In the wake of the supply chain disruptions due to the ongoing Covid-19 pandemic, Japan has earmarked over US$2bn to encourage its companies under FY2020 Primary Supplementary Budget to move operations out of China and relocate production bases across a number of countries, including those of the Association of Southeast Asian Nations (ASEAN).

However, completely decoupling from China is not going to be easy for Japanese companies, says GlobalData, a leading data and analytics company.

The Covid-19 pandemic has resulted in severe supply chain disruptions in early 2020 for Japanese companies. For instance, Nissan had to temporarily stop production at one of its domestic plants because of the delay in parts supply from China.

The new national security law of Hong Kong passed by China in June 2020 coupled with recent territorial disputes in the South China Sea has reignited the demand in Japan for the country’s companies to lower dependency in China.

As a result, Japan is concerned as more than 1,400 Japanese companies operate out of Hong Kong. The city accounts for about 2.5% of Japan’s total trade in 2019, making it one of top 10 trading partners. Japan is also closely monitoring the China-United States trade war, as possible higher import tariffs from their Chinese production units into US could also exert pressure on Japanese companies to shift production base.

Gracio Benher, Practice Head at GlobalData, comments: “Even before the current geopolitical stand-off between China and Japan, some Japanese companies in China have been mulling about cutting down their Chinese presence, following the increased labor costs and unfavorable exchange rate between Japanese Yen and Chinese Yuan.”

For Japanese companies, a total pullout from China has its own set of challenges. Japanese companies have over US$100bn investments in China, and one of the prerequisites to gain access to the Chinese market is to invest in local supply chains. In addition, China, which is the world’s second largest economy, accounts for about one-fifth of Japan’s exports.

Benher explains: “At a time, when the global business outlook looks grim, Japanese companies would not want their Chinese market position to be undermined by hasty exit plans. For some Japanese companies, China is the single largest market for their products, which could leave with no other option but to remain in China. Other major challenges include cost-related to shifting operations and expansive domestic supply chain dependencies for industries such as automotive, and higher probability of a short-term operational disruption.”

Interestingly, Japan continues to engage with 10 member states of ASEAN—Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam, even as uncertainty surrounds around the signing off the Regional Comprehensive Economic Partnership (RCEP) deal comprising all 10 Southeast Asian Nations and their top five trading partners Australia, China, South Korea, Australia, and New Zealand in the current environment.

Benher concludes: “Japanese companies can establish new supply chains across ASEAN member states, without totally diluting their dependence on China. This will provide supply chain flexibility in the event of any future exigencies.”