Strategy Note /

China's pragmatic zero-Covid spike and Foxconn riot hit global manufacturing

  • China's more pragmatic 'zero-Covid' inevitably spikes infections: witness lockdown in Zhengzhou and Foxconn factory riot

  • Reminder of China's deep links with global supply chain, particularly top alternative manufacturing location Vietnam

  • 'China +1' manufacturing is positive long-term theme for investors in other EMs; short term, China disruption hurts all

China's pragmatic zero-Covid spike and Foxconn riot hit global manufacturing
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
24 November 2022
Published byTellimer Research

Covid-associated disruption has demonstrated multiple times the interconnection of China with the global supply chain. The shift to a more pragmatic zero-Covid policy is resulting in higher new Covid infections and implies there will be no quick and wholesale exit from Covid lockdowns, particularly in the absence of the deployment of mRNA vaccines.

Long term, this disruption drives manufacturing investment in alternative countries but, short term, it causes pain for global manufacturing, particularly in the rest of Asia, given the reliance on Chinese intermediate inputs.

Consequently, 'China +1' is a positive theme for investors in other emerging markets with a long-term, or multi-year, timeframe, not a short-term one.

Covid spike and Foxconn factory riot

Reports and video footage, which emerged on 22 November, of protests, in some cases violent, at Foxconn's Zhengzhou factory, which employs 300,000 workers and where 80% of Apple's advanced phones are manufactured, provide the latest example.

On the same day, local authorities in Zhengzhou announced a Covid lockdown in urban areas from 25 to 29 November.

Protests between workers and local police, company guards and management are over alleged grievances ranging from fears of rising Covid infections in a 'closed loop' operating environment – ie workers stay onsite without outside contact to minimise Covid infection, but this can actually exacerbate infection within the bubble – as well as low pay and access to medication.

Foxconn, owned by Hon Hai Technology of Taiwan (Bloomberg code: 2317 TT) issued a press release on 23 November, acknowledging the dispute but refuting the allegations that there were any shortfalls in contractual allowances or that new hires are co-located with Covid infected workers.

China cases spike after more 'pragmatic' zero-Covid policy

Most manufacturing alternatives are still linked with China supply

This sort of disruption is a reminder of why, for the foreseeable future, the theme of new investment in 'China +1' manufacturing in cheaper locations, particularly in India, should it get back on the reform track, as well as the rest of Asia and Africa, is not a simple one.

It is correct that multinationals will diversify their reliance on Chinese manufacturing by locating capacity elsewhere – although, even as Foxconn itself admits, no alternative, apart from India should it address barriers to foreign investment, can come close to its scale – but that is not to say that they can easily escape the reliance on intermediary inputs from China.

  • Vietnam, our top pick as a beneficiary of China +1 investment, demonstrates this, with imports from China equating to over one-third of pre-Covid GDP.

  • Malaysia, the Philippines and Singapore have over 10% of GDP exposure.

  • Bangladesh, Korea, Taiwan and Thailand have between 5% and 10% exposure.

  • India, Indonesia, Mexico and Turkey have below 5% exposure.

  • Chile, Kazakhstan, Pakistan and South Africa also have 5% to 10% exposure, but this is likely driven by machinery and infrastructure-related imports, rather than intermediate manufacturing inputs.

  • The UAE has 9% exposure, but this is likely mainly for re-export, rather than for use in locally based manufacturing.

China deeply interconnected with Asian EM manufacturing

Long term, concerns over China, whether driven by rising costs, Covid policies, US trade friction or ESG considerations – however inconsistently applied at the country level – should drive investment in manufacturing elsewhere, benefiting the recipient countries in their quest for the elixir of manufacturing export-led growth. But, short term, disruption in China hurts all of the likely beneficiaries of China +1.

Cheap manufacturing-exposed EM

Apart from China itself, relatively cheaper exposure to manufacturing – with at least a 15% contribution to GDP – is found in the following emerging equity markets:

  • Bangladesh,

  • Hungary,

  • Korea,

  • The Philippines,

  • Poland,

  • Vietnam.

Relatively expensive exposure is found in these:

  • Indonesia,

  • Mexico,

  • Romania,

  • Taiwan,

  • Turkey.

Manufacturing exposure in EM equities cheap in China,  Bangladesh, Hungary, Korea, Philippines, Poland, Vietnam