By David Dayton
This is the body of a presentation that I give for Global Sources at the China Sourcing fairs. Global Sources asked for a presentation that was aimed at helping new buyers to China understand what some of their options for financing are now that the world economy is so bad. There are, to be honest, no new options (TT’s and LC’s are still the standard), but there are some unique situations that may offer some new opportunities for buyers coming to China.
Know your market
Just because we keep seeing bad news in China and the all the other world markets, for example, exports form China have dropped up to 60% in many industries, that doesn’t mean that we have the whole picture. There are pieces missing, both good and bad, from a broader view that are important to understanding the economic situation in China today. Having a better understanding of what’s happening in individual factories and in industries and regions will help you make the most of your sourcing experience in China.
For starters, an important additional component to the bad export numbers is the fact that imports into China have dropped as much or more. This means that China isn’t buying like a “strong” economy should. Neighboring counties in Asia are not getting the economic lift from China that you’d expect from an economy that officially is predicted to hit 8% growth this year.
Now there are indeed a lot of reports saying that buying in China is up this year. But there are some significant caveats to the numbers that help us see the context more clearly. First, retails sales for Chinese New Year were down by as much as 30%. This is the biggest buying period of the year for China—some industries estimate that up to 40% of their annual sales happen during this time. Second, sales numbers are not consistent across all industries or all regions. This suggests that there are some artificial stimulators in the economy and that investment/buying may not be sustainable. For example, the Shanghai stock exchange has had some serious investment since the release of stimulus cash. Coincidence? Probably not.
Another example is the increase in car sales. Again, there are significant incentives to buyers right now. Chinese, who mostly buy cars with cash, are being given great opportunities to buy right now and are taking advantage of a good thing—but a one-time event to be sure. And, on the more cynical side, a new car in the midst of a bad economy is a huge social status boost (face).
Finally, there is speculation that rise in recent orders (international and domestic) is just retailers refilling their inventories that they’ve let go as long as possible. Orders are not large (compared with previous years) and this is the start of the big fall/holiday push (back to school, Halloween, Christmas).
One of the other consequences of the Economic Tsunami is a rash of consolidation in many industries in China. This started with toy factories in Guangdong province in 2007 and has spread to just about every industry in every region. This is not necessarily a bad thing. Many smaller, borderline-quality factories have gone out of business in the past year leaving the larger, financially stronger factories to pick up the few remaining orders. In the long run this should, theoretically, help with raising the standard of Chinese products.
Difficulties in China
This difficult economic situation in across the globe has led to some unique hardships for businesses, particularly local entities, in China.
First, from a macro perspective, the weak banking system in is in danger of becoming even weaker. For decades now, Chinese banks are not really solvent. The percentage of nonperforming loans is significantly higher than in the West—even now. But the difference is (or was) the larger level of government involvement here in China. The Chinese government will most likely not let the major banks fail; indeed these banks are flush with cash via the stimulus packages right now. This cash is not sitting around like government stimulus in the West either, the Chinese government is pushing banks to get it out, and get it out quickly. Banks have give out more loans in first quarter of 2009 than in all of 2008. Short-term that’s not bad a bad way to get cash into the economy. But long term, it means that more likely than not, the rate of NPL’s will increase significantly.
And while the money supply is definitely larger, money from the banks is mostly pushed through specific local governments and their direct connections. Officially the money is targeted to specific industries and areas like Western China and green and higher tech and infrastructure projects.
Second, Chinese consumers do not consume, they save. The complete converse is the American consumer who does not save at all. But a comparison between the two has some value. The US economy with one trillion dollars in losses and twenty percent of China’s population still has an economy that is three times as large.
In China, loans are up, yes but overall consumer spending is not. This means that while incentives are helping specific industries for the short term, confidence in the market is not yet strong. With low prices in the housing market some people with cash are taking advantage of historic opportunities. This is an optimistic sign, but over-all consumers are still cautious.
Third, Chinese business aren’t paying their bills. With no orders for the last 6-8 months, factories have been left with raw-materials inventory and many unfinished or canceled orders. No cash to pay the bills has had a ripple effect up the supply chain that is only just in the last month or so being reported. In addition to the financial impact the already poor payment history of Chinese businesses has hurt the fragile hope in the domestic economy as a regional savior.
Fourth, due to a lack of both foreign and domestic buyers, there is over capacity, under employment and over production in many industries. Lines outside of factories offering day labor in Dongguan are common. Factories don’t have orders and are not paying their workers—dragging the local economies down even further. Many factories that are still technically in business are, in reality, underwater but either don’t know it yet or are just holding on as long as possible waiting for the recovery (and the 8% growth prediction to be realized).
Fifth, trust in foreign companies is very very low right now. More Chinese factories than I have ever heard of before have been stiffed for payments and had cancelled orders by foreign companies. We have been ask more than once over the last 6 months how a Chinese factory could do some due diligence on a potential foreign client. I have never even heard of this ever happening before. This is a lesson for foreigners that times have changed. You are no longer seen to be the cash cow, the e-ticket, or the trusted legal/honest party in a business relationship. Now it is Chinese factories that have serious and well-founded mistrust of foreigners and their willingness to honor legal agreements. You can no longer go into China with the attitude that “Hey, you should trust me, I’m from the developed country, I’m the on that doesn’t trust you.” The roles have been reversed. Maybe you have cash, and that’s certainly a negotiating plus, but you no longer have the moral high ground of “my system is better than yours.”
Finally, China says it will hit 8% growth this year. But no one else really believes they will. Even the Chinese government has backed off this a bit when they presented their latest (3rd) stimulus plan last month. Like most Chinese statistics, the goals have as much or more political/propaganda value than do the actual numbers. Most people think that China has to have 8% of higher growth each year just to suck up the new entrants into the labor force. If this number isn’t reached each year fears of social unrest increase proportionally. IMF predictions for China in 2009 are between 5.5% and 6%. If you figure in the “green” GDP that China tried to release a few years ago China’s growth numbers for 2009 will certainly be negative.
David Dayton is the owner and manager of Silk Road International. David has nearly twenty years experience working in and with Asia and he leads SRI from our Shenzhen, China office.
This is the first part of “China: Sourcing in Bad Economic Times”, next week we will publish the second part.