STIMULUS PROVIDES LIFELINE TO CHINA'S TEXTILE AND APPAREL

UNCLAS SECTION 01 OF 05 SHANGHAI 000201

SENSITIVE
SIPDIS

TREASURY FOR OASIA/INA/HAARSAGER AND WINSHIP
DEPT FOR EAP/CM, INR/B, EEP/TRA/AN
USDOC PASS BUREAU OF ECONOMIC ANALYSIS
USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI
STATE PASS USTR FOR STRATFORD, WINTER, TWINELAND
NSC FOR LOI, SHRIER

E.O. 12958: N/A
TAGS: ECON EFIN PGOV ETRD ELAB KTEX CH
SUBJECT: STIMULUS PROVIDES LIFELINE TO CHINA'S TEXTILE AND APPAREL
INDUSTRY


1. (SBU) Summary: Government stimulus policies have saved
thousands of apparel manufacturers in East China from shutting
down production as dramatic drops in volume, sharp price cuts
and RMB appreciation erode profit margins. During a series of
meetings with Yangtze River Delta (YRD) apparel and textile
executives and Chamber of Commerce officials the week of April
13th, Conoff explored the effects of recent stimulus measures on
the industry. According to textile industry representatives,
tax rebates, loose credit policies, and lenient application of
labor laws are keeping a major percentage of the industry's 25
million employees at work. In addition, YRD manufacturers, who
account for half of China's total textile and apparel exports,
are able to remain competitive and stay in business. Although
the stimulus provides short-term relief from the global economic
downturn, industry insiders voiced concern about the long-term
viability of the industry. Company leaders and Chamber of
Commerce officials believe that the industry requires additional
stimulus and expressed relief that Chinese Premier Wen Jiabao
recently expressed his willingness to "use every possible means"
to support export growth. End Summary.



Central Government's Commitment to Save "Pillar Industry"

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2. (SBU) Until recently the Chinese Government encouraged
manufacturers to move away from textile and apparel, industries
traditionally considered too labor-intensive and low-margin to
fuel the higher value-added production that Chinese officials
hope will drive China's economy in the future. Despite this,
Zhang Tao, a Textile Industry Chamber of Commerce (CCOIC TEX)
official, estimates that China's 450,000 textile and apparel
manufacturers have seen their business volume triple in the last
ten years. The sector now provides jobs for 25 million direct
and 100 million indirect employees and is considered a key
element of China's economic growth and social stability.
Although exact statistics are difficult to obtain from the
government, industry insiders believe that in the recent past,
10 percent of the industry's factories have shut down in
Zhejiang Province, where 40 percent of the economic output comes
from textile and apparel manufacturing, and claim that an even
higher percentage of textile and apparel manufacturers in
southern China have closed. In response, Premier Wen Jiabao
declared in late 2008 that textiles and apparel are a "pillar
industry" and committed government support to revitalize the
industry.



Companies Plagued by Weak Orders, Low Prices and No Profit

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3. (SBU) Vice President Hong Xuechun from Zhejiang Orient, a
holding company with USD 500 million annual sales and 16
subsidiaries, reports that plummeting orders are the biggest
problem the industry faces. Hong and executives from the
company's 5 largest subsidiaries explained that for the past
several years annual sales grew by 15-20 percent, but in 2008
orders were flat. According to statistics released by Xinhua
news agency, China-wide textile and apparel exports still grew
in 2008 by 8.2 percent, a much slower rate than 2007's 18.9
percent growth. The first quarter of 2009 has been extremely
difficult for the industry as textile exports fell 15 percent
and apparel exports dropped 5 percent year-on-year. According to
Leonard Liu, Vice General Manager of Garmtex, which sells
apparel to major US retailers including Macy's, volume drops of
this size have a devastating effect in an industry with
relatively low profit margins. Liu estimated that in the YRD, 5

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percent net profit is considered healthy for apparel companies
and even less is acceptable for a textile manufacturer.
Higher-end manufacturers have not been protected by larger
margins because their sales volume plunged faster than the
industry average. DZ Group executive Lilian Song, explained
that because her company supplies high-end goods to upscale
retailers such as Nordstrom and Land's End, they suffered a 30
percent drop in sales in 2008 and expect another 30 percent fall
in 2009.




4. (SBU) The economic downturn has decimated profits for an
industry that accounted for USD 185 billion annual sales in

2008. U.S. buyers, facing the weakest retail environment in
decades, are now reluctant to invest significant amounts into
one style before it has been market tested. Accordingly, they
have cut order sizes by as much as 50 percent, making it
difficult for manufacturers who depend on large scale factory
runs to make a profit. At the same time, increasing competition
for fewer orders has led to a sharp drop in the price
manufacturers receive. According to Ningbo Seduno Group General
Manager Xu Jianchang, whose company has 3,500 employees and USD
180 million annual export sales, prices have dropped 10 percent
on average since the beginning of the economic downturn.
Unfavorable RMB exchange rates have further eroded profits.
Song from DZ Group clarified that her company's profit levels
have decreased from 30 percent in the 1980s, 15 percent in the
1990s, 8 percent from 2000-2007, to 5 percent in 2008 and most
likely 0 percent in 2009.



Rebates Sustain Ailing Companies

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5. (SBU) Export tax rebates are the key component of the
government's stimulus plan to support textile and apparel
exports. In an attempt to reduce exporter's costs, the Ministry
of Finance started raising the export tax rebate in August 2008.
Since then, in a series of unprecedented moves, the rate has
jumped from 11 percent to 16 percent, its highest level in 10
years. Sun Ting from China Council for the Promotion of
International Trade (CCPIT) Ningbo Information Department
explained that when exports weakened, industry officials
immediately lobbied for this reform because they regard export
tax adjustment as the most efficient stimulus the government can
provide to their industry. CCPIT Hanghzou official Chen Jiyang
stated that the increase has an enormous impact and that "if you
don't have the refund, you can't run a business because there is
currently no profit in foreign trade." One Citic securities
analyst cited in the press estimates that each 1 percent
increase in the rebate tax adds several billion RMB of profits
to the industry. Seduno Group General Manager Xu agreed that
the rebate has helped him to be more competitive by allowing him
to lower unit sales price.



New Bank Lending Keeps Companies Solvent

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6. (SBU) Another key measure of the stimulus plan is increased
liquidity for apparel and textile small- and medium-sized
enterprises (SMEs). In the past, SMEs have struggled to obtain
capital from Chinese banks that are reluctant to lend to apparel
and textile manufacturers. Seduno Group General Manager Xu
estimates that 60 percent of the SMEs in Ningbo are currently
using this new liquidity to stay in business. Nonetheless,

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Chairman and General Manager of Flying Horse, a subsidiary of
industry giant Shanghai Knitting Company, Lu Longsheng, believes
that many companies still face difficulty obtaining loans. Lu
described how Shanghai based SMEs are creating alliances in
which they approach banks as a group and provide guarantees for
each other. He also described a new phenomenon where executives
request that banks allow them to mortgage their personal homes
to obtain operating funds. Zhejiang Orient Senior Vice
President and Finance Director Jerry Zheng, described how even
his company, an extremely well capitalized former state-owned
enterprise, faces cash flow challenges. Well known U.S. retail
customers are all demanding longer settlement terms of 60 days
instead of the traditional 45 days. In this volatile
environment, a cancelled order after production is complete or
the bankruptcy of a buyer can trigger serious cash flow problems
and force companies to cease operations.



Economic Downturn Undermines Worker Protections

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7. (SBU) In order to avoid massive layoffs, government
officials are rolling-back several of the key measures put in
place by the 2008 Labor Law. DZ Group Human Resources Manager
Lilian Song explained how the Shanghai government allows
companies that are suffering economic losses to postpone the
payment of new social insurance requirements which comprise 42
percent of the company's total wage costs. CCOIC Tao defended
the law as "a good law, but one that adds a burden to the
operations of manufacturers." However, Mrs. Song argues that
the law hurts the industry by driving wages up 15 percent. She
added that the minimum wage and overtime regulations are
unevenly enforced. General Manager of Flying Horse Lu explained
how the local government in the Minhang District of Shanghai is
following the central government directive to avoid layoffs by
providing grants that fund alternative training for idle
workers. CCPIT Ningbo official Liu Yanlan considers that the
relaxed application of the law is "very helpful, it allows
companies to hold onto money and fund cash flow and operations."
However, despite these initiatives to keep workers employed,
with production facilities running at 50-70 percent of capacity,
even industry giant Zhejiang Orient executives admitted that,
although they had not yet cut staff, they are now "seriously
considering it."



Government Support for Brands Less Helpful to East China's SMEs

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8. (SBU) In an attempt to revitalize the industry and help
companies move higher up the value chain, the government
introduced measures that fund marketing and production costs for
Chinese brands. The government's stimulus plan encourages
manufacturers to shift their operating model from an
export-driven model to a domestic sales model so that local
brands can benefit from the 30 percent annual growth in China's
apparel market. CCPIT Ningbo official Sun Ting estimated that
90 percent of Zhejiang's apparel and textile manufacturers'
production is focused on foreign trade. Ting explained that
although Zhejiang has a reputation as one of the most
entrepreneurial environments in China, local SMEs are not
capturing any benefit from this government program. For
example, Seduno Group General Manager Xu explained that selling
to the Chinese market is "totally different, with different
rules" and that his company has no plans to change their
operating model to sell domestically. Zhejiang Orient Group
Home Textiles General Manager Barry Kong reiterated this

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sentiment and explained that despite the stable position of his
large and well capitalized company, their company's strength is
manufacturing and shipping goods abroad, not managing inventory
and domestic distribution channels. Even DZ Group executive
Song, whose company has experience providing design services,
says that the cost and risks associated with building a Chinese
brand and selling to Chinese retailers are still too high for
the company to attempt expansion into the Chinese market.



Rising Wages Threaten Low Cost Production Model

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9. (SBU) For decades, the competitive advantage of YRD apparel
manufacturers has been their ability to deliver high quality
goods at low prices on a large scale. As the GDP per capita in
YRD's major cities rose to several times the national average,
to stay competitive, manufacturers relocated production to
regions with lower real estate and labor costs. According to
Flying Horse General Manager Lu, his company has dramatically
increased its outsourcing from 40 percent in 2007 to 80 percent
in 2008. Zhejiang Orient now outsources 70 percent of its
garment business and 100 percent of its accessory production to
lower cost areas in the YRD like Shaoxing and Yiwu. However,
outsourcing undermines manufacturer's ability to deliver high
quality goods on time. Zhejiang Orient subsidiary Garmtex Vice
General Manager Leonard Liu noted that India and Bangladesh are
in the process of building capacity with modern factories that
offer vertically integrated supply environments that rival those
of the YRD. Zhang Tao, who also serves an official role at
Beijing based CCPIT Sub-Council of Textile Industry, explained
that, despite the shift to outsourcing, labor rates in China
have risen to two times wages in Bangladesh and one and a half
times wages in India and Vietnam. Although the stimulus has
allowed companies to lower costs and survive the economic
downturn, rising competition from other countries poses a long
term challenge.



Limited Prospects for Shifting Exports to Emerging Markets

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10. (SBU) Although the government encourages YRD manufacturers
to build sales networks in emerging markets to offset the fall
in Western demand, SMEs face a challenge controlling risk in
these markets. Flying Horse General Manager Lu explained that
counterparty risk is a huge problem for Chinese exporters who
are forced to use letters of credit, export credit insurance and
other costly financial tools to protect themselves against
unknown buyers. Although large companies can absorb these
finance fees, the cost is prohibitive for SMEs. CCPIT Hanghzou
official Chen Jiyang described one SME who attempted to enter
the Russian market. Despite the company's efforts to protect
itself by requesting a 30 percent down payment and full payment
before shipping, the relationship dissolved when administrative
fees wiped out all of the YRD exporter's profits.



Concern that Protectionism Will Limit U.S. Market Share Gains

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11. (SBU) Although Seduno Group's General Manager Xu reports
that there are "no signs yet" of a recovery, exporters see

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potential to capture U.S. market share from other Southeast
Asian countries. US safeguard restrictions negotiated in 2005
expired on January 1, 2009. Zhejiang Orient's New Asia
subsidiary executive Hu Zhen who oversees sock sales to
companies including Walmart, Kohls, and JC Penny, explained how
in 2008 he quickly reached his quota of 2 million units. He
believes that in a quota-free environment, and with the help of
stimulus measures, he can increase his volume to 4 million by
undercutting suppliers in other countries. (Note: Statistics
from the International Trade Administration (ITA) in the U.S.
indicate that this is a growing trend. In January, 2009, U.S.
apparel imports fell 6.3 percent, but imports from China rose
7.5 percent to 35 percent of total apparel imports, up from 31
percent in 2008, and 16 percent in 2005. End note.) Xu
expressed concern that the GOC efforts to help the textile and
apparel industry may lead to a protectionist backlash in the
U.S. He is worried that, although the end of safeguards hasn't
been as dramatic an event as the end of WTO quotas in 2005 when
certain export categories surged 600 percent and prices dropped
40 percent, protectionist policies may limit hopes of gaining US
market share.



Additional Stimulus Needed

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12. (SBU) According to CCPIT Ningbo official Ting, the
government's tax rebate and liquidity policies "are keeping
companies in business" but he remains anxious for the government
to clarify other stimulus programs. Despite CCPIT's close
relationship with the GOC, Ting expressed concern about the lack
of transparency regarding the industry stimulus plan, explaining
that "everything is a surprise, I learned about the tax rebate
on television." Ting confirms that for now, businesses remain
focused on survival and haven't taken crucial steps toward
operating higher in the value chain or increasing productivity.
From the perspective of CCOIC's Tao who tracks the industry
across China, although the stimulus "could work to some extent
in the short term, we believe that the whole industry will have
to solve the problem of overcapacity under the circumstance of
decreasing market demand." In recent weeks, the government has
announced further stimulus, in the form of plans to help the
industry with trade finance and technology upgrades. It remains
to be seen how these additional measures will influence YRD
apparel and textile manufacturers.
CAMP