 100 150 200 250 300StorageAirports

MRTSOil and gas pipelines

PortsWater supply and sanitation

Renewable energyIrrigationRailways

Roads and bridgesTelecommunications

Electricity

Source: Planning Commission (Government of India)

PublicPrivate


attitude, but failed to address the most critical issues. While the budget promises a “stable” tax environment, it does not go far enough to scrap the controversial retroactive tax. The decision to raise investment caps in insurance and defense sectors from 26% to 49%, while a step in the right direction, may not be sufficient to lure big-ticket investments, particularly from defense manufacturing companies looking for a controlling stake in Indian joint ventures to retain ownership over their sensitive technologies. The government would therefore need to take bolder steps to send a stronger pro-investor signal, including:

• Set up a time-bound project clearance mechanism, particularly for land acquisition clearances

• Legislatively remove the retroactive tax amendment introduced in 2012

• Set up a unified goods and services (value-added) tax by the end of 2014 and announce a specific timetable to introduce a direct tax code

• Allow 51–100% participation in insurance and financial services, defense manufacturing, railways, retail, and e-commerce.

Meanwhile, we expect the multi-brand retail sector to remain subject to state protectionism, given that the small businesses that stand to lose most from increased competition constitute a large portion of BJP’s electoral base.

Macroeconomic imbalances to gradually correctAside from reviving investment, IHS expects the new government to pursue more prudent macroeconomic policies to correct structural imbalances and boost potential growth. Reducing India’s structurally high inflation and trimming the fiscal deficit are among the first government priorities, but addressing these issues will require difficult decisions that are likely to face social and political opposition.

Thus, we expect the government to take a gradualist approach to resolving structural imbalances, while the near-term goals of keeping inflation and fiscal deficits in check will have to be met through tighter fiscal and monetary policies. In fact, this may initially hurt growth by keeping domestic demand from rising rapidly, but will lead to a gradual macroeconomic stabilization over the medium term, allowing both the government and the central bank to become more supportive of growth down the line.

Despite a three-year tightening campaign by the Reserve Bank of India (RBI) in 2009–12, inflation has persisted, with retail inflation running at near double-digit rates since 2009. India’s high inflation is linked both to supply-side constraints and market price distortions via subsidies (see chart on page 16).

Supply and distribution of food are of particular concern, given that food accounts for 46% of the consumer price basket. India’s food supply is mostly disorganized, leading to non-transparent pricing, inefficient distribution chains, excessive wastage, opportunistic profiteering, and high overall costs. For instance, in the fruits and vegetables value chain, intermediaries take around 65% of the maximum retail price, while farmers receive only 15%.

Source: International Monetary Fund, Reserve Bank of India

0

10

20

30

40

50

20132012

20112010

20092008

20072006

20052004

20032002

US$ billions

0.5

1.0

1.5

2.0

2.5

3.0

3.5% GDP

Foreign direct investment (FDI) as a share of GDP has declined significantly over the past five years

Net inflows of FDI into India, 2002-2013

Debt-to-equity ratio, % (excluding banks)

India’s non-financial sector debt-to-equity ratio is the highest among emerging market peers

0 20 40 60 80 100China

Thailand

Mexico

Russia

Indonesia

Brazil

India

Source: International Monetary Fund, Bureau of Indian Standards


Opening the retail sector to FDI could greatly improve efficiency in India’s food supply and lower costs. The BJP’s reluctance to do so would force the government to accelerate other efforts to deliver on its lower inflation promise. These could include stricter control over minimum support-price increases, abolition of the wage indexation to CPI as part of the Mahatma Gandhi National Rural Employment Guarantee Scheme, incentives to private-sector investment in agriculture, and improving infrastructure for the production and marketing of agricultural products. Given that the RBI is equally committed to price stability, the dual focus on inflation may well succeed in bringing India’s CPI down to 6% by January 2016, in line with RBI’s target.

The focus on reducing inflation implies that drastic subsidy cuts are unlikely in the near term, and the FY2014 budget confirms this view. The budget allocates US$43.4 billion on subsidies this year—2% above last year’s spending—which puts the subsidy bill at 3.2% of GDP. Nonetheless, fiscal pressures and efforts to increase supply and

efficiency in the energy sector will force Modi to rationalize some subsidies in the next 12 months. Among others, liquefied natural gas and diesel will see administered prices at least double within this period. A move toward more targeted subsidies through direct cash transfers is also anticipated.

The new budget also lays out a roadmap for the medium-term fiscal consolidation, which would bring the fiscal deficit down to 3% of GDP by 2017 (from an average of 5% in 2009–13). However, with little detail on how the deficit reduction will be achieved, the government will have to give more clarity on its fiscal consolidation plans before the likelihood of their implementation can be assessed.

Outlook and implicationsConsidering the overwhelming scope for required reforms, IHS expects the BJP government to make enough progress to reverse India’s recent negative economic trends. However, we see the government’s approach to reform distinguishing between the less controversial fast-impact measures focused on investment

revival and more complex and contentious reforms, such as subsidy and labor, which will take longer to pursue, but will help correct India’s structural imbalances over the long term.

The former are likely to see implementation within the next 6–12 months, helping India’s near-term recovery. However, as both the government and private sector go through the round of consolidation, their ability to deploy fresh capital will be limited, suggesting that a sharp rebound in the near term is unlikely. As a consequence, IHS expects India’s real GDP growth to accelerate to only 5.4% in FY2015. In the meantime, the timeline and substance of the latter set of reforms will greatly depend on Modi’s ability to work with the local governments. If successful, they could advance India’s growth to the mid-to-high 7% range by the end of the decade.

Hanna Luchnikava is South Asia economist

at IHS Economics

bit.ly/HannaLuchnikava

For more information on this topic, visit ihs.com/QE13India

India's inflation rate, 2008-2014: Wholesale Price Index (WPI), Consumer Price Index (CPI) for food, and CPI overall (% change y/y)

Despite tight monetary policy, India's inflation rate remains stubbornly high

Source: Central Statistical Organization (Government of India)

-5

0

5

10

15

20

2014201320122011201020092008

WPI CPI food CPI overall

https://www.linkedin.com/pub/hanna-luchnikava/7/102/982

http://www.ihs.com/QE13India


China’s overcapacity meets the housing bubbleFor years, China has been struggling to resolve its industrial

overcapacity problem. Now, as the housing market softens and

construction growth slows, the situation will likely get worse

before it gets better, especially for steel and related industries.

By Brian Jackson

Indicating the growing frustration of China’s top policymakers, the State Council issued a document

in October 2013 entitled View on Resolving Grave Overcapacity. It’s a guiding policy outlining the ever-worsening overcapacity problem plaguing heavy industry, specifically the steel, cement, aluminum, flat-panel glass, and shipbuilding sectors. The policy targeted an 80% utilization rate for each by the end of 2017, which is well above their current capacity utilization rates.

The situation is indeed grave. Industrial overcapacity in China is a decade-long problem, with no immediate solution

in sight. Contrary to common misperceptions, many of China’s overcapacity problems actually precede the 2009 fiscal stimulus package and the massive credit surge that accompanied it. There is no doubt, however, that stimulus policies made the overcapacity problem worse.

Now, just as plant managers and shipyard foremen look to boost production and fill idle capacity, they’ve been hit hard by China’s faltering housing market. As construction growth slows, industrial overcapacity in some sectors is expected to get worse, potentially much worse.

Steel’s dire predicamentWhile overcapacity plagues a number of sectors, the steel industry is emblematic of the inherent failures of the system. Chinese officials flagged steel-sector overcapacity as a concern at least eight years ago, but conditions have continued to deteriorate significantly since then: capacity utilization rates dropped from about 80% in 2005 to 75% in 2009 and 71% in 2013 (see the figure on page 18). Between 2008 and 2012, profit growth in the steel sector averaged a paltry 1.9% annually, one tenth of the 19.3% average reported among all industrial sectors.


By 2012, average debt per steelmaker reached CNY360 million (US$58 million), almost three times higher than average debt levels reported by industrial enterprises nationwide. The only sectors with higher average debt levels per enterprise are ultra-capital intensive (and largely state-led) sectors such as nuclear fuel processing.

The average annual output for a steelmaker in 2012 was measured in the tens or hundreds of thousands of tonnes, which is remarkably low in an industry where scale is normally measured in millions of tonnes. That figure likely includes thousands of very small, inefficient, and possibly largely idle furnaces.

Without a doubt, the steel sector capacity overhang of 321 million tonnes captures the most attention and fear. But other sectors are in dire straits as well. The estimated volume of current idle capacity for the shipbuilding industry is equivalent to 26 million tonnes; cement is 65 million tonnes; and plate glass is 206 million tonnes. Wind turbine production, a sector favored in years past, now also faces severe overcapacity of about 33,900 megawatts; such facilities’ capacity utilization was a paltry 32% in 2012.

With little evidence of capacity constraints in China’s existing steelmaking sector, total production capacity grew by 13% a year from 2005 to 2012. The result has been weak profit growth, a large and worsening debt burden, and low steel prices, which make the sector increasingly unappealing to investors. Together these facts beg the question: Why does investment continue in a sector with a reputation for overcapacity and low profits?

Incentive issues from top to bottomThe answer boils down to skewed incentives both at the top and bottom of the supply spectrum. State-owned

enterprises (SOEs) play a big role in the steel sector and have business objectives that sometimes compete with the need to maximize profit and return on investment.

Of the more than 10,000 enterprises operating in China’s steel industry, some 400 are SOEs. However, this relatively small number accounts for a disproportionate share of the assets, debt, and output of the sector as a whole. For instance, the average value of assets among private steelmakers is roughly CNY270 million but for SOEs it’s 30 times higher at CNY7.5 billion. Similarly, a private steelmaker’s average annual revenue is about CNY450 million, while the average for SOEs is more than 10 times higher, at about CNY6 billion.

All told, these 400 SOEs generate about half the combined revenue stream of their 10,000-plus private sector counterparts. High revenues are coupled with even higher debt: the debt-to-revenue ratio for steel SOEs is more than double that of their private-sector competitors.

These weaknesses are likely further concentrated among a lower tranche of both low-efficiency SOEs and private companies, according to data from the China Iron and Steel Association (CISA). The association’s 81 members include China’s largest producers and accounted for about 56% of sector revenue in 2013. That implies very low, inefficient output or simply idled capacity among many of the other 10,000-plus enterprises in the sector.

On average, private steelmakers produce about a tenth of the annual tonnage of their state-led competitors. Collectively they are profitable (though margins are low), whereas SOEs in the sector have been broadly registering losses in recent years. While the 400 SOEs account for about one third of sector revenues and

Source: IHS

0

50

100

150

200

250

300

350

2006 2007 2008 2009 2010 2011 2012 2013

Capacity growth Production growth

Mill

ion

tonn

esP

ercent change (y/y)

0

5

10

15

20

25Excess capacity

China's steel overcapacity keeps getting worse

China's overcapacity in millions of metric tons (left scale) and annual percent change (right scale)


output, in 2012 they experienced total losses of about CNY21 billion, compared with profits of about CNY191 billion among their private-sector counterparts.

Private-sector actors recognize that overcapacity will eventually lead to consolidation. But rather than restraining their capacity investment, they continue to invest, albeit at a decelerating rate. One reason for this is they hope to be among the few larger survivors of the inevitable round of consolidation that eventually must take place.

By repeatedly emphasizing mergers and acquisitions as a critical step to correct capacity issues, government leaders have, in fact, unintentionally encouraged this strategy. A recent example was in November 2013 when the China Banking Regulatory Commission (CBRC) signaled favorable lending conditions to fund mergers and restructuring.

Second, and perhaps delaying—and thereby worsening—the sector’s eventual correction, is the high social importance local economies place on steel production. In Hebei, for example, the steel sector accounts for about 15% of industrial employment, or 20% when including closely related upstream and downstream metals industries; together the sector employs nearly 750,000 in the province.

Third, steelmaking contributes 17% of value-added taxes collected from industrial enterprises, and about one third of industrial value-added taxes in the province. Government leaders are charged with maintaining social stability

through stable net job creation, improving government finances, and maintaining healthy, if slower, total economic growth, and thus are understandably reluctant to take the steel sector head-on, at least in Hebei.

In Tangshan, a major steel-producing city in Hebei, more than 1 million jobs rely indirectly on economic activity generated by steelmakers. Government estimates reported by the Xinhua news agency indicate that for every 40 million tons of excess capacity eliminated in Hebei, about 60,000 of those 750,000 jobs would be lost from closures, while another 300,000 jobs might be lost indirectly due to weaker demand for other goods

and services. China is currently working to create about 13 million new jobs per year, and with already slowing growth leaders are reluctant to deepen that challenge.

A needle for a bubbleChina’s slowing GDP growth is a “double whammy” for industries struggling with overcapacity. The combination of the real-estate construction sector slowdown and tightening credit poses tremendous challenges for these companies.

On the one hand, real estate is a key factor in the current slowdown. This is hugely problematic because much of the steel capacity expansion over the last decade—as well as its

actual utilization—was closely tied to growing steel demand from the construction sector. This included steel for high-rise apartments and supporting infrastructure as urban China expanded.

However, during the first half of 2014 residential floor space starts fell by 20%, or 139 million square meters from a year ago. That translates into more than 1 million fewer units started.

In recent years China has added around 14 million new apartment units per year across both commercial and public housing markets. Notably, officials are planning to bring forward some future plans for public housing, which may soften the impact on

commodities. Even so, commodities such as steel are likely to take a beating as a result of the 2014 housing slowdown.

Tightening credit conditions represent another key risk for steel producers. Tighter credit has been brought about largely by more aggressive policies to curb overcapacity. If successful, these will limit steel companies’ access to new finance, potentially making it harder to roll over loans. That may push them further towards shadow banking, a rapidly growing area of finance that leaders are increasingly vigilant about but which nonetheless poses considerable near-term systemic risk.

For every 40 million tons of excess capacity eliminated in Hebei, about 60,000 jobs would be lost from closures, while another 300,000 jobs might be lost indirectly.


Recently, the CBRC reported that formal lending to the steel sector totaled CNY2 trillion; the CISA separately reports that sector debt (including formal and informal lending) exceeds CNY3 trillion. This implies that at least one third of debt in the sector is borrowed outside of regulated financial channels. The CISA additionally reports that the sector faces a large repayments wave this year, with at least CNY140 billion in loan payments due in 2014, not to mention interest rates creeping up.

Steel is not alone in facing considerable debt problems. New energy industries hold debt exceeding CNY1.5 trillion and face a grave overcapacity issue. Shipbuilders’ debts exceed CNY500 billion, while combined debts of panel-glass makers, cement producers, and other metals makers are in the CNY1 trillion range, according to CBRC data.

While the potential for risk transmission among these sectors is not transparent, it is clear they all are facing

a riskier environment in 2014 with implications for China’s economic growth. IHS estimates that in recent years the steel sector contributed as much as 0.2 percentage points to real growth a year, while real estate contributed 0.4 percentage points last year and construction added 0.6 percentage points. These numbers may seem like a small slice of China’s overall 7.7% GDP growth in 2013, but taken together they could drag GDP growth down by more than a full percentage point.

No quick fixWhile industrial overcapacity presents serious challenges, there have been some positive signs recently. Debt levels in the steel sector, for example, peaked in mid-2013 and have been declining slowly since. While the change in direction is welcome, the speed of correction is likely to be as slow as the buildup—hinting at a multi-year, if not a decade-long, resolution. Not surprisingly, that change will hit some regions harder than others. During the first

Eastern China: Pain central

Correcting China’s capacity glut will cause considerable pain across a number of industry sectors. And that pain is likely to be most acute in the densely populated, heavily industrialized eastern part of the country. For instance, 25% of China’s annual production of steel comes from Hebei province, which

surrounds Beijing and Tianjin. Combined, the eastern provinces of Hebei, Jiangsu, Liaoning, and Shandong produce just over half of China’s annual steel production.

Hebei features prominently in other industrial sectors that are struggling with overcapacity. In the plate glass sector—which supplies the struggling office and

residential construction market—Hebei leads with 20% of national output. The provinces of Hebei, Guangdong, Hubei, and Shandong account for more than half of national output. Although there isn’t an obvious provincial leader in plate-glass production, output concentration among leading provinces in the sector is actually higher than in steel.

Where is China’s industrial output located?

Top 10 provinces ranked by percent share of total output for 2012

Steel production Cement production Plate glass production Shipbuilding

Hebei 24.93% Jiangsu 7.65% Hebei 19.85% Jiangsu 32.98%

Jiangsu 10.25% Shandong 6.99% Guangdong 10.78% Shanghai 16.67%

Shandong 8.68% Henan 6.74% Shandong 10.53% Zhejiang 9.24%

Liaoning 7.15% Sichuan 6.09% Hubei 9.81% Shandong 7.64%

Shanxi 5.46% Hebei 5.94% Jiangsu 8.62% Liaoning 6.70%

Hubei 4.02% Zhejiang 5.24% Fujian 6.19% Guangdong 5.96%

Henan 3.06% Guangdong 5.20% Sichuan 5.45% Hubei 1.07%

Jiangxi 3.01% Anhui 4.98% Zhejiang 3.99% Fujian 0.95%

Anhui 2.97% Hunan 4.78% Liaoning 3.36% Hebei 0.82%

Tianjin 2.93% Hubei 4.70% Anhui 3.18% Tianjin 0.58%

So

urce: IH

S, N

ation

al Bu

reau

of S

tatistics


IHS Maritime data shows even higher concentration in shipbuilding, with Jiangsu province and Shanghai municipality accounting for about half of output by tonnes; nearly 80% of national output comes from these two plus Guangdong, Liaoning, Shandong, and Zhejiang provinces.

Cement is far more dispersed, with the top provincial producer, Jiangsu, accounting for only about 8% of national production, and the top four provinces representing only one quarter of national output. Greater dispersion of cement production is presumably due to higher transport costs relative to pricing, higher dispersion of input materials, and relatively strong and dispersed demand over the last decade to match construction growth.

With steel, cement, and plate glass targeted by government overcapacity policies, it’s clear Hebei stands to lose the most if

closures were to be commensurate with current capacity. Also hard hit would be Guangdong, Hubei, Jiangsu, and Shandong.

Meanwhile, central China is enjoying an increase in industrial capacity from about 2% in 2012 to nearly one third in 2013. This may be partly motivated by environmental concerns in relatively wealthier eastern China such as Hebei, but also by plans for steady urbanization over the next decade in China’s interior.

There are even anecdotes of a more radical shift in production. In mid-May, Reuters reported that equipment from two dismantled nickel smelters in China was in transit to Indonesia for renewed operation there, fueled by export bans on some types of ore. Last year’s View on Resolving Grave Overcapacity included the broad target of reducing domestic production in certain industries by providing financial support to relocate them outside China.

Brian Jackson

quarter of 2014, for instance, Hebei experienced a sharp drop in growth, roughly halving its 8.2% expansion in 2013 to 4.2%.

Worrisome for Hebei and some other heavy industrial champions is that a correction will not happen overnight. Assuming production growth remains modestly positive, while net new capacity additions fall close to zero, government leaders could feasibly hit their target of 80% utilization by the end of this decade. In recent months investment growth into steel capacity has gone negative, although in terms of absolute level still remains considerable at CNY89 billion during the first quarter of 2014.

Overcapacity in heavy industry is not a negative across the board. As costs of industrial manufacturing inputs are pushed down, the costs to downstream manufacturers are reduced, with either higher profits or lower final prices as a result. For example, in the case of motors, inputs from sectors with overcapacity

account for about half of total costs, according to a 2013 IHS Pricing and Purchasing study. Those savings for higher-value-added industries won’t ease the pain for regions with heavy overcapacity, and in the short term are unlikely to provide enough growth to balance against the headwinds heavy industry will face in the coming quarters and years. Nonetheless, it may keep China’s manufactured products cost competitive.

Brian Jackson, economist, IHS Economics, is based in Beijing, China

bit.ly/BrianJackson

For more information on this topic visit ihs.com/QE13China

Source: China Iron and Steel Association

0

4000

8000

12000

16000

2012 2013Northeast Southwest

Cub

ic m

eter

s

CentralNorthEast Northwest

Slowing growth in steel capacity except in central China

New steel capacity by region in cubic meters of furnace volume

https://www.linkedin.com/in/briannjackson

http://www.ihs.com/QE13China

India’s non-financial sector debt-to-equity ratio, highest among the BRIC nations

5

83%


NumBeRs

Proceeds from Kenya’s issuance of its debut eurobond in June 2014

4xNumber of times larger Vietnam’s manufacturing sector has grown since the country’s 2007 WTO accession

Average wage per hour of a Chinese manufacturing worker

Percentage by which Thailand’s industrial production dropped between september 2011 and April 2014

Number of years before Asia (excluding Japan) overtakes North America as the world’s largest region, as measured by GDP

US$3.50

US$

2 billion

15.5

Preparing for any scenario just got easier. With the Global Link Model, you can generate scenarios powered by the most comprehensive macroeconomic model commercially available.

• Interlinks 68 country models and financial flows, trade flows, and commodity prices

• Enables powerful, fast scenario generation via a user-friendly desktop application— the Economic Simulation Engine

6360_0814PB

Learn more IHS.com/scenarios

http://www.ihs.com/scenarios

Industry information and expertise…

from copper to communications

Every decision matters.

That’s why leaders rely on IHS to help them make the best choices.

As the premier provider of global market, industry, and technical expertise, we understand the rigor that goes into decisions of great importance, guiding them with thinking that matches the scope of their needs.

IHS… when decisions matter

5407_0414P

B

Sh

uttersto

ck

is india ready for modi? - markitcdn.ihs.com/ihs_quarterly_economics_q3_2014.pdfis india ready for...

Documents