Insight archive for Kelvin Lau | Standard Chartered

Elevated expectations: the next step for the Greater Bay Area

Kelvin Lau — Thu, 05 Sep 2019 08:08:49 +0000

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The Pearl River Delta (PRD) region has long been China’s manufacturing powerhouse, spearheading its economic and financial opening. It is, however, now undergoing a major upgrade and integration to form the world’s largest city cluster called the Greater Bay Area (GBA) linking Guangdong, Hong Kong and Macau.

With the announcement of the GBA Outline Development Plan in February, aligning one of China’s most robust and dynamic regions with the country’s long-term economic priorities, the GBA is expected to drive China’s economic transformation and reshape how companies operate in the region for decades to come. In our 10th annual survey of PRD manufacturers, we spoke to over 250 manufacturers to find out about their growth expectations, relocation and industrial upgrading plans and opportunities and challenges arising from the GBA.

A reality check amid trade headwinds

The dual headwinds of rising US-China trade friction and slowing global growth have impacted clients’ growth expectations for 2019. Almost 80 per cent of respondents see the US-China trade dispute having either some or a substantial impact on their sales and orders in 2019 up from 74 per cent in 2018. It is therefore no surprise that the trade war topped the list of concerns for 2019 followed by Renminbi volatility and China’s slowdown making the top three.

The China-ASEAN connection strengthens

As trade uncertainty looms, moving overseas remains an attractive proposition from a cost-saving perceptive with the added benefit of diversification. Almost two-thirds of respondents are actively considering (or would be willing to consider) moving capacity outside China with about 70 per cent of them saying that the US-China trade dispute has made them more actively consider such a move.

Vietnam and Cambodia are the top destinations for survey respondents looking to move out of China, followed by Bangladesh, Thailand and Myanmar. Labour availability (both quantity and quality) remains the top-cited reason for moving out. This matches our findings that ASEAN economies are likely to be winners (relative to other regions) from lingering US-China trade tensions if production to meet US demand moves from China.

Industrial upgrading faces a short-term slowdown

When asked about their industrial upgrading plans in 2019, more respondents see a ‘deceleration’ than ‘acceleration’ across all key forms, including artificial intelligence, robotics, big data and internet-related investment, citing uncertain economic and business outlooks as the biggest hurdles to industrial upgrading (29 per cent of respondents). This is evidence of the long shadow cast by the US-China trade war.

Long-term GBA optimism

The good news is that despite the headwinds, a strong 64 per cent respondents see the GBA presenting new business opportunities some years down the road. This is up from a mere 49 per cent a year prior, suggesting that all the market talk running up to and following the announcement of the GBA Outline Development Plan has clearly boosted awareness and lifted expectations.

We believe this optimism is based on the GBA’s size and uniqueness, and on GBA-related policies. A decent 63 per cent respondents said that an accelerated launch of GBA policies would have positive impact on their business in 2019. Clients favour more direct and immediate policy reliefs, like ‘more tax cuts’ (72 per cent), ‘more support to SMEs and private enterprises’ (72 per cent) and ‘fee reduction’ (69 per cent), possibly in hopes of geographical- or industry-specific benefits boosting market access.

The Greater Bay Area has a comprehensive plan and strong policy backing but to achieve its full potential, the GBA would require freer flow of capital, goods, people and information, better integration of different legal systems, and functional specialisation via well-defined roles and priorities, among many other things. We believe the need to integrate multiple legal and social systems is a unique challenge and opportunity for the GBA; the key is to uphold the ‘one country, two systems’ principle.

Belt and Road shines through the US-China trade dispute

Kelvin Lau — Wed, 21 Nov 2018 10:29:57 +0000

Launched just five years ago, the Belt and Road Initiative (B&R) has come a long way in a short time. While the rising risk of a prolonged US-China trade dispute looks set to reshape the global trade and investment landscape, we believe that it could fuel B&R’s growth and make it even more important for the long-term development of China and its partner countries.

Belt and Road connections continue to thrive

The latest data indicates that China’s trade with B&R partner countries grew 13.4 per cent in 2017, accounting for over a third of the country’s total trade. In the past five years, China’s direct investment in B&R has exceeded USD70 billion, with an average annual growth rate of 7.2 per cent year-on-year.

B&R’s presence has been felt even more by its partner countries. The continued expansion of South-South trade corridors and rising investment in regional connectivity along B&R routes are key antidotes to US-China trade uncertainty, in our view. China could stand to gain more allies and reduce its dependency on the US via B&R, as trade tensions could persist long enough to reshape the global supply chain.

"China's commitment to expanding Belt and Road in Africa is clear"

About 7 per cent of ASEAN and North Asia’s (ASA) foreign direct investment (FDI) in 2014-16 came from China, while investment from China accounted for 2-3 per cent of GDP in Laos and Cambodia. Meanwhile, China now absorbs a fifth of sub-Saharan Africa’s (SSA) exports, and the region’s imports from China have grown quickly in recent years due to capital-goods imports for B&R projects.

Expanding from East Africa

Beyond Asia, B&R is reshaping investment flows into SSA: Ethiopia and Kenya, which signed up for projects early, are now the top destinations for inbound contract work from China, whereas oil exporters Nigeria and Angola were the top destinations for such work in 2010.

China’s commitment to expanding B&R in Africa is clear based on recent evidence from the China-Africa Cooperation forum, at which Beijing pledged an additional USD60 billion of investment and concessional lending to the region. A notable takeaway from the event was an emerging shift in B&R’s focus beyond East Africa, with trans-regional infrastructure development becoming a key future theme.

Moving to the Middle East, North Africa, Afghanistan and Pakistan (MENAP) region, B&R’s impact has seen the region go from a trade surplus with China to a deficit in recent years due to lower oil prices and rapid growth in B&R-related imports from China. We believe MENAP’s oil exporters would welcome the prospect of China sharing the burden of infrastructure spending, as lower oil prices have hit government revenues.

"Five years of rapid Belt and Road expansion has led to some challenges, but none are insurmountable"

Challenges and risks

Of course, B&R’s fast-expanding scope and the large financial commitments required for its infrastructure projects are creating challenges and risks – but the trade war could be the catalyst that encourages China to address them.

A key growing pain has been the deterioration in trade balances of countries receiving B&R investment. These countries have increasingly needed to import capital goods for projects, but will only see returns at later stages of the investment cycle. Weaker external trade positions increase these countries’ exposure to currency volatility and reduce their policy support options.

B&R projects are also typically costly and often funded with substantial debt, especially relative to the size of many partner countries. The long gestation periods of such projects make debt servicing more difficult.

Worsening fiscal positions in B&R countries, the crowding-out of other viable investment, and rising country risk premia could all become part of a growing debt sustainability problem, although we see low systemic risk at the current stage thanks to bilateral debt relief offered by China.

"If anything, we believe the US-China trade dispute could play a key role in bringing all Belt and Road parties together"

Clearly, no amount of debt relief is enough if countries involved in B&R do not ensure that a project is commercially and socially viable. Improving the transparency of the deals encourages market scrutiny.

We think China should also rely less on bilateral resolution of debt issues, as this may further strain relationships. Rather, China may benefit more from aligning its policies with multilateral conventions, such as having a Paris Club-like collective approach to handling distressed debtors. China could also help domestic companies involved in B&R select appropriate projects and better manage related risks.

US-China trade tensions are unlikely to go away any time soon. In the meantime, prolonged uncertainty is likely to impede global growth, reshape global supply chains, and forge new geopolitical rivalries and alliances. Five years of rapid B&R expansion has led to some growing pains and exposed some inherent challenges, but none are insurmountable, especially if China is to commit to a more transparent and multilateral approach.

If anything, we believe the rising US-China trade dispute could play a key role in bringing all B&R parties together via closer trade and investment links. China gets to cement its new leadership by driving globalisation, while B&R partner countries are likely to get much needed boosts to their infrastructure, production capacity and general competitiveness.

How is Belt and Road making its presence felt?

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One Belt. One Road. One Bank

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Our survey says… China’s tech future lies in the Greater Bay Area

Kelvin Lau — Wed, 01 Aug 2018 11:12:26 +0000

China’s Pearl River Delta (PRD) region is getting ready for its biggest transformation ever.

The region, an industrial powerhouse in southern China boarding Hong Kong, is getting an upgrade with the impending announcement of the Greater Bay Area (GBA) plan – China’s ambitious proposal to transform the PRD region into a technology powerhouse to rival the likes of the San Francisco and Tokyo Bay areas.

We saw evidence that manufacturers in the PRD region are optimistic about the GBA’s prospects. In our annual survey of clients in the region, now in its ninth year, almost half said they see new business opportunities arising from the GBA in the next three to five years.

This comes despite concerns about renminbi volatility and a potential US-China trade war, which topped the list of manufacturers’ concerns.

This file opens in a new windowHow Chinese manufacturers are preparing for tomorrow. Download the report

Rising costs are not not stopping innovation

Our survey indicates that industrial upgrading is already happening amid resilient growth, rising wage costs and labour shortages. Wage growth continues to rebound from a 2016 trough, matching the underlying improving economic cycle. They are expected to rise by an average of 7.7 per cent this year, up from 6.3 per cent in 2017 and a 5.9 per cent trough in 2016 (see chart below).

"Almost half are investing in automation to counter labour shortages and rising wages"

Kelvin Lau Senior Economist, Hong Kong

The labour shortages are a good sign, implying solid economic activity. In fact, it’s driving investment.

Almost half of the respondents (46 per cent) are choosing to invest in automation as a primary response for countering labour shortages and rising local wages. Meanwhile, the percentage of manufacturers opting to move production to cheaper markets – such as Vietnam, Cambodia and Myanmar – fell to a five-year low of 10 per cent; it was 17 per cent in 2017.

This trend is interesting as it bodes well for China’s plans to improve productivity and upgrade technology – something that looks to accelerate under the to-be-announced GBA plan. Encouragingly, seven in 10 (71 per cent) manufacturers plan to increase capital spending this year.

Transitioning into the Greater Bay Area

A key focus of the GBA’s development is the integration of systems and the facilitation of cross-border flows of people, goods, capital and information. The challenge in the case of integrating Hong Kong with the rest of the PRD, therefore, is to make border controls less cumbersome, while preserving the ‘one country, two systems’ principle.

But this shouldn’t detract from the PRD region’s progression, especially the significant investment taking place in large-scale infrastructure projects, such as express rail and road links between Hong Kong and the mainland and the bridge between Zhuhai, Hong Kong and Macau, which will slash travel times in the region and improve labour mobility.

Our survey findings indicate that China’s manufacturing powerhouse is on course to become a centre for innovation, technology and investment, and that the PRD’s transition into the GBA will be far more than a name change. We believe the transition will allow the region to grow into a hotbed of innovation and a bridgehead for China’s Belt and Road (also known as One Belt One Road) initiative.

What does this mean for China? It means the GBA is going to be one of the most exciting stories coming out of the country over the next decade.

Important disclosures regarding content from Standard Chartered Global Research can be found in the Global Research Terms and Conditions.

One Belt. One Road. One Bank.

Turn our Belt and Road expertise into your global opportunity

Find out more

China: reinventing through robotics

Kelvin Lau — Tue, 11 Jul 2017 15:28:53 +0000

Faced with rising wages and labour shortages, China’s manufacturers are reinventing themselves.

That’s according to our latest client survey of 200 China, Hong Kong and Taiwan-based manufacturers of Pearl River Delta (PRD) companies.

More than two-thirds (68 per cent) of respondents plan to increase capital expenditure this year, and most of them plan to boost productivity through automation.

This is good news for China as, in time, the PRD will be able to improve its high-end manufacturing abilities and get its desired industry mix. China could move up the manufacturing value chain by producing goods with greater accuracy and complexity, while maintaining high-volume output at affordable costs.

Robots or relocate?

While most high-end PRD manufacturers are countering cost pressures through robotics, a growing minority of low-end factory owners are more interested than ever in relocating to ASEAN. For the first time, clients looking to move operations overseas overtook those looking to move inland.

Cambodia and Vietnam remain the top destinations, favoured for their ‘better labour supply’. A still-large wage gap with China, fewer infrastructure bottlenecks and strong economic fundamentals should help drive more ASEAN-bound investment over time.

China will be stronger

The findings from our survey, now in its eighth year, support the view that labour shortage and other challenges can be positive for an economy, if they force the right behavioural changes among manufacturers. All this could translate into sustainable margins as well as wage increases over time, which could support a continued rise in services activity and household consumption.

Manufacturers in the PRD, while collectively maintaining their dominance as a global manufacturing powerhouse, have faced persistent challenges over the past decade. The companies which have successfully faced down such challenges have probably emerged stronger from last year’s economic slowdown.

This file opens in a new windowShop talk - China, ASEAN and the future

"What pushes manufacturers to upgrade and innovate themselves will make China stronger"

We have long argued that the PRD bears the brunt of China’s economic transition plan. Only by allowing uncompetitive low-end manufacturers to fail can the region move into advanced technology and services.

We believe that more painful economic transformations are yet to come, but what doesn’t kill the PRD, and instead pushes the region’s manufacturers to upgrade and innovate themselves, will ultimately make China stronger.

Important disclosures regarding content from Standard Chartered Global Research can be found in the Global Research Terms and Conditions.

The unstoppable ascent of the renminbi

Kelvin Lau — Wed, 10 Jun 2015 08:02:42 +0000

Next month marks five years since China launched the renminbi (RMB) on its unstoppable global ascent with the opening of the offshore RMB market (CNH) in Hong Kong.

Today, few companies or investors can afford to ignore China, or avoid dealing in RMB.

Our Renminbi Globalisation Index (RGI) – which tracks the internationalisation of the RMB across markets – has risen more than 21-fold since December 2010, underscoring the overwhelming response to the RMB around the world.

"Almost a quarter of China’s total goods trade is now invoiced in RMB"

People’s Bank of China (PBoC) swap lines, offshore RMB clearing banks and Renminbi Qualified Foreign Institutional Investor (RQFII) quotas span the globe. Most recently, Chile was granted all three by China, and Brazil, Russia and Indonesia are among the candidates to host new RMB clearing banks, in our view.

Almost a quarter of China’s total goods trade is now invoiced in RMB. More than 500 foreign companies and institutions have access to China’s onshore bond market, and we estimate that official reserve holdings of renminbi assets have reached USD 70-120 billion, representing around 0.6-1.0 per cent of global foreign exchange reserves.

Crucial IMF move

The RMB has become so global that – in our view – it now meets the technical requirements for inclusion in the International Monetary Fund’s Special Drawing Rights (SDR) basket.

We assign a 60 per cent probability to SDR inclusion happening later this year, giving the RMB much-deserved recognition as a global reserve currency and driving diversification of global investments into RMB assets.

Strong policy momentum

And the next five years? We expect big things for the Chinese currency. Backed by a strong policy momentum, further capital account liberalisation should result in ‘managed convertibility’ for China by 2018. While some safeguards will remain in place, only short-term speculative flows are likely to be tightly controlled.

By 2020, we expect almost half of China’s goods trade to be invoiced in RMB, while offshore deposits could have reached CNY6 trillion, up from CNY1.8 trillion. Inflows to the onshore bond market could total up to CNY4.5 trillion in five years’ time, even if the IMF delays the RMB’s SDR inclusion.

Important disclosures regarding content from Standard Chartered Global Research can be found in the Global Research Terms and Conditions.

ASEAN set to become Asia’s next Pearl River Delta

Kelvin Lau — Tue, 26 May 2015 07:53:27 +0000

ASEAN is poised to become Asia’s next low-cost manufacturing powerhouse as wages in China’s Pearl River Delta (PRD) factory belt continue to creep up. As China sees waning wage competitiveness, ASEAN stands to gain, with its lower costs and abundant supply of labour over the next 20 years.

ASEAN’s high rate of GDP growth, and rising household affluence, means companies relocating from the PRD could capture a share of a large and growing consumer market.

Our latest survey shows that manufacturers in the PRD – spanning nine cities in China’s Guangdong Province and accounting for 27 per cent of Chinese exports – continue to face persistent labour shortages and rising wages.

"Rising wages reflect China’s improving productivity and the increasing complexity of the products it makes"

At the macro level, this is good news for China, as maintaining a stable labour market and healthy income growth are priorities for Beijing. Rising wages reflect the country’s improving productivity and the increasing complexity of the products it makes. It confirms China’s transition to high-end manufacturing and a more sustainable growth model.

At the company level, however, labour shortages mean more cost for PRD manufacturers.

We spoke to 290 Hong Kong and Taiwan-based manufacturers operating in the PRD, and more that 85 per cent said labour shortages are at least as bad as last year. Migrant worker wages are expected to rise 8.4 per cent on average this year, against 8.1 per cent in 2014, pointing to an overall real wage growth of 6.8 per cent.

Manufacturers relocate overseas

Wages account for over one-fifth of the PRD manufacturers’ total cost base on average, so another year of strong wage growth could materially impact their bottom line. The companies we spoke to also expressed continuing concerns about narrowing margins, tight credit conditions, the still-cautious outlook for orders, and an increasingly volatile Chinese yuan.

Despite these short-term challenges, there are opportunities in China for those willing to adapt. Investing in automation and streamlining processes is the most common response to labour shortages and rising wages among the PRD manufacturers in our survey. This lends weight to the International Federation of Robotics’ estimate that China is set to overtake the EU and North America by 2017 as the world’s biggest user of industrial robots.

But more than 30 per cent of the companies we spoke to are planning to respond by relocating their factories – some further inland in China, and some overseas, with Vietnam and Cambodia the preferred location.

"Vietnam is poised to be one of the biggest beneficiaries, as low-costs manufacturing shifts away from the Pearl River Delta"

As China’s manufacturing sector transforms, ASEAN’s is likely to grow. While wages may still be competitive in some parts of China, particularly the West, the shrinking labour force means that wages are likely to catch up quickly with those in Eastern China.

Vietnam, with its geographical proximity to China, is poised to be one of the biggest beneficiaries, as low-costs manufacturing shifts away from the PRD. The companies in our survey estimate that moving here could give them an average cost reduction of 19 per cent. Cambodia, on the other hand, could yield a 20 per cent saving on wages.

As a whole, ASEAN has strong and varied manufacturing capabilities – from low-cost factories in Cambodia, Laos, Myanmar, Vietnam and Indonesia, to mixed manufacturing and electronics in Thailand, Malaysia and the Philippines, and high value-added production in Singapore.

Take note of China’s experience

To make the most of these diverse strengths, however, ASEAN needs to achieve better integration. In addition to improved infrastructure links, a common regional framework for investment regulation would make it much easier for companies to adopt a pan-ASEAN strategy with operations located across the region.

Many factors have contributed to China’s extraordinary performance as a global exporter, but its strong openness to trade and investment – including the establishment of Special Economic Zones with lower taxes, limited trade barriers and a supportive bureaucracy – has been key, in my view.

ASEAN may well take note of China’s experience, which demonstrates the importance of external trade in improving economic structure and propelling growth. The potential prize is huge. As foreign direct investment continues to shift from China to ASEAN, the region may close its gap with China and become one of the world’s largest exporters.

Important disclosures regarding content from Standard Chartered Global Research can be found in the Global Research Terms and Conditions.

Renminbi’s international march gathers pace

Kelvin Lau — Wed, 10 Jul 2013 23:00:28 +0000

The renminbi’s (RMB’s) long march towards becoming a global currency has just received a major fillip: the State Council has decided to proceed with a plan to make the currency convertible on the capital account, in addition to proposing interest rate reforms and allowing individuals to invest offshore.

These steps cement Beijing’s commitment towards making the RMB an internationally accepted reserve currency and confirm that the endgame is getting nearer.

Given the already rapid take-up of the currency in locations as far apart as Hong Kong, London, Singapore, Taipei, Paris, New York and Sydney, it’s hard to believe that it has been barely three years since China allowed companies anywhere in the world to settle their international trade in RMB.

In 2010, Beijing embarked upon its ambitious programme to make the RMB an international currency, rivalling the clout of the US dollar and the euro, and reflecting its own heft in global trade.

Standard Chartered’s Renminbi Globalisation Index (RGI) shows that the international use of the currency has soared ten-fold since we started tracking it in December 2010.

As of the first quarter of 2013, around 14 per cent of China’s total trade in goods and services was settled in RMB, up from less than 8 per cent at the end of 2011. While this is impressive, it also reveals the tremendous scope for further internationalisation of the currency. According to SWIFT data, the RMB is the world’s 13th most-used international currency, accounting for 0.8 per cent of all global cross-border payments. In comparison, the euro and US dollar together account for almost 75 per cent of all SWIFT payments.

RMB internationalisation is an irreversible process

Reflecting its growing stature, the RMB is being used increasingly by global investors and businesses as a currency for storing wealth and for raising capital. By the end of May, outstanding amounts of offshore RMB certificates of deposit and so-called Dim Sum bonds – RMB-denominated bonds issued offshore – totalled over RMB480 billion or almost 70 per cent of Hong Kong’s total RMB deposit base.

The latest RGI reading adds conviction to our view that RMB internationalisation is an irreversible process that will accelerate further in 2013. Governments across Asia, Europe, the Americas and Africa want to encourage the development of offshore RMB centres in their financial capitals. They see it as critical to future trade with China, which is expected to emerge as the world’s largest economy by the end of this decade. And they are taking policy measures to facilitate this development.

"European multinationals have embraced the RMB amid rising euro-area uncertainty"

Within Asia, Singapore is in a strong position to capture the structural rise in flows between China and the Association of South East Asian Nations (ASEAN) – which we see as the catalyst for the next wave of RMB conversion – much like London has benefited as European multinationals have embraced the RMB amid rising euro-area uncertainty.

In May, Standard Chartered issued the first ever Dim Sum bond listed, cleared and settled in Singapore – right after the city’s RMB clearing services went live. Singapore’s new RMB clearing capabilities will raise awareness among ASEAN companies of the benefits of RMB over US dollar invoicing.

RMB deposits in Hong Kong will reach RMB750 this year

London has signed a RMB200 billion currency swap arrangement with China, providing reassurance that enough RMB liquidity will be made available in the local market, if and when needed. Australia is also supporting the RMB by committing to invest 5 per cent of its reserves in China’s sovereign bonds. Meanwhile, Hong Kong’s recent removal of regulatory impediments will boost its offshore RMB liquidity. We expect RMB deposits in Hong Kong to increase to around RMB750 billion by the end of the year.
Taiwan too is catching up fast, as the use of the RMB for cross-border trade settlement by local businesses soars. In February, Taipei became the fourth-largest offshore centre for RMB settlement, behind Hong Kong, London and Singapore, up from seventh place in August 2012. RMB payments accounted for 12 per cent of Taiwan’s bilateral trade with mainland China in March 2013. This compares with 6 per cent in August 2012, when Taiwan first allowed such trade to be settled in RMB via offshore banking units.

"Are companies and investors ready to capitalise on one of the biggest shifts in the financial markets this century?"

The next leg of the RMB’s international march will possibly be led by international investment, as Beijing continues to encourage two-way capital flows. This complements the recent news that 13 multinational corporations are now allowed to move funds worth up to 30 per cent of their invested capital in China across the border.

For Beijing, this has never been a one-sided business, as internationalising a currency involves more than pushing money offshore; rather, the intent is to create a deeper pool of offshore RMB liquidity.

Next step in the RMB’s long march overseas

The expansion of the Renminbi Qualified Foreign Institutional Investor scheme (RQFII) – a quota allowing overseas institutional investors access to China’s financial market – creates more RMB-denominated investible assets offshore. It exemplifies China’s experimentation model for capital account liberalisation: opening new avenues and, over time, granting larger quotas, expanding eligibility thresholds, and widening the accessibility of various onshore markets.

Expanding RQFII eligibility beyond asset management licence holders in Hong Kong to Taiwan’s financial institutions could be the next natural step in the RMB’s long march overseas. Other global financial centres would be next in line. Are companies and investors ready to capitalise on one of the biggest shifts in the financial markets this century?

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China’s rising wages reach a critical milestone

Kelvin Lau — Tue, 18 Jun 2013 23:00:07 +0000

China has reached its Lewis Turning Point. This is a critical milestone for a developing economy, when urban factories, restaurants and other businesses have to start raising wages faster than the inflation rate to attract rural workers. Until that point, factory wages can remain flat and still attract farm workers living on subsistence incomes at home.

It will take years for China to reach the end of the turning point, when urban and rural wages are equal. In the meantime, real wage hikes for unskilled workers are here to stay.

We saw further evidence of this in our survey earlier this year of manufacturing clients in the Pearl River Delta region, the industrial powerhouse in southern China bordering Hong Kong. The annual survey, conducted after the Lunar New Year holidays, showed that manufacturing wage growth across the region is likely to accelerate to an average 9.2 per cent rate this year, from 7.6 per cent last year.

"The implications of rising wages are huge"

Salary increases are outpacing consumer price inflation, which we estimate will accelerate to 4 per cent this year from 2.6 per cent last year. This extends a long-running trend of rising real wages, and provides further confirmation that China has arrived at the Lewis Turning Point, named after Nobel prize-winning economist Arthur Lewis.

The implications of rising wages are huge. Higher incomes help China move closer towards its goal of becoming a domestic consumption-driven economy and away from its current investment-dependent structure. At the same time, they leave companies across the Pearl River Delta facing three choices: move their factories inland, where labour costs are cheaper; shift plants overseas; or step up automation to save on labour costs. The majority of the companies in our survey say they plan to go for the third option, at least for now, although an increasing number are looking at the other two.

Although the rise in remuneration may be partly driven by minimum wage increases and stricter enforcement of social insurance contributions, the majority of our clients believe that growing labour shortages are the main cause. Fortunately, most companies also say that output per worker has risen faster than wages, a sign that wage growth is backed up by productivity.

Wage pressures have clearly increased over the past 12 months. Relative to last year’s survey, more companies expect salary increases of more than 10 per cent this year, while fewer companies expect no hikes. Almost one-third of the companies surveyed said labour shortages have worsened since 2011.

Our survey results indicate that there were no material job losses during last year’s downturn. They also show that demand from both within China and overseas is picking up again. More than half the companies in the survey said they expect their orders to increase over the next three months; a quarter were operating their plants at full capacity, while the majority were running at more than 80 per cent capacity.

Last year’s slowdown triggered in part by government policy measures to cool the red-hot domestic housing market and exacerbated by Europe’s economic crisis, caused China’s economic growth to slump to 7.7 per cent – the slowest pace in more than a decade. We expect growth to accelerate to around 8.3 per cent this year.

"As salaries rise, only the fittest will survive"

Wage increases are partly government-driven. China’s 12th Five Year Plan aims to raise the national minimum wage by an average of at least 13 per cent each year, faster than in previous years. Localities are free to set their wages above the national level. In fact, provinces have increased minimum wages by an average of 16 per cent this year, following a 20 per cent increase last year. Shenzhen province in the Pearl River Delta tops the list in terms of minimum wage levels, with minimum monthly pay of CNY1,600 (USD258). This has forced more than half the companies in our survey to raise wages more than they had planned, particularly for the least skilled part of their workforce.

As salaries rise, only the fittest will survive. Naturally, larger companies are better able to compete by investing more in technology and securing larger, longer-term orders from overseas customers. Three out of five companies surveyed said they are responding with bigger investments in machinery. They are also investing in process automation tools, outsourcing or partially sub-contracting production, boosting in-house design functions, and hiring employment agencies to find new workers.

Moving production to cheaper locations is also an option, but it is a costly one and such decisions are not driven purely by labour cost considerations. Relocation means losing proximity to suppliers and customers, dealing with new tax and regulatory regimes, and bearing higher transport costs. That said, our survey suggests that companies are increasingly willing to consider moving out of the Pearl River Delta or expanding to new locations.

Around 30 per cent of the companies surveyed said they plan to move factories inland, while 10 per cent said they plan to move out of China altogether. Both of these figures have more than doubled from last year. Within China, many companies in the Pearl River Delta want to move westward to Guangxi province, where wages are 30 per cent lower. Other popular destinations include Jiangsu, Hunan, Hubei and Jiangxi provinces. The favoured overseas destinations are Cambodia, Bangladesh and Vietnam.

Labour shortages have long been a challenge in the Pearl River Delta. But we have found in past years that manufacturing wage trends in the region reflect the national situation because the labour market is highly mobile. A squeeze on the surplus labour pool in the Delta leads to rising inland wages and pushes up real wages for migrants leaving agriculture jobs.

There is also a new element fuelling the wage spiral – China’s ageing workforce. The number of people aged between 15 and 59 fell by 3.45 million in 2012, the first absolute decrease in the labour force since the late 1970s. Add this ingredient to the mix, and it’s easy to see why the Lewis Turning Point has arrived in China a few years earlier than many had anticipated.

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