The City of Ordos






Just after 11:00 am on Wednesday 28th October 2011, the doors to ET2C’s Shanghai office opened and 5 factory workers walked into our lobby intent on not leaving without money that their boss had said was owed to him. The problem was that no outstanding debt was owed and we had proof of payment and chopped contracts to prove it. There was simply no legal basis for their claim. It was not that they intended to cause harm, but simply that their manager owed money to one of his suppliers and was resorting to a form of bullying to prise money from somewhere. Although they spent the rest of the working day asleep on the sofas in our reception, with the eventual assistance from the police, they left.

The situation was made all the more farcical when the 5 factory workers attempted to up the ante by going downstairs and taking their protest onto the streets (directly outside our Shanghai office), but once the Police got a whiff of the protest, they were quickly ushered back into our lobby; at least now they were hidden from the public.

Although on a small scale, it serves as an illustration of a shortage of funds. In fact, the current credit squeeze in China has already been well documented. There have been numerous reports of violent mobs going after creditors. For example, in Wenzhou, it is claimed that 400,000 businesses are facing financial hardship because of rising raw material costs, soaring interest rates (black market) and the recent credit squeeze. Even though inflation has begun to slow (consumer prices rose 5.5% in October), the shortage of credit has led to further expansion in what is a burgeoning unregulated private lending industry. To put a quantity on the value of this industry, which is absolutely staggering, some estimates put private loans (remembering that it is illegal in China to lend unless you are a bank) at 4 trillion Yuan; that is $627bn or £406bn. The interest rates on these loans range from 14% up to 70%. For businesses that have had to borrow from these ‘shadow banks’, and with the global economy slowing down, the interest repayments are sometimes too much to bear.

It is not just the ‘off-balance sheet’ creditors that are cause for concern. The other large concern is the huge number of loans extended to local governments. According to the China Banking Regulatory Commission (CBRC) these loans totalled 10.7 tn Yuan in 2010 or 80% of bank lending. This summer Moody’s, the ratings agency, warned that ‘economic non-performing loans could reach between 8% and 12% of total loans’.

The current picture painted can only be described as bleak. The question that needs to be asked though is whether China is heading for a soft or hard landing, and what the impact will be on the manufacturing sector. Credit has certainly tightened and this may have the potential to derail supply chains if vendors are not managed effectively.

The City of Ordos

The property market is often a good measure of economic downturn and in China, most commentators have been talking about a property bubble for a while now. One particular example (and perhaps extreme) of a bubble bursting can be found in the City of Ordos. A city not plucked from antiquity, but rather the Inner Monglia Autonomous Region. Ordos, which grew around the nearby coal mining industry, has rapidly grown since the beginning of the property boom in 2006. Although it is unlikely that you have ever heard of Ordos, a report by China’s Ministry of Housing and Urban-Rural development showed recently that the GDP per capita of Ordos even surpassed that of Hong Kong.

The number of wealthy people in the city who are worth more than 100 million Yuan ($15.48 million) is in excess of 7,000. One out of every 15 people in Ordos has more than 10 million Yuan ($1.54 million). In contrast, those who have only one million Yuan ($154,680) are understandably considered to be poor.

However, since February, home sales have stalled with only around 10 percent of the properties on the market being sold. As with many second and third tier cities in China, the local property market has now become so dire that the city has been frequently labelled by Chinese media as a ‘Ghost Town’. This is just one extreme example of the way in which credit constraints (even in such a wealthy neighbourhood) have already hit the Chinese property market and there is a growing sway amongst economists that that bubble has now well and truly burst. Whether this is the spark for a ‘hard landing’ in the truest sense will likely be a popular discussion amongst leading economists in the coming months.

The fact is that a wide scale adjustment is already taking place in China and, with property interests closely linked to the benefit of every Chinese person, Central Government will certainly be taking an active interest; even more because of the fear of widespread social unrest from a political standpoint. Also, the negative growth forecasts in Europe, as China’s largest trading partner, will further dampen the Chinese growth machine even if current economic data suggests that a loosening of fiscal and monetary policy is now possible.

The Manufacturing Sector

The implications for the export manufacturing sector in China, which is inherently linked to other export manufacturing countries, are complex. Global trade is a dynamic and fluid marketplace. That said, if you were to simplify the likely implications of an economic adjustment in China on the export manufacturing sector, one argument would perhaps suggest a two-fold outcome:

1) The risk of purchasing from Chinese/Asian suppliers will increase; and 2) there will be a slowdown (or reduction) in the price inflation that has led to factory gate prices being closely aligned to an exponential growth curve. This will likely be further exacerbated by a global slowdown in demand from Europe.

In this context, having a local presence and vendor management capability is important.Mitigating the risk of purchasing from overseas whilst leveraging the benefit will help any company add to their bottom line.

To set politicking aside (the US is moving into an election year re RMB), the PMI (‘Purchasing Manager’s index’) for China in October has dropped to its lowest level in almost three years. Although there is always a variance (different samples) in the data between that released by the Chinese Government and HSBC, the general theme is that output from China’s manufacturing base has stagnated and there has not been real relative growth. The PMI was seen, “as a reflection of slowing momentum in the economy” and exports may “slow sharply in coming months” as was quoted by one Hong Kong based economist at UBS AG.

However, looking into the detail, positive signs for buyers (as well as policy makers) include a decline in a measure of input prices to a four month low. The drop does suggest that cost pressures are already beginning to drop. China's Producer Price Index (PPI), a main gauge of inflation at the wholesale level, also slowed from 6.5% to 5% year-on-year in October

In this context, companies should be positioning themselves to manage the increasing level of risk that will manifest itself in global supply chains. Whether it is being more flexible on payment terms, being aware of possible ‘short-cuts’ being taken due to cash constraints such as quality of products or looking to outsource production to save money, it is important to be vigilant. On the flip-side, there will undoubtedly be benefits and it is necessary to be positioned to take advantage of these.

ET2C India Office

We are very excited to announce the operational launch of ET2C’s Indian Office (Bangalore) which is now up and running. We not only believe that India currently offers an excellent alternative to China as a Low Cost Country but that, in the medium to long term, India may be a preferable destination. We believe that by offering our clients access to the India export sector (in addition to both China and Vietnam) we will only strengthen their supply chains and existing vendor databases.

There has been a visible paradigm shift in India over the past 5-10 years owing to its competitive stand in the world. The Indian economy is on a robust growth trajectory and boasts of a stable annual growth rate, rising foreign exchange reserves and booming capital markets amongst others. Currently, India’s share of global trade is a little under 20 percent of China’s total but, with an economy about to break into the global top 10 in terms of size (currently 12th position), the global community is both starting to take note of India’s rise and to appreciate its clout; as well as the opportunities such power brings. There is a real emphasis from the government to drive exports and the results are beginning to show. This becomes that much more apparent when directly compared with China.

As China has wound down its free trade zones and special economic zones for the purpose of export manufacturing, India has ramped its up. China has become too dependent upon export manufacturing to the detriment of its overall economy, while India does not have enough manufacturing capability and is too dependent upon services. It is these realignments that are creating the opportunities.

From a sourcing and export perspective, the factors that stand out in particular are the political stability that India offers as well as the favorable demographic. In 2025, India is expected to benefit from the “demographic dividend” with a median age of 30 whereas China is expected to start declining over the same period. By 2020, the average Indian will be 29, while the average Chinese person will be 37. It is important to recognize that in addition to the young demographic, due to cultural aspirations, males outnumber women (Males: 623.72 Million and Females: 586.46 Million) which is likely to also play an important role in the labour market in the future.

Whilst China is certainly not going to disappear or lose its grip on global trade in the short to medium term, India does now matter from an export perspective. India matters because, ultimately, being in China alone is not going to be enough to provide the level of service, cost comparisons and options to your clients given the dynamics of change that India will and is already bringing to China and the global economy as a whole.

In truth, the China vs India debate is a no-brainer. Its neither one, nor the other, and although some cross over in capabilities will undoubtedly emerge, it is quite apparent that global strategy must now embrace China and India as two unique, but complementary jurisdictions to achieve a broad based global supply chain. We want to offer our clients access to this dynamic and are looking forward to working with you on India in parallel to your existing supply chains.

November 2011
The City of Ordos

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