LI & FUNG China Trade Quarterly

Transcription

1 LI & FUNG China Trade Quarterly Domestic and Foreign October 2008 Issue 12 IN THIS ISSUE : Part One : Domestic Trade I. Recent developments 2 II. Highlights 6 III. Outlook 9 Part Two : Foreign Trade I. Recent developments 13 II. Highlights: 17 III. Outlook 21 Domestic Trade GDP growth fell to 9.0% in 3Q08, the lowest in 5 years. Both retail sales and FAI maintained steady growth rates. However, these growth rates are likely to decline in next few quarters as we predict the Chinese economy will continue to slow due to weakening global demand. CPI growth moderated while PPI growth showed easing sign. The September CPI growth recorded 4.6% yoy, the lowest since June 2007, mainly due to slower food prices growth and higher base in 2H07. On the other hand, the September PPI growth moderated to 9.1% yoy, in line with the recent drop in global commodity prices. The Chinese government launches rural land reform. It is viewed as one of the most important and ambitious government policies to develop both rural and urban economies in recent years. The reform will allow farmers to transfer or lease the use rights of their farmland. Foreign Trade Export growth maintained whilst import growth decelerated. In 3Q08, China s export growth maintained at 23.1% yoy, compared to 22.3% yoy in 2Q08. Meanwhile, import growth decelerated to 25.9% yoy in 3Q08, significantly lower than the 32.2% yoy in 2Q08. RMB has halted its appreciation against the USD recently; but has started rising against the Euro. The RMB/USD exchange rate was around the same level as it was 3 months ago. Meanwhile, the yuan has appreciated by around 27% against the Euro in the last three months, posing significant downside risks to China s export growth. Helen Chin, Timothy Cheung Tel: (852) helenchin@lf1937.com timothycheung@lf1937.com Li & Fung Research Centre 13/F, LiFung Centre, 2 On Ping Street, Shatin, Hong Kong Tel : (852) Fax : (852) lfdc@lf1937.com Chinese textile exports to the US and the EU will no longer be put under safeguard quotas or license management next year, announced by China s Ministry of Commerce on 26 October. We expect this will encourage both US and EU importers to shift their orders towards Chinese suppliers in However, the US or the EU are likely to use other trade measures if there is a surge of China s textile export in early China has raised export VAT rebate rates to prevent big drop in export. China s Ministry of Finance raised export VAT rebate rates on a number of textile and garment products in August 2008 and will further raise the rebate rates for 3,486 items in November

2 LI & FUNG China Trade Quarterly October 2008 Issue 12 Part one: Domestic trade I. Recent Development 1. GDP growth slowed down further in 3Q08, the lowest in 5 years Affected by the global slowdown, China s real GDP growth fell to 9.0% yoy in 3Q08, the lowest in 5 years. In the third quarter, China s GDP amounted to 7,101.2 billion yuan (see Exhibit 1). Exhibit 1: China s real GDP growth, 2Q05 3Q08 Source: National Bureau of Statistic, PRC 2. Retail sales maintained stable growth amid slower economic growth Retail sales maintained stable growth although China s economic growth showed moderation. In 1-3Q08, China s retail sales reached 7,788.6 billion yuan and its growth accelerated to 22.0% yoy, compared to 21.4% yoy in 1H08 and 16.8% yoy in FY07. Retails sales in both cities and rural areas registered strong growth. In 1-3Q08, urban retail sales reached 5,316.5 billion yuan, up by 22.7 % yoy. Rural retail sales showed a fast pace of growth of 20.6% yoy, and totaled 2,472.1 billion in 1-3Q08. A detailed breakdown by commodity is shown in Exhibit 2. 2

3 Domestic and Foreign Exhibit 2: China s retail sales growth by commodity, 1Q-3Q08 yoy growth (%) 1Q08 1H08 1-3Q08 Clothing Cosmetics Stationeries and offices accessories Sports and entertainment goods Goods for daily use Home appliances and video equipments Furniture Grains and oil Meat, poultry and eggs Gold, silver, and jewelry Telecommunication equipments Automobiles Petroleum and related products Building and decoration materials Source: National Bureau of Statistic, PRC 3. Rural income maintained strong growth while urban income growth moderated In 1-3Q08, rural residents income maintained strong growth. The per capita cash income of rural households increased to 3,971 yuan, up by 11.0% yoy in real term. The growth was higher than the 9.5% yoy growth in FY07. Meanwhile, the per capita disposable income of urban households reached 11,865 yuan in 1-3Q08, grew only by 7.5% yoy in real term, much lower than 12.2% yoy in CPI growth moderated while PPI growth showed easing sign China s CPI growth recorded 4.6% yoy in September 2008, the lowest since June The inflation rate has continued to slow after reaching the peak of 8.7% yoy in February The moderation was mainly attributable to slower food prices growth and higher base in 2H07. In September 2008, urban CPI rose 4.4% yoy while rural CPI grew by 5.3% yoy. Food price was still the biggest factor, soaring by 9.7% yoy in September and 17.3% yoy in 1-3Q08. Exhibit 4 shows the breakdown of the CPI by commodity (see Exhibit 3 & 4). 3

4 LI & FUNG China Trade Quarterly October 2008 Issue 12 Exhibit 3: China s CPI growth, Jan 2007 Sep 2008 Jan % Feb % Mar % Apr % May % Jun % Jul % Aug % Sep % Source: National Bureau of Statistic, PRC Exhibit 4: China s CPI growth by commodity, Apr Sep 2008 yoy growth (%) Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Food Meat and poultry Pork Vegetables Grains Cooking oil & Fat Condiment Tobacco Wine Dress Apparel Durable goods Medical healthcare & personal care Traffic & telecommunication Recreational, educational products & services Recreational products Source: National Bureau of Statistic, PRC In line with the recent drop in global commodity prices, the producer price index (PPI) showed easing sign as its growth moderated to 9.1% yoy in September 2008, down from the recent peak of 10.1% yoy in the previous month. (see Exhibit 5 and 6). 4

5 Domestic and Foreign Exhibit 5: China s PPI growth, Jan 2007 Sep 2008 Jan % Feb % Mar % Apr % May % Jun % Jul % Aug % Sep % Source: National Bureau of Statistic, PRC Exhibit 6: Indices of purchasing prices of raw materials, fuels and power, 1-3Q08 yoy growth(%) Period Non-ferrous metals Ferrous metals materials Fuel and power Raw chemical materials Jan Feb Mar Apr May Jun Jul Aug Sep Source: National Bureau of Statistic, PRC 5. Industrial production growth fell to 6-year low China s industrial production growth slowed further to 11.4% yoy in September 2008, the lowest in 6 years. Since June 2008, China s manufacturing sector has deteriorated more rapidly. The reasons include slackening global demands; power shortage; weakening domestic demands on property and automobile. (see Exhibit 7) 5

6 LI & FUNG China Trade Quarterly October 2008 Issue 12 Exhibit 7: China s Industrial production growth, Apr 2007 Sep FAI growth maintained at high level In September 2008, China s nominal urban fixed asset investment (FAI) maintained high growth at 29.0% yoy. The large amount of projects launched last year and the rapidly rising fixed asset investments prices have contributed to the high nominal FAI figure. It is also noteworthy that this year is the beginning of the five-year term of local leadership. Government officials tend to build bridges and roads in their regions in order to showcase their achievements. The increase in local governments spending on infrastructure since March 2008 has also fueled the FAI growth. II. Highlights 1. Gradual relaxation of monetary policies Facing the worst global financial crisis since the Great Depression and the weakening Chinese economy, China s top leaders have switched and become more concerned about the country s economic growth, rather than inflation. Credit, thus, has been relaxed gradually to boost the economy. Below is a summary of the measures taken since August (1) Raising annual loan quota In August 2008, the People s Bank of China (PBOC) decided to raise the annual loan quota, which commercial banks have to strictly follow, by 5%. The newly extended loans to the market amounted to 180 billion yuan, targeting mainly at SMEs, the agricultural sector and export enterprises. (2) Cutting interest rates For the first time in 4 years, the PBOC announced to reduce the benchmark-lending rates on 15 September In the meantime, the benchmark deposit rates were kept unchanged. On 7 October 2008, central banks from seven countries 1 announced to cut interest rates and China was one of them. This time, China s central bank cut both benchmark lending and deposit rates. To intensify support for the domestic enterprises, the PBOC further cut rates on 29 October 2008 (Exhibit 8). 1 The central banks of US, Europe, England, China, Canada, Sweden and Switzerland coordinated global interest rates cut on 7 October

7 Domestic and Foreign Exhibit 8: One-year lending rate adjustments, 1-3Q08 Announcement date Adjustment Lending rate after the adjustment Effective date 15 Sep -27 bps 7.20% 16 Sep 7 Oct -27 bps 6.93% 9 Oct 29 Oct -27 bps 6.66% 30 Oct Source: The People s Bank of China (PBOC) (3) Reducing RRR After having raised the reserve requirement ratio (RRR) for 15 times since 2007, China s central bank announced to cut RRR of banks except six major banks 2 by 100 bps on 15 September 2008; and cut RRR of all banks by 50 bps on 7 October 2008 (see Exhibit 9). Exhibit 9: RRR adjustments, 1-3Q08 Announcement date Adjustment RRR Effective date 16 Jan +50 bps 15.0% 25 Jan 18 Mar +50 bps 15.5% 25 Mar 16 Apr +50 bps 16.0% 25 Apr 12 May +50 bps 16.5% 20 May 7 Jun +100 bps 17.5% 15 Jun for 50 bp; 25 Jun for another 50 bp 15 Sep -100 bp or 0 bps 16.5% or 17.5%* 25 Sep 7 Oct -50 bps 16.0% or 16.5%* 15 Oct * RRR of six major banks which include Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank, Bank of Communications, and Postal Savings Bank Source: The People s Bank of China (PBOC) 2. 4Q08 economic work priorities set by the State Council In response to the tough economic environment and poorer export outlook, China s central government has intensified its fiscal support to maintain stable economic growth, financial system, capital market and social harmony. In mid- October, Premier Wen Jiabao presided at a State Council meeting, setting the work priorities of economic and social development in the 4Q08. The measures include: 1. Increasing investment in agriculture, urban and rural infrastructure, energy, transport and quake-zone reconstruction; 2. Supporting housing demand by expanding the scale of public housing construction and reducing transaction taxes; 3. Supporting export growth by raising export VAT rebate rates on both labor intesive products and high value-added machinery and electrical products; 4. Supporting small- and medium-sized enterprises (SMEs) by encouraging financial institutions to extend more credit to SMEs and giving more fiscal support for their technological innovation; 2 These six banks include Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank, Bank of Communications, and Postal Savings Bank. 7

8 LI & FUNG China Trade Quarterly October 2008 Issue Increasing rural income by raising the minimum procurement prices of grain and farm subsidies; 6. Introducing measures to ensure the living standard of low-income people; 7. Strengthening supervision of the financial sector and capital market. 3. The Implementation Regulation for the Labor Contract Law was issued in September 2008 To promote harmonious employment relationships, China enacted its influential Labor Contract Law in January To better explain the law and clarify some areas causing confusion, the State Council issued an Implementation Regulation for the Labor Contract Law (hereafter referred to as the regulation) on 18 September 2008 with immediate effect. There is no substantial change in content while the regulation has clarified and addressed the following issues: 1. Reiterating the circumstances under which a labor contract can be terminated Some employers are concerned that the open-term contract would be tantamount to guaranteeing lifetime employment. To clear this misconception, the regulation reiterates the 14 circumstances under which an employer can terminate the contracts 3. On the other hand, employees can also terminate the labor contracts if one of thirteen circumstances stipulated in the regulation is met Addressing the issues of workers refusing to sign labor contracts There are cases that workers in China refused to sign written contracts as they wished to increase flexibility in switching between jobs, skip insurance payments; or misconceived that the Labor Contract Law requires employers to compensate workers twice the monthly wage for each month of employment should there be no written contract. The regulation now allows employers to protect themselves by granting them the right to terminate an employment relationship if the employee refuses to sign a written contract. Except the above-mentioned issues, the regulation also further clarifies the issues regarding severance pay, economic compensation, labor dispatching, etc. The regulation reflects the Chinese government s commitment to protect workers interest and, at the same time, eases concern that workers protection may be overemphasized at the expense of employers interests and labor market flexibility. Detailed discussion of the regulation can be found in our newsletter Issue 54: The Implementation Regulation for the Labor Contract Law. 3 see Implementation Regulation for the Labor Contract Law, Article 19 4 see Implementation Regulation for the Labor Contract Law, Article 18 8

9 Domestic and Foreign III. Outlook 1. The Chinese government launches rural land reform to develop the economy On 12 October, the 3 rd Plenary Session of the 17 th Central Committee of the Chinese Communist Party was concluded. A long-term goal of doubling farmers income by 2020 from the 2008 level was set. A rural land reform plan was announced, which is viewed as one of the most important and ambitious government policies in recent years. According to the rural land reform plan: 1. Farmers are allowed to transfer, sub-contract, lease, exchange, or to offer/transfer through a shareholding system the use rights of their farmland 2. Government will establish markets for the lease of contracted farmland and the transfer of farmland-use rights. Before the reform, farmers can only lease farmland for long-term use, typically 30 years. While individual farmer only leases small plots of farmland, the agricultural production in China is mostly in small scale. After the reform, farmers can choose how to exercise their farmland-use rights and hence, economic efficiency can be boosted. The reform is expected to encourage farmland consolidation. With larger farmland, farmers will have more incentive to make investments and raise the mechanization level of the agricultural production. Meanwhile, the process of urbanization would be accelerated as farmers can be compensated for leaving rural areas and moving into cities. The rural land reform is one of the major policies to develop both rural and urban economies, and is consistent with the government strategy to stimulate domestic demand which has become particularly important amidst the global economic slowdown. We expect more capital will be attracted to the countryside for developing a modern agricultural industry. Besides, rural residents wealth will increase, as they are entitled to the income from their land-use rights. In addition, it is expected that a lot of rural residents will leave the rural areas and migrate to cities. This will greatly stimulate the demand for housing (and related products and services) in the urban areas. 2. China economy is set to slow further China s economic growth decelerated to 9.0% yoy in 3Q08, compared to 11.9% yoy in We predict the Chinese economy will continue to slow in the near future due to both weakening external and domestic demands. Comparatively speaking, China s financial sector has not been hit as badly as other countries by the global financial crisis: China has not yet fully opened up its financial sector, and its capital account is still not fully convertible yet and they served as an effective firewall. Besides, it was reported that China s financial institutions did not hold a large amount of subprime-related securities. According to a recent interview of the Academy of Social Science office, the total value of outstanding subprime-related securities in China was not very high, estimated at around US$10 billion and, of which, around US$ 8 billion was held by Chinese banks. However, the financial tsunami is still likely to have serious impact China through affecting the real side of the economy, especially as the US and the EU are China s two biggest export markets. 9

10 LI & FUNG China Trade Quarterly October 2008 Issue 12 In 3Q08, China s export still managed to maintain stable growth at 23.1% yoy, compared to 21.9% yoy in 1H08. However, in view of the worsening global economic outlook, it is very likely that China s export growth will fall soon. Besides, according to the National Development and Reform Commission (NDRC), around 67,000 SMEs closed and more than 20 million workers lost their jobs in 1H08. Some indicators such as industrial production growth 5, PMI 6, etc, have also shown a weakening manufacturing sector in China. Though retail sales growth remained robust in 1-3Q08, factors such as lower real disposable income growth 7 of urban households, negative wealth effects caused by adjustments in A-share market and property market, unemployment due to factory closure, etc. suggested that retail sales growth is likely to decline in next few quarters. Many analysts suggested Chinese economy would slow in 4Q08 because one of its economic drivers, the 2008 Beijing Olympics, ended in late August. However, we argue that its impact on the economy should be marginal, compared to the smaller host countries in the past such as Spain, Greece and South Korea economic growth of these countries decelerated after the Olympic game. The Chinese government invested US$ 41 billion to build infrastructure in the past 7 years for the Olympic game, but the amount of total investments only accounted for around 1% of GDP in Taking all these factors into account, economic growth in 2008 and 2009 should be much lower than that in Yet, the Chinese economy in 2009 will be bolstered by the Chinese government s expansionary fiscal policy. For example, in late October 2008, the administration announced to raise export VAT rebate rates for 3,486 items, effective on 1 November 2008, and exporters will probably save 22 billion yuan per year. Moreover, the market is anticipating the readjustments of the value-added tax (VAT) regime and therefore, enterprises can save up to 150 billion yuan annually. There are rumors that personal income tax rate will be cut. And we also expect a significant rise in spending on public infrastructure by the government. 3. CPI growth is likely to fall in 4Q08 The CPI growth peaked at 8.7% yoy in February 2008 and then slowed down to 4.6% yoy in September. We predict it will continue to fall for the rest of 2008 with food prices moderation. Food prices hike since 1Q07 has been the major driver pushing up China s inflation rate. Due to increased food supply and the higher base effect, food prices growth and thus CPI growth has fallen markedly. Looking ahead, boosted by the recent grain harvest and the increasing meat output this year, CPI growth is likely to decline further in 4Q08. We believe the impact of the other factors such as energy prices hikes, rising ex-factory prices, etc., on inflation in 4Q08 is likely to be limited. Although the rise in the prices of refined oil products in late June 2008 has been resulting in higher PPI, its effect on the CPI will not be significant because of the low weight of energy products in the CPI basket. Besides, the PPI pass-through to the CPI is expected to be weak, due to the intensified competition and overproduction, and enterprises in the downstream industries will have to absorb most of the increased costs. 5 The industrial production growth in September 2008 slowed to 11.4% yoy, the lowest level in 6 years. 6 The July and August PMI stayed at 48.4%. It was the first time the PMI was below 50% since its launch in January The PMI then rebounded to 51.2% in September. 7 The per capita disposable income of urban households grew only by 7.5% yoy in real term in 1-3Q08, much lower than the 12.2% yoy in

11 Domestic and Foreign 4. Electricity prices may be raised further to tackle the power shortage and over-utilization Many provinces in China such as Shandong, Guangdong, Henan, etc., have been experiencing power shortage. In fact, electricity shortfall is one of the major bottlenecks for industrial production, curbing China s economic growth. For example, manufacturers in Guangdong, one of the key manufacturing bases in China, were asked to shut down operations for a few days a week in Spring this year. Many analysts suggested that the distortion in energy prices, rather than insufficient power production capacities, was the main cause of the electricity shortfall. Electricity prices, currently controlled by the Chinese government, have been maintained at low levels and have not kept pace with the rising prices of coal, the major raw material for generating electricity. As the electricity prices are well below the production costs, power producers are discouraged to produce electricity, which would incur further losses. On the other hand, the artificially low electricity prices have encouraged the inefficient and over-utilization of such scarce resources. The Chinese government is well aware of the importance of energy conservation, and it has set a national goal of reducing energy consumption per unit of GDP by 4% every year. Therefore, the government is aimed at pushing forward the energy pricing mechanism reform so that, in the long run, the electricity prices would be mainly determined by market demand and supply. However, high inflation since 2H07 has left little room for price adjustments or reform. For the first time in 2 years, in order to relieve power shortage, the government raised the electricity prices in July Still, power producers were reported to make losses even after the prices rise. As the CPI growth continues to moderate in 4Q08, it is widely expected the electricity prices will be raised again, probably by the end of the year. 5. Entrepreneurs were less optimistic in 3Q08 In 3Q08, the national Entrepreneur Confidence Index (ECI) fell to 123.8, down by 11.0 ppt from 2Q08. In general, entrepreneurs were less optimistic about the prospects of their respective industries. ECIs of all ten sectors surveyed decreased in 3Q08, compared to 2Q08. Of which, ECIs of manufacturing sector; information transmission, computer service and software; property sector registered double-digit qoq drop in 3Q08. Compared to the same quarter last year, ECIs of all industries except mining industry were lower in 3Q08 (see Exhibit 10). 11

12 LI & FUNG China Trade Quarterly October 2008 Issue 12 Exhibit 10: Entrepreneur Confidence Index, 2-3Q08 2Q08 3Q08 Compared with the previous quarter National Lower By sector Manufacturing Lower Construction Lower Transportation, storage & post service Lower Wholesale & retail Lower Social services Lower Information transmission, Lower computer service and software Hotel & catering Lower Property Lower Electricity, gas & water Lower Mining Lower Source: National Bureau of Statistic, PRC 6. The September PMI rebounded to 51.2% The PMI rebounded to 51.2% in September from 48.4% in August, after having stayed below 50% for 2 consecutive months. 5 of the 11 sub-indices registered readings below 50%, indicating a moderating manufacturing sector. Note that input prices index dropped further to 44.7% in September, the lowest since the PMI was launched in January 2005, suggesting the softening of input cost pressure for manufacturers (see Exhibit 11). The PMI provides an early indication each month of economic activities in the manufacturing sector. A PMI reading above 50% indicates an overall expansion in the manufacturing sector; below 50%, an overall contraction. Exhibit 11: China manufacturing PMI at a glance, September 2008 Index S. adj. index Index compared with the previous month Direction PMI 51.2 Higher Expanding Output 54.6 Higher Expanding New Orders 51.3 Higher Expanding New Export Orders 48.8 Higher Contracting Backlogs of Orders 47.3 Higher Contracting Stocks of Finished Goods 50.5 Higher Expanding Purchases of Inputs 50.8 Higher Expanding Imports 46.4 Higher Contracting Input Prices 44.7 Lower Contracting Stocks of Major Inputs 47.5 Higher Contracting Employment 50.3 Lower Expanding Suppliers Delivery Time 50.8 Higher Quickening Source: Li & Fung Research Centre 12

13 Domestic and Foreign Part two: Foreign trade I. Recent developments 1. Export growth maintained whilst import growth decelerated in 3Q08 In 3Q08, China s export growth came in at 23.1% yoy, slightly up from the 22.3% yoy in 2Q08. Since 4Q07, export growth stayed at around 21-23% yoy, down from around 26-28% in 1-3Q07. The decline in growth rate was mainly attributable to the slackening global demand, rising production costs in China and faster appreciation of RMB against US dollar and Euro (see Exhibit 12 & 13). The export slowdown of several types of low-valued manufactured products has continued export growth of garment and textile moderated to 1.8% yoy and 21.3% yoy respectively in 1-3Q08, compared to 3.4% yoy and 26.8% yoy in 1H08. It is noteworthy that export growth of mechanical and electrical products, which accounted for 57.4% of total export value, has not dropped that much: It maintained its growth at 24.0% yoy in 1-3Q08, compared to 25.4% yoy in 1H08. (see Exhibit 17 & 18). Meanwhile, import growth decelerated to 25.9% yoy in 3Q08, significantly lower than the 28.6% yoy in 1Q08 and 32.2% yoy in 2Q08, as global commodity prices have dropped and domestic consumer demand has weakened recently. With import growth decelerating and export growth maintaining at similar level, China s trade surplus growth rebounded to 13.3% yoy in 3Q08, after having registered negative growth in the first two quarters of Exhibit 12: China s quarterly foreign trade data, 2008 USD billion (yoy growth) Trade Balance Export Import 1Q 41.4 (-10.6%) (21.4%) (28.6%) 2Q 58.3 (-11.8%) (22.3%) (32.2%) 3Q 83.3 (13.3%) (23.1%) (25.9%) Source: China Customs Exhibit 13: China s monthly foreign trade data, 2008 USD billion (yoy growth) Trade Balance Export Import Jan 19.5 (22.7%) (26.7%) 90.2 (27.6%) Feb 8.6 (-63.9%) 87.4 (6.5%) 78.8 (35.1%) Mar 13.4 (98.2%) (30.6%) 95.6 (24.6%) Apr 16.7 (-0.1%) (21.8%) (26.3%) May 20.2 (-9.9%) (28.1%) (40.0%) Jun 21.4 (-20.5%) (17.6%) (31.1%) Jul 25.3 (3.6%) (26.9%) (33.7%) Aug 28.7 (14.9%) (21.1%) (23.1%) Sep 29.3 (21.9%) (21.5%) (21.3%) Source: China Customs 13

14 LI & FUNG China Trade Quarterly October 2008 Issue General trade plays a more important role, especially in import Note that both export and import under the general trade category grew much faster than those under the processing trade category 1 in 1-3Q08. Under general trade 2, export grew by 26.9% yoy, while import increased sharply by 47.3% yoy, 18.6 ppt higher than the import growth rate of FY07. Under processing trade, export growth decreased to 15.6% yoy, 5.4 ppt lower than that of FY07; import increased by 10.8% yoy, 3.8 ppt lower than that of FY07 (see Exhibit 14). Therefore, processing trade has been losing weights in total foreign trade, total exports and total imports. In 1-3Q08, processing trade accounted for only 40.8% of the total trade value, compared with 45.4% in By contrast, general trade is playing a more important role its share in China s total trade value rose to 48.6% in 1-3Q08 from 44.5% in This trend was in line with the government s policy direction to discourage processing trade and the exports of products that are energy- and resource-intensive, highly polluting, labor-intensive and low value-added. Since September 2006, the Chinese government has eliminated or slashed value-added-tax (VAT) rebates on certain products, and expanded the prohibited and restricted list for processing trade. However, in view of the softening economic growth, the survival threats of many labor-intensive industries and the weakening global demand, China s Ministry of Finance raised export VAT rebate rates on a number of textile and garment products in August 2008 and will further raise the rebate rates for 3,486 items in November We will discuss the details in the Highlights section. Exhibit 14: Foreign trade of China (general & processing trade), 2007 & 1-3Q08 yoy growth (%) Share (%) Item Q08 3Q Q08 3Q08 Exports Of which: General Trade Processing Trade Imports Of which: General Trade Processing Trade Total of Imports and Exports Of which: General Trade Processing Trade Source: China Customs 1 Processing trade refers to the business activity of importing all or part of the raw and auxiliary materials, parts and components, accessories, and packaging materials from abroad, and re-exporting the finished products after processing or assembling by enterprises within the Chinese Mainland. 2 General trade refers to the import or export of goods by enterprises in China with import-export rights. According to the Chinese statistics, the scope of general trade covers: import and export using loans or aids; the import of materials by foreign invested enterprises (FIEs) for processing of goods for sale in the domestic market; the export of goods purchased by FIEs or manufactured by processing domesticallyproduced materials; the import of food and beverages by restaurants and hotels; the supply of domestically-produced fuel, materials, parts and components to foreign vessels or aircraft; the import of goods as payment in kind in lieu of wages in labour service cooperation projects with foreign countries; and the export of equipment and materials by enterprises in China for their investment abroad. 14

15 Domestic and Foreign 3. Trade surplus formed a significant part of the accumulation of China s foreign exchange reserves in 3Q08 As at 30 September 2008, China s foreign exchange reserve amounted to US$1.91 trillion. The accumulation in 3Q08 reached US$96.8 billion, less than the US$153.9 billion in 1Q08 and US$126.6 billion in 2Q08. Contrary to the case in 1H08, a significant part of the additional foreign exchange reserves in 3Q08 came from the current account as trade surplus formed 86.1% of the accumulation of the reserves (See Exhibit 15). Given China s huge foreign exchange reserves and trade surplus, the possibility for RMB depreciation is relatively low in the near future. While many other currencies have been depreciating rapidly amid the current global financial tsunami, relatively stable RMB exchange rate would certainly be an important stabilizer to both the Chinese economy and the global financial system. This will also enhance the relative importance of the renminbi currency, as well as the relative attractiveness of China as an investment destination. Exhibit 15: Foreign exchange reserve by quarter, 1Q07 3Q08 USD billion Accumulation End of the quarter 1Q , Q , Q , Q , Q , Q , Q ,905.6 Source: State Administration of Foreign Exchange, PRC 4. The EU remained China s biggest trading partner; China s trade with India posted the strongest growth among the top 10 trading partners Same as in 2007, the European Union (EU) was China s biggest trading partner in 1-3Q08, accounting for 16.4% of the total trade. The Sino-EU trade sustained its strong growth at 25.9% yoy in 1-3Q08, compared to 27.0% yoy in FY07 (see Exhibit 15). The US was China s second largest trading partner in 1-3Q08. The Sino-US trade reached US$251.5 billion in 1-3Q08, grew by 13.8% yoy. Though the US was still China s second largest exporting country, faster RMB appreciation against the US dollar and the slowdown of the US economy had led to the downward trend of China s export growth to the US from 14.4% yoy in 2007 to 11.2% in 1-3Q08. However, China s import from the US has been growing at an accelerating pace: at 22.1% yoy in 1-3Q08, compared to 17.2% yoy in FY07. Japan was the third largest trading partner of China. The Sino-Japan trade hit US$202.7 billion in 1-3Q08, increased by 17.8% yoy, compared to 13.9% yoy in FY07. China s trade with other emerging countries has been growing robustly. China s foreign trade with ASEAN (Association of South East Asian Nations) grew by 22.9% yoy in 1-3Q08 and ASEAN remained China s fourth-largest trading partner. 15

16 LI & FUNG China Trade Quarterly October 2008 Issue 12 Note that the Sino-India trade registered the fastest growth of 54.9% yoy in 1-3Q08, among China s top 10 trading partners this year. In fact, China is now India s largest Asian trading partner. Bilateral trade between China and India has climbed from US$3.6 billion in 2001 to more than US$ 38.6 billion in Imports from other BRIC economies posted remarkable growth China s imports from Brazil, Russia and India recorded high growth in 1-3Q08: 80.2% yoy, 34.6% yoy and 74.8% yoy respectively. The strong growth reflects that (1) China has been importing an ever-increasing amount of commodities such as crude oil and mineral ores; (2) the economic and trade growth of the BRIC economies have remained relatively robust (see Exhibit 16). Exhibit 16: China s trading partners, 1-3Q08 Country/ Share of Export Import Yoy growth (%) Region Trade value total trade value value total trade Export Import (USD billion) (%) (USD billion) (USD billion) EU US Japan ASEAN Brazil Russia India Source: China Customs 6. Guangdong ranked first in China s foreign trade, but its share has fallen In the first 8 months of 2008, the top three provinces/municipalities (ranked in terms of foreign trade values) Guangdong, Jiangsu and Shanghai jointly accounted for 54.3% of China s total foreign trade, 4.7 ppt less than that of FY07. The total value of export and import of Guangdong was US$451.3 billion, up by 13.4% yoy. Note that Guangdong s foreign trade growth has moderated and its share in the national total fell to 26.2% in the first 8 months of 2008, down from 29.2% in Total value of export and import of Jiangsu province was US$266.4 billion, up 21.0% yoy, 15.5% of the national total. Total value of export and import of Shanghai was US$217.7 billion, up 21.6% yoy, 12.6% of the national total. It is noteworthy that total value of export and import of Beijing was US$189.5 billion, soaring by 56.3% yoy, in the first 8 months of 2008, compared to 17.3% yoy in the same period last year. 16

17 Domestic and Foreign Exhibit 17: Export by category, 2007 & 1-3Q08 yoy growth (%) of export value, calculated in US$ Q08 Textile materials & products Garments & clothing accessories Footwear Toys Coal Crude oil Refined oil Steel Source: China Customs Exhibit 18: Import by category, 2007 & 1-3Q08 yoy growth (%) of import value, calculated in US$ Q08 Cereal & cereal flour Soybean Iron ore Crude oil Refined oil Steel Synthetic yarn (1000 tons) Vehicles and related parts (1000 units) Source: China Customs II. Highlights: 1. China has raised export VAT rebate rates to prevent big drop in export Since 4Q07, the business environment for mainland manufacturers has become much tougher, caused by slackening global market demand, fast RMB appreciation and rising production costs. In fact, export enterprises in several traditional light industries have encountered extremely difficult situation - export growth of garments and toys fell sharply to 1.8% yoy and 3.7% yoy in 1-3Q08, compared to 20.9% yoy and 20.3% yoy respectively in As a result, a number of players in these industries have ceased operations this year. To prevent big drop in export, the Chinese policy makers have taken numerous measures to help manufacturers to withstand the global economic slowdown. One of its recent moves is to raise export VAT rebate rates for numerous products and thus, improve exporters margins. 17

18 LI & FUNG China Trade Quarterly October 2008 Issue 12 On 31 July 2008, China s Ministry of Finance and the State Administration of Taxation jointly announced to raise export VAT rebate rates on a number of textile and garment products to 13%, up from 11%, effective on 1 August It is estimated that export enterprises will save up to 17 billion yuan with these measures in place. On 21 October 2008, the Chinese government announced to raise the export VAT rebate rates for 3,486 items, effective on 1 November More product categories were covered this time, compared to the measure announced in August 2008, ranging from labor-intensive products such as textile, garment, toy, etc, to high value-added items such as anti- AIDS drugs, tempered glass, etc, and accounting for 25.8% of total products covered by the country s Customs Tariffs. (see Exhibit 19) Exhibit 19: Types of products included in the export VAT rebate rates adjustment in November 2008 Product category Before adjustment After adjustment Changes Garment, Textile 13% 14% +1% Toys 11% 14% +3% Furniture 9% or 11% 11% or 13% +2% Plastic 5% 9% +4% Porcelain 5% 11% +6% Source: China s Ministry of Finance We believe further policy adjustments targeting the struggling exporting industries are likely to be made, which may include supporting policies such as providing better financing access for SMEs, and broadening the value-added tax reduction scheme for fixed asset investments. 2 RMB has halted its appreciation against the USD recently; but has started rising against the Euro On 28 October 2008, the RMB/USD exchange rate was 6.84, around the same level as it was 3 months ago. In fact, the RMB appreciation against the US dollar has started to slow since April On the other hand, since mid-march 2008, the yuan has started appreciating against the Euro (the yuan had depreciated against the Euro earlier in 2008). The RMB appreciation has also shown an accelerating trend recently: the yuan has appreciated by around 27% against the Euro in the last three months. Faster RMB appreciation against the Euro, coupled with the weakening Eurozone 3 economy, will continue to pose significant downside risks to China s export growth if we bear in mind that EU is China s largest export market. We maintain the view that RMB appreciation will slow down for the rest of Whilst China s two trading partners, EU and US, are likely to face recession, further RMB appreciation will add pressure on China s export growth, the key driver of China s economy and employment. Recently, many mainland exporters have been hit by both global economic slowdown and mounting cost pressure. We also see industry consolidation taking place in some traditional light manufacturing. Thus, there is growing opposition to the current pace of the currency appreciation among government officials and economists in China (see Exhibit 20). 3 Eurozone member countries include Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovenia, Spain. 18

19 Domestic and Foreign Exhibit 20: RMB/USD and RMB/Euro, Chinese exporters margins have been squeezed Chinese exporters profit margins have continued to be squeezed, mainly by fast RMB appreciation and mounting production costs. (1) RMB While most mainland manufacturers settle their export orders in US dollar, RMB appreciation against the US dollar means a direct cut in revenue in terms of RMB. Besides, part of the production costs are settled in RMB which would further harm their export margins. It is however noteworthy that, in the past 6 months, the RMB appreciation against the US dollar has slowed down: by around 2.2% over the period, compared to 4.16% in the first 3 months of (2) Raw material prices Prices of major raw materials such as non-ferrous metals and raw chemical materials, ferrous metals, etc, have been increasing. Since April 2008, the growth rates of the purchasing price indices of non-ferrous metals and raw chemical materials have been in upward trend while that of ferrous metals has been in downward trend. In September 2008, the indices of non-ferrous metals, raw chemical materials and ferrous metals grew by -1.5% yoy, 8.2% yoy and 23.2% yoy respectively (see Exhibit 21) 19

20 LI & FUNG China Trade Quarterly October 2008 Issue 12 Exhibit 21: China s purchasing prices indices growth, Apr - Sep 2008 (3) Urban labor costs Urban labor costs in China have continued to grow strongly. Accumulative average earnings of urban workers have increased by 17.9% yoy in 1H08, reaching 12,851 yuan. Note also that the minimum wages in different areas in Guangdong province have been raised by 10.3% %, effective on 1 April (4) Energy costs In late June 2008, the Chinese government raised fuel prices, which have been subject to price control: Gasoline and diesel prices were both up by about 17-18% while jet fuel price was raised by 25%. In addition, effective on 1 July 2008, electricity prices for commercial units were hiked by an average of 5%, the first price rise since Doha round failed to conclude in July 2008 The Doha round, the current trade-negotiation round of the World Trade Organization (WTO), failed to conclude in July One of the main reasons for the failure was the disagreement between the US and the developing countries over a special safeguard mechanism (SSM), a measure to protect poor farmers in developing countries by imposing a tariff on specified agricultural goods if there is an import surge. The developing countries were concerned that, without the protection from the SSM, the domestic food markets would easily be dominated by imported produce from the developed countries. The Doha round commenced in November 2001 and was originally scheduled to end in December After the collapse of negotiations in late July 2008, however, it is widely predicted that major negotiations will not be resumed until Indeed, this failure was in line with the rising tide of protectionism. In the near future, trade barriers such as safeguard measures, anti-dumping measures, tariffs, subsidies etc, are expected to be used by both developed and developing countries more frequently. This would probably increase uncertainty and cost of trade and thus, reduce the benefit of global sourcing as a procurement strategy for multinational companies. 5. Chinese textile exports to the US and the EU will no longer be put under quantitative or license management next year Textile quotas among WTO members have been removed since 1 January However, China s textile export to the US and the EU surged afterwards, leading to numerous trade frictions. Thus, China agreed with the US government and the European Commission to curb those exports through safeguard quotas or license management in that year, and such measures will expire at the end of this year. 20

21 Domestic and Foreign On 26 October 2008, China s Ministry of Commerce made it clear that it will not continue to implement those policies starting from 1 January 2009 while it also mentioned its concern that China s textile exporters were facing difficult situation amid the global economic slowdown. Meanwhile, the ministry pledged to strengthen its dialogues with the related countries and offer more support to industrial upgrade in China. In addition, it called on the domestic industry associations to help maintain well-regulated export orders, and exporters to improve the quality of their goods. We expect the elimination of quantitative restraints will encourage both US and EU importers to shift their orders towards Chinese suppliers in the coming year. However, if there is a surge of China s textile export in early 2009, the US or the EU are likely to use other trade remedies, such as anti-dumping actions, transitional product-specific safeguard mechanism, global safeguard mechanism, etc, to restrain the influx of Chinese textile products. III. Outlook 1. US economy remains weak Of particular concern to China s foreign trade outlook is the US economic situation. The US GDP contracted by 0.3% yoy in 3Q08, down from positive growth of 2.8% yoy in 2Q08, the biggest drop in 7 years. (Exhibit 22) The US industrial production posted negative growth of 2.8% mom in September 2008, the worst in almost 34 years. (see Exhibit 23). Employment market in the US has worsened. In September 2008, the US s unemployment rate reached 6.1%, the highest since Nonfarm payroll employment reduced by 159,000 in September, the biggest reduction in five years (see Exhibit 24). US retail sales dropped by 1.2% mom in September, registering negative monthly growth for the third consecutive month. Exhibit 22: US national accounts, Q08 yoy growth (%) Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 GDP Source: US Department of Commerce Exhibit 23: US industrial output growth, 2008 mom growth(%), seasonally adjusted Jan 08 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Industrial production Source: US Federal Reserve 21

22 LI & FUNG China Trade Quarterly October 2008 Issue 12 Exhibit 24: US employment situation, 2005 Sep 2008 Unemployment rate (%) Jan Feb Mar Apr May Jun Jul Aug Sep yearly figures: annual average monthly figures: seasonally adjusted Nonfarm payroll employment, 2008 In thousands, seasonally adjusted Source: US Department of Labor US economic outlook is worse than we thought 3 months ago. The subprime mortgage losses have led to credit crunch and badly hit US financial institutions. Just in September, Lehman Brothers filed for bankruptcy; Merrill Lynch was bought by Bank of America; Washington Mutual was taken over by JPMorgan Chase; Wachovia was sold to Citigroup; Fannie Mae, Freddie Mac and AIG were rescued by the US government. To rescue the US financial sector, the US government announced a US$700 billion bailout plan to buy up the bad debts and acquire stakes in major US banks in October However, the bailout plan would undoubtedly be funded by issuing more US Treasury bonds. This would expand the US money supply and consequently, put downward pressure to the US dollar and upward pressure on inflation in the long run. Meanwhile, credit will continue to be tightened and it will be much more difficult for firms to get funding. The prospect of the US retail market is worrisome. The US consumer confidence index posted the record single month drop in October, down by 12.7 from the previous month (Exhibit 25). Against the backdrop of the weakening US economy, we are worried that China s export growth to the US will drop sharply in the coming months. Exhibit 25: US consumer market, 2008 Jan 08 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Oct 08 Retail and food 0.3 (0.5) (0.6) (0.4) (1.2) services sales (mom growth %)* Reuters/University of Michigan index of consumer sentiment *seasonally adjusted 22

23 Domestic and Foreign May 08 Jun 08 Jul 08 Aug 08 Sep 08 CPI (yoy growth %) Source: US Department of Commerce, Reuters/University of Michigan Surveys of Consumers, US Department of Labor 2. Eurozone economy is threatened by credit crunch The Eurozone economy has shown weakening sign as its GDP fell by 0.2% qoq and grew by 1.4% yoy in 2Q08, compared to +0.7% qoq and +2.1% yoy in 1Q08. In the same quarter, household final consumption expenditure declined by 0.2% qoq; investment fell by 1.0% qoq; export posted negative quarterly growth of 0.2% qoq and import dropped by 0.5% qoq (see Exhibit 26). Exhibit 26: Eurozone GDP growth, Q08 yoy growth(%) Q07 2Q07 3Q07 4Q07 1Q08 2Q08 GDP Source: Eurostat Eurozone s CPI growth moderated from the peak of 4.0% yoy in July 2008 to 3.6% yoy in September The main components with the highest yoy growth rates in the month were housing (6.2%), transport (5.8%) and food (5.7%) (see Exhibit 27). Exhibit 27: Eurozone consumer market, Dec 2007 Sep 2008 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Total retail trade (mom growth %, (1.1) (0.2) 0.6 (0.8) seasonally adjusted) CPI (yoy growth %) Source: Eurostat The financial strength of European banks has declined sharply in the past few months after having written down around US$ 220 billion since To save the financial sector in Europe, the European central bank in October 2008 cut the benchmark interest rate for the first time since In addition, during the Euro-15 summit in mid-october, the Eurozone leaders agreed to adopt an action plan, which included guaranteering new bank debts until the end of 2009, and recapitalizing banks in distress. Meanwhile, Germany, France and Spain have already set up bail-out programs worth around 960 billion euros whilst the UK has allocated 500 billion pound to rescue its banking sector. The credit crunch and the deteriorating economic sentiment 4 have worsened markedly the outlook of the Eurozone economy. As a result, the weakening Eurozone market, together with the recent sharp Euro depreciation 5 against RMB, pointed to significant difficulties facing China s export to the Eurozone market (see Exhibit 28). 4 The Eurozone s economic sentiment indicator fell to 87.7, the lowest since Euro has depreciated by around 27% against RMB in past 3 months 23