Bad News Sinks In: It's Worse than We Thought it would be -

UNCLAS SECTION 01 OF 03 GUANGZHOU 000042 SENSITIVE SIPDIS STATE FOR EAP/TC, EAP/CM, S/P, INR/EAP STATE PASS USTR CHINA OFFICE E.O. 12958: N/A TAGS: ECON ETRD EINV ELAB TW CH SUBJECT: Bad News Sinks In: It's Worse than We Thought it would be - the Inevitable Economic Downturn in Dongguan REF: A) 2008 Guangzhou 518, B) 2008 Guangzhou 618, C) 2008 Guangzhou 655, D) 2008 Guangzhou 668, E) 2008 Guangzhou 715, F) 2008 Guangzhou 719 ¶1. (SBU) Summary and Comment: It's always instructive and well worth revisiting Dongguan, a Pearl River Delta (PRD) export manufacturing center that is a barometer of the worst economic downturn China has confronted in the past decade or two. According to the head of the local Taiwan Businessmen Association (TBA),production overcapacity driven by price competition has brought major factory closures (ref D); even the most competitive firms are dramatically cutting their workforces. While measures enacted by the Dongguan municipal government to assist local enterprises have been helpful, the provincial government has been les engaged in the bail out, perhaps the result of Party Secretary Wang Yang's continued focus of getting energy-inefficient, labor-intensive companies to move out of the PRD. Lack of financing for SMEs remains a serious challenge. The TBA head was skeptical that Taiwan firms would be able to take advantage of financing programs being implemented by the central and municipal governments. ¶2. (SBU) What's new in this diagnosis is that business leader expectations of recovery are adjusting downward as the severity of the global economic downturn becomes more apparent. As recently as November many investors had looked forward to a recovery of export orders in the spring, in sync with the normal yearly business cycle. Now these same leaders are more pessimistic -- preparing for a difficult 2009. The Dongguan municipal government's activist response and preparations for large numbers of unemployed migrant workers signal that government officials share this more realistic assessment. End summary and comment. Dongguan Doomed to Downturn -------------- ¶3. (SBU) The economic downturn - though perhaps not initially its severity - was inevitable in Dongguan, according to Andrew Yeh, chair of the Taiwan Businessmen Association of Dongguan (TBA-DG) and YFC-Boneagle Electric Co. He blamed reckless expansion of production capacity driven by intense competition to lower prices by manufacturing in larger volumes. Yeh also said U.S. consumers who developed a habit of demanding large quantities at very low prices shared responsibility. With spending power of Americans reduced by the financial crisis, the closure of factories in China was unavoidable, he said. ¶4. (SBU) Approximately 900 Taiwan-invested firms in Dongguan closed in the second half of 2008, according to Yeh, out of 3,000 foreign-invested firms that shut down in the city during the same period. (Note: As reported ref D, the TBA-DG Secretary General told us that 500 Taiwan enterprises had closed in Dongguan as of November. End note.) He speculated that 99 percent of factories in Dongguan had had to downsize as orders had dropped by as much as 70 percent for many firms. ¶5. (SBU) He underscored that the financial crisis was just the last straw. Many firms had already seen their profit margins fall to 2-6 percent before the crisis due to reduced value-added tax (VAT) rebates, rising wages caused by the new Labor Contract Law, high fixed costs for materials and energy, and renminbi appreciation. When China later restored the VAT rebate rate to 11-13 percent, it wasn't enough to make up for the lost orders. Even the Survivors Are Cutting Way Back -------------- ¶6. (SBU) Yeh commented that even though the impact on his company, which mainly manufactures electronic cables and networking equipment, had been minimal, he was still in the process of cutting costs and reducing his workforce. Well before the financial crisis, YFC-Boneagle had cut employment at its Dongguan factory from 1,900 workers in 2006 to 1,600 in 2007 and then to 1,200 by the end of ¶2008. He cut salaries by 20 percent for staff working in subsidiaries in Los Angeles and 10 percent for Taiwan employees. Yeh noted that although orders for one of the major products made by GUANGZHOU 00000042 002 OF 003 its Los Angeles subsidiary had dropped by 30 percent, orders for its other major product had remained stable because one of its major competitors had shut down. ¶7. (SBU) Similarly, Mohamad Amini, President of Lacquer Craft MFG Co in Dongguan, told us that his firm, another Taiwan-owned firm, had already cut its workers from 3,500 when the plant was at its peak to 3,000 today. Although costs had declined 5-10 percent in 2008 due mostly to lower transportation and input prices for petrochemical products, it had only been enough to restore margins to a level where the firm no longer needs to raise prices it charges customers. ¶8. (SBU) Zhang Xifan, Chair of General Jack Technology Ltd, which is also Taiwan-owned, said his company has seen orders drop by 40-50 percent even though it had been able to keep some steady customers. General Jack has cut staff from a high of 2,300 workers in 2007 to 1,400 today. However, Zhang noted that this was a good time to attract skilled employees from large companies that are laying off. Dongguan City Government to the Rescue -------------- ¶9. (SBU) YFC-Boneagle's Yeh praised the Dongguan municipal government's efforts to assist enterprises during the economic downturn. For example, the city waived the site-use fee for foreign-invested enterprises (FIEs) starting on August 1, 2008, cut the embankment protection fee by half on November 1 and suspended payment of guarantees for the Handicapped Employment Security Fund on January 1, 2009. He estimated that these measures alone will cut operation costs for firms by hundreds of thousands of renminbi. ¶10. (SBU) In addition, the Dongguan government will provide RMB 1 billion (about USD 143 million) in financing for small and medium enterprises (SME) and another RMB 1 billion to help enterprises upgrade their operations. He doubted that Taiwan businesses would be able to take advantage of these programs but noted that TBA-DG had invited Taiwan's China Productivity Center to assist Taiwan businesses to upgrade. TBA-DG is negotiating with the Dongguan city government to subsidize 30-50 percent of the program's cost. ¶11. (SBU) General Jack's Zhang echoed Yeh's praise for Dongguan's efforts to support SMEs. He said that city officials meet with TBA-DG once a month to learn more about their difficulties. He said that city Customs, Taxation Bureau and Labor Bureau officials refrained from excessive interference and noted that enforcement of regulations had become more lax. But Zhang complained that fees from township-level governments are still a heavy burden for FIEs. A TBA-DG survey found that some township governments in Dongguan impose more than 40 separate administrative fees. In addition, he explained that most land in Dongguan is collectively owned by villagers. Despite the fact that 30 percent of factories in Dongguan are unoccupied, according to Zhang, factory owners still find it difficult to negotiate lower rents. ¶12. (SBU) In contrast, Yeh indicated that the Guangdong provincial government had provided almost no help to Dongguan's struggling FIEs and SMEs. He said they had been largely absent and the policies they had in place didn't make much sense. Comment: This might well be because Party Secretary Wang Yang would like to see many of these factories - labor intensive, energy inefficient - go out of business and let a new generation of service and high-tech companies sweep in behind them. End comment. Financing a Persistent Problem -------------- ¶13. (SBU) Affirming what we've heard repeatedly from executives and financiers in south China, Yeh said that SME's are still having trouble getting the credit they need. He pointed out that the Taiwan Affairs Office had recently announced that China would allocate RMB 160 billion (about USD 23.5 billion) in financing for Taiwanese companies on the mainland over the next two or three years. The financing will be provided by three of China's major GUANGZHOU 00000042 003 OF 003 banks: Industrial and Commercial Bank of China, Bank of China and China Development Bank. However, Yeh argued that mainland banks would still be reluctant to provide loans to most Taiwan enterprises due to inadequate collateral or credit information. He said credit problems for Taiwan enterprises would be a top priority for the next round of SEF-ARATS talks between Chen Yunlin and Chiang Pin-kung to be held in March or April, focusing in part on how opening the mainland market to Taiwan banks can assist Taiwan enterprises here. In the meantime, TBA-DG is working with the Dongguan municipal government to set up a joint guarantee company. Yeh is trying to persuade Dongguan to fund 40 percent of the company. Double Transfer? Not for Taiwan Enterprises -------------- ¶14. (SBU) Yeh commented that few Taiwan enterprises would move their factories out of the Pearl River Delta (PRD) to less-developed parts of Guangdong as called for in the province's double transfer policy. He claimed the new Labor Contract Law made it too expensive to lay-off existing employees in the PRD and lack of financing made it difficult to build a new factory somewhere else. Yeh said that the Taiwan Affairs Office had once called on Taiwan-owned firms to sign up for a "group transfer" but not one firm expressed interest. Dongguan Adjusting Expectations -------------- ¶15. (SBU) Yeh emphasized that no one knows how many more companies will close after the Lunar New Year holiday; it depends on whether orders recover. He explained that U.S. buyers normally stop placing orders around October and resume buying again in February. Every one is watching whether the same will happen this year, he said. ¶16. (SBU) He commented that many migrant workers had just gone home for "a longer than usual vacation," without being told that they were laid-off. They will return because this is the only way they can earn money, according to Yeh. He said the government was watching closely, hoping that enough factories will be able to hire workers, but at the same time, preparing for large numbers of jobless migrants. ¶17. (SBU) Yeh is not optimistic, predicting that U.S. consumer purchasing power will drop 50 percent in 2009, especially for autos and furniture. Zhang is equally pessimistic (Comment: or perhaps realistic... End comment.),forecasting that orders would not recover any time soon and that it would take more than one and a half years for the economy to revive. GOLDBERG