Wednesday, March 28, 2012

Bangladesh is the next hot spot in RMG sourcing. What about Nepal?

Due to declining profit margins and capacity constraints in China, investors are looking at other lower costs countries for ready-made garments (RMG) investment, production and sourcing. A recent survey by McKinsey found that 86 percent of the chief purchasing officers (CPOs) in leading apparel companies in Europe and the United States planned to decrease levels of sourcing in China over the next five years. McKinsey surveyed 28 European and US chief purchasing officers at leading apparel companies from September to November 2011. They account for US$46 billion in total apparel-sourcing value and 66 percent of all apparel exports from Bangladesh to Europe and the United States. McKinsey also conducted a telephone survey of more than 100 local suppliers.

CPOs identified Bangladesh as the next hotspot because the “country’s ready-made-garment industry identified solid apparel-sourcing opportunities there”. The top hotspots indicated by CPOs are Bangladesh, Vietnam, Indonesia and Cambodia. RMG exports of Bangladesh accounted for 13% of GDP and 75% of total exports (of US$15 billion) in 2010. McKinsey forecasts export-value growth of 7 to 9 percent annually within the next ten years, suggesting that the market will double by 2015 and nearly triple by 2020.

Our survey of chief purchasing officers found that European and US companies that focus on the apparel market’s value segment plan to expand the share of their sourcing from Bangladesh to 25 to 30 percent by 2020, from an average of 20 percent now. Midmarket brands, which generate about 13 percent of their sourcing value in Bangladesh, plan to increase that share to 20 to 25 percent over the same period. While growth in current product categories will drive some of the increase, 63 percent of the chief purchasing officers said that they want to expand into more fashionable or sophisticated items, such as formal wear and outerwear.

What is so attractive in Bangladesh?

  • Attractive prices
  • Competitive price levels due to increase in efficiency to offset rising wage costs (labor cost is expected to rise by 30% in the next three years. Wages were raised for the first time in 2010 after revision in 2006)
  • Supply capacity to produce RMG. The McKinsey study notes that “with 5,000 factories employing about 3.6 million workers (of a total workforce of 74.0 million), Bangladesh is clearly ahead of other Southeast Asian suppliers in this respect.” Indonesia has about 2450 factories, Vietnam 2000, and Cambodia 260 factories. Bangladesh’s exporters are known for supplying good quality and large order sizes for the value and lower mid-market. They are now expanding into more value-added services.
  • Favorable trade agreements: EU-GSP rules on duty-free imports of garments to include products with two-stage processing made sourcing from Bangladesh more attractive.

However, challenges remain in Bangladesh for apparel companies seeking to investment in Bangladesh.

  • Infrastructure: Transportation bottlenecks leading to inefficient lead times for garments and delay deliveries to customers. Energy supply is also a concern, but the government has prioritized improvement in this area. Lead time for sea freight is increased by about ten days due to the lack of a deep-sea harbor. Productivity at Chittagong port suffers from inefficient processes (such as manual processing), limited crane capacity and strikes.
  • Compliance: labor and social-compliance issues; environmental compliance being also looked upon by purchasing officers
  • Supplier’s performance and skilled workforce: Suppliers’ productivity must improve to mitigate the impact of rising wages (and also to close gaps with other sourcing countries); lack of investment in new machinery and technologies; insufficient size of skilled workforce (middle management)
  • Raw materials: Lacks a noteworthy supply of natural or artificial fibers; dependence on imports creates sourcing risks and lengthens lead times
  • Economic and political stability: Political unrest, strikes, and the ease of doing business are major concerns for investors. In the survey, about half of the chief purchasing officers interviewed stated that they would reduce levels of sourcing in Bangladesh if its political stability decreased.
  • Realizing the potential: Government, suppliers, and buyers need to work together to realize the potential of Bangladesh’s ready-made-garment market.

What is changing in China?

  • Labor shortages: Workers in costal regions are moving on to more attractive industries and better jobs, creating shortage of labor for RMG sector.
  • Increase in wages: Wages in coastal areas are rising amidst tight labor supply market.
  • Capacity limit for western buyers: Chinese producers are switching to serving the rapidly growing and more profitable domestic market. The government is supporting more value-added industries to rebalance the economy. It means Western buyers are reaching their limits in sourcing RMG from China.

Nepal versus Bangladesh

Now, this presents a problem for the already troubled RMG sector in Nepal. Nepal’s RMG export was Rs 11.12 billion in 1999/00. In 2010/11, it reduced to Rs 4.08 billion (total export was Rs 64 billion). The average annual growth of RMG exports over 1999/00-2010/11 was –1.89%. The growth rate of RMG exports declined for five consecutive years beginning 2003/04. Looking at the numbers in the table below and the choice of investors (i.e. Bangladesh), Nepal’s RMG industry’s prospect look gloomy. Unless we fix the supply-side and structural constraints, our RMG industry is further doomed. See an earlier post for the reasons for the downfall of Nepal’s RMG industry.

Nepal's export of RMG
Fiscal year Rs billion Growth rate
1998/99 8.15
1999/00 11.12 36.44
2000/01 11.62 4.50
2001/02 7.96 -31.50
2002/03 12.02 51.01
2003/04 10.22 -14.98
2004/05 6.72 -34.25
2005/06 6.58 -2.08
2006/07 4.71 -28.42
2007/08 3.32 -29.51
2008/09 4.35 31.02
2009/10        3.76 -13.61
2010/11        4.08 8.67

Nepal sends RMG to mainly USA (19.58% of total RMG export in 2010/11), France (16.59%), UK (14.93%), India (10.64%), Germany (8.80%), Japan (4.98%), Canada (4.42%), Italy (3.95%)and Spain (3.28%). With slowdown of import demand in almost all of these countries (save India), there is a high possibility that our RMG exports will further suffer, if corrective measures to boost factor cost and retail price competitiveness are not taken immediately. Meanwhile, Bangladeshi exporters see China, India, Australia, Brazil and South Africa (along with traditional destinations such as Germany, US, Japan, UK, and Canada) as new destination markets. Looks like Nepal is competing in similar product range (with Bangladesh enjoying more efficiency and productivity) in similar destination markets. Nepal is bound to lose to Bangladesh.

Our RMG businessmen are hoping that investors will come to Nepal to exploit the expanding opportunities in India and China. However, most of the CPOs feel that Bangladesh is the next hot spot sourcing country. Even Pakistani investors are flocking in to Bangladesh to set up RMG factories. Bangladesh borders India and has better transportation and transit links than Nepal has with India. It could use both ground transport as well as sea transport. Bangladesh’s bilateral trade with India is also increasing rapidly. So, the optimism regarding increase in investment in RMG industry as booming India is close to Nepal, which is shared by businessmen and policymakers alike, might be a little bit more exaggerated.

Furthermore, it has dedicated export processing zones (EPZs) and SEZs—something Nepal lacks. Bangladesh has less labor problems than Nepal. Power shortage is not as acute as it is here. Bangladesh’s overhead wages is two times lower than in Nepal (and still the stupid Maoist-affiliated trade unions go on repeated strikes demanding more perks and facilities, which might result in the closure of the few remaining MNCs!). Bangladeshi producers are more innovative than Nepali producers.

Now, here is a ray of hope. Though the CPOs favor Bangladesh in the region, they are also thinking of shifting a large share of their sourcing value away from China in the next five years to Pakistan, Nepal, Bhutan and Southeast Asia as well. If Nepal could address the above mentioned constraints on time, then may be we could draw in the attention of some of the CPOs to our economy.