Firms may need to reduce risks and contain possible loss as the investment and business climate becomes worsening.
MNCs may need to protect their reputation and branding by not conducting business in a country which government is non-democratically elected
Sanctions, despite being targeted, could complicate cross-border financial transactions for international businesses
Businesses may need to reduce pressure from all stakeholders, particularly consumers.
The entire economy including the garment industry has been paralyzed by the civil disobedience movement supported by workers in most industries, both private and public.
Myanmar’s garment and footwear production will be severely hit by the diversion of foreign investment. FDI inflows have fueled the growth of Myanmar’s garment industry over the past decade, but the sector itself is prone to diversion of foreign investment or relocation of foreign factories because of its current structure. Myanmar’s export-oriented garment sector is primarily driven by low value-added cut-make-trim (CMT) production. This type of production is prone to relocation. Box 1 presents a simplified supply chain of the garment industry.
Under the CMT production process, factories only supply labor to cut, make and trim designs into completed products. They are provided with product specifications, tech packs, fabrics, patterns, stitching requirements and other details demanded by tier-1 suppliers or international agents in the industry, without direct contact with brands or retailers. Factories are paid a processing fee rather than prices for final products. The CMT process simply comprises assembly and manufacturing activities that require low skills and the factories depend mainly on low wages to stay competitive. As a result, that derives the smallest economic value-add in the entire production chain. In addition, CMT production is sensitive to labor costs and can be shifted to any sourcing country that offers competitive wages. Based on the ILO report[1], in Asia, only garment exporters in Cambodia and Myanmar operate at the CMT stage. Exporters in other countries such as Bangladesh, Indonesia, Pakistan, and Vietnam have OEM capacities, while China, India, and Sri Lanka have OEM and ODM capacities.
The garment industry has been influenced by international fashion brands and multi-national fast fashion retailers. We expect them to seek alternative low-cost sourcing destinations in the region to avoid disruption to business and to minimize reputation risk as well as risks associated with targeted sanctions. For brands and buyers to remain competitive in the red ocean fast-fashion markets, they need to consider several factors when choosing a sourcing country. They include low labor costs, proximity to main consumer markets or source of materials, short lead times, and flexibility to meet fast-changing consumer demands, and environmental, social, and governance (ESG) issues as there is rising awareness among consumers of the industry’s social and environmental footprint. The recent examples are ongoing issues surrounding sourcing cotton from China’s Xinjiang region and fast fashion retailers such as H&M[2]. Therefore, manufacturers in sourcing destinations are expected to be able to respond to emerging global trends as well as changing end-consumer behaviors. By taking buyers’ views into consideration, there is likely to be a diversion of foreign investment from Myanmar to other countries in the region.
Other garment production hubs in the region could become an alternative production destination for Myanmar. Myanmar accounted for about 0.9% of global export value of garment products in 2019, which is relatively small compared to regional peers such as Vietnam with 5.9% share and Cambodia with 1.6%. Given the simple and low value-added process, the CMT production in Myanmar can be easily shifted to other production hubs in the region as Asia is the world’s largest garment producer. They include Bangladesh, Cambodia, China, India, Indonesia, Pakistan, Sri Lanka, Thailand and Vietnam. Based on 2019 data, China is the largest exporter of garment and footwear products with 31% share. According the ILO, the ecosystem and supply chains for garment production in China is fully-developed. However, rising wages and the expansion of higher value-added sectors, mostly labor-intensive manufacturing, have prompted producers to relocate to Southeast and South Asia. Consequently, there is a flourishing garment industry in Bangladesh, Cambodia, Indonesia, Myanmar, Sri Lanka and Vietnam where there is a large pool of cheaper labor and tariff-free access to major markets, particularly the EU and the US.
Cambodia, Vietnam, Bangladesh, and Sri Lanka could receive a windfall from FDI diversion from Myanmar
Cambodia, Vietnam, Bangladesh, and Sri Lanka, respectively, could be key beneficiaries if there is substantial diversion of foreign direct investment triggered by political disruptions in Myanmar. Given the unfavorable investment climate, there is high probability that CMT production activities in Myanmar would be relocated to other Asian countries with similar or higher-value add production, and that are equally attractive foreign investment destinations, especially for garment manufacturing. Cambodia, Vietnam, Bangladesh, and Sri Lanka are potential alternative investment destinations because they have several comparative advantages: (1) efficiency – low labor cost, (2) eligibility for tariff-free access to major markets, and (3) similar export structure and destinations, as well as proximity to China, a main source of raw materials,. These four destinations are among the key garment production hubs in Asia based on ILO data, along with China, India, Indonesia, Pakistan, and Thailand.
We identified the potential beneficiaries of FDI diversion based on a composite index comprising 10 sub-indices: (1) labor cost, (2) free trade agreements or trade privileges in major markets –the EU and the US, (3) export structure, (4) export markets, (5) proximity to China, (6) production specialization, (7) ease of doing business, (8) business start-up costs, (9) trade openness, and (10) political stability (Figure 12).
The export-oriented garment and footwear production sectors in Cambodia, Vietnam, Bangladesh, and Sri Lanka remain a sunrise industry. They account for a substantial share of the respective country’s total export value and register strong export growth. This means that it would be easy to divert sourcing orders to these countries, while buyers would receive at least the same level of competitiveness or attractiveness offered by Myanmar. In Cambodia, exports of garment products accounted for 66% of national exports (by value) in 2019 and the 5-year average growth rate was 10% (CAGR). In Vietnam, GTF exports accounted for about 20% of total exports and growth averaged 9.6% CAGR (Figure 13).
The export structure of and destinations for Cambodia, Vietnam, Bangladesh, and Sri Lanka are similar to Myanmar’s. This would be another pull factor for them to be alternative production destinations. In 2019, Myanmar’s exports to the EU was dominated by garment and footwear products, at more than 90% share. That is second only to Bangladesh with 97%. Cambodia has two major categories of exports to the EU: (1) garment and footwear at 83% share, and (2) bicycles at 8% share. Among the four candidate countries, Vietnam has a relatively wide range of exports to the EU. Exports of electronics and machinery products dominate total exports with 48.6% share, while exports of garment and footwear products hold 23.5% share. China is at the stage of exiting low-end garment production as labor costs are rising and there are other challenges, including the extended trade dispute with the US and the COVID-19 pandemic shock. India and Indonesia have relatively small share of garment and footwear exports and weak export growth, which suggests their garment industry remains small and is still developing. In Thailand, it is a sunset industry (Figure 14).
In term of efficiency, the four candidate sourcing destinations offer favorable wages for manufacturing activities, including for the CMT production, compared to Myanmar. While there a number of factors that influence international brands and buyers in choosing their suppliers and sourcing destinations, wage is one of the key factors, particularly for the CMT production which is labor-intensive. To measure and compare production costs and wages across the region, we refer to the survey conducted by JETRO in December 2020[3]. Although production costs and wages are slightly higher in Cambodia and Vietnam, they remain lower than those in China, India, and Indonesia. In Bangladesh and Sri Lanka, production costs and wage rates are even more attractive (Figure 15).
Lastly, Cambodia, Bangladesh, Sri Lanka, and Vietnam are developing countries that are eligible for trade privileges or tariff-free access to major markets, particularly the EU and the US, similar to Myanmar (Figure 16). Tariff-free access to these major importers is another key deciding factor for buyers in selecting their sourcing destinations to reman competitive in the red ocean fast fashion industry. Myanmar has been unilaterally granted preferential access to the EU market under the Everything But Arms (EBA) scheme since 2011 after the bloc lifted all its sanctions and signed a bilateral investment protection agreement. Over the past decade, this has led to a surge in garment exports to the EU, from only USD0.06bn to around USD3bn in 2019. This reflects the importance of preferential trade arrangements in driving garment exports. And, based on the buyers’ perspectives on the strength of each major garment exporter, Cambodia and Vietnam, have a network of unilateral and reciprocal trade privileges. For example, Cambodia signed an FTA with China in October 2020 which would help the Cambodian garment manufacturers to access cheaper raw materials from China.
Implications for Thai businesses and investors
There is high probability of foreign investment being diverted away from Myanmar to other countries in the region.The following are key implications for Thailand:
1. The diversion could put additional downward pressure on Myanmar’s vulnerable macroeconomic conditions, financial sector, and external sector stability, on top of the domestic political chaos. Amid the persistent current account deficits and suspension of foreign partners’ assistance, the diversion of FDI inflows would severely hurt a country that is dependent on foreign investment, like Myanmar. Over the past decade, FDI inflows have sufficiently financed current account deficits and supported the exchange rate stability. But going forward, if foreign investment drops drastically, the exchange rate could fall substantially. This could cause trouble for Myanmar’s external stability. In addition, the weak currency would put additional upward pressure on inflation through higher import prices as the country also depends substantially on imports. In a country where financial markets are in its infancy with limited tools for currency risk management, businesses are recommended to have risk management strategies in place.
2. Higher risk of severe disruption to bilateral trade and investment between Myanmar and Thailand. The political disruptions and subsequent unrest are likely to lead to an extended period of economic recession in Myanmar, especially against a backdrop of the economy that is already reeling from the COVID-19 impact. This could lead to a substantial drop in Thailand’s exports to Myanmar as we expect domestic demand to be weak.
Although Thailand’s exports to Myanmar is dominated by necessity products (Figure 17), unrest and civil disobedience would disrupt trade flows and transportation. In addition, Thai investors should have measures and strategies to contain risks and costs arising from targeted sanctions imposed by the US and the EU, particularly costs involving cross-border financial transactions.
3. Thai businesses in Cambodia and Vietnam, particularly in garment and electronics production, could suffer from management problems such as shortage of workers, higher wages, and higher costs for other manufacturing elements. On the one hand, the diversion of FDI would be favorable as this could help to boost the post-COVID economic recovery and stimulate domestic demand in Cambodia and Vietnam . On the other hand, greater FDI inflows could also increase competition for local workers, which would push up wages, and possibly lead to shortage of labor, particularly for the labor-intensive garment and footwear industries.
[1] ILO (2017), From Obligation to opportunity: A market system analysis of working conditions in Asia’s garment export industry
[2] For information please refer to, for example, What Is Going On With China, Cotton and All of These Clothing Brands?, the New York Times.
[3] JETRO Survey Report: Survey on Business Conditions of Japanese-Affiliated Companies: Asia and Oceania, December 2020