Riding Out the Freeze

By staff reporter ZHANG HUI

It was at the lowest level I've ever experienced," says Li Zhongjian, describing last year's business confidence in Zhejiang Province's economic powerhouse, Wenzhou. Li, who has been doing business for 30-odd years, is president of Wenzhou Orient Light Industry Co., Ltd, one of the city's most prominent enterprises.

Nowadays, however, Li is cautiously hopeful about the future. After the release of the China's 12th Five-year Plan (2011-2015) for the Growth of Small and Medium-sized Enterprises (SMEs) following Premier Wen Jiabao's visit to Wenzhou last October, things are looking up, Li says.

Li's company is the market leader in Wenzhou's light manufacturing industry. Over 95 percent of its products are exported. For nearly a year, however, Li has been hesitant about accepting new orders. "I wouldn't dare expand my exports. Profit margins are being squeezed and there are too many uncertainties, such as the appreciating RMB. It's too risky to accept a lot of orders at the moment."

Center Group, an eyeglass manufacturer in Zhejiang Province, resumed operations on October 20, 2011. Photos by China Foto Press

The Plight of China's SMEs

In China, Wenzhou is known as China's private enterprise capital and its manufacturing center for small wares. More than 400,000 SMEs have clustered here, most of which are engaged in the labor-intensive manufacturing industry.

Although his company employs more than 500 workers and enjoys an annual export turnover of RMB 80 million, Li says annual profits are actually smaller than those of his son's bakery. Soaring prices of raw materials and rising cost of labor and borrowing all contribute to lackluster profits.

China's Producer Price Index (PPI), a major measure of inflation at the wholesale level, had recorded a year-on-year increase which peaked at 7.5 percent in July 2011. Since that time the PPI has fallen back somewhat, subsiding to five percent by October of that year. Manufacturers have certainly felt the pinch, reporting increases in the prices of raw materials of about 10 percent last year.

Labor costs have surged even more. "For our company, labor costs increased 20 to 30 percent last year, and yet it's still difficult to recruit qualified workers," Li says.

Li is most distressed by exchange rate volatility and the scarce availability of capital. With a production period for big orders ranging from three to six months and currency forward rates needing to be determined from day one, Li says there is considerable risk in accepting such work. An appreciating RMB could wipe out any profit from an order and push him into the red. Because of such worries, Li actually declined several orders worth in total more than RMB 100 million last year.

According to a survey of 855 enterprises conducted by the Wenzhou Foreign Trade and Economic Cooperation Bureau, 25 percent of labor-intensive businesses such as shoes, garment, glasses and light industry manufacturers are afraid to accept orders because of a lack of skilled workers and tight availability of capital. A quarter of enterprises are facing losses and one third see annual profits of only three percent. Only one in every 100 businesses in the region enjoys profit margins of over five percent.

Wenzhou's SMEs are not the only ones to suffer. A report on the operation and financing situation of small enterprises in the Pearl River Delta jointly released by the National School of Development at Peking University and Alibaba Group in October, 2011 showed that the order volume of small enterprises in the Delta area dropped by 30 to 40 percent in 2010, the main cause of which was slack U.S. and European demand. The Pearl River Delta is another SME hub in which most players are engaged in the export re-processing business.

Liang Yanguang, owner of Yangyang Metal Products Co., Ltd. in Jiangmen City, Guangdong, has seen his orders falling to a level that at which he can barely keep his machines running. "Orders for our furnishing products have declined by 70 percent due to the struggling European and U.S. economies. As more and more competitors both at home and abroad enter the fray and as factor prices continue to rise, we are losing our price edge. I suppose this is because our products are all stock standard household goods with no distinguishing or value-adding characteristics to speak of," he laments.

The price advantage of China's small enterprises in manufacturing has been impaired recently by factors such as the increasing prices of domestic raw materials, rising labor costs and the appreciation of the RMB. Vietnam and India have emerged as strong low-cost competitors who threaten to undercut China's low-end manufacturing business.

Such a threat is cogently depicted by Liu Jun, head of the Shenzhen office of Baoding Zeguang Towel Factory. "Recently, we offered a price of RMB 2 per towel to a trading company. That's our bottom line. Our profit would have been less than three percent at this rate. A Vietnamese company however offered RMB 1.9 per towel as its first offer. We just couldn't compete with that."