Vietnam's Automotive Component Industry

Industries Automotive

Vietnam’s Automotive Component Industry: Ready to go global?*

*connectedthinking

Table of Contents

Introduction ...... 2

The Vietnamese Automotive Industry ...... 3

Japanese Automakers: The driving force behind Vietnam’s automotive development ...... 8

Infrastructure – Transportation ...... 11 – Power ...... 12 – Telecommunications ...... 12 Labour Market ...... 12

The Investment Environment in Vietnam: A comparison with other emerging Asian countries . . . 14

ASEAN Free Trade Area and Common Effective Preferential Tariff Impact ...... 16

Taxes ...... 18

Conclusion ...... 20

PricewaterhouseCoopers LLP | Introduction

Vietnam is the next investment destination for many: Does this hold true for the automotive and auto parts industry?

Increasing political and exchange-rate stability, along with promising gross domestic product growth have catapulted Vietnam to the top of many investors’ agendas .

On Jan . 11, 2007, Vietnam became the 150th member of the World Trade Organization, six years after China gained membership . Vietnam’s acceptance into the WTO validated its global economic viability and left many people asking, “Is Vietnam the next China?”

Vietnam’s recently transformed and relatively young stock markets currently offer some of the world’s highest returns, with the market index skyrocketing from just over 300 points in early 2006 to well beyond 1,000 points by year’s end .

But what does rapid economic growth mean to the domestic automotive and auto parts industry? Will Vietnam replicate the success China enjoyed in the automotive industry after joining the WTO?

This study assesses the state of the Vietnamese automotive industry and identifies the main drivers and key factors to consider with regard to investing in Vietnam . For�� the intrepid, Vietnam does offer possible medium to long-term opportunities . However, the Vietnamese automotive industry is still in an early developmental stage and significant challenges remain .

| PricewaterhouseCoopers LLP The Vietnamese Automotive Industry

The automotive industry in Vietnam is relatively young . Before 1992, most vehicles were procured by the government and imported from the former USSR and other Eastern-bloc countries .

In 1986, the Vietnamese government initiated a set of policy changes to stimulate and liberalize the economy, known as the Doimoi (or renovation) policy . While the Communist Party remained in control of the political system, the government incorporated elements of capitalism, granting auto assembly licenses to more than 30 regional assemblers . These included state-owned enterprises, local Vietnamese companies, joint ventures and foreign-owned original equipment manufacturers (OEMs) . Complete knock- down (known as CKD) assembly began in 1995, with Mitsubishi, Toyota and Isuzu becoming some of the first global OEMs in Vietnam .

A decade later, Japanese auto assemblers have proved there is still a long way to go in order to achieve economies of scale in automobile production in Vietnam . The table below depicts 2006 actual production by Japanese auto assemblers .

Table 1: 2006 auto production in Vietnam by Japanese companies

AUTOMOBILE PRODUCTION COMPANIES Capital Headquarter’s Production Automaker Company Products Established Production Investment Stake Capacity (3) Vietindo Daihatsu Automotive 1 Daihatsu Corporation Hijet, Citivan, Terios 1995 483 units US $12.3 million 26% 1,800 units 2 medium and heavy-duty Hino Hino Motors Vietnam, Ltd. trucks and buses 1996 645 units US $8.1 million 51% 1,000 units 3 Honda Honda Vietnam Co., Ltd. (1) Civic 1996 1,651 units (2) US $62.9 million 42% 10,000 units

4 F-series, N-series, Isuzu Isuzu Vietnam Co., Ltd. Hi-Lander 1995 2,428 units US $15 million 35% 10,000 units Lancer, Pajero, Jolie, 5 Mitsubishi 1,080 units 25% Vina Star Motors Corporation Grandis (VSM) 1995 US $16 million 5,000 units 6 Mitsubishi Fuso Canter 1,389 units 0% 7 Carry, Wagon R+, Vitara, Suzuki Vietnam Suzuki Corporation APV 1995 1,296 units US $21.7 million 35% 10,000 units 8 Camry, Corolla, Hiace, Toyota Toyota Motor Vietnam Co., Ltd. Land Cruiser, Innova, Vios 1995 13,976 units US $49.14 million 70% 20,000 units (1) Inclusive motorcycle business. (2) Started production in 2006. (3) Capacity figures from AMAV Source: JAMA (Japan Automobile Manufacturers Association)

In recent years, new automobile sales in Vietnam have slowed . Among the factors affecting sales are:

• Consumer preferences for motor bikes - automobiles are too expensive for many Vietnamese; • Better and more roads are needed; • Parking is scarce; • Tax policy

The table below shows the increase of special sales tax for passenger cars that has increased automobile prices .

Table 2: Special Sales Tax

Year 2003 2004 2005 2006 Special Sales Tax 5% 24% 40% 50%

PricewaterhouseCoopers LLP | In 2006, the government lifted a ban on pre-owned car imports, allowing pre-owned vehicles aged less than five years into the country . The auto market has also been held back by the state of Vietnamese infrastructure, particularly the lack of highways and parking facilities .

Recent economic growth has been strong . GDP rose 6 .8 percent from 1997 to 2004, 8 percent in 2005 and 8 . percent in 2006 . With this boom�� and stock market development, the local automotive industry expects to reap significant benefits, but an overall strong economy has not yet translated into automotive success .

Will the new wave of cheap cars “hit the spot?”

The market for passenger vehicles is already overcrowded with participants, but this has not stemmed the steady flow of eager entrants . Many automotive companies, like Shanghai Automotive Industry Corp . (SAIC), expect Vietnam’s WTO membership to result in an economic upturn . SAIC has announced plans to establish a joint venture with an anticipated capital investment of $50 million .

Seven years ago, low-cost Chinese-made motorcycles took Vietnam by storm, taking substantial market share from the Japanese market leader . Whether a similar situation will emerge with low-cost Chinese cars is far from certain: quality perception is important to Vietnamese consumers and low-cost Chinese cars will likely have to prove their worth by standing the test of time .

Sluggish automobile sales growth in Vietnam does not come as a surprise when the following factors are considered:

• Underdeveloped infrastructure • High taxes • Low per capita income • Removal of pre-owned car ban

One indication of whether an emerging economy has transformed itself from agriculture-based to manufacturing-based (or experienced export-led expansion), is the growth of automobile sales compared with the growth of motorcycle sales .

The ownership ratio of motorcycles to cars in Vietnam is one of the highest in the world and continues to rise . The number of motorcycles is expected to double within the next 15 years, according to Vietnam’s current motorcycle master plan demand forecast . By comparison, passenger car ownership levels in Vietnam are among the lowest in the Asia Pacific region, with .5 units per 1,000 people in 2004 . This is an indicator of tremendous untapped market potential .

Table 3: Motorcycles in Vietnam

Year 2000 2005 2010 2015 2020 Population forecast (millions) 77 .6 83 . 88 .7 94 . 99 .4 Motorcycle demand forecast (millions) 6 .4 15 .2 24 .2 28 .8 3 .8 Average persons per motorcycle 12 .2 5 .5 3 7. 3 3. 3 .

Source: Vietnam Development Forum

| PricewaterhouseCoopers LLP Table 4: Auto sales by unit and market share in 2006 and 2005 by VAMA members

Year 2006 Year 2005 Change Brand Unit % Unit % Unit % Toyota 14,784 36% 11,813 30% 2,971 25% Truong Hai 5,354 13% 4,325 11% 1,029 24% Ford 3,610 9% 5,040 13% (1,430) -28% Isuzu 2,344 6% 2,157 5% 187 9% Vinaxuki 2,393 6% - 2,393 VinaStar (Mitsubishi) 3,398 8% 4,212 11% (814) -19% Mercedes-Benz Vietnam 1,202 3% 1,683 4% (481) -29% Visuco (Suzuki) 1,807 4% 3,365 8% (1,558) -46% Vidamco (GM Daewoo) 1,634 4% 4,198 11% (2,564) -61% VMC (BMW, Mazda, Kia) 659 2% 1,042 3% (383) -37% Mekong (Fiat, Ssangyong, PMC) 597 2% 509 1% 88 17% Hino 613 2% 541 1% 72 13% Vindaco (Daihatsu) 530 1% 453 1% 77 17% Vinacomin - Vinacoal 340 1% - 340 SAMCO 478 1% 538 1% (60) -11% Honda 1,110 3% - 1,110 Total 40,853 100% 39,876 100% 977 2% Source: Vietnam Automobile Manufacturers’ Association

Figure 1: Automobile sales in Vietnam in 2000-2006

Unit sales % Change

50,000 70% 45,000 60% 40,000 50%

35,000 40% % change 30,000 30% 25,000 20% 20,000 Unit sales 15,000 10% 10,000 0% 5,000 -10% - -20% 2000 2001 2002 2003 2004 2005 2006

Source: Vietnam Automobile Manufacturers’ Association

Uncertainties about an increase in the special sales tax, the lifting of an import ban on second-hand cars, the elusive domestic market and consistent infrastructure issues have hindered any significant progress in the automotive and supporting industries .

PricewaterhouseCoopers LLP | The 2006 Vietnam Development Forum’s study on “Building Supporting Industries in Vietnam” found that progress in automotive localisation (currently only 5-15% per unit assembled) is slow and far below the level of competitiveness required by Japanese companies, which have been most active in the Vietnamese automotive industry . Most significantly, the Forum reports that imported parts are still less costly than locally produced parts, mainly because of economies of scale, and quality .

In addition, localisation operations have concentrated on producing low-value parts, which reflect the low production volume of light vehicles (see Table 5) and the rather limited number of makes and models being built . Consequently, the only viable option for the infant Vietnamese automotive industry is to import CKD kits for assembly . As a result, Vietnam currently lacks the capital, experience and technology to manufacture advanced auto parts and components locally .

Table 5: ASEAN Member Light Vehicle Capacity and Utilization Forecast

2006 2007 2008 2009 2010 2011 2012 2013 2014 Capacity 606,726 695,955 707,639 704,821 795,718 820,384 823,688 823,694 823,690 Indonesia Utilization 64 60%. 67 20%. 76 60%. 84 .70% 84 .30% 83 .60% 87 .70% 89 .30% 89 .70%

Capacity 767,000 916,033 1,025,355 1,030,045 1,030,055 1,029,934 1,030,045 1,030,051 1,030,048 Malaysia Utilization 63 50%. 5 .50% 49 00%. 54 .0% 53 .70% 54 .90% 54 .80% 54 .50% 55 .30%

Capacity 268,075 266,977 238,076 238,078 238,076 238,078 238,080 237,104 238,076 Philippines Utilization 36 00%. 39 30%. 5 .80% 55 .00% 57 .40% 59 .90% 6 00%. 6 .30% 6 60%. Capacity 1,426,373 1,596,248 1,712,833 1,838,825 1,838,827 1,838,825 1,831,288 1,838,831 1,838,826 Thailand Utilization 86 40%. 84 .0% 82 70%. 82 .20% 84 .00% 87 .20% 90 .40% 9 .30% 9 20%.

Capacity 87,938 94,529 94,916 94,532 99,551 99,137 99,546 99,547 99,542 Vietnam Utilization 47 70%. 48 30%. 5 .40% 52 .40% 54 .0% 60 .20% 63 .00% 62 .30% 62 .60%

| PricewaterhouseCoopers LLP The lack of capital investment and Figure 2: The stages of automotive and auto parts requisite experience/technology to industry in Vietnam manufacture components considerably Creativity hamper Vietnam’s automotive industry . Coupled with stagnating automobile sales, STAGE FOUR Technical Full capability in Vietnam simply does not currently have absorption STAGE THREE innovation and product design as the infrastructure necessary to support a Agglomeration Technology and global leader modern automotive industry . The results management STAGE TWO mastered, can are disadvantages in quality, cost and Have supporting produce high- Japan, US, EU delivery . This prevents local Vietnamese industries, but still quality goods STAGE ONE under foreign South Korea, suppliers from building financial resources Simple guidance manufacturing Taiwan and investing in capital improvement or under foreign Thailand, Malaysia management systems . Linking supply chain guidance systems is only compounded by these Vietnam challenges . Source: Kenichi Ohno (VDF & GRIPS) 2004

For local Vietnamese suppliers, quality and Figure 3: Two Causes of High Prices cost are the two key challenges impacting the lack of economies of scale and the (1) Market size country’s nascent automotive development . No economics of scale The primary operations being localized Small are welding, painting and attaching bulky market items or low-value parts that are fit for local Low sourcing, such as tires, batteries and wire High price Vicious Circle production harnesses (see Wire Harness Case Study) . efficiency These challenges create problems for global OEMs and suppliers in Vietnam that High parts cost want to locate and partner with acceptable High taxes No growth of local suppliers . Furthermore, the majority and tariffs parts industries (2) Tax factor of acceptable local suppliers are usually wholly owned subsidiaries or joint ventures; Source: Kenichi Ohno Vietnam Development Forum most automotive parts companies that have ISO accreditation are also wholly owned foreign companies or joint ventures .

If auto parts are to be produced locally, Figure 4: Automobile Cost Comparison in 2004 solely to satisfy domestic demand, it is ( Vietnam’s parts = 100 ) unlikely that cost objectives can be reached due to the lack of economies of scale . If Tax factor sufficient economies of scale cannot be 200 achieved, auto parts costs in Vietnam are Domestic taxes 150 likely to be higher than in other Association Tariff of Southeast Asian Nations (ASEAN) Parts cost countries that produce the same models of 100 cars . Additionally, the lack of raw materials, 50 and the absence of a mold and die industry and/or modern machinery present key 0 challenges in further developing the auto Vietnam Malaysia Thailand Philippines parts support industry in Vietnam . Parts cost factor

Source: VDF estimate for a typical Japanese car model.

PricewaterhouseCoopers LLP | Japanese Automakers: The driving force behind Vietnam’s automotive development

In Asia, the Japanese have a strong foothold in the automotive industry and are usually pioneers in establishing external bases for automotive and auto-supporting industries, especially in emerging countries . In the latest JETRO survey on Japanese companies’ international operations, released in March 2007, Japanese companies predicted that future sales and operating profits would primarily come from overseas operations, with Asia contributing the highest sales increase of 39 percent .

In terms of business expansion, production of mid- and low-end products is an area in which Japanese companies prefer to expand overseas at much greater levels than in Japan . This is also the case for the entire global automotive and auto parts industry .

Table 6: Japanese companies’ expansion plans by industry

No . of Expand business Expand business companies overseas in Japan All companies 729 65.4% 52.8% Chemicals 46 87 .0% 58 .7% Food and beverage 49 73 .5% 59 .2% Car/car parts/other transportation machinery 56 7 .4% 46 .4% Coal and petroleum/plastics/rubber products 30 70 .0% 53 .3% General machinery 63 66 .7% 38 .% Textiles/clothing 24 66 .7% 50 .0% Electric equipment 39 64 .% 5 3%. Medical products and cosmetics 27 63 .0% 55 .6% Precision equipment 40 62 .5% 65 .0% Source: JETRO FY2006 Survey of Japanese Firms’ International Operations, March 2007

In the 2006 JETRO survey, China was four times more likely than Vietnam to be a destination for the manufacturing of mid- to low-end products . However, Vietnam ranked higher than India, and Vietnam’s ranking in the 2006 survey eclipsed 2005 survey results .

| PricewaterhouseCoopers LLP Table 7: Japanese companies’ expansion plans by operations (multiple answers per respondent)

Production Production Sales operations (mid to low-end products) (high-end products) 2006 % 2006 % 2006 % Ranking country/region survey changes country/region survey changes country/region survey changes 1 China 56 4%. - .8 China 33 .5% -3 . China 20 5%. 5 .2 2 United States 27 7%. .8 Thailand .5% -2 .7 Thailand 6 5%. -0 .4 3 Western Europe 19 9%. 2 9. Vietnam 8 .4% 3 .2 United States 6 3%. .5 4 Thailand 18 0%. 0 6. United States 7 .8% 3 .2 Western Europe 5 7%. 2 .6 5 India 15 5%. 2 3. India 5 .7% 3 .4 South Korea 2 9%. .8%

Source: JETRO FY2006 Survey of Japanese Firms’ International Operations, March 2007

While China’s survey score, with regard to production of mid- to low-end products, is diminishing, the shift is upward for higher-end products . Changes in China’s investment environment, such as rising labour costs and concerns about reduced refunds on the value-added tax for labour-intensive products, have influenced the shift . The Vietnamese mid-to-low-end manufacturing sector should benefit from these trends in China .

In addition to the strong recent economic performances of Vietnam and India, the “China plus one” strategy (investing in China and another country or region to reduce overdependence on China) seemed to account for greater interest in the two countries . However, there are critical differences between Vietnam and India in terms of the types of products Japanese companies produce . Japanese companies in the iron and steel/non-ferrous metal/metal products industries, as well as those in the foods and beverages industries, showed more interest in Vietnam, while those producing auto/auto parts, other transportation machinery demonstrated greater interest in India . How Vietnam’s automotive industry will reflect these results is yet to be seen .

Rising production and labour costs in Japan are catalysts behind the transfer of production bases for Japanese companies . In the past three years (and in the next three years), the production base transfer trend has been (and will be) from Japan to China, Japan to Thailand, and China to Vietnam .

Vietnam is an ideal place for skilled, labour-intensive manufacturing; labour costs are low and the quality of its workforce has been praised by many foreign investors . Because global Japanese auto parts companies exhibit systematic approaches to manufacturing, which includes built-in quality systems, Vietnam has increasingly become a popular destination for wire-harness assembly for Japanese firms .

Unfortunately, due to low production volumes, current auto part production costs in Vietnam remain too high and, thus, less competitive . As economies of scale cannot be achieved in low-volume manufacturing, auto parts exported from Vietnam to Japan are primarily labour-intensive parts . Furthermore, the localisation rate is low because most raw materials are imported . For Vietnam to become a more attractive parts-manufacturing destination for Japanese companies and other global entities, cost reductions and building upstream business is required .

Very few Western auto parts suppliers are currently doing business in Vietnam . US-based Johnson Controls recently set up a plant in Binh Duong with an investment of US $8 .0 million to supply automotive interiors for export markets in Japan and Malaysia, as well as to serve the domestic markets .

PricewaterhouseCoopers LLP | Case Study: Wire Harnesses

As most of the raw materials for wire harnesses are imported, the main value- adding that occurs in Vietnam is labour . Sumitomo Electric Industrial Ltd ., Japan’s largest supplier of wires, cables and optical fibers, is currently targeting Vietnam, which is the largest automotive wire producer in Southeast Asia . Sumitomo Electric’s first two wire harness operations in Vietnam, Sumi-Hanel Wiring Systems and Sumidenso, have sales greater than US $100 million . Sumitomo recently established another company, the Sumiden Vietnam Automotive Wire Co . Ltd ., to supply copper wire . Sumiden has investment capital of US $100 million and will employ 8,000 workers, with operations scheduled to begin in mid 2007 .

Wire harnesses are the leading automotive part exported from Vietnam . Global Japanese wire harness companies like Yazaki, Furukawa and Sumitomo have enjoyed growth and expanded their businesses to meet demand in Japan . Furukawa, for example, has revised its investment promotion license more than 10 times since 1997 and it has enjoyed eightfold export growth during that time, from US $12 .3 million a year to more than US $100 million a year . Under a company named CFT Vina Copper Ltd ., Furukawa established, operates a joint venture with CADIVI (a leading cable manufacturer in Vietnam), and Tomen to manufacture copper rods and drawn wire .

Yazaki has two wire harness plants, in Binh Duong and Hai Phong, and has enjoyed rapid export driven growth .

Thus, wire harnesses are a likely auto part to be produced in Vietnam for some time to come, especially because most of the raw material is imported and its production does not require advanced machinery . Most machinery used in Vietnam would be considered obsolete by modern standards, and is either a remnant from former East European socialist countries or second-hand Chinese or Taiwanese equipment . Because wire harness manufacturing is so labour-intensive, it is expensive in Japan, where hourly wage rates are substantially higher . Wire harnesses can also be standalone parts that do not need to be sequenced “just-in- time” on the production line .

10 | PricewaterhouseCoopers LLP Infrastructure Figure 5: Businesses’ problems with Infrastructure

Vietnam’s infrastructure, despite improvements, is poor and presents considerable obstacles to automotive supply chain operations .

Transportation

Vietnam has no major expressways and only 26 percent of the national highways have two or more lanes . Only 10 percent of the capital city Hanoi is developed for roads, while in most global capitals, 25 to 30 percent is typically dedicated to vehicular traffic .

Source: Investment climate survey (2005), World Bank, feedback from firms Other significant road infrastructure rating specific infrastructure sectors as either the first or second restrictions: highest priority for infrastructure improvements. • Vietnam’s road system consists of 210,447Km of roads, of which only 3,211Km are urban roads; • Majority of roads are narrow and of low quality; Figure 6: Percentage of enterprises that consider the • Parking is scarce in urban areas . transportation system a constraint for their Hanoi and Ho Chi Minh City have business in some Asian countries acute shortages of space .

Source: Vietnam Society of Automotive Engineers % 30 Underdeveloped infrastructure has been cited 25 as a leading constraint in Vietnam, and when compared with other industrial and economic 20 factors, transportation ranked high in investor 15 considerations . 10 Vietnam has eight major seaport complexes 5 and the development of deep sea ports is currently underway . Though the level of ship 0 traffic is lower than other countries in the Malaysia India Thailand Indonesia Philippines Vietnam region, significant growth is foreseeable and will help with Vietnam's international trade . Source: Investment climate surveys in Vietnam, 2005, World Bank

PricewaterhouseCoopers LLP | 11 Power

As Vietnam’s consumer and industry economy grows, the demand for power between 2006-2010 is projected to grow at 16% per year . Between 2011-2015, power growth demand is forecasted to increase to 11% per year .

Telecommunications

Telephone density is approximately 42% and mobile telecommunications serves as the primary growth agent . As the use of mobile communication devices continues to increase rapidly, telephone density will grow and will remain one of the highest density figures in the world . While use of the Internet is low, every year, several million people in urban areas gain access and Internet Service Providers have ambitious expansion plans that, include broadband development .

Labour Market

Vietnam’s population was estimated at 83 . million in July 2005, and it is expected to reach 90 million by 2010, an annual growth rate of .6 percent . More than 60 percent of the population is under 25 years of age and approximately 15 .5 percent is considered to be trained or skilled workers with elementary qualifications or higher .

Vietnamese employees work a maximum of 48-hours per week and have fewer holidays compared with China and other ASEAN countries . However, a number of businesses, including foreign direct investment companies, are being encouraged by the government to adopt a 40-hour week . In the long term, Vietnam may lose its cost advantage in terms of longer working hours .

Yet, labour costs are still relatively low compared with other countries in Asia, including China .

Vietnam has dual minimum wage policies: one for local Vietnamese enterprises and the other for foreign-investing enterprises . However, a single minimum wage policy is likely to be reached by 2010 .

The monthly minimum wage for workers in foreign investing enterprises is as follows: • Approx . US $54 for unskilled workers in urban districts of Hanoi and Ho Chi Minh City • Approx . US $49 in rural districts of Hanoi and Ho Chi Minh City • Approx . US $44 for other provinces

There is no minimum salary for local Vietnames companies (“domestic private enterprises”) . The Ministry of Labour, War Invalid and Social Affairs (MoLISA) plans to set minimum wage levels for three regions:

Region 1 — Inner Hanoi and inner Ho Chi Minh City Region 2 — Suburbs of Hanoi and Ho Chi Minh City, inner Hai Phong, Ha Long (Quang Ninh Province), Bien Hoa (Dong Nai), Vung Tau (Ba Ria – Vung Tau), Thu Dau Mot town, Thuan An, Ben Cat, Tan Uyen (Binh Duong Province) Region 3 — All other localities

12 | PricewaterhouseCoopers LLP Figure 7: Changes in minimum, wages (Monthly Basis)

160

135 140 Rising labour costs have become a pressing 121 120 issue in most emerging 110 101 countries, with strong 98 100 90 increases seen in China . 86 74 2005 Wages in other ASEAN 80 US $ 73 69 2006 countries show upward 62 55 trends, but at less 60 50 advanced rates than in

40 35 China .

0 ) ) nd sia es m u n dia ila e in tna ho ua In a on ipp ie gz gg Th nd il V n n I Ph ua Do (G a ( ina hin Ch C Source: JETRO Comparative Survey of the Labour Environment in ASEAN, China, India, October 2006

Table 8: ASEAN Labour Challenges

Apart from rising labour costs, a shortage of engineers is common in all emerging Asian countries . Vietnam is no exception . Thailand Total Valid Increaseofemployee wages Difficultyin recruitment localof (general staffs workers) Difficultyin recruitment localof (middle staffs management) Difficultyin recruitment oflocal staffs (engineers) Lowrate workerof retention PersonalcostsofJapanese (expatriate) officersand staffs Restrictionsondismissal staff and reduction Laborissues (strikes, labor unions, etc.) Restrictionson employment foreignof workers Localizationmanagementof level employees andsite chiefs Heavyemployer burden for pension, social insurance,etc. Otherproblems Unknown faces the most critical 966 942 615 126 367 364 248 299 262 176 72 327 67 37 24 Total 100.0 100.0 65.3 13.4 39.0 38.6 26.3 31.7 27.8 18.7 7.6 34.7 7.1 3.9 2.5 shortage, due to the 897 881 571 121 351 349 226 284 242 157 71 320 65 36 16 rising trend of major ASEAN Subtotal 100.0 100.0 64.8 13.7 39.8 39.6 25.7 32.2 27.5 17.8 8.1 36.3 7.4 4.1 1.8 automotive companies C 201 199 123 49 86 106 82 53 26 28 9 86 3 2 2 o Thailand 100.0 100.0 61.8 24.6 43.2 53.3 41.2 26.6 13.1 14.1 4.5 43.2 1.5 1.0 1.0 establishing R&D u n 172 169 85 30 61 64 56 47 52 9 32 45 13 8 3 operations in the t Malaysia 100.0 100.0 50.3 17.8 36.1 37.9 33.1 27.8 30.8 5.3 18.9 26.6 7.7 4.7 1.7 r country . y 96 94 58 18 28 26 20 25 3 4 14 31 7 3 2 / Singapore 100.0 100.0 61.7 19.1 29.8 27.7 21.3 26.6 3.2 4.3 14.9 33.0 7.4 3.2 2.1 a r 158 155 133 6 58 43 10 67 72 49 9 49 26 10 3 e Indonesia 100.0 100.0 85.8 3.9 37.4 27.7 6.5 43.2 46.5 31.6 5.8 31.6 16.8 6.5 1.9 a 185 181 109 6 69 68 33 59 74 61 2 79 10 9 4 Philippines 100.0 100.0 60.2 3.3 38.1 37.6 18.2 32.6 40.9 33.7 1.1 43.6 5.5 5.0 2.2

85 83 63 12 49 42 25 33 15 6 5 30 6 4 2 Vietnam 100.0 100.0 75.9 14.5 59.0 50.6 50.6 39.8 18.1 7.2 6.0 36.1 7.2 4.8 2.4

69 61 44 5 16 15 22 15 20 19 1 7 2 1 8 India 100.0 100.0 72.1 8.5 26.2 24.6 36.1 24.6 32.8 31.1 1.6 11.5 3.3 1.6 11.6

Source: JETRO report, “Actual Management Conditions of Japanese Manufacturing Industry in Asia,” released March 2006

PricewaterhouseCoopers LLP | 13 Investment Environment in Vietnam: A comparison with other emerging Asian countries

Problems with the legal and tax systems and protection of intellectual property rights are perceived to be major business risks in China . In Vietnam, the major business risks include:

• Underdeveloped infrastructure • Underdeveloped legal system and problems with legal procedures • Underdeveloped or no accumulation of related industries

Despite these risks, Vietnam is viewed favorably when compared with other Asian countries for the following reasons:

• Political and social stability • Local currency • Slowly increasing labour costs

Table 9: Japanese companies’ ranking of investment concerns

Underdeveloped legal system/problems with legal Ranking Political/social instability Concerns over local currency Underdeveloped infrastructure procedures 1 Philippines 52.5% Indonesia 23.5% India 57.2% China 59.9% 2 Indonesia 50.4% China 20.5% Vietnam 47.9% India 35.3% 3 China 41.3% Thailand 9.1% Philippines 32.2% Vietnam 32.2% 4 Thailand 28.3% Vietnam 8.5% Indonesia 29.8% Indonesia 28.2% 5 India 15.4% Philippines 7.9% China 21.6% Philippines 13.0% 6 Vietnam 9.7% India 6.5% Malaysia 7.8% Malaysia 6.5% 7 Malaysia 3.3% Malaysia 5.3% Thailand 7.4% Thailand 5.9% 8 Singapore 0.8% Singapore 3.3% Singapore 0.0% Singapore 0.0% Underdeveloped or no accumulation of related Problems with protection of Ranking industries intellectual property rights High/increasing labor costs Risks/problems of taxation 1 Vietnam 31.4% China 59.2% Singapore 39.3% China 33.2% 2 Philippines 20.9% India 13.9% China 28.4% India 17.9% 3 India 18.4% Vietnam 11.9% Thailand 20.4% Indonesia 15.5% 4 Indonesia 15.1% Indonesia 9.2% Malaysia 13.9% Vietnam 10.2% 5 Malaysia 12.7% Philippines 9.0% Indonesia 5.5% Thailand 7.6% 6 Thailand 6.2% Thailand 6.2% Vietnam 5.1% Philippines 7.3% 7 China 4.7% Malaysia 4.1% Philippines 4.0% Malaysia 6.5% 8 Singapore 3.7% Singapore 1.6% India 3.5% Singapore 2.0% Source: JETRO FY2006 Survey of Japanese Firms’ International Operations, March 2007

Compared with China, Vietnam has a superior investment environment with respect to political and social stability, employee communication and lower foreign exchange risks . However, Vietnam has a less positive perception regarding local suppliers, infrastructure, and research and engineering skills .

14 | PricewaterhouseCoopers LLP

Source: 2006 JETRO white paper on international trade and foreign direct investment Table 10: Investment in ASEAN countries and India, compared with China

(China = 0; positive values = superior; negative values = inferior)

ASEAN Thailand Malaysia Singapore Indonesia Philippines Vietnam India Political and social stability 0.48 0.91 0.85 0.96 -0.23 -0.17 0.74 0.50 Communicativeness of employees 0.42 0.35 0.53 0.88 -0.07 0.63 0.20 0.72 Investment law transparency 0.39 0.69 0.66 0.93 -0.17 0.10 0.07 0.23 Tax system 0.32 0.50 0.62 0.97 -0.35 0.10 0.07 -0.13 Infrastructure 0.07 0.65 0.67 0.96 -0.60 -0.65 -0.75 -0.78 Ease of managing labor 0.34 0.52 0.21 0.85 -0.04 0.17 0.48 0.00 Research and engineering skills -0.14 -0.07 -0.10 0.75 -0.66 -0.35 -0.21 0.33 Local suppliers -0.31 0.28 -0.07 0.22 -0.71 -0.86 -0.85 -0.32 Foreign exchange risks -0.03 0.13 0.30 0.52 -0.68 -0.46 0.28 -0.13 Customs procedures 0.35 0.42 0.64 0.96 -0.14 0.23 -0.07 -0.41 Intellectual property protection 0.23 0.34 0.39 0.94 -0.12 -0.02 -0.07 0.04 Average 0.19 0.43 0.43 0.81 -0.34 -0.12 -0.01 0.04 Source: 2006 JETRO Whitepaper on International Trade and Foreign Direct Investment

According to the World Bank and the International Finance Corporation’s annual Doing Business 2007 Report, out of 175 countries surveyed, Vietnam’s position in “ease of doing business” slipped six places from a ranking of 98 in 2005 to 104 in 2006 .

Vietnam’s fall in the survey is largely because of the complexity of starting a business in Vietnam . These challenges include: • The numerous procedures and time necessary to begin operations • The cost of minimum capital requirements • Registering property • Attaining credit • Cross border trading • Contract enforcement Vietnam’s neighbors in the region fared better: Malaysia ranked 25th, and China and Russia ranked 93rd and 96th respectively . Nevertheless, Vietnam ranked higher than some other emerging economies, including Brazil (121st) and India (134th) .

Foreign currency risks in Vietnam are considered much lower than in other countries in Asia, partly because the Vietnamese Dong has been stable over the past decade . It should be noted, however, that the Dong is not a freely-convertible currency, and the Vietnamese monetary system has restrictions in the foreign exchange system .

PricewaterhouseCoopers LLP | 15 ASEAN Free Trade Area and Common Effective Preferential Tariff Impact

As a participant in the ASEAN Free Trade Area (AFTA) and Common Effective Preferential Tariff (CEPT) agreements, Vietnam could position itself as a hub for auto parts supply into ASEAN countries – if the country utilizes its competitive advantages . Vietnam joined ASEAN in 1995 and has participated in AFTA since 1996 . In 1998, it became a member of Asia-Pacific Economic Cooperation and gained WTO membership in 2007 .

Table 11: Intra- and extra-ASEAN trade by commodity group, 2005 (in US $ millions)

Commodity group Intra-ASEAN Extra-ASEAN Total ASEAN 2-digit HS Total Total Total code Description Exports Imports trade Exports Imports trade Exports Imports trade

Vehicles, parts and 87 accessories 5,227 4,006 9,232 9,690 12,819 22,510 14,917 16,825 31,742 Percentage 57% 43% 43% 57% 47% 53%

Source: ASEAN Trade database

Within the ASEAN region, Thailand remains the leading exporter of auto parts to Japan, accounting for nearly half of all exports from ASEAN, followed by Indonesia and the Philippines, whose respective shares each account for almost a quarter of total exports . Vietnam currently provides 6 percent of the total auto parts exports from ASEAN to Japan . Most exported parts are produced by global Japanese parts suppliers that have established low-cost operations for the purpose of exporting back to Japan . Consequently, local Vietnamese suppliers or state-owned enterprises are not currently exporting auto parts to Japan .

Table 12: Japan’s import from and export to ASEAN and China by commodity, 2005 (in US $ millions)

Type Category Total ASEAN Brunei Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore Thailand Vietnam China Road Motor Vehicles excl. Import Cycles 7,777.1 61.0 - - 1.5 - 0.8 - 0.5 0.7 57.4 0.1 10.6 Road Motor Vehicles excl. Export Cycles 84,394.5 3,364.5 68.5 6.0 513.3 7.6 792.6 19.8 215.7 896.7 672.6 171.9 1,210.9 Trade balance 76,617.4 3,303.5 68.5 6.0 511.8 7.6 791.8 19.8 215.2 896.0 615.2 171.8 1,200.3 Parts of Road Motor Vehicles Import excl. Cycles 3,573.3 584.3 - - 137.3 - 18.6 - 127.6 3.9 259.8 37.1 627.5 Parts of Road Motor Vehicles Export excl. Cycles 23,804.9 3,042.0 0.7 0.9 611.8 0.2 589.4 1.1 276.9 98.6 1,412.6 49.7 2,423.5 Trade balance 20,231.5 2,457.7 0.7 0.9 474.5 0.2 570.8 1.1 149.4 94.8 1,152.8 12.5 1,795.9

Source: ASEAN Trade database

16 | PricewaterhouseCoopers LLP Figure 8: Japan auto parts import from ASEAN and China in 2005

ASEAN 584.3 China US$ Million 627.5 48% US$ Million 52%

Figure 9: Japan auto parts import from ASEAN countries in 2005

Vietnam Indonesia 6% 23%

Laos 0% Malaysia 3%

Myanmar Thailand 0% 45%

Philippines 22% Singapore 1%

In 2006, auto parts exports from Vietnam to the United States totaled approximately US $24 million, accounting for a mere 0 .03 percent of all auto parts imported by the United States . Total ASEAN auto parts exports to the United States totaled US $2 .264 billion, accounting for 2 .4 percent of the total auto parts imported, while the Chinese Economic Area showed strong export growth with a market share of more than 9 percent and a total value of US $8 85. billion .

PricewaterhouseCoopers LLP | 17 Taxes

Vietnam has high taxes on luxury goods, especially on automobiles, which make car prices in Vietnam higher than in many ASEAN and Asian countries . For most Vietnamese, cars are unaffordable, and, as stated previously, this has restricted the growth of a local automotive industry . At the same time, taxes applicable to the automotive and auto parts industry are designed to encourage exports and protect local production . This policy is supported by significant corporate tax incentives available to newly established companies, particularly to companies located in investment zones or operating in encouraged sectors . Automotive and auto parts are not included in the list of encouraged investment sectors, but investment projects in the automotive industry may be entitled to tax incentives based on other criteria .

Encouraged investment projects are also entitled to import duty exemptions with regard to the import of fixed assets .

Auto parts imported from ASEAN countries into Vietnam or exported from Vietnam to other ASEAN countries are subject to an import duty of up to 5 percent if they satisfy ASEAN content requirements . Import duty refunds are available for raw materials used for producing goods for export . An extension of import duty payment is also available to reduce working capital requirements . Beginning in 2007, import duties based on the CKD scheme have been completely removed . Import duties for disassembled parts will apply .

Within seven years of accession to the WTO, import duties applicable to completely built units (CBUs) and parts will be reduced . Import duties on CBUs could be reduced up to 50 percent . Import duty rates applicable to CBUs have been reduced to 80 percent in 2007, and a 5 percent sales price reduction is expected . The quota for second-hand CBU imports will also be gradually removed . WTO valuation principles are now implemented, instead of the arbitrary minimum dutiable price system . Imported and locally produced CBUs will be subject to the same special sales tax treatment from 2007 . Under the WTO, incentives based on export ratios may be removed . New incentives based on other criteria would apply .

18 | PricewaterhouseCoopers LLP The two main positive impacts of Vietnam’s WTO membership on foreign direct investment are: • Duty reductions – Import duties are considerably reduced for goods used as inputs for domestic production as well as private and government consumption . In many cases, import tariff rates on inputs for producing exports and other goods such as machinery and equipment have been significantly reduced during the WTO negotiation process . Moreover, exporters are refunded import duties on inputs used for producing exports . • Liberalization of the services market – Under WTO classification, provision of services will be divided into four modes: . Cross-border (e .g ., electronic money transfer services between countries) 2 . Abroad consumption (e .g ., tourist services) 3 . Commercial presence (e .g ., foreign direct investment in services in Vietnam) 4 . Movement of natural person (e .g ., foreigners come and provide services in Vietnam)

Liberalization of the services sector, especially in modes 1 and 4, will affect investment flows to Vietnam . Initially, the services sub-sectors that were once closed or restricted from foreign investment (such as distribution, transport, telecommunication, finance, etc .), will be largely liberalized despite some limited conditions and a transitional period of three to five years .

Vietnam is actually engaged in a multitude of trade covenants . Vietnam is a member of AFTA, the ASEAN-China Free Trade Association, the ASEAN-Korea Free Trade Association and is in the process of negotiating free trade agreements with Japan, India, Australia and New Zealand .

Source: Vietnam: A Guide for Business and Investment, Ministry of Planning and Investment of Vietnam, Foreign Investment Agency - FIA

PricewaterhouseCoopers LLP | 19 Conclusion

Opportunities for sourcing are available to global OEMs and suppliers in Vietnam, although it will require an investment of time and resources in order to identify and select the right partners and parts to be sourced . A thorough risk assessment will be needed in order to identify or develop Vietnamese suppliers that have the experience, quality, cost control and ability to integrate into complex global supply chains .

While this may sound difficult for the tepid, for the intrepid Vietnam clearly offers medium term opportunities . State-owned enterprise and privately owned automobile manufacturers that plan to establish auto parts operations are potential partners and Vietnam’s membership of the World Trade Organization and other free trade associations should help to create additional opportunities for auto parts sourcing .

Vietnam’s prospects of becoming a global destination for investment by the automotive industry will increase if several challenges facing the automotive industry can be addressed:

• Introduction of tax and regulatory policies that encourage the rapid growth of a domestic market for passenger cars would help grow automotive manufacturing, as seen elsewhere, most notably in China . • Continued investment in vehicle infrastructure, specifically road and parking construction, will help create an economy and environment more conducive to vehicle ownership . • Ideally Vietnam will continue to prepare itself to become a high value added parts destination, as part of an integrated plan to align Government policies in support of the promotion of hi-tech industries and to position Vietnam as a clear investment alternative to China . • Human resources are crucial to the development of the automotive industry . Rising labour cost for unskilled labour and the shortage of skilled engineers are key challenges which need to be addressed .

20 | PricewaterhouseCoopers LLP Contacts General Inquiries

Dinh Thi Quynh Van Harry Wisniewski Partner Global Automotive Knowledge PricewaterhouseCoopers Vietnam Ltd . Management Tel: + 84 4 825 1215 Tel: + 1 313 394 6366 Email: dinh .quynh van@vn. .pwc com. Email: harry .j .wisniewski@us .pwc .com

Oranuch Tritrungtusana Mekong Automotive PricewaterhouseCoopers Thailand Tel: +66-2-344-1000 Email: oranuch tritrungtusana@th. pwc. .com

Stephen D’Arcy Global Automotive Leader Tel: +1 313 394 6755 Email: stephen darcy@us. .pwc com.

Wilson Liu Asia Automotive Leader Tel: +86 10 6505 9738 Email: w .liu@cn .pwc .com

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