Dealing with the Global Economic Crisis - Officials and

UNCLAS SECTION 01 OF 05 GUANGZHOU 000218

SENSITIVE
SIPDIS

STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LEE
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER
STATE PASS SAN FRANCISCO FRB FOR CURRAN
TREASURY FOR MOGHTADER

E.O. 12958: N/A
TAGS: EFIN ECON CH
SUBJECT: Dealing with the Global Economic Crisis - Officials and
Foreign Firms Tell AUSTR Stratford How the Downturn is Affecting
South China

Ref: A) GUANGZHOU 163, B) GUANGZHOU 42, C) 08 GUANGZHOU 719, D) 08
GUANGZHOU 715

(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: The global economic downturn got an early start in
South China, but most U.S. companies here have been less severely
affected and many continue to grow, according to business leaders
who met with visiting Assistant U.S. Trade Representative for China
Timothy Stratford April 2-3. Highlights:
-- American Chamber of Commerce-South China representatives pointed
out that many firms in the region began to suffer after
implementation of new regulations (VAT rebate reductions, the Labor
Contract Law),many aimed at labor-intensive export processors, well
before the start of the global financial crisis. U.S. firms were
generally already compliant with the new rules and were better able
to deal with the changes, but they have still suffered some effects
from the downturn.
-- Procter and Gamble has seen an uneven impact across product
categories but is still growing, albeit at a more modest pace than
before.
-- Wal-Mart officials told Stratford that they have positioned
themselves well for the future, but acknowledge there are likely
more hard times ahead for manufacturers in Guangdong.
-- A representative of a major foreign shipping company highlighted
overcapacity in a shipping industry exacerbated by the downturn and
the Chinese government efforts to assist local shipping lines.
-- Local Guangdong government officials expressed the desire to
increase cooperation on trade, investment and intellectual property
rights (IPR) issues, but one official (as well as Taiwan investors
in Dongguan and academic researchers in Shenzhen) noted that it
would take time before China could shift exports to the local market
and increase domestic demand to levels comparable to more developed
countries. End summary.

Local Factors Preceded the Financial Crisis
--------------


2. (SBU) Executives from U.S. firms based in South China emphasized
that the economic slowdown in the PRD preceded the global financial
crisis, due in large part to Chinese regulatory changes. Harley
Seyedin, president of the American Chamber of Commerce in South
China (Amcham),told AUSTR Stratford at a breakfast meeting that
large numbers of factory closures in Guangdong started in late 2007
after the Chinese government reduced value-added tax (VAT) rebates
for export goods. The Labor Contract Law, which came into force in
January 2008, created further difficulties for many firms.


3. (SBU) However, Seyedin explained that U.S. companies were not as
affected by the changes and are faring relatively well even through
the global financial crisis. The cut in VAT rebates affected export
producers; Seyedin pointed out that 72.5% of Amcham companies
provide goods and services primarily to the China market. In
addition, most U.S firms were already compliant with the stricter
standards of the Labor Contract Law. Seyedin noted that no Amcham
member had shut down any major operation recently and nearly 96% are
profitable or expect to be profitable within two year. The
factories that had closed, he said, were those that exploited cheap
labor, took advantage of lax environmental regulations and were
energy inefficient.


4. (SBU) Other Amcham leaders at the breakfast reported a mix of
challenges and opportunities emerging from the economic downturn.
An AIG executive said that sales of marine insurance had declined
30-35% with the fall in exports, but the firm still sees much
potential for growth in Guangdong Province since insurance
penetration rates are low. The general manager of a sensor system
manufacturer said that sales had fallen 15% in FY09 after years of
15% growth. However, he speculated that the market for his product
had already reached the bottom, and sales would start to recover
soon. The representative from a major accounting firm told AUSTR
Stratford that merger and acquisition work had increased recently
with more U.S. companies looking to buy distressed Chinese firms.

GUANGZHOU 00000218 002 OF 005



P&G Managing Slower Growth
--------------


5. (SBU) Procter and Gamble (P&G) is still growing in China, but is
adjusting to a much slower pace of growth during the downturn, P&G
Greater China President Daniela Riccardi told Stratford. Whereas
the challenge for P&G had previously been managing dramatic
expansion each year, the company is now looking at more modest
growth. Riccardi explained that sales had gone flat in some product
categories and even contracted in others. The battery market, for
example, had practically collapsed in October as many wholesale
buyers shut down. She said a dramatic slowing in retail expansion
in China had had a major effect on P&G because new stores building
inventory had been an important source of sales. Riccardi also
noted that disposable diaper sales had been strongly and quickly
affected by the downturn. Diaper sales are particularly sensitive
to overall economic growth because many buyers quickly resort to
more traditional child care techniques (split pants in China) when
the outlook turns negative.


6. (SBU) On IPR protection, Riccardi commented that cooperation with
local officials was good overall. She said that P&G had
successfully employed a strategy of explaining to local officials
that the loss in tax revenues that it would pay on legitimate sales
was greater than any potential economic loss from shutting down
manufacturers and vendors of counterfeit goods. P&G's cooperation
in Guangzhou's Baiyun District, a long-time center for IPR piracy,
has been particularly good.

Wal-Mart Growing, More Pain Ahead for Factories
-------------- --


7. (SBU) Wal-Mart's sourcing in China has grown over the last year,
according to executives at the firm's global procurement
headquarters in Shenzhen. David Heartquist, the vice president for
systems and strategy, explained that the increase in Wal-Mart Global
Procurement's sourcing in China was due in part to Wal-Mart's
expansion of direct importing. Wal-Mart has been moving away from
buying through other importing companies largely because direct
importing allows it to maintain more control over its supply chain.
(Note: In addition, Wal-Mart has managed to buck the overall decline
in U.S. retail sales since the downturn, reporting significant
growth in February and March. End note.) Heartquist said that
Wal-Mart had seen some upside in its China procurement operations
from the economic downturn, strengthening its relationships with
Chinese suppliers who have been affected by the bankruptcy of Linens
N' Things and other U.S. retailers.


8. (SBU) However, Mark Green, another vice president who works
closely with Wal-Mart's suppliers, said there was likely more pain
to come for many South China manufacturers. Most retailers placed
their orders for the holiday 2008 and spring 2009 retail seasons by
spring/summer 2008, before it was clear how severe the downturn
would be. Orders fell severely in the fall due to declining sales
and the need to reduce inventories. Many factories have been able
to survive the decline in orders so far - but won't be able to hold
out indefinitely, according to Green. He indicated the March-July
period would be critical.


9. (SBU) The Wal-Mart executives expressed frustration with certain
aspects of U.S. product safety and quality requirements. Quality
Assurance Vice President Tony Judge emphasized that Wal-Mart worked
hard together with its suppliers to meet all safety and quality
requirements and had been successful at ensuring compliance.
However, he said that variation across states made compliance
extremely challenging in some cases. Different standards by state
raise costs for Wal-Mart substantially because it insists that all
products it sells in the United States meet the standards for every
U.S. jurisdiction, according to Judge. He also pointed out that
some requirements, especially at the state level, had been
implemented quickly without much consultation with industry, and a
few were not entirely scientifically justified. In addition, Judge
told us that some U.S. regulations needed further clarification,
citing new labeling requirements as an example.

GUANGZHOU 00000218 003 OF 005



Shipping Industry Facing Overcapacity
--------------


10. (SBU) The shipping industry has seen a substantial decline in
business out of South China ports so far in 2009 that will
exacerbate long-term problems of overcapacity, according to a senior
executive with a major foreign shipping company. He said Shenzhen's
total port throughput had fallen 21.1% year-on-year in January and
February, closely tracking Guangdong's trade performance for the two
months. His company has seen some modest improvement in March, but
still foresees a 12-15% decline in the monthly sales figures that
were not yet available. Many of its customers have indicated that
they expect shipping volumes to be "back to normal" in June, but the
executive commented that such predictions could be naive. Clients
who export furniture and lighting equipment from South China have
been the hardest hit.


11. (SBU) The downturn is compounding overcapacity that already
exists and appears likely to grow as more vessels ordered by
shipping companies come online. The industry already has
approximately 500 idle vessels anchored near Singapore, according to
the shipping executive, because shipping companies are unable to
cover the variable costs of operating the vessels. He pointed out
that Chinese shipping company COSCO has enough ships on order to
double its current capacity and become the fourth largest fleet in
the world.


12. (SBU) The executive also argued that COSCO and China Shipping
benefit from Chinese government support that allows them to offer
reduced rates to Chinese exporters. He said there was "no paper
trail" to document these efforts to lower logistical costs and
enhance the competitiveness of Chinese exports. However, he
asserted that COSCO and China Shipping had benefitted from the
government's fiscal stimulus efforts; COSCO had just received RMB
740 million (about US$110 million) from the Chinese government to
support its low-profit liner business; and the Bank of China had
recently raised COSCO's line of credit to RMB 76 billion (about
US$11 billion).

Help for Exporters, Domestic Market Obstacles
--------------


13. (SBU) Dongguan Taiwan Businessmen's Association (DGTBA) Vice
Chair Morgan Teng told AUSTR Stratford that the Dongguan municipal
government had been very active in its support for Taiwan companies
hit by the economic downturn. Echoing comments we've heard before
from DGTBA and other investors in Dongguan (refs A, B, C and D),
Teng said about 10% of DGTBA members had shut down over the last
year, most in the last quarter of 2008. Among the survivors, orders
were down by an estimated 20-30%. In response, Dongguan's municipal
government had postponed tax payments for some firms, waived certain
administrative fees, financed loans, offered subsidies for research
and development, and assisted export manufacturers in expanding
sales to the local market. Dongguan's vice mayor convinced local
customs officials to establish a special tax bonded zone to allow
export makers to change the tariff-free status of their goods before
selling to the domestic market, instead of having to export the
products and then re-import them to China.


14. (SBU) However, Teng emphasized that despite these efforts it was
still very difficult for Taiwan companies in Dongguan to shift their
production from exports to goods for the domestic Chinese market.
Taiwan firms lack brands and distribution channels in China, and it
would be costly and time consuming to build them. The only
companies to find success in this area so far began the transition
years ago. Hong Kong investors in Dongguan have recently made
similar comments to Congenoffs. They also noted that features and
specifications differ for products sold in China. In addition, the
average consumer in China cannot afford many of the goods produced
by Dongguan's export makers, and recent changes in the economic
environment of the PRD make it nearly impossible for factories to
cut costs much further, according to Hong Kong executives.


15. (SBU) Researchers at the China Development Institute, a

GUANGZHOU 00000218 004 OF 005


government-sponsored think-tank in Shenzhen, also identified many of
the same obstacles preventing local export makers from easily
transitioning to the domestic Chinese market, providing data to
elaborate. According to Professor Qu Jian, 50% of exporting
companies in Guangdong do not have domestic sale channels; 32% say
profit margins in the domestic market are too low and 28% believe
that logistical costs for moving goods from the Pearl River Delta to
other parts of China are too high. He also pointed out that many
exporting enterprises in Guangdong get their financing from sources
in Hong Kong which might not be willing to finance domestic
expansion.


16. (SBU) Nevertheless, Qu and his colleague Professor Feng Subao
laid out some of the measures that the provincial and local
governments had taken to assist firms in shifting their focus to
domestic Chinese consumers. The Shenzhen municipal government has
helped local exporters attend regional trade fairs that target the
domestic markets. Infrastructure planning in Guangdong has been
more focused on improving transportation links that can efficiently
and cheaply carry goods to other parts of China. In addition, they
emphasized that stimulus measures at the national and local level,
such as consumption coupons that the Guangdong provincial government
is considering issuing, would help spur domestic consumption.


17. (SBU) Qu also commented that there are two schools of thought
among academics in Guangdong about what action, if any, should be
taken to help export manufacturers. (Comment: Qu did not say so
explicitly, but this difference of opinion likely extends to
government officials as well. End comment.) Some believe that the
province should stick with its export-oriented strategy because U.S.
and other foreign markets for China's exports will eventually
recover. The other school believes that the economy must
restructure to rely more on demand in China and Southeast Asia.
Feng also noted that even as the province seeks to assist export
manufacturers and stabilize employment, Guangdong is still pursuing
the strategy of "emptying the cage for new birds" championed by
Provincial Party Secretary Wang Yang. That strategy involves
allowing heavy-polluting and labor-intensive export processors to
fail or move to less developed parts of China while encouraging the
development of more high-tech, high-value-added and service sector
industries.

Officials Express Support for Cooperation
--------------


18. (SBU) Zhong Jianhui, the deputy director general of the
Guangdong Department of Foreign Trade and Economic Cooperation (GD
DOFTEC),told AUSTR Stratford that his agency was ready to work with
the U.S. government to promote trade and the development of
foreign-invested enterprises in Guangdong. AUSTR Stratford
underscored the need for both China and the United States to address
economic imbalances that have contributed to the global downturn.
He expressed the need for other countries, including China, to work
on increasing demand to help stimulate recovery. Citing the steel
industry as an example, AUSTR Stratford also pointed out that when
China takes steps to help domestic industries, the effect should not
be the stabilization of China's exports in a shrinking market at the
expense of other producers. Zhong said he appreciated AUSTR
Stratford's frank remarks but commented that it would take time to
increase consumption in China enough to eliminate the difference in
demand levels between developed and developing countries.


19. (SBU) Guangdong Intellectual Property Office (GD IPO) Director
General Tao Kaiyuan outlined for AUSTR Stratford the series of
exchanges that had taken place between U.S. officials and GD IPO in
recent years. She said the time for the province to take action on
strengthening the protection of IP was now. AUSTR Stratford named
four areas where the U.S. government would like to enhance
cooperation with GD IPO: additional bilateral discussions with
visiting USTR officials; participation in an industry-led South
China IPR summit sometime in the next year; work with U.S. companies
on specific IPR enforcement problems; and more bilateral dialogues,
exchanges and technical training programs.

20 (SBU) Tao responded positively to each of the suggestions. She

GUANGZHOU 00000218 005 OF 005


said that Guangdong wanted to be open to the outside efforts to
understand its IPR enforcement program, including USTR's provincial
review process. GD IPO holds a press conference annually to release
its IPR white paper toward that end. On the IPR Summit proposal,
she said that it was a common goal of the GD IPO and USTR to assist
U.S. companies and pointed out that her agency had co-hosted the
2007 Pearl River Forum on IPR. She expressed willingness to work
with U.S. companies on specific problems but also the hope that they
would be able to resolve most of those problems through China's
legal system. In addition, Tao expressed strong support for
bilateral exchange programs, especially the State Department's
International Visitor Leadership Program.

GOLDBERG