Posted by: mulrickillion | February 8, 2012

Making it on the Mainland

Six Questions – Hong Kong Trader, Feb 8, 2012 —

Irons Sze

Irons Sze is Executive Director of Hang Tung Resources Holding Ltd, a Hong Kong company involved in property development and manufacturing on the Chinese mainland. Hang Tung is also engaged in mainland trade, selling upstream materials, including raw material for garments and plastics products to the mainland market.

Mr Sze assumed the helm of the Chinese Manufacturers’ Association of Hong Kong last month. The association’s new president discusses strategies for tough economic times, including adopting more upstream market opportunities and exploring the mainland market.

How have your businesses been affected by external economic factors in recent months?

Companies engaged in the raw material trade have to deal with market fluctuations. For example, the price of cotton was as low as US$0.6 to US$0.7 per pound at one point two years ago. By early last year, the price had nearly quadrupled, to US$2.3, and now stands at US$1. So raw material prices have been extremely volatile.

I understand that for most of 2011, when many factories had yet to use up the material they purchased at a high price, buyers were already asking for discounts. All the losses incurred were borne by the manufacturers.

I find that some Hong Kong manufacturers tend to put too much emphasis on exporting their products directly to the consumer market when, in fact, there are plenty of opportunities to develop the upstream and midstream markets on the mainland. My company does semi-finished products and does not sell directly to the consumer market.

Why do you think business in the upstream market has been good, seemingly unaffected by issues that manufacturers of finished goods face?

The upstream market is not as labour-intensive as the downstream market. In my factory in Jiangxi, for instance, annual sales amount to about Rmb1 billion, but I only hire 2,000 workers. The cotton spinning industry is becoming more automated. In the past, a 10,000-spindle, state-owned factory would employ 5,000 to 8,000 workers. A factory on the scale of mine would need 150,000 workers.

But increased automation reduces our reliance on manpower. Plus, trading in China is usually settled in the local currency, so appreciation of the renminbi doesn’t have much of an impact on us.

The 12th Five-Year Programme and changes in China’s economic growth model both suggest that processing with supplied materials or imported materials will no longer be viable, because it is high in energy consumption, labour-intensive and low in productivity.

Five years from now, labour costs may increase to Rmb6,000 [per month]. By then, [processing activity] won’t have any comparative advantage, as wages will only keep increasing.

What would your advice be when it comes to operating on the mainland?

My usual practice is to team up with mainland partners, as the procedures for domestic sales are extremely complicated. The first problem that one will face is the tax issue, which can become very problematic if not handled properly.

The second issue is how to collect payment. The biggest worry of companies involved in domestic sales is not getting paid. A small- or medium-sized enterprise doing business on the mainland definitely needs a guiding hand that knows the local market well.

How does that compare to the situation 20 years ago?

It was much better then because our clients were all state-owned enterprises. Collecting payment was never a problem. Today, most of our clients are private enterprises. The changes are tremendous.

With the scrapping of state planning and decentralisation of economic power, many state-owned enterprises have been transformed into joint-stock companies or privatised. So it’s very difficult to do business these days. We must find good partners and cooperate with them. In recent years, many enterprises involved in processing supplied materials were not successful in transforming their business and have closed down, whether it’s due to unresolvable tax problems or business-related issues.

Are these problems attributable to changes in the current tax system?

Let me give an example. I import flour to make cakes. Processing with supplied materials enjoys exemption of import duties. After the cakes are made, they are exported. This has been the practice in the past.

On the other hand, processing with imported materials is subject to import duties when the materials are imported. When the finished products are exported, there will be a tax rebate. Here is where the problem arises: with processing using supplied materials, some of the products have already been sold in the local market when they are imported – 100 tonnes in, 95 tonnes out (five tonnes being wastage); this has been permitted in some localities. But strictly speaking, the practice could be deemed as tax evasion.

Tax issues of a similar nature will have to be managed. So I always remind friends involved in domestic sales to be cautious about tax issues. They should seek help from tax consultants.

Do you have plans to explore new markets, or would you rather strengthen your business on the mainland?

The 12th Five-Year Programme indicates that domestic consumption will be encouraged. From reliance on processing with supplied materials in the early days to infrastructure investment, property development and emphasis on domestic consumption nowadays, there are opportunities amid the challenges.

The sluggish economies of Europe and the United States may have a short-term impact. From a long-term perspective, however, Hong Kong companies can first establish their own brand, then develop the mainland market, and perhaps move on to the Southeast Asian market after achieving success in China.

Global investment capital will redouble to the Asia-Pacific region over the long term. Given the severity of the European debt issue, banks will reduce loans in Europe due to its lacklustre outlook. This will be an opportunity, but one will have to sail through difficult times in the short term.

I believe Hong Kong still has the energy. During the 1997 financial crisis and the bursting of the information technology bubble in 2000, the property and stock market bubbles were much bigger than those of today. After the SARS outbreak in 2003, the Individual Visit Scheme was launched to promote spending [by mainland visitors] in Hong Kong. The inflow of foreign capital has not been interrupted since.

For more on the interview with Irons Sze, please see the December issue of the HKTDC Trade Quarterly, which can be ordered at: http://bookshop.hktdc.com/.

hktdc.com – Making it on the Mainland

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