Rising labor cost may affect flow of FDI, says Nomura

China's fast rising labor costs are likely to affect the flow of foreign direct investment (FDI) and will make the country's labor-intensive manufacturing industry face more intense competition from other Asian economies, Nomura Securities said in a report.

"For some labor-intensive manufacturers, China's wage level is no longer attractive. The manufacturing factories will likely be moved to China's inland provinces or to countries such as Vietnam, Thailand and Indonesia where labor costs are much lower," Nomura Securities said.

Nomura expected the pace of China's wage increase to exceed the Association of Southeast Asian Nations in the mid-term, which will change the pattern of foreign direct investment in Asia.

Despite the significant wage increases, China's manufacturing sector has continued to attract FDI inflows over the past several years. In fact, FDI in the manufacturing sector still accounts half of the total FDI in the country, Nomura Securities said.

But economists warned that such trend may start to shift as China gradually loses the advantages of its cheap work force given the expectation of further wage increases and the yuan's appreciation.

Local governments in China have announced plans to raise the standard minimum wage, with Beijing and Jiangsu province raising it by 21 percent and 18.8 percent respectively, this year.

The central government also said in its 12th Five-Year Plan (2011-2015) that it will significantly raise the percentage of wages in the national household income in order to raise the proportion of consumption in the overall economy.

According to Robert Subbaraman, chief Asia economist for Nomura Securities, China should quicken its pace of economic restructuring by boosting consumption and reduce its reliance on investment. Currently, investment is close to half of the country's GDP.

"We are happy to see that China's consumption is picking up, and it should be a key driver for growth in the following years," said Subbaraman. "However, consumption-led growth will probably increase China's inflationary pressure."

"As the factors driving up inflation this time are more broad-based and the pressure for wage growth is building because of labor shortages, we believe China's inflation will stand at 4.5 percent this year and grow to 5 percent next year," said Subbaraman.

China's consumer price index (CPI), a main gauge of inflation, rose to a 28-month high of 5.1 percent in November. The growth was mainly driven by an 11.7 percent surge in food prices, which accounts for one-third of the basket of goods used to calculate the country's CPI. The December CPI rate dropped to 4.6 percent, with food prices rising 9.6 percent, government data showed.

Lu Zhengwei, senior economist at Industrial Bank Co, forecast that CPI would accelerate to 5.3 percent this month, outpacing November's figure.

"To curb inflation, the government needs to improve the Total Factor Productivity by boosting the efficiency of labor and capital, besides employing tightening monetary policies," said Subbaraman.

Nomura expects China's GDP growth to reach 9.8 percent this year and slow slightly to 9.5 percent in 2012.