Economy, Talking Point

When the chips are down

Will the quake in Japan cause a supply crisis for Chinese manufacturers?

When the chips are down

Nuclear meltdown: crush in a Shanghai supermarket last week as panicked shoppers fought to buy salt

“I bought this salt at six yuan ($0.91) a pack. Then I heard the supply of salt wasn’t tight, so I want a refund.”

CCTV was reporting on a disgruntled conversation between a 60 year-old woman from Shanghai and a store manager last week, as she sought to get her money back on 50 packs of salt she’d panic-purchased. Shoppers snapped up 370,000 tonnes of salt on Thursday last week, plus another 220,000 the following day, according to China National Salt Industry Corp, on rumours that the condiment was a radiation antidote. Typically, 15,400 tonnes of salt are sold in stores daily, says the China Daily.

Two days later, the shops were once again mobbed, but this time with salt-hoarders wanting their money back.

It was one of the more unlikely economic effects China experienced as a result of the recent earthquake in Japan.

How about the impact on economic growth in the region?

After such a shocking catastrophe, plus the subsequent struggle to control the Fukashima nuclear reactors, the outlook of most of the region’s economists seems positively benign. That’s despite forecasts from the World Bank that Japan may need five years to rebuild from a disaster that has caused up to $235 billion of damage.

Instead, the general consensus is that Japanese consumer demand will slip in the immediate aftermath of the disaster but that subsequent investment in the earthquake-affected regions is likely to offset any longer term slowdown in growth.

Even if there is decline, the expectation is that it won’t trigger a wider, regional slowdown. Japan’s contribution to Asian growth has been near zero for the last five years, says Moody’s.

What about the Asian supply chain?

Getting more focus is what the disaster means for the flow of Japanese exports into the regional economy, and especially for the intermediate goods that arrive in Asian factories to be assembled and then sold on worldwide.

Unsurprisingly, China is the major recipient of Japan’s intermediate exports (semi-finished items and components used in manufacturing). According to the Japanese Research Institute of Economy, Trade and Industry, they make up the large majority of Japanese exports to China (70% for the most recent data, for 2009). That is $90 billion worth, the Financial Times’ Beyond Brics blog reported this week, more than twice the value of comparable exports to the US and to Europe. Electrical machinery, chemicals, iron, steel and non-ferrous metals make up the lion’s share.

Which industries could be hit first?

Cars and consumer electronics are being monitored the closest.

So far, the Chinese automakers are downplaying any concerns. A spokesman for Toyota China was fairly typical, telling the People’s Daily that most parts for its locally produced, joint-venture models are now sourced from domestic suppliers.

China auto industry commentator Greg Anderson thinks that is probably correct, although he also told WiC that some more complex parts are still produced in Japan, shipped in and “snapped in as black boxes” (to minimise the risk of their being reverse-engineered).

NetEase Auto, an auto industry website, agrees that a small number of parts are still sourced directly from Japan, but that in most cases Chinese factories still have sufficient stock for the foreseeable future. It was also hopeful of early replenishment, given that most Japanese auto component production is outside the earthquake zone.

In electronics, there is more palpable sense of concern. Top of the list are the assembly plants that source a sizeable share of their higher-end components from Japanese suppliers (items like LCD glass and memory chips), as some of these exporters have manufacturing bases located within the quake zone on the northeast Japanese coast.

Media attention turned first to the supply of memory chips (that store and transfer data in smart phones and tablet computers). For example, Japan is said to account for about 40% of production of NAND flash memory chips and in the days immediately after the disaster, spot prices surged as much as 20% as electronics manufacturers rushed to buy up any spare supply.

In fact, one outcome in the coverage of the disaster is plenty of evidence that Japan’s industrial obituary has likely been penned a little hastily by its critics.

Aside from NAND technology, Japanese companies also top the list in the production of silicon wafers (materials used to make semiconductors, the base blocks in computer chips). The largest supplier, Shin-Etsu Chemical, has two plants located in areas close to the earthquake’s epicentre, and Reuters reported this week that both remain out of service. Another wafer plant in the affected area, owned by SUMCO, is still shuttered. Analysts say the closures mean global wafer supply has been cut by a quarter.

There could be a similar bottleneck with bismaleimide triazine (BT to the chemists), a resin used heavily in mobile phone circuitry. Apparently, 90% of global production comes from Japan, much of it from Mitsubishi Gas Chemical, which has been forced to shut down production lines in Fukushima and Ibaraki prefectures due to damage to equipment and buildings.

Why are problems occurring?

The worst of the supply chain anxiety may be premature, says Frederic Neumann, Co-Head of Asian Economics Research at HSBC, who notes that there are no reports of major manufacturing facilities being destroyed.

Peter Chou, chief executive at HTC Corp, the Taiwanese smart phone maker, was more direct last week, telling a conference audience that “everyone is overreacting”.

But conditions have continued to be difficult since the main quake hit two weeks ago. Even in cases in which facilities may not have been directly damaged, aftershocks have disrupted efforts to resume normal operations. Tremors coming in above five on the Richter scale lead to automatic shutdown of sensitive equipment, say industry experts. Damage to transport infrastructure has also made it difficult to move inventory.

Nor can silicon wafer production proceed without a stable power supply. Wafers go through dozens of steps over a number of days, and have to be discarded in event of a major failure in the production process (like a power cut). Some of the chemicals involved in fabrication can also turn hazardous if the power fails. As a result, many factories aren’t likely to return to fuller operation until they are sure power is reliable.

But HSBC is more hopeful here too, suggesting that such an important sector of the local economy will get preferential supply.

Can’t components be sourced from elsewhere?

It’s an option being discussed in the media, with Taiwan and South Korea regarded as the main candidates to meet any shortfall from Japan.

The problem, says Gu Wenjun at market research service iSuppli, is that parts of the supply chain have become so specialised that switching between partners isn’t always easy.

Take Apple’s iPad 2, assembled in China by Foxconn and which, according to iSuppli, has five Japanese suppliers. Three of the five components provided (the touch screen glass, the battery and the digital compass) are probably of proprietary design and would be difficult to source elsewhere.

Something similar seems to apply for BT resin. Alternative resins are available but most suppliers will not be prepared to integrate them immediately into production. Qualifying the materials – just like recalibrating machinery for slightly different components – can require weeks of preparation.

Michael Clendenin, managing director at Shanghai-based RedTech Advisory, also says that it will take months for competitors to reach the high-quality, low-cost capacity long since established by Japanese firms. Further, it is a risky investment, as the Japanese might recover share within a few months.

So is there a supply shock?

“In the short term there won’t be much impact. We are more worried about the impact in the next quarter,” Lenovo chief executive Yang Yuanqing told reporters in Shanghai last week.

Certainly, manufacturers have been quick to assure their customers that they can cope with the immediate disruption. Inventory levels vary, says RedTech: 4 to 5 weeks of silicon wafer supply for chip makers, at little less for the battery cells needed by notebook PC makers, and perhaps not much more than a week for more specific items, like the touch screen materials for Foxconn’s iPad production.

That means that most assembly lines will have had at least two weeks of stock in reserve before the earthquake hit. If there are going to be shortages, it might start showing up at the beginning of next month.

In the meantime, bosses will be hoping that Japanese production begins to ramp up again. Others will be battling it out to source alternative supply. Larger customers are probably in a better position to grab their share, and RedTech reports that Apple has already managed to up its supply of flash memory chips from Samsung.

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