Trade disruption: will Southeast Asia benefit?

When the US-China trade tensions started, many companies drew up contingency plans with hopes that these need not be activated. They did not want to change their supply chains, unless necessary. They were looking at options to mitigate and manage the cost of the trade sanctions.

More than a year on, with no concrete resolution in sight, business sentiment is leaning on the belief that there is no easy way out. In a recent EY webcast that surveyed 2,300 trade executives, almost three-quarters of respondents expect the disruption to continue for the foreseeable future, while nearly 20 per cent think the disruption is here to stay.

It is important for companies to plan for now and the future. The pressures of business mean that companies should consider alternative options, which may be more disruptive to their supply chains. Increasingly, more companies are utilising capacity and expanding investments in countries other than China.

As some businesses change their supply chains and shift their manufacturing bases from China, Southeast Asian markets - notably Thailand, Vietnam and Malaysia - have emerged as a beneficiary. Is Southeast Asia ready to take advantage of this wave of opportunities?

ASEAN bucking the trend in FDI flows

Recent foreign direct investments (FDI) trends appear to augur well for ASEAN's growth prospects. While global FDI flows declined in recent years, FDI flows in Southeast Asia - at a growth of 5.4 per cent in 2018 - remain resilient. The strong FDI inflow into Southeast Asia is by no means accidental. ASEAN governments have been making a concerted push over the years to attract investments using fiscal policy tools such as tax incentives.

While tax regimes in the ASEAN countries differ from one another, each country has various incentive schemes to provide a wide range of options for foreign investors. These may involve setting up special or designated economic zones, granting additional tax allowances and credits to investments, providing tax exemption and concessionary tax rates, personal tax reductions, as well as indirect tax and customs incentives.

For example, the Vietnam government has a strong focus on attracting innovation-driven and job-generating businesses and introduced a slew of measures, including investment and tax reform, enterprise-government dialogue and e-government enablement, to draw FDIs.

This investor-friendly environment allows Vietnam to capture opportunities as companies shift their supply chains in response to the trade tensions. The first half of 2019 saw FDIs into Vietnam rise by nearly 8 per cent year-on-year to US$9.1b, with the largest chunk of investments in the manufacturing and processing industry. About 1,300 new projects have been granted with investment licences in the first five months this year - a 26 per cent increase year-on-year.

ASEAN governments are conscientious in ensuring that their tax incentives meet international standards on countering Base Erosion and Profit Shifting (BEPS) activities. When the Organisation for Economic Co-operation and Development triggered a review of incentives rules under Action 5 of its BEPS Project to counter harmful tax practices, ASEAN jurisdictions are proactive in signing up to the Inclusive Framework and having their country's incentives reviewed and cleared by the Forum on Harmful Tax Practices. This helps to ensure that their incentives continue to be relevant, accepted and impactful for attracting FDIs.

Yet, ASEAN governments should note that staying attractive goes beyond incentives. At the recent EY Asean Tax Forum, close to 40 per cent of participants had chosen stability and transparency of the political, legal and regulatory environment as the top criteria when deciding on investment locations.

Realising the potential of FTAs

Another bright spot for investors in Southeast Asia is the various free trade agreements (FTAs) available to them. Across Asia, an additional 42 FTAs have been negotiated or completed in the past five years.

In Southeast Asia, there is similarly an expansion of its FTA landscape. ASEAN, at present, has FTAs with Australia and New Zealand, China (mainland), Hong Kong, India, Japan, and South Korea. It is in talks to seal a larger regional trade pact - the 16-country Regional Comprehensive Economic Partnership - which holds massive opportunities for businesses, as the 16 participating countries make up almost half of the world's population and contribute about 30% of global GDP and over a-quarter of world exports.

FTAs can help to drive the increase of exports and bring subsequent benefits of job creation and wage raises. This is important to developing countries in Asia. Yet, the benefits of an FTA will not materialise just because an FTA exists, but only when local companies utilise it. The rate of FTA utilisation has been low historically, so there are opportunities to work on this area. Efforts geared towards this have paid off for some countries. For example, in Thailand, FTA privilege use increased by 15.2 per cent from the year before to reach US$69.6b in 2018.

To drive FTA utilisation, one way is to make professional FTA support, such as FTA consulting, available to companies. Another is to provide systematic analysis solutions for companies to search for tariffs and product-specific rules of origin in an FTA portal. For this, tariff finders i.e., simple search functions that identify a product's FTA benefits and sometimes rules of origin by harmonised system codes, have proven benefits. Ultimately, heightened FTA awareness will enable companies to make smart decisions on growing their international business to its fullest potential.

As companies look to disrupt their supply chains in the new global trade environment, focusing on FTAs to realise untapped opportunities can be a competitive advantage. Combined with a favourable investment climate on their home ground, Southeast Asian companies should be well-placed to thrive as shifts in global trade continue to unfold.

Amarjeet Singh is the EY Asean Tax Leader and Partner at Ernst & Young Tax Consultants Sdn Bhd. Adrian Ball is Partner, Global Trade - Asean, at Ernst & Young Solutions LLP. The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global EY organization or its member firms.