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Moody's Reviews China's Credit Rating, Overseas Investment, Domestic Market News and more
HIGHLIGHTS FROM CHINA
About ARC China
ARC China is a Shanghai-based investment manager focused on investments in consumption-driven, entrepreneur-owned small and medium sized enterprises in China's Tier II and Tier III regions. ARC China maintains a team of investment and due diligence professionals with headquarters in Shanghai and offices in key Tier II and Tier III cities throughout China.
ARC China's investment strategy centers on value-oriented, activist, and exit-driven equity investments within a diversified portfolio of high-growth businesses in these regions. ARC China's strategy and investment focus is aligned with both major macroeconomic and demographic trends within China and with the Chinese government's strategy of shifting the economy towards domestic consumption and increased growth in the interior and still developing coastal regions of the country.
Moody's Reviews China's Credit Rating for an Upgrade Amid Faltering Credit in Most Other Economies
Moody's is considering to further raise China's credit rating in the imminent future as the country begins to rebalance its economy to one driven more by domestic consumption and more independent from outside forces.
The agency said that the country has limited exposure to the eurozone sovereign debt crisis and that China's policy response to the 2008 crisis has been effective. The strength of China's external payments position, high savings rates, and a current account surplus have made the country capable of preventing the debt crisis from spreading to itself.
With economic prospects worsening in crisis-hit Europe and the United States, China is increasingly seen as the main source of optimism in the global economy. The world's second-largest economy was holding close to $3.3 trillion in foreign exchange by the end of the thrid quarter this year, envied by many developing countries and coveted also by Europeans now craving capital to ease their debt crisis.
China's gross domestic product (GDP) grew 9.1 percent in the third quarter of 2011 compared with the same period last year. The ratings agency said it expects China's real economic growth will stand at on average 9.5 percent over the next five years and expects the ratio of central government debt to GDP will fall from 16.5 percent this year to 9.3 percent in 2016.
In November last year, Moody's had already raised China's credit rating from A1 to Aa3, the fourth highest ranking, and maintained its positive outlook, based on the country's resilient economy. The agency explained that their action was premised on the ability of the Chinese authorities to protect systemic stability from the underlying threats arising from the extraordinary credit expansion evident in 2009.
Beijing's money policy has been effective in taming inflation (now 5.5 percent) and the rise in asset prices. It has also slowed the number of property transactions and the rise in property prices, squeezing developers lacking deep pockets. Total national financing, a new measure to gauge total credit supply which includes loans, fundraising in the capital markets, and activity in the shadow banks, is set to reach RMB14 trillion this year. Private consumption has been rising even faster than nominal GDP growth as China strives to achieve sustainable growth through re-balancing its economy.
Adam Roseman
Founder & Managing Partner
ARC China
CHINA GENERAL
China's October CPI to Ease to 5.5%
China's consumer price index (CPI), a main gauge of inflation, will ease for a third consecutive month in October, economists said.
China's CPI is likely to fall to 5.5 percent in October, due to falling food prices, said Yuan Gangming, a researcher at the Institute of Economic Research under the Chinese Academy of Social Sciences.
According to data from the Ministry of Commerce, the wholesale prices of 18 staple vegetables fell 2.2 percent during the last week of October, while prices of pork and eggs dropped by 1 percent and 0.6 percent, respectively.
In addition to lower food prices, declines in world commodity prices and weakening tail-raising factors will also contribute to the CPI's decline, said Lian Ping, chief economist for the Bank of Communications.
Lian said he expects the country's CPI to stand at 4 percent in December, with the full-year CPI reaching 5.5 percent.
China's CPI has reached a turning point and will be kept below 5 percent during the last two months of the year, said Peng Sen, deputy director of the National Development and Reform Commission.
Currency's Value Rise Considered 'Reasonable'
The renminbi is coming close to having a reasonable exchange rate, Chinese Commerce Minister Chen Deming said at the G20 summit.
Chen said that the yuan has risen by about 30 percent against the US dollar since 2005, and China's trade surpluses are declining when compared with the value of its gross domestic product. In September, selling pressure appeared for the yuan, showing that the market perception of the currency is starting to change, Chen added.
The Chinese yuan closed at a record high against the dollar beginning of November. Its reference rate was set at 6.3165 on the 4th of Novermber, the highest it has been since July 2005. Chen said the eurozone troubles have not had a big effect on China's exports to that region, but said he expects that they will affect global trade more as time goes on.
The world and China have an interest in helping Europe overcome the difficulties, he said. China will concentrate on importing more from Europe, Chen added.
China has long faced pressure from the US and other Western nations to allow the value of its yuan to float more freely, but it has refused to bow to those demands.
"The renminbi should appreciate in a controlled way," said Yao Shujie, head of the UK-based University of Nottingham's school of Contemporary Chinese Studies.
China's economy still has many obstacles it must overcome if it is to grow more. Those include its shortage of energy, dependence on manufacturing and its production primarily of low-tech goods, Yao said.
"Rapid appreciation will hit exporters, and particularly medium-sized and small enterprises," Yao said.
Yao said world leaders should try to understand the difficulties that a rapid currency appreciation will impose on China and recognize that any harm done to the country's economy will harm the world as well.
"Allowing the currency to move at a faster pace is not the ultimate solution to China's core problems," said Simon Derrick, head of currency strategy at BNY Mellon, a New York-based investment management and investment services company.
"It therefore seems to me that these latest developments in monetary policy in the US and elsewhere only increase the pressure on China to pick up the pace of currency liberalization," Derrick said.
G20 leaders met in Cannes in beginning of November to discuss Europe's work to deal with its debt crisis and revise their plans for rebalancing the world economy.
Chen also published an article in the Daily Telegraph , saying China is doing its part to rebalance global trade by stoking domestic demand and cutting import tariffs. Chen wrote that other countries should not think that they can improve their domestic conditions by criticizing China's trade and currency arrangements and resorting to protectionism.
"Rather, they could negate our efforts to expand imports, crush global market confidence and cast a dark shadow over the recovery prospects of the world economy," Chen said. As China takes steps to further open its economy, it is expected to bring in more than $1.7 trillion worth of imports this year and about $10 trillion during the next five years, Chen said.
The Grand Designs of Chinese Manufacturers
Yang Mingjie was happy and proud when his packaging design, which he considered a statement of simple elegance, won the admiration and approval of his client, Joyoung of Shandong province, best known for its machines that make soy milk for a specially designed cooker, whose color changes reflect changes in temperature, on display at an exhibition in Beijing. Design-based brand-building has become a buzzword for manufacturer's homes.
However, Yang's excitement was short-lived. Consumers in various markets were quick to show their displeasure at the new packaging, which they considered too bland. "Chinese consumers want to see lots of color and patterns on the packaging," Yang said. "We had to do a complete redesign to suit the consumers' taste while trying to avoid looking too chintzy," he said.
Yang's story exemplifies the steep learning curve that Shanghai designers are experiencing as demand grows for their services from manufacturers keen to move up the value-added chain by building their own brands. Indeed, brand-building has become a buzzword among the many thousands of manufacturers in the Yangtze River Delta as they struggle to skim a profit in industries squeezed by rising costs and slowing demand.
For many factory owners with a background in contract manufacturing for overseas buyers, tapping the domestic market with their own branded products is the only way to survive over the longer term. Their newly adopted business strategy has spawned a multi-billion-yuan creative industry in Shanghai, a city playing host to a growing crowd of Western-trained designers, advertising experts and marketing professionals.
Meanwhile, Shanghai's municipal government has made the creative industry the focus of its efforts to promote the city's service sector as it tries to further diversify its growth engines from over-reliance on manufacturing and real estate investment. At a Shanghai municipal government working conference for the fourth quarter of 2011, Mayor Han Zheng emphasized that the city was undergoing a critical period of transition, driven by innovation.
Han says the Shanghai economy will maintain moderate but high-quality growth in the coming years, during an accelerating process of economic restructuring and upgrading.
Yang studied design in Germany and worked for the world-renowned company designaffairs GmbH before coming to Shanghai in 2005 to start his own studio, called Yang-Design.
The company has a large client base, ranging from the Shanghai branches of multinationals to domestic start-ups. "We have different strategies tailor-made for different individual clients," he said.
"Many manufacturers looking to transition came to us. Some well-developed domestic companies are well aware of the significance of brand identity. But for start-ups, it is still something remote and new. They are concerned more about the design of single products," Yang commented.
Julong Case & Bag Co Ltd, based in Yiwu, Zhejiang province, and one of China's largest luggage companies, is a typical example of a domestic manufacturer trying to re-engineer its business model with its own brand. Established in 2002, the company had been engaged almost entirely in original equipment manufacturing (OEM), producing goods under contract in strict accordance with the designs and specifications of its overseas customers.
Business was booming until 2008 when demand tumbled as many overseas buyers were hit hard by the financial crisis that sent the global economy into a tailspin. "It was a hard time for the company," recalls Lu Chenghang, Julong's general manager. "We never knew that things could get so bad in a global recession," he said.
To Lu, and many other private-sector entrepreneurs in the Yangtze River Delta, that recession was nothing short of a siren call that has woken them to the reality of over-dependence on OEM work. The seemingly inexhaustible supply of low-cost labor had "lulled us into believing that the good times would last forever", Lu said.
Not anymore. The recession hit at a time when labor costs and raw material prices were on the rise, further trimming the manufacturers, already narrow profit margins. Official figures show that manufacturing workers' wages have risen at an average double-digit rate in the past several years.
Running out of options, Lu talked his partners into trying something new to save their business. The company began developing its own brands in 2009 to tap the domestic market. Before then, spending on product development, mainly to find ways of cutting costs, accounted for less than 1 percent of total expenditure. Now, "we have budgeted at least 3 percent, or 2 million yuan (US$316,000 or 230,000 euros), a year for product and brand development", Lu said.
For that, the company looked to Shanghai for help. It started off by seeking advice from design institutions such as the University of Shanghai for Science and Technology (USST). But "we realize that if we are serious about developing our own brands, we will have to hire experts in commercial design and marketing. We cannot skimp on such expenses," said Lu.
Competition in China's luggage industry is extremely fierce, according to experts. It's crowded by a host of foreign brands selling products that are made in China at highly competitive prices.
Lu says that he aims to carve out a share of the niche market for young consumers who are more appreciative of appearance and style than established brand names. For example, the company came up with an idea of customizing its more up-market Baoli brand by accepting requests to print a portrait of the customer on the outer surface of the suitcase. The company also has another brand, Julong, which targets the mass market.
The idea has become something of a hit in secondary cities and rural townships. Lu says that many of those who warmed to the idea of having their portraits printed on their luggage are newly-weds going on honeymoon or students heading off to study overseas. "Customer-oriented design is gaining traction in the markets in Europe and the United States," said Lu. "We hope that we can make a profit with this new idea."
Other than marketing "gimmicks", the company has employed the services of USST to design more durable products. "They (the university designers) are making our cases lighter, prettier and more user-friendly," said Lu.
But to compete on quality alone is going to be an uphill fight because Chinese consumers have a bias toward foreign brands that is hard to change. "Customer-oriented design is still going to be the key to getting a bigger share of the market," said Lu.
And that's not going to be easy either, because of the highly diverse tastes of Chinese customers in the country's many different regions, says Wang Yang of the Kiefezapfzen Design Studio in Shanghai. Although she says her dealings with clients have mostly been pleasant and productive, "there were times when we found to having to stand firm and defend our designs which clashed with our clients' perceptions of the market," she said.
Wang says that clients that have been exposed to a foreign marketing culture are the easiest to work with because they are ready to accept the innovative ideas needed to compete with foreign brands in the domestic market. For instance, "we have a good relationship with a company that manufactures bathroom accessories for many years, because its manager is forward thinking and innovative," Wang said. "He (the manager) frequently travels abroad and closely follows the latest trends in bathroom accessories," she said. This client, she says, has agreed with some of her more avant-garde designs.
A growing number of Chinese manufacturers are beginning to realize that risk-taking is part of the brand-building process. "You can never know for sure if the product you spent months, or even years, developing will become a hit. It's not like OEM when you can work out everything down to the last dime," she said.
Wang recalls that she once had a "terrible time" convincing a manufacturer of stationery products to improve the design of his best-selling line of pens to improve his profit margins. The manufacturer didn't see the need to go through the trouble and expense because he had no problem selling millions of the pens to buyers from around the world.
Last year, the manufacturer came to Wang for help. Dwindling overseas demand had toppled his tried and trusted business model built on economies of scale. "He now sees the need to maximize his profit margins by selling fewer, but more expensive, pens," said Wang. "He has seen the light."
Economic Balance Shifting East - Interview with Alistair Darling, Former UK Finance Minister
Alistair Darling believes the economic crisis will see a shift in the economic balance of power from the West toward China and the rest of Asia.
The former British chancellor of the exchequer (finance minister), who was arguably the first major Western politician to publicly recognize the severity of the looming financial turmoil, believes this is an inevitable consequence of the meltdown of the Western banking system.
"There is no doubt in my mind this crisis will accentuate the move of the center of economic gravity from the West to the East," he said.
Darling, who has been out of office for 18 months since former Prime Minister Gordon Brown's government lost the UK election last year, was in a relaxed mood in his modern suite of offices in Portcullis House, opposite the Houses of Parliament.
The relative calm was in marked contrast to the events he describes in his new book Back from the Brink, which records his central role in the economic storm.
It was he, in fact, who drew the comparison between what was unfolding and the aftermath of the Wall Street crash in an interview he gave to The Guardian newspaper while on holiday on the Scottish isle of Lewis just over three years ago.
He said the world was facing the prospect of the worst economic downturn for more than 60 years. His comments, which he says "unleashed the forces of hell", went round the world. He was under pressure from Brown's advisers to retract them. Then three weeks later came the collapse of Lehman Brothers and everyone was silenced.
"Sixty years is possibly wrong. It is probably 100 years. You take your pick. It is bad," he said.
With Brown, he was eventually responsible for putting together a rescue package for the British banks in 2008 that was to provide the blueprint for how nearly all other nations responded to the economic crisis, including China with its own 4 trillion yuan ($630 billion, 455 billion euros) injection into its economy.
"It culminated in a meeting (of government heads) in London where he (Brown) locked the door and said no one was going until we reached an agreement. Communists countries, democracies, East and West all did the same thing," he said. "And China certainly did. It made a decision it was going to maintain consumer spending and the banks were instructed to lend money and they did."
Darling, who speaks with a gentle Scottish burr and has a ready dry wit in private, has fond memories of China and on one visit to Beijing he was treated to a special dinner because it was his birthday.
"I like Chinese food and they put on this fantastic Chinese meal. I had no idea they knew it was my birthday," he said.
He says the longer-term perspective Chinese politicians can take on issues is often in marked contrast to the realities politicians face in the West.
"I was struck by one conversation I had. We were talking about the medium term and my interlocutor said: 'Yes. The next 100 years will be quite difficult.' And I was thinking how many elections do we have between now and then. They certainly do take a longer term view," he said.
Darling does not come from a traditional socialist background of many Scottish Labour politicians. A great uncle was a Conservative MP and he himself went to one of Scotland's top schools, Loretto, before being admitted as an advocate at the Scots bar.
He is content with being the member of parliament for Edinburgh South West for the time being and is away from the frontline of British politics for the first time in more than two decades.
His period as chancellor was a stormy one not just because of the financial crisis but because of the partial breakdown in his relationship with Brown, who at one point wanted to sack him, something that Darling resisted.
Darling's book, which was serialized in the UK, was one of the first insider's account of an often troubled government.
Is he still on speaking terms with Brown?
"Yes but we haven't seen much of each other since the election. We probably saw more of each other than we ever thought we would during our time together. We needed time apart," he said.
The book is not short on humor such as at one point when in Chong-qing, in the southwest of China, he was asked why his eyebrows did not match his gray hair and whether he dyed them. Everyone else at the function had regulation jet-black hair.
"He was a leader of a delegation. I thought it was amusing that after my interesting talk on the European banking system this was the only thing that had exercised him," he recalled.
Darling had many dealings with bankers at the outset of the financial crisis including Sir Fred Goodwin, the controversial former chief executive of the Royal Bank of Scotland, which the UK government eventually took over. He at one stage came knocking at Darling's Edinburgh home.
Does he have sympathy for groups such as Occupy Wall Street and other similar groups in Europe who believe bankers should have gone to jail instead of receiving big pension payoffs, as in Goodwin's case?
"The rule of law is quite an important principle. I don't think subsequently you can turn round and say that collapsing a bank is now a criminal offence and therefore you should go to jail. Bad judgment is not something that is against the law.
"I understand people's anger but I think you have to bear in mind that beating everybody up may not actually be the answer in the long term."
Some argue that the banks should not have been bailed out in the first place since it just passed their liabilities on to the taxpayer and that had they been left to fail, the spoils would have been left for the stronger financial institutions to pick up.
"It depends how sanguine you think you can be about such things. I think you will find no government that would sit back and says that it doesn't really matter. If you couldn't get your money for your tube journey back home or something to eat tonight, that would be a problem."
Darling says the current situation in Europe is very problematic and that European politicians have struggled to grasp the seriousness of the situation despite the huge major precedent - the collapse of Lehman Brothers - occurring only three years before.
He thinks on balance the euro will survive but with not necessarily everyone remaining in it.
"If you had asked me six months ago, I would have said 'yes, unqualified'," he said.
Now he is not so sure but away from the eurozone, he believes other parts of the world, including China, face major challenges in the years ahead.
"The question is how long the Chinese economy will continue to grow and can the government make sure that all it's people benefit from it. The problems start to arise when some people are benefitting and others are not. That will be the big challenge for the Chinese government."
He also believes that China's fate is still also heavily dependent on what happens in the West and that is why the world's second-largest economy needs to be represented at the top table of international forums.
"You are struck if you go to somewhere like Shanghai at the sheer number of containers heading for the States and Europe," he said.
"It is in China's interests that the West is in a position to buy these goods and that is why we need China at the table."
China Housing Prices Decline
A decline in China's property prices is picking up steam, suggesting Beijing has had some success in taming housing costs, while also raising concerns that prices could drop too far and fast when the rest of the world is relying on the country as an engine of growth.
House prices were flat or falling in a majority of China's top cities, shows weekly data. The weekly data, though volatile, add to evidence that housing prices are headed downward after years of consistent increases.
Beijing has been trying to calm property prices for about two years in an effort to make housing more affordable and douse a possible catalyst for social unrest. Steps by regulators include tightening lending and putting tougher restrictions on buying homes.
An unanswered question is whether China can gently let the air out of its real-estate bubble or whether the bubble will burst, undermining economic growth. With the European Union and U.S. struggling to kick-start their own economies, global growth depends increasingly on the health of the Chinese economy, the world's second-largest.
Beijing's top officials say they plan to stay the course. "I will especially stress that there won't be the slightest wavering in China's property-tightening measures—our target is for prices to return to reasonable levels," Premier Wen Jiabao said in a speech in Russia in early November.
Real estate is a major driver of growth in China and a big source of demand for steel and cement, as well as of domestic demand for manufactured goods such as furniture. As much as 25% of the Chinese economy may be tied up in real estate and related industries, according to analysts. Ordinary Chinese frequently invest in real estate, so a sharp downturn could batter their savings.
Prices in the major southern cities of Shanghai and Guangzhou are down from their levels at the start of the year, according to data released by the China Real Estate Index System.
Prices fell by 0.23% nationally in October compared with September, faster than the 0.03% drop posted in September from August, according to data from the same index.
In Shanghai, China's business capital, average prices for new residential real estate in many parts of the city are under asking prices for existing homes, according to Shanghai Urban Real Estate Surveyors-Appraisal Co., a consulting firm.
Steeper declines may lie ahead. "The correction is not over; it has just started," J.P. Morgan said in a note. "However, the likelihood of a nationwide collapse is very small…. Bursting the bubble is clearly not part of the policy objective."
J.P. Morgan analysts forecast that prices nationally could fall 5% to 10% over the next 12 to 18 months, and as much as 20% in some major cities.
Real-estate developers are having greater problems finding financing to complete projects or start new ones. Trust-investment vehicles—a key part of China's shadow lending system—have become a major source of funding for developers, after bank lending all but dried up this year.
New financing provided by trust companies to property developers fell 17% in the third quarter from the second, after regulators stepped in to curtail trust lending to the sector, according to data released in early November.
China's trust companies provided 113.9 billion yuan ($18 billion) of funding to property developers in the three months ended September, according to data on the China Trustee Association website, down from 136.7 billion yuan in April through June. In the first quarter, they provided 71.1 billion yuan in funding.
Trust companies don't take on the risk of an investment themselves, but funnel funds from companies and wealthy individuals into a wide range of investments, including private equity, loans, direct stakes in property development, and even bonds and stocks.
For the Chinese public, complaints still focus largely on housing affordability. But the price drops have also prompted some outcry. In late October, more than 40 people gathered at the showroom of developer Greenland Group in Shanghai amid heavy security to express frustration that properties had been discounted after they had made their purchases.
A real-estate agent with the company said discounts for 28% were on offer.
"I bought an apartment here in September and now I've lost more than 400,000 yuan ($63,000)," said a businesswoman in her 40s. "That is my hard-earned money, how can the developer be so ruthless?"
Greenland Group said that the protests have died down, but didn't provide other details.
Property developers have long held back from cutting prices on new developments, hoping the government would blink first and relax restrictions on purchases. Instead, authorities have continued to increase pressure.
The southern city of Zhuhai last week implemented a cap on the prices developers can charge for new housing, a temporary move that emphasizes the pressures officials face to cool the housing market.
Hangzhou-based property developer Greentown China Holdings Ltd. said it is considering disposing of some of its property projects to boost its cash flow, rather than cut prices.
"Selling the projects is a better option than offering large discounts, which would tarnish our image with our end-customers," Chief Financial Officer Simon Fung said. He said disposing of projects outright is also faster than selling individual units at discounted prices.
China's banking regulator asked trust companies in September to report their exposure to Greentown, amid concerns about how some developers have funded their projects. Greentown executives say the company remains strong.
Overseas Investment Up 12.4% from January to September
Chinese companies invested $40.8 billion in non-financial sectors overseas in the first three quarters, up 12.4 percent from a year earlier, despite the global financial crisis, a senior official said.
Chinese companies have been investing vigorously in foreign countries this year, despite the global slowdown in international investment activity caused by faltering economic recovery, Zhang Xiaoqiang, deputy director of the National Development and Reform Commission (NDRC), the country's top economic planner, said at the third China Overseas Investment Fair in Beijing.
China's outbound direct investment reached $68.8 billion in 2010, up 21.7 percent from a year earlier, ranking above developing countries and surpassing Japan and Germany to be the world's fifth largest source of foreign direct investment outflows, Zhang said.
By the end of 2010, Chinese companies had invested a total of $317.2 billion in more than 178 countries and regions, according to Zhang.
He said that as State-owned enterprises speed up overseas investment, more and more private-owned companies are also seeking opportunities abroad.
The government will continue to support competent Chinese companies in investing abroad in the future, with improved protection mechanism, legal system, services and supervision, Zhang added.
The NDRC granted its provincial arms more authority in approving overseas investment in February, a step toward giving enterprises a greater say in investment project decisions.
Under the new rule, companies planning to invest less than $300 million in the resource sector, or less than $100 million in other industries overseas, only need approval from provincial economic planners, and not from the NDRC.
Chinese Factories Eye Cheaper Labor Overseas
Frank Leung, the owner of a Hong Kong-based women's footwear company, has flown to places he never imagined he would visit.
The owner of New Wing Footwear has been to Dhaka and Addis Ababa, looking for alternative production bases to his factory in Dongguan in southern China. But despite searching far and wide, he has been disappointed.
The pressure to move is clear and growing. Labor costs in China have risen 15-20 percent annually over the past couple of years, squeezing margins and creating increasingly testing times for Guangdong, the engine room of Chinese manufacturing.
The rising costs - along with the rise in the renminbi - have forced Mr. Leung to reduce headcount in Dongguan from 8,000 three years ago to 3,000 today.
The wages in Bangladesh, he reports, are about 20 to 30 percent of those in China. Workers also work 48 hour weeks against the legislated norm of 40 hours in China. The government is offering a 10 year tax holiday.
But instead of sounding ebullient, Mr. Leung is shell-shocked. "They have crazy traffic congestion and everyone uses a generator in factories (because the power supply is erratic)," he says. "The logistics make it very hard to work efficiently."
A couple of weeks after his trip to Dhaka, Mr. Leung flew to Addis Ababa. Wages were even lower than those in Bangladesh but he could not find the supporting industries, such as manufacturers of shoe soles and cardboard. "Ethiopia has less congestion but it is in the middle of nowhere," he says. India's oppressive poverty put him off altogether after a visit to Chennai. Now Mr. Leung is uncertain whether he will move production from China after all.
The climate for manufacturers in Guangdong has prompted many to move to countries in south and south-east Asia. Last week, Gavekal Dragonomics, the research firm, forecast that export growth in China would slow to just 9 percent next year. Deduct the price increases Chinese manufacturers have passed through to consumers in the west this year, and export volumes rose by only 12 percent in the first three quarters of this year.
Many factory owners, such as David Liu, whose company makes handbags, have looked into moving to countries like Vietnam but elected to stay in Dongguan because supplier networks and worker productivity are better.
Mr. Liu made several trips to Hunan in central China to see if a factory there would be viable. Again, the distance from support industries and tool-makers scuppered the plan. He has elected instead to work harder at retaining older skilled workers in Dongguan by, for instance, giving married couples their own private rooms and installing air-conditioners for them. The norm is for workers to live in dormitories of six to eight people.
Mr. Liu says his profit margins have dropped from as high as 10 percent to as low as 3 percent, but he has passed price increases of 8 percent annually to retailers in Europe on stylish hand-bags, which retail for €300-€400.
Mr Liu is the rule, not the exception. The unit price of Chinese exports to the EU rose by 10 percent between January and August. This increase was marginally higher than Turkey's but well below those of Mexico (17 percent) and India (23 percent), according to Gavekal.
None the less, Beijing's decision to double wages for factory workers by increasing the minimum wage every year over the next few years will encourage factories to migrate from China.
Some companies have opted to keep bases in China as well as abroad. Texhong Textile opened yarn factories in Vietnam in three stages between 2007 and this year, when it added another 2,000 jobs there, according to Charles Hui, chief financial officer of the Hong Kong-listed company. Wages in Vietnam are the equivalent of Rmb1,200 a month compared to Rmb2,000 in China. And the new Vietnamese factories are more highly automated and require fewer workers.
Texhong now employs 4,000 workers in Vietnam as well as 10,000 in China. More than three-quarters of the company's production is sold to China, one reason it keeps factories there.
In addition, says Mr. Hui, Chinese-owned companies are typically reluctant to relocate because they are "not familiar with managing workers who do not have the same culture".
Gavekal found that even in industries as labor intensive as textiles, garments and toys, where the headlines suggest factories are fleeing to south-east Asia, China's manufacturers have raised prices by 10 to 20 per cent this year, "indicating they have gained some pricing power". Dong Tao, an economist with Credit Suisse, says the reason is simple: "There is no developing country that can match half the efficiency China offers."
China's combination of a huge workforce with higher productivity and far superior ports and highways compared with other developing countries makes it hard to find alternatives. "When China grows out of this, there will not be another China," he said.
CONSUMER INDUSTRY
Domestic Toy Market Perks Up
Wanted: BFF; pretty in pink; not too trashy; lower maintenance than Barbie. Must speak Chinese.
Meet Princess Secret, a potential best friend forever for the children of China's swelling mass of consumers, who increasingly demand better-quality toys at cheaper prices than foreign brands can offer. The doll's manufacturer, closely held China Focus (Yiwu) Ltd, is among Chinese exporters seeking licenses to sell on the domestic market as overseas growth flags.
"Our products probably cost twice as much as those designed for the local market, but that's not a problem because they're still cheaper than imports," Maggie Zhang, a sales manager, said at the country's biggest trade fair last month, while staffing a stall stacked with Princess Secret pink dolls, gloves, scarves and cosmetic bags.
The nation's toy market is expected to double to 60 billion yuan ($9.4 billion) by 2015 from 2010, according to the China Toy & Juvenile Products Association. In contrast, overseas sales grew 8.9 percent in the first nine months of the year, lagging the 23 percent growth in total China exports.
"Chinese toy exporters are coming to a turning point where domestic growth is starting to outpace that of overseas orders," said Hua Zhongwei, a macroeconomic analyst with Huachuang Securities in Beijing.
In March, Mattel closed its first Barbie-dedicated store in China two years after opening the six-story Shanghai outlet. The toy company, which didn't provide a reason for the closure, had lowered the outlet's sales targets by at least 30 percent.
Mattel is now expanding its distribution network into smaller Chinese cities, Jean-Christophe Pean, Asia-Pacific general manager, said in an e-mailed response to queries.
Chinese toy exporters, who made $7.9 billion of overseas sales in the first nine months according to customs data, are also turning their eyes to home because of weak prospects in the US and Europe.
The United States Conference Board's confidence index slumped in October to the lowest level since March 2009 as Americans' outlooks for jobs and incomes soured, figures from the New York-based private research group showed in late October.
The US toy market is about $21.9 billion and the global market is about $83.3 billion, according to NPD Group, a market research company based in Port Washington, New York.
China Increasingly Intoxicated with Burgundy
For years, Chinese fine wine buyers have tended to favor high-end juice from France's Bordeaux region. Lately, however, wines from another part of France — Burgundy — have started to seep into the Chinese market.
One highly anticipated barometer of the wine region's progress among Chinese consumers was a Burgundy-dominated auction held by Acker Merrall & Condit in Hong Kong where there was good news for Burgundy producers: 98% of the lots sold for a total of $14.5 million.
Acker boasted the total was the highest for any single wine auction this year.
"The results are a testament to the growing demand for Burgundy in the international marketplace, also proving that Chinese wine lovers have diversified their interest and taste in wine appreciation and collecting," said John Kapon, Acker's chief executive, in a statement following the auction.
Chinese Tourists to Reshape Global Travel Industry
The continued growth in Chinese outbound and domestic travel will change the global hospitality industry, a report revealed in early November.
According to the Global Trends Report 2011, which was released at World Travel Market in London, Chinese tourists will spend $57 billion on accommodations this year, third in the world behind the United States and Germany.
By 2015, Chinese tourists will rise to the number two spot, with their spending up 17 percent to US$67 billion.
The report, produced in association with Euromonitor International, said that some global hotel chains are partnering with Chinese businesses to get a foothold in the domestic market, while others are customizing their offer to cater to Chinese tastes.
"Companies will use their experience in the Chinese domestic market to feed best practices back to properties abroad in key destinations for Chinese travelers," the report said.
Spanish hotel giants Sol Melia and NH Hotels have both taken the partnership approach. Sol Melia has partnered with Jin Jiang Hotels, while Chinese travel group HNA bought 20 percent of NH Hotels to help the Spanish chain enter the Chinese market.
"The importance of the Chinese market has been known for some time, but we are now starting to see how their desire to travel - domestically and internationally - will reshape the business, with hotels at the forefront of these changes," Chairman of World Travel Market Fiona Jeffery said.
World Travel and Tourism Council figures show China is the world's third largest market for outbound tourists, and China also received 56 million international tourists in 2010.
Number of Hotel Rooms Set to Soar
China's hotel market is expected to overtake the United States to be the world's largest from 2025, according to a report issued by InterContinental Hotels Group (IHG), the largest hotel company in the world by number of rooms.
It is estimated China will have 6.1 million hotel rooms by 2025, the same as the United States by then. By 2039, the number of China's hotel rooms will reach 9.1 million, four times of the size it is today, said the report, which was based on the figures from the National Bureau of Statistics in China and the United Nations World Travel Organization.
In 2009, the State Council added tourism as another pillar industry in the 12th Five-Year Plan (2011-2015), which is widely believed to be the major factor that propels the country's hotel industry.
According to the Opinions of the State Council on Accelerating the Development of Tourism Industry released in 2009, tourism will contribute 4.5 percent to China's gross domestic product by 2015 and revenue will grow by 12 percent annually.
A report released by the Boston Consulting Group this year predicts that China will surpass Japan to become the world's second largest tourist market by 2013, holding 8 percent of the global tourist market share.
China National Tourism Administration also expects the number of inbound travelers to reach 3.3 billion by 2015.
A rapidly emerging group of upper-middle class is another crucial driver of the country's hotel market.
McKinsey Insights China and statistics from the US Census Bureau showed that in less than 15 years China's wealthy and upper-middle class combined will be twice the size of its US counterparts.
"Many of China's biggest cities already have as many wealthy consumers as major US ones. This is leading to a dramatically increasing demand for leisure travel. Affluent consumers are increasingly willing to spend on luxury experiences and not just on luxury goods," said Keith Barr, chief executive officer of IHG Greater China.
"Compared with their counterparts in the West, Chinese consumers prefer famous brands, which signal quality in their eyes," he said.
Major international hotel chains are planning a big expansion in China by opening hotels not only in first-tier cities, but also second- and third-tier cities.
IHG, which currently manages 154 properties in China, has 142 in the development pipeline, the largest in China and a quarter of the company's total globally.
Hilton Worldwide said it will have 100 hotels in China by 2014, four times the number of properties it manages in the country now. China will then become its second largest market, after the US.
Starwood Hotels and Resorts with 70 existing hotels in China has more than 90 new hotels in development.
However, the rapid growth of the hotel portfolio in China has aroused concerns of oversupply.
"The oversupply of hotel rooms in China is inevitable," said Zhao Huanyan, a tourism industry expert with the Shanghai Academy of Social Sciences.
"If we compare the average occupancy rate and room rate of the hotels in Beijing and Shanghai with those in Hong Kong and New York, we can see a sign of oversupply on the Chinese mainland," he said.
For instance, in April, the average occupancy of five-star hotels in Beijing and Shanghai was 64 percent, while that in Hong Kong and New York was 88 percent.
Zhao said that the country will have more than 1,500 new hotels each year from 2010 through 2015, with total investment of nearly 400 billion yuan ($62.5 billion).
But the hotel operators remain optimistic.
IHG's interim financial results showed that the company's revenue per available room (RevPAR) in China was 12.7 percent up year-on-year, including rate growth of 7.1 percent, while its global RevPAR growth was 6.7 percent.
RevPAR is a performance gauge in the hotel industry. It is calculated by multiplying a hotel's average daily room rate by its occupancy rate.
"Morgan Stanley forecasts continued annual GDP growth for China in excess of 9 percent through 2015. Given the only modest reduction in GDP, Morgan Stanley forecasts China's hotel industry could experience double-digit RevPAR growth," said Barr.
The booming tourist market in China has brought changes to international hotel operators. Various international hotel chains have tailor-made packages to serve the unique preferences of Chinese travelers.
For instance, Hilton Worldwide and Starwood Hotels and Resorts launched similar programs in their properties in gateway cities around the world in the third quarter, which feature additional guest room amenities including kettles and slippers and Chinese food such as congee.
"Today, more than 50 percent of our guests in China are Chinese. The Chinese are beginning to become a major global travel force as well," said Simon Turner, president of global development for Starwood.
"When they travel abroad, the Chinese will stay with the hotel brands they know from home, which underscores the significance of our growing footprint of flagship hotels in China and its halo effect on Starwood's hotels around the world," he said.
IHG has moved a step further by developing a new five-star hotel brand especially for the mainland market. The first hotel under the new brand is scheduled to open in late 2012 or early 2013.
The company has signed 12 contracts for the new brand on the mainland, the name of which has not yet been unveiled. The new brand will be built in Beijing and Shanghai, but the majority will be located in second- and third-tier cities. The company plans to spread the brand globally two or three years after the first hotel opens.
RECENT CHINA TRANSACTIONS
PepsiCo to Sell China Bottling Operations
PepsiCo, the US drinks and snacks group, said in early November that it was selling its Chinese bottling operations to Tingyi Holding, the Tianjin-based Taiwanese beverage company, as it looks to expand its presence in the world's fastest-growing drinks market.
Pepsi said it will take a 5 percent stake in Tingyi's beverage subsidiary, which will become its franchise bottler in China. It will have the option of expanding that holding to a 20 percent stake by 2015.
The move comes as Pepsi is working to catch up with rival Coca-Cola in China. According to data from Beverage Digest, Coke currently controls 55 percent of the carbonated soft drinks market in China, with Pepsi at 32 percent.
"To win globally, we need to have absolutely the best business partners locally," Indra Nooyi, Pepsi's chief executive, said in a statement.
Tingyi will sell and distribute Pepsi's carbonated beverage and Gatorade brands and will co-brand its juice products with Tropicana. Pepsi said that the joint venture would allow it to distribute its products more efficiently across China and to cut costs.
"Tingyi and PepsiCo will continue building up the capacity to seize market opportunities and satisfy consumers' diversified demands with world-class products," said Wei Ing-Chou, Tingyi's chief executive.
Analysts at Barclays estimate the potential value of a 20 percent stake in Tingyi's beverage business at $14.2bn and note that Pepsi's Chinese bottling business was worth about $600m, while losing $175m after taxes in 2009 and 2010.
Pepsi's franchise model in China and in other international markets is different from in the US, where last year it acquired its bottlers.
According to Steve Powers, beverage analyst at Bernstein Research, the deal will help Pepsi because it will not have to spend as much money investing in distribution infrastructure in China and because Tingyi will have its own motivations to expand.
"If they can get the deal structure in place, they'll be a more formidable competitor to Coke," Mr. Powers said. "It if works, it can be a powerful combination."
PepsiCo has been investing heavily in China recently. Last year, it announced a $2.5bn investment over three years, after announcing a $1bn investment in 2008.
In August, Coke said it was it was increasing its focus on China with a $4bn investment over the next three years.
Shares of Pepsi slipped 1.29 percent to $61.99 in midday trading.
Yum! Gets Clearance to Buy Out Popular Chinese Hot-Pot Chain
Yum! Brands Inc. has gained the Chinese industry regulator's approval to take over leading domestic hot-pot chain Little Sheep Group Ltd. in a move that observers say will consolidate Yum!'s dominance of China's food service sector.
The Ministry of Commerce has cleared the deal under China's anti-monopoly law, both companies said. The Hong Kong-listed Little Sheep saw its shares soar over 15 percent following the news.
Yum! is offering 6.5 HK dollars a share in cash to gain a 93.2-percent share of Little Sheep, with the remaining 6.8-percent stake to be held by the creator of the Chinese company. The privatization plan is still subject to the approval of Little Sheep shareholders.
The Louisville, Kentucky-based Yum!, which owns KFC and Pizza Hut, bought a 20 percent stake in Little Sheep in 2009 and raised the share-holding to 27.2 percent last year.
The market previously worried that the buyout would fail the anti-monopoly review, meeting the same fate as Coca-Cola's 17.9-billion-HK-dollar-bid to take over China's largest juice maker, Huiyuan, two years ago.
Little Sheep's shares stumbled 12.46 percent in late October when the ministry announced it would extend the anti-monopoly review.
"The buyout will definitely consolidate Yum!'s leading position in China's catering sector," said Feng Enyuan, secretary general of the China Cuisine Association, adding that it would be even harder for Yum!'s competitors to overtake it in the near future.
The association rated Yum! and Little Sheep as the top two market players in 2010. Little Sheep, which focuses on popular Chinese hot-pot, runs 3,000 restaurants in the country and reports an annual revenue of 2 billion yuan (about US$315 million).
Yum!, on the other hand, has nearly 3,500 KFC restaurants and about 560 Pizza Hut restaurants in China. Last year, the company's China division reported a revenue of 33.6 billion yuan.
Both Yum! and Little Sheep enjoy immense popularity among China's younger generation.
Hot-pot, a traditional Chinese dish, sees people sit around a simmering fondue-like pot into which they dip raw food such as meat slices, fish, vegetables and noodles to cook. Hot-pot is a New Year signature dish for many Chinese families in and outside China.
"Our research shows that hot-pot has considerable market potential overseas," said Samuel Su, CEO of Yum! Brands China Division. "With it's global network and experience, Yum! is able to explore the overseas hot-pot market with Little Sheep."
But Su told reporters that Yum! would not change Little Sheep's business model in the short term.
Kang Jianhua, an analyst with China Investment Consulting, said the takeover will have an impact among market competitors and might accelerate a market shakeup in the food service sector.
OVERSEAS TRANSACTIONS
Bank of America to Sell Pizza Hut Franchisee NPC to Olympus Partners
Bank of America Corp. has agreed to sell the biggest U.S. Pizza Hut franchisee to a company formed by Olympus Partners as Chief Executive Officer Brian T. Moynihan narrows the focus of the lender.
The debt of Charlotte, North Carolina-based Bank of America's NPC International Inc. will be repaid by the purchaser at the completion of the deal, which is expected by December 28th, 2011, according to a regulatory filing from NPC.
Moynihan is focusing on retail and commercial banking customers while scaling back operations acquired under his predecessor, Kenneth D. Lewis. The bank inherited NPC in it's 2009 takeover of Merrill Lynch & Co., which bought the pizza purveyor in May 2006 for $615 million, according to a filing. Overland Park, Kansas-based NPC was founded in 1962 and operates more than 1,000 eateries.
The acquisition is expected to be financed by a credit facility arranged by affiliates of Goldman Sachs Group Inc. and Barclays Plc, which are advising Olympus. The restaurant operator got advice from JPMorgan Chase & Co. Terms weren't disclosed in the statement.
The bank was in talks to sell the franchisee for more than $800 million, two people with knowledge of the discussions said in September. Jerry Dubrowski, a spokesman for Bank of America, declined to comment on the transaction.
Volkswagen Targets 5% Share of Middle East Car Market
Volkswagen could become the world's largest automaker by the end of this year, selling more than eight million vehicles. But Stefan Mecha, managing director of the German company's Middle East operations, is not one to be distracted by what the short term has in store, however weighty the result it yields.
He has set his eyes firmly on VW achieving a five percent share of the automotive market in the Middle East in the mid-term. Right now, he is rolling out a new model strategy that would help the German manufacturer move closer to its regional aspirations.
"What we have seen is that VW is successful among the European brands, but these account for only six percent of the entire auto market in the region," said Mecha. "This is why VW got interested in putting its feet on the ground here and thus taking a long-term perspective to developing market share.
"While we have great heritage models that have done well — such as the Touareg — it's time for the new models to start pulling their weight."
By the looks of it, the recently launched mid-sized Jetta is surely doing so.
"We can't obviously build a customer base overnight, but what we have seen in the four months since the launch is that more Jettas were sold than in the same while last year," said Mecha. "This is a segment seeing a lot of volumes and the car is making its way."
This will pave the way for VW to make its sharpest play yet in ramping up the regional numbers. Next summer is expected to bring the introduction of the Passat model made at the company's recently-opened plant in the United States.
While being more spacious than its European counterpart, the American version will also be strategically priced. "This car is spot-on for the markets here," said Mecha.
What it will also provide is an entry into the region's corporate fleet market, a category that VW has not had much of a say in so far.
"We are fully aware of the necessity to enter the fleet business as in some of the markets here these account for 50 percent and more of the overall unit sales," said Mecha. "Our rent-a-car volumes are rather low — the new models will come and then we can start capitalizing. Our fleet share will definitely increase, but finding a balance with sales to individual buyers is important."
But couldn't VW try and get the shipments in before next summer?
"The car was only launched in the U.S. in September; first it has to cater to the domestic market before production is ramped up for new territories."
"We will be one of the few overseas markets to get the model — and keep in mind that shipments from the US take time," said Mecha.
Apart from the much-anticipated Passat launch, there will be the re-introduction of the Polo brand.
"It gives us an entry model into the VW brand and that will bring in new customers," Mecha said.
"That in turn allows us to accompany a VW customer over a lifetime of his model needs."
In 2002 the earlier version was phased out. The new model will be shipped in from the plant in Russia.
Having a network of manufacturing plants straddling the globe represents a huge bonus, according to Mecha.
"This way we have an instrument to hedge against currency changes by shipping in models from dollar-denominated markets," he said.
"Because you certainly can't explain to a customer why the price for a model is $100,000 (Dh367,310) and a few months later it's $120,000. We have a price commitment that is dollar-based."
If all of these strategies yield the desired results, VW is in with a shout to capture a five percent share of the Middle East auto market. Beyond that anything is possible.
"Let's take it step by step, but what's needed now is a gradual improvement from the two percent share we have," Mecha said.
Currently the world's third largest automaker behind Toyota and General Motors, Volkswagen could catapult to Number One by selling more than eight million units by year-end. Toyota has had distractions from the March earthquake and tsunami and could also be impacted by the recent floods in Thailand, while GM is still picking up speed following its restructuring.
"We still have two months to go to see whether we can finish the year as Number One," said Mecha. "In our strategy, which we have named Mach 18, our objective is to become the world's largest automaker by 2018, not just in sales volumes but on employee and, above all else, customer satisfaction. We will know next year what we have to work for."
Best Buy Leaves U.K., Reboots Phone Venture
Best Buy Co. is closing its U.K. big-box stores and paying $1.3 billion to buy out its partner in U.S. mobile-phone retailing as the electronics giant retools its struggling business to focus on smaller shops.
Best Buy and Britain's Carphone Warehouse Group PLC will maintain a joint venture called Best Buy Europe, focusing on roughly 2,500 phone stores there. But they will stop sharing revenue from similar stores called Best Buy Mobile in the U.S. and Canada, which have become Best Buy's growth engine.
"Going forward, we are capturing the full profits from our Best Buy Mobile format," Chief Executive Brian Dunn said in a conference call with investors, adding that the U.K. big-box stores "could not overcome the challenging macro environment and did not provide the results we had expected."
Best Buy said the move to purchase all of Best Buy Mobile and stop sharing its profits with Carphone Warehouse would lift future earnings next fiscal year by $120 million to $140 million as it continues opening the smaller stores.
The Richfield, Minn., retailer, which is trying to reverse five consecutive quarters of sales declines at stores open at least 14 months, already closed big-box locations in China and Turkey earlier this year as it reins in capital investment.
It said, however, that it would continue to work with Carphone Warehouse on a new international venture called Global Connect that will bring small-format mobile-phone stores to other markets, starting with China and Mexico.
Best Buy entered into a profit-sharing agreement with Carphone Warehouse, Europe's biggest mobile phone retailer, in 2007 as it played catch-up in the booming U.S. mobile phone business. Its motivation was to bring to the U.S. Carphone Warehouse's retail formula of offering phones by many different makers and phone-service carriers under one roof.
While that strategy paid off for Best Buy in North America—the retailer now claims roughly 5% of the U.S. mobile phone market—investors grew impatient with Best Buy's attempts to expand its big-box stores in Europe, where they didn't catch on with consumers.
The decision also ends a dispute between the companies over splitting revenue from tablets such as Apple Inc.'s iPad, which they had not envisioned at the time of their original profit-sharing agreement.
"A good joint venture, like a good marriage, includes plenty of debate, but I would not describe it as contentious at all," Mr. Dunn said in an interview. "Anyone who saw tablets growing like this outside of Cupertino," Apple's California headquarters, he added, "is telling you a fib."
