In the May monthly note covering the need to address income inequality and weak domestic demand across Asia, I noted that: ‘To absorb surplus export capacity as DM demand growth remains depressed, Asia will be forced to broaden domestic consumption patterns via accelerating minimum wage levels…with the added benefit of strengthening social cohesion and sustaining political legitimacy for local elites.’ That process is well underway, but isn’t without risks. Following protests last month, the governor of Jakarta agreed to raise the city’s monthly minimum wage for 2013 by 44% to $230. This comes on the heels of similar moves earlier by six other provincial governments who approved a hike in minimum wages of up to 26% for next year (compared to the 10% average seen this year) and other provinces are expected to follow.
While higher wages will narrow Indonesia’s cost advantage over its Asian peers (the monthly minimum wage in Bangkok is $195, for example), it’s unlikely to reverse the recent FDI surge, a large part of which is directed toward domestic consumers in any case – FDI in Indonesia jumped 22% in Q3 y/y to a record $5.9bn. However, while I’ve been happy to overweight Indonesian equities this year, the implications of a further consumption surge for the IDR, inflation and trade account in 2013 are ominous unless the country’s commodity export prices rally soon and/or fuel subsidies are cut.
Indonesian consumption has already been growing at above trend so far this year, and accelerating wage hikes next year will drive an even faster rise. Which is all great for the domestic demand theme, but you can have too much of a good thing, and certainly too soon. Brazil for instance offers a cautionary tale of excessive domestic consumption growth gone horribly wrong, in the absence of structural reform and infrastructure investment, with a crashing currency as the solution. YTD at end October, Indonesia’s trade balance was in deficit by $561m, compared with a surplus of $23.6bn in the same period last year. In 2013, there is a growing risk that either inflation lets rip, or the trade deficit turns ugly. In either case, BI would be forced to hike rates to defend the IDR.
The rapid wage hikes are a shock for local low margin local manufacturing, but as in China, there is still a wide minimum wage discrepancy between regions which allows room to relocate within the country. For capital intensive industries such as metals, autos and chemicals, average labour costs are a small percentage of input costs. The consumption boost will be inevitable in coming quarters; Thailand, which lifted wages across the country by up to 40% in April this year, saw private consumption rise 2.2% in Q3, accelerating from 0.9% in Q2. Across ASEAN, Malaysia is set to introduce minimum wages for the first time in 2013, while Vietnam is set to increase its minimum wage by 25-30% for the private sector next year.
In China, average salaries in USD terms in the coastal regions are still 50-60% higher than those in Jakarta and ‘Pull Through’ wage inflation across ASEAN from the demographic shift in China underpins the domestic demand investment theme, but ultimately remains dependent on faster local productivity growth as China’s accelerates back to double digits if it reforms SOEs decisively. It also requires higher investment to remove growth bottlenecks and avoid a destabilising deterioration in inflation and trade balances, the latter already evident in Indonesia, only partly because its terms of trade have reversed with weak commodity export prices. October exports plunged 7.6% y/y, following a 9% y/y slide in September. Imports surged nearly 11% y/y, led by oil and gas purchases, boosting the deficit to a new record monthly peak. Subsidized energy comprises about 55% of the trade deficit, and all those new motorcycles on the road next year as a result of these wage rises won’t help.
‘If Australia is on the wrong side of China’s medium term structural growth shift, Mexico rather than any Asian country will probably be the biggest winner from rising Chinese wage costs. The all-in cost for an average factory worker in the Chinese coastal industrial zones is now only 10-20% cheaper than for a Mexican and that gap will be eliminated in the next 18mths. Low wage growth owing to strong labour force growth (the product of favourable demographic trends and migration back from the US of illegals), and an undervalued currency despite this year’s rally have boosted Mexico’s attractions as a competitive hub for US manufacturing, as evidenced by the country’s rising share of US merchandise imports, now at 13% or just behind China, and a 10-year high trade balance.
The country’s new President has long campaigned for structural reform of the country’s labour laws, tax code, and liberalisation of the state owned PEMEX dominated energy sector, which would boost FDI and other capital inflows medium-term. This is exactly the reform path which ASEAN countries will have to take to keep pace if they are to benefit from low margin, labour intensive manufacturing migrating from China, after a very lacklustre productivity performance in recent years, largely a function of the sustained underinvestment post the late 1990s crisis, with investment/GDP ratios still well below levels seen 15 years ago from Thailand to Malaysia.
Over the rest of this decade, it’s not in China’s interest to remain as the low-cost and low economic-value-added manufacturing hub for global OEMs. To advance decisively into middle- income status before demographic decline hits hard, it clearly needs to derive a greater portion of its economic output from the high-value-added manufacturing and service sectors, which is the hugely challenging task occupying the new leadership. As that process unrolls, it will have disruptive impacts across the region on relative terms of trade and potentially exacerbate structural weaknesses e.g. for Indonesia, with weaker commodity export prices, higher domestic wage inflation and over time a weaker currency pushing up import prices and widening balance of payment deficits. While mass consumer plays will get a further boost from a region wide leap in mandated incomes for the bottom 25% of households (even Singapore will eventually succumb), in terms of relative valuation and the unmet investment needs to sustain high trend growth rates and higher wages, ASEAN infrastructure and construction exposure looks a better medium term bet.