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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