TRADE
Chinese Manufacturers Face Challenges in a Credit-Sapped Economy
August 20, 2009
David Tsoi

Most Chinese coastal small- and medium-sized enterprises (SMEs) are exclusively export-oriented and rely upon foreign customers for their sales. These SMEs generate almost 60% of China's GDP and 68% of China's total exports. However, during the current financial crisis, foreign orders have declined substantially and many SMEs have gone out of business.

The China Economic Review estimates that 3,631 toy exporters-more than half the industry-went out of business in 2008. The same study suggests that more than 10,000 export-oriented clothing and textile industries players closed. As a result, the Chinese government estimates that more than 20 million displaced workers, or 15.3% of rural workers employed outside their hometowns, have returned to their family homes without jobs.

Chinese exporters face four challenges
A review of the current economic landscape reveals four challenges for Chinese manufacturers:

1. Shrinking global demand: This is the biggest concern for most manufacturers. The World Trade Organization estimated a reord 9% drop in world trade in 2009-the largest decline since World War II.

2. Currency appreciation: Since July 2005, China's currency, the Renminbi (RMB), is no longer pegged to the U.S. dollar-a change which was intended to ensure that the currency reflects more of a true market price. China reformed the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand. Since then, RMB has appreciated about 20% against the U.S. dollar.

   Throughout the current financial crisis, the value of the U.S. dollar has risen sharply while RMB has remained relatively stable compared to the currencies of other countries, which have significantly declined against the dollar. Consequently, Chinese exports are now more "expensive" and cannot compete with goods from countries whose currencies have fallen against the dollar. For example, both the Indonesian Rupiah and the Indian Rupee have fallen 18% and the Pakistan Rupee has fallen 13% against the dollar since August 2008, making goods exported from these countries less expensive compared to Chinese exports.

3. Higher labor costs: In January 2008, the PRC government introduced the Labor Contract Law to enhance workers' rights by setting minimum wages, creating overtime limits, and requiring one month's pay for each year worked for dismissed employees. This new law added a financial burden to companies already struggling to cope with the economy. The law is proving to be an obstacle to hiring temporary workers-a common practice to cope with fluctuating orders. It is estimated that this law has driven up labor costs 20%.

4. Difficulty obtaining bank financing: Difficulty for SMEs in raising capital has become a critical bottleneck as commercial banks are generally very cautious about lending to them. As the cross-border financing industry has moved payment terms away from traditional Letter of Credit (LC) to the riskier Open Account process, Chinese banks have are more reluctant to provide pre-shipment and/or post-shipment financing to exporters without ways to mitigate buyer risk. When banks do extend credit it is usually under very rigid conditions; some exporters have had to pledge their production lines and factory buildings to get financing.

China acts to support Chinese manufacturers
The Chinese government has responded to these challenges with three policy measures:

1. Boost domestic demand: In November 2008, China announced an aggressive spending initiative valued at 4 trillion yuan ($585 billion) to boost domestic demand. An example of this measure is a subsidy scheme to help farmers buy household appliances (including designated brands) that would increase demand for domestically produced TVs, refrigerators, mobile phones, water heaters, air conditioners, and computers.

2. Support exports by increasing VAT rebate: China also increased the export tax rebates of approximately 3,500 items in November 2008-the third time in a year that China raised its export tax rebate. This rebate mainly affects items produced by labor-intensive industries such as toys, textile, garments and furniture-products which account for 25.8% of China's customs tariff revenues. This increase in the VAT rebate is expected to ease financial pressure for export enterprises and enhance their competitiveness in the global market, which should help increase exports.

3. Monetary policy-loosened credit: The People's Bank of China has made several changes to its monetary policy to ease liquidity conditions and boost corporate financing by cutting interest rates, reducing reserve requirements for banks, and lifting administrative controls on banks' lending business. These changes contributed to a sharp growth in RMB loans. In the first quarter of 2009, RMB loans outstanding soared 29.8% compared to the fourth quarter in 2008-the highest on record.

Impact of China's actions
The results of the policy measures is mixed:

• The subsidy program is boosting domestic demand although it only supports a specific group of manufacturers, not the exporting community as a whole.
• Domestic trading rights have loosened, a seemingly attractive avenue for manufacturers, as it opens up the domestic market to many companies that had been prohibited from selling domestically. However, several shoe and textile manufacturers are not interested in the domestic market.
• The export tax rebate is a boon to exporters by reducing their costs and improving the competitiveness of their products.
• Although there has been an increase in RMB loans, the amount being lent to SMEs is unknown.

How global buyers can help Chinese manufacturers
In today's economic environment there are two sure-fire solutions to help China's SMEs: Letter of Credit and Supply Chain Financing.

Buyers that do have credit lines should use them to issue LCs to Chinese exporters. This will help exporters obtain local financing to manufacture the product and, in many cases, this financing will probably be at a lower cost, helping to minimize the amount of finance cost that gets built into the cost of goods.

On the other hand, if an international buyer decides to migrate to the riskier Open Account (OA) payment term, buyers should work with their banks to provide supply chain financing to their suppliers, typically SMEs in China. For example, an apparel firm may have moved all its sourcing from LC to OA two years ago. At that time the global economy was stable and there was no need to provide supply chain financing to suppliers. Today, however, this apparel buyer should now offer financing to suppliers to keep them viable and manufacturing product-a major concern for buyers with highly specialized suppliers.

David Tsoi is the Asia-Pacific Global Supply Chain Manager for the Global Trade Services group at J.P. Morgan.

Copyright © ChinaForum 2009