Government Incentives Diminishing in South China Investment

UNCLAS SECTION 01 OF 02 GUANGZHOU 000092

SIPDIS

SENSITIVE
SIPDIS

STATE PASS USTR CHINA OFFICE


E.O. 12958: N/A
TAGS: EFIN ETRD EIND ECON SENV PGOV CH
SUBJECT: Government Incentives Diminishing in South China Investment
Environment

REF: A) 2007 GUANGZHOU 1094; B) SHANGHAI 0029

(U) This document is sensitive but unclassified. Please protect
accordingly. Not for release outside U.S. government channels. Not
for internet publication.


1. (SBU) Summary: Government policies encouraging investment in
south China have significantly diminished and are no longer a major
factor in most foreign and domestic companies' investment decisions
here, according to local manufacturers who met with visiting U.S.
International Trade Commission (ITC) analysts. China's regulatory
environment has grown stricter in recent years, and many firms,
especially labor-intensive manufactures like textile makers,
complained that rising labor costs and the appreciation of the
renminbi (RMB) against the dollar have dramatically reduced profit
margins. Currently, the government's main tool for influencing new
investment decisions is control of land resources. Even as textile
manufacturers describe plans to move production elsewhere, south
China's high-end manufacturers in automobile and telecommunications
equipment manufacturing see a bright future ahead with plans for
expansion. End summary.

Incentives Disappearing, Regulation Tightening
-------------- -


2. (SBU) Manufacturers in south China seem to agree that tax
incentives and export subsidies previously used by the Chinese
government to encourage investment, both foreign and domestic, are
no longer major factors in corporate decision making. This was a
theme echoed repeatedly by the telecommunications equipment, textile
and automotive manufacturers visited by U.S. ITC analysts in late
January as part of a second visit to examine China's economic
policies on trade and investment. Corporate decisions to build new
factories or expand existing ones in south China are now based more
on factors like production costs, availability and cost of labor,
transportation, infrastructure, and the quality and availability of
suppliers, according to Zhai Xiaoping, General Manager of China Silk
Enterprise Ltd. He described this as a major change from 5 or 10
years ago when government connections and tax incentives also
factored significantly in every investment decision. Instead,
elimination of most incentives has made it more difficult for
manufacturers who previously relied on favorable treatment to
maintain profit margins.


3. (SBU) Stricter regulations have also created challenges for some
manufacturers. China's new labor law and tighter enforcement of
environmental regulations have raised costs for some companies not
already in compliance as they struggle to raise standards. However,
Henry Tan, CEO of Luen Thai Holdings, noted companies that already
meet the regulations have benefited from the negative effect on
competitors.

Rising Wages, Appreciating RMB Hit Hard
--------------


4. (SBU) Managers across industries complained about increasing
labor costs and the appreciation of the RMB, but the impact appears
to be most severe for labor-intensive manufacturing like the
textiles industry. (Comment: The comments of textile manufacturers
in the Pearl River Delta were consistent with those from Yangtze
River Delta manufacturers as reported in ref B. End comment.)
Textile executives Zhai and Tan both said these factors had cut
their profit margins to as low as 2 or 3 percent. Zhai explained
that China Silk's attempt to cut costs by opening a new factory in
Zhejiang province in 2001 only provided short-term relief. As wages
in Zhejiang rose to levels approaching those in the Pearl River
Delta, higher costs for transportation eliminated the advantage of
the new location. Tan told us that Luen Thai would continue
shifting low-end production from China to Southeast Asia and
Bangladesh. He noted that while China still maintained advantages
for production of quick-turnaround, seasonal and fashion clothing,
labor costs in Vietnam and Bangladesh were 20-25 percent of China's.


Government Allocation of Land Rights Remains Key
-------------- ---


5. (SBU) Manufacturing executives also agreed that the government's
control of land allocation was still a key factor in some investment
decisions. Huang Zhixiong, Senior Manager of Planning at Guangzhou
Toyota described government support for a project as critical to the
deal's success. Without such support, land would be difficult or
impossible to secure. Li Zanjie, the firm's Marketing Manager said
subsidized rent was a significant incentive for his firm's decision

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to establish a joint-venture in Guangzhou. However, he also pointed
out that the presence of an existing supply chain serving one French
and two other Japanese automotive manufacturing joint ventures was
the primary reason to begin production here four years ago. In
addition, he commented that China's new labor law, environmental
regulations and R&D investment requirement did not have much impact
on Guangzhou Toyota's operations because the requirements were
consistent with Toyota's own internal policies. The Guangzhou joint
venture currently produces 200,000 Camry vehicles per year and has
another production line under construction.

High-Tech Manufacturers Optimistic
--------------


6. (SBU) High-technology manufacturers in the telecommunications
equipment industry told us that despite diminishing government
incentives their operations are expanding and exports are growing.
Guangdong Nortel Director of Research and Development Rick Li
described his company's plans to further expand research and
development (R&D) operations in China. Nortel currently employs
1,300 engineers, approximately 10 per cent of Canadian company's
global R&D workforce, in the south China joint venture. The low
cost of conducting R&D is the main reason for Nortel's initial
investment and ongoing expansion here. Li said the firm's Chinese
joint-venture partners have played an important role in its success.
However, the company only conducts research on certain product
lines inside China, for fear of losing valuable intellectual
property if sensitive technology for other key products were brought
into the country.


7. (SBU) Carl Liu of Huawei Technologies and Jiang Xiangyang of ZTE
Corporation, two of China's leading telecom equipment manufacturers,
separately described strong export growth for virtually all of their
product lines. Huawei's international sales accounted for 70
percent of total revenue in 2007 compared to 60 percent for ZTE.
Both Liu and Jiang emphasized that labor costs for Chinese high-tech
workers were much lower than the salaries they paid R&D staffs in
the United States, India and Europe. Managers of both firms pointed
out that expiring tax incentives and export rebates have not
affected their companies but could affect firms like Ericsson or
Nokia, which may have based their decisions to invest in China in
part on those benefits.


8. (U) This cable was not reviewed by the ITC delegation.

GOLDBERG