Economist’s Note

July 30, 2019

By Michael Kokalari, CFA

Chief Economist

Huyen Tran
Research Manager

Is Vietnam “Too Full” For More FDI?

Some recent articles in the international business press lament that FDI inflows to Vietnam
prompted by the US-China trade war are pushing up Vietnam’s factory wages, inflating industrial
land prices, and straining the country’s logistics capacity. The CEO of a top Hong Kong-based
garment manufacturer captured the crux of these articles with his comment in a widely read
Bloomberg article that “Vietnam is full, completely full.” 1

Although such articles seized the attention of some analysts and investors, Vietnam’s industrial
capacity is far from being fully utilized. The prices of production inputs such as land and labor have
risen somewhat, as savvy locals take advantage of the surge of interest by foreign companies to
relocate production to Vietnam 2, but:

1) The amount of industrial land currently available in Vietnam is sufficient for FDI companies
to nearly double their investments in the country 3

2) Vietnam’s seaports and airports still have 20-25% spare capacity, and are in the process of
boosting capacity by another 25-50% 4

3) Less than 10% of Vietnam’s workforce is currently employed in the FDI sector
Further to that last point, over 40% of Vietnam’s workforce is still employed in the agriculture sector
according to the World Bank, so Vietnam is far from its, “Lewis Turning Point”, at which a country
runs out of workers who can move “from the farm to the factory” to fuel industrialization 5.

Also, the “Vietnam is full” narrative is being propagated by companies in “low value-added”
industries such as garments and furniture manufacturing. A modest increase in wages typically
prompts producers in those industries to move onto the next low wage destination (i.e., Cambodia,
Bangladesh, etc.), in order to sustain their razor thin profit margins. The garment company
mentioned above is well-known for aggressively encouraging its suppliers to minimize their costs.

Finally, Vietnam’s manufacturing sector still only contributes about 20% of the country’s gross
domestic product, but the manufacturing industries of every other Asia Tiger economy contributed
over 30% of those countries’ GDPs at their peaks, so Vietnam has a long way to go before its
industrial sector reaches its potential.

The Trade War Impact on Vietnam Is Still Modest…But Increasing

Several articles and research reports published over the last year assert that Vietnam is the biggest
beneficiary of the US-China trade war. The recently published articles in the international business

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press mentioned above go one step further, and also assert that some existing FDI companies are
now being “crowded out” of the local labor market because newly arriving FDI companies are
aggressively bidding up input costs (wages, rents, etc.) in certain local geographies, such as in the
Binh Duong industrial suburb of HCMC.

VinaCapital was among the first to publish reports on the beneficial impact of the trade war on
Vietnam’s economy, but we believe that the immediate impact of the trade war is being overstated
because of the long lead time that it takes companies to relocate their production facilities from
China to Vietnam. This is one reason we do not ascribe to the “Vietnam is full” narrative of the
articles mentioned above.

That said, the trade war has prompted several companies to announce their intentions to move to
Vietnam and/or to explore moving to Vietnam, and it has led to a four-fold surge in newly registered
FDI from Chinese companies to Vietnam in the first half of this year (albeit from a small base) to
USD1.7 billion in 1H19.

Figure 1: FDI companies have already MOVED a part of their production from China to Vietnam

According to industry research, foreign companies in the following sectors are considering moving
production from China to Vietnam (ranked in order):

1) Electronics
2) Healthcare Equipment (medical devices, etc.)
3) Garments & Footwear
4) Auto Parts (tires, etc.)
5) Renewable Energy Equipment (solar panels, etc.)
6) Petrochemicals

According to another survey by Standard Chartered Bank of over 250 Chinese manufacturers in the
Pearl River Delta that was published earlier in July, the companies that have already actually moved
or are in the process of moving production from China to Vietnam as a result of the trade war are

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primarily low-end producers in sectors such as textiles and garments, which is not surprising given
that about 20% of Vietnam’s exports to the US are of garments and footwear.

Since firms in low-value added industries such as garments and furniture were the early movers to
relocate their factories to Vietnam as a result of the trade war, we are also not surprised that
competition for production inputs (including labor) between incumbent and newly arriving firms in
those industries has squeezed already tight profit margins, and resulted in the laments captured in
the articles mentioned above.

However, margin pressures for those firms in low value-added industries will intensify as Vietnam
continues to move up the value chain, and as firms in higher value-added industries, such as some of
those mentioned in the unpublished, joint public-private survey above, relocate their production to
Vietnam.

Further to that last point, about 70% of the Chinese manufacturers surveyed by Standard Chartered
are considering moving production out of China as a result of the US-China trade war 6, and Vietnam
is their most preferred destination. According to the bank’s annual survey, only 6% of the firms that
are motivated to move their production out of China as a result of the trade war had actually done
so, and only another 20% were actually in the process of moving some of their operations out of
China.

Figure 2: FDI companies are CONSIDERING moving part of their production from China to Vietnam

This reinforces our belief that Vietnam’s economy will benefit for years to come from the on-going
trade tensions between the US and China, as does the recent news that: 1) Samsung will close its last
factory in China, while simultaneously progressing the development of a new 3,000 employee R&D
center in Hanoi, and; 2) Apple asked its suppliers to investigate moving 15-30% of their production
capacity to Southeast Asia, with Vietnam a favored location, according to Japan’s Nikkei newspaper.

Finally, the fact that the growing backlog of prospective FDI firms in high value-added industries such
as electronics and medical devices will eventually make it uneconomic for companies in low value-
added industries such as garments and furniture to manufacture in Vietnam is an issue that every
other “Asian Tiger” country encountered in the course of its economic development.

Vietnam’s transition to higher value-added industries will help boost the income of its emerging
middle class citizens, as well as the skills of is burgeoning white collar work force, but factory wages

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in Vietnam are still two-thirds below those in China, and Vietnam’s ~7% annual wage inflation is only
slightly above China’s 5% wage inflation, so we do not expect an abrupt exit of foreign FDI firms in
low value-added industries from Vietnam.

What if FDI Floods from China into Vietnam?

China’s economy is 55 times bigger than Vietnam’s, and the USD2.1 trillion of FDI China that has
attracted is 15x Vietnam’s USD145 billion total stock of accumulated FDI inflows 7.

We’ve estimated what would happen if an additional USD105 billion of FDI (i.e., 5% of China’s total
stock of FDI) were to flow from China to Vietnam over a five-year period. To be clear, we are
indifferent if the source of these new FDI inflows to Vietnam (that would augment existing inflows) is
attributable to the relocation of foreign companies that are currently operating in China, or from
Chinese manufactures.

We estimate that:

• Annual FDI inflows to Vietnam would likely surge from USD20 billion next year to USD50
billion, five years later
• The growth rate of annual FDI inflows would double from ~10% per year to 20% per year
• The wage growth of FDI manufacturing workers would increase from 7% per year to 12% per
year

The inputs we used to calculate these estimates include the facts that: 1) Vietnam’s total stock of FDI
is currently increasing about 9% annually (driven by ~10% growth of annual FDI inflows), and 2) the
above-mentioned inflow of an additional USD105 billion of FDI over five years equates to an
additional 13% per year of increases total FDI, leading to the simplistic assumption that Vietnam’s
total FDI stock would increase by 21% per year going forward.

However, we do not believe it is feasible for the total amount of FDI in Vietnam to increase at a 21%
per year pace, so we have arbitrarily assumed that about half of the existing annual FDI inflows
would be “crowded out” by new, trade war prompted FDI inflows from firms operating in China. In
that case, the total stock of FDI would increase by about 16% per year, which equates to annual FDI
inflow increases of about 20% per year over the next five years.

The reason we have focused on the rate that Vietnam’s total would likely increase each year in the
scenario outlined above is because the annual increase in total FDI stock is closely linked to wage
growth, and to the increase in the utilization of other resources used by the FDI sector, such as
industrial land and logistics capacity.

FDI workers’ wages in Vietnam increased at .75x the rate that the country’s total FDI stock grew over
the last six years. We are assuming that Vietnam’s FDI stock will increase at a 16% annual rate over
the next five years, which implies 12% annual wage growth for FDI factory workers going forward.

The close relationship between wage inflation and increases in Vietnam’s total stock of FDI are due
to the close link between increases in Vietnam’s FDI stock and the total number of workers
employed by the FDI sector. For that reason, we assume that annual increases in the country’s FDI
stock are also a good proxy for the increased demand of other production inputs by the FDI sector,

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such as industrial land, logistics capacity, and even the steel structures required to produce
warehouses, factories, etc.

In the scenario we have hypothesized, Vietnam’s total stock of FDI would surge by ~130% over five
years driven by the relocation of 5% worth of China’s FDI stock to Vietnam, coupled with existing FDI
inflows to Vietnam being cut in half due to “crowding out”.

Vietnam has sufficient industrial land available to cope with about half of this increase, and there is
probably ample farmland that can be readily rezoned to absorb the remaining increase in FDI
investment. However, the logistics capacity increases that are currently in progress will only be
sufficient to cope with less than half of this increase in Vietnam’s total FDI, so the government
urgently needs to accelerate the development of the country’s physical infrastructure in order to
absorb those inflows.

Finally, we note that the .75x ratio between Vietnam’s increases in FDI workers’ wages and the
annual increase in the total stock of accumulated FDI comparable to the 0.6x ratio that persisted in
China when it was at a similar stage of development as Vietnam, as can be seen in the table below.
We believe that Vietnam’s ratio is a bit higher than China’s was at a comparable stage of
development because Vietnam’s ~8% of GDP FDI inflows are more than double China’s FDI inflows
(as a % of GDP) at that time.

Figure 3: China’s three phases of FDI absorption

The other thing that can be seen in the table above is that China experienced three distinct phases of
FDI absorption. The impact that surging FDI inflows had on wage inflation increased significantly in
each phase because as the total stock of FDI increased, and as the country industrialized, the
number of freely available workers who could move, “from the farm to the factory” declined.

Which Listed Stocks Benefit From FDI Inflows

We conclude this report by highlighting some listed stocks that we believe would benefit from a
surge in Vietnam’s FDI inflows.

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 Figure 4: New demand created from the surge of FDI inflows and stocks impacted

Finally, note that some of the companies in the table above have relatively small market
capitalizations, and would benefit significantly from increased FDI inflows such as industrial park
operator Vietnam Construction and Import-Export JSC (VCG). However, others have large market
capitalizations and would only experience a modest pick-up in their overall revenues from surging
FDI, such as building materials companies like Hoa Phat (HPG), Hoa Sen (HSG), and Ha Tien 1 (HT1).

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 Endnotes

1
https://www.bloomberg.com/news/articles/2019-07-14/nike-supplier-pivots-away-from-vietnam-after-exiting-china

2
One article in the South China Morning Post claimed that industrial land prices in HCMC’s industrial Binh Duong suburb
soared 80% over the last three years, but our sources tell us the figure is closer to 30%.

3
Vietnam currently has 95,000 ha of industrial land, 66,000 of which are already occupied, and 40,000 of which are
occupied by FDI companies, according to MPI, and there is still ample farmland that can readily be converted to industrial
use.

4
Notes: 1) Most of the new air cargo capacity is being added in northern Vietnam, near the burgeoning electronics
industry, and 2) the road infrastructure to access the new container seaport capacity being developed is still in serious
need of upgrading.

5
Notes: 1) China passed its Lewis Turning Point around 2015, and 2) the productivity of Vietnam’s agriculture sector is still
only half that of Thailand’s because most farms are sub-scale, so employment in the sector has been steadily declining
(more than half of Vietnam’s workforce was employed in the agriculture sector a few years ago).

6
Notes: 1) the US-China trade war tops the list of concerns of Chinese firms surveyed, followed by China’s economic
slowdown and the Yuan’s volatility, because 80% of firms said they have suffered lower orders/sales as a result of the trade
war, and; 2) in addition to side-stepping the trade war by relocating, companies expect to cut their costs by about 20% by
moving production out of China.

7
The differential between the two figures reflects the fact that Vietnam has courted FDI companies more aggressively than
China.

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