VZCZCXRO2972
RR RUEHCN RUEHGH
DE RUEHGH #0201/01 1200857
ZNR UUUUU ZZH
R 300857Z APR 09
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7902
INFO RUEHBJ/AMEMBASSY BEIJING 2758
RUEHGZ/AMCONSUL GUANGZHOU 0418
RUEHSH/AMCONSUL SHENYANG 1953
RUEHCN/AMCONSUL CHENGDU 1962
RUEHHK/AMCONSUL HONG KONG 2130
RUEHIN/AIT TAIPEI 1749
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 8547

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" 
 
--------------------------------------------- ------------ 
 
 
 
¶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 
 
--------------------------------------------- ------------- 
 
 
 
¶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 
 
SHANGHAI 00000201  002 OF 005 
 
 
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 
 
-------------------------------- 
 
 
 
¶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 
 
---------------------------------------- 
 
 
 
¶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, 
 
SHANGHAI 00000201  003 OF 005 
 
 
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 
 
--------------------------------------------- -- 
 
 
 
¶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 
 
--------------------------------------------- ------------------ 
 
 
 
¶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 
 
SHANGHAI 00000201  004 OF 005 
 
 
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 
 
--------------------------------------------- -- 
 
 
 
¶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 
 
--------------------------------------------- ------------- 
 
 
 
¶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 
 
--------------------------------------------- ---------------- 
 
 
 
¶11. (SBU) Although Seduno Group's General Manager Xu reports 
that there are "no signs yet" of a recovery, exporters see 
 
SHANGHAI 00000201  005 OF 005 
 
 
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 
 
-------------------------- 
 
 
 
¶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