Malaysia to benefit from trade diversion amid heightened geopolitical tensions

This article first appeared in The Edge Malaysia Weekly, on August 8, 2022 - August 14, 2022.
Nancy Pelosi (Photo by Reuters)

Nancy Pelosi (Photo by Reuters)

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US House Speaker Nancy Pelosi’s visit to Taiwan is the latest trigger point to strain US-China ties again. Calling the visit a provocative move by the US, China fired ballistic missiles and deployed fighter jets and warships in military drills that encircled Taiwan.

The US’ and China’s next course of action will be closely monitored to gauge potential signs of further escalation in the trade war between the two countries.

Pelosi was the highest ranking official to visit Taiwan in 25 years. In 1997, the then US House Speaker Newt Gingrich visited the country but it did not spark Beijing’s anger as bilateral relations between the US and China were improving at the time.

Nonetheless, Sunway University economics professor Dr Yeah Kim Leng sees positive spillover effects in terms of the relocation of industries from China and the US to this region in order to avoid future risks arising from increased US-China tensions.

“There will be positive trade and investment diversion to the Asean countries, including Malaysia. For now, Malaysia is among the leading attractive countries, although Vietnam is still the favourite destination for investors,” he tells The Edge.

Yeah says the semiconductor, telecommunications and technology industries will be the key beneficiaries of investment diversion. There is a need, however, to enhance competitiveness and the policy environment to offset the attractiveness of Vietnam, Singapore and Indonesia as investment destinations.

The Associated Chinese Chambers of Commerce and Industry of Malaysia’s Socio-Economic Research Centre (SERC) executive director Lee Heng Guie says Malaysia and some other countries in the region have already benefited from the first round of the US-China trade war via a trade diversion.

“A lot of investors and multinational companies, whether in China or in the US, have learnt that they need to diversify the risk of concentration. We don’t know if there will be a second round of diversion. The US and China will continue to face geopolitical fragmentation going forward,” Lee explains.

A potential trade diversion to Malaysia will augur well for foreign direct investments, which registered a higher net inflow of RM48.1 billion in 2021, compared with RM13.3 billion in the previous year, following a gradual recovery in the global economy.

In view of the deepening US-China tensions, Yeah says US Treasury Secretary Janet Yellen’s proposal to lower US tariffs on Chinese goods may be put on the back-burner. In April this year, Yellen said such a move could have “desirable effects” on lowering soaring inflation in the US.

Yeah is hopeful the repercussions from Pelosi’s visit to Taiwan will be short-lived. On the US side, mid-term elections will be held in November, while Chinese president Xi Jinping is seeking to secure a third term as leader of the Communist Party later this year during the national congress, which is held once in five years.

“Drastic sanctions are not likely given that China has responded appropriately in terms of conducting the first comprehensive military exercises to demonstrate its power. That is the red line that is not likely to be crossed. As long as an open confrontation is avoided, generally that would be the desired outcome,” he says.

That said, Yeah believes China may impose more sanctions on Taiwan, which will destabilise trade in Southeast Asia as well.

“We may see more prolonged supply chain disruptions on top of the slowdown in the Chinese economy because of the Covid-19 lockdowns. There are concerns that increasing tensions may put downward pressure on China’s trade with Southeast Asia and will dampen the growth prospects in the region.”

As soon as Pelosi left Taiwan, China suspended the import of certain fruit and fish from Taiwan. It also halted the shipments of sand to the island.

Lee is unsure if the military drills are just the first move by China in response to Pelosi’s visit.

“If there is another round of deepening of US-China tensions, leading to uncertainties, definitely it will darken the global outlook. China’s growth has slowed down significantly and the zero-Covid approach has not been abandoned. The war in Ukraine is still ongoing, so the world can’t afford another big shock.”

One of the US’ key strategies to contain China’s rise is through sanctions on the transfer of technology. The recent passing of the CHIPS Act by the US Senate is a good example. Under the act, the US government will set aside US$52 billion in subsidies for the production of high-end semiconductors. However, companies accepting the subsidies will not be allowed to expand their chipmaking capacity in China or any other foreign country for 10 years.

Last Monday, Reuters reported that the US was considering limiting shipments of American chipmaking equipment to memory chip producers in China that make advanced semiconductors. The curbs would stop chipmakers such as South Korean giants Samsung Electronics and SK Hynix,  which have or are building plants in the US, from shipping new technology tools to factories they operate in China.

“The CHIPS Act is a micro strategy to curb China’s access to advanced technologies. It will spur China to intensify its R&D and ability. Given the sheer size of resources, China will be able to catch up. The priority for China is to reduce dependency on Taiwan and the rest of the world,” says Yeah.

What is also of concern is technology decoupling, to the extent that a country will have to choose a side, resulting in a much more inefficient global system due to the fragmentation, he notes.

“It will be disruptive and force the reconfiguration of the supply chain and future demand pattern. Investments will also be reshaped by the worsening split. Aside from political polarisation, it will disrupt businesses and social economic activities. “We may see global growth slowing down and it will be negative for the region despite its being the most dynamic region in the world,” Yeah adds.

Meanwhile, Malaysia Semiconductor Industry Association (MSIA) president Datuk Seri Wong Siew Hai is worried about the risk of supply chain disruption following China’s military exercises.

“Even if there is no war, if logistics are blocked, it will also cause supply chain disruption,” he stresses.

Commenting on the US’ CHIPS Act, Wong says Malaysia has the chance of grabbing investment opportunities as it has a favourable ecosystem, including talent, infrastructure and a business-friendly environment.

“In a way, more companies will be looking for investments outside of China. Then we would have a good opportunity. Of course, we need to compete with countries like Vietnam, Thailand, the Philippines and so on.”

MIDF Research economist Zafri Zulkeffeli foresees a pick-up in re-export activities in Malaysia with the new act.

“In fact, we saw a strong pick-up in re-export activities in Malaysia during the Trump-led US-China trade war in 2018 and 2019. We expect a similar trend to persist in the near term with strong re-export patterns.”

He warns, however, that if the trade war worsens, emerging countries, including Malaysia, which depend on the external trade sector will experience negative consequences in the form of weak export growth and high input inflation.

 

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