China economy

Trade war: Chinese exporters’ front-loading beats US tariffs – but for how long?

  • As manufacturers operate flat-out to fulfil US orders brought forward to avoid tariffs, the possibility of a sharp fall in demand in 2019 looms large
  • Some are speeding up relocation of factories to other countries in Southeast Asia, where costs are lower and US tariffs do not apply
PUBLISHED : Sunday, 04 November, 2018, 10:04pm
UPDATED : Monday, 05 November, 2018, 11:18am

Guangzhou Seagull Kitchen and Bath Products, which relies on the US market for over a third of its revenues, has been running its production lines in China around the clock for the past three months, according to its workers.

Uniformed employees outside its factory compound said they were working 12-hour shifts to expedite orders for early next year, making sure their tap handles arrive in the United States ahead of a scheduled tariff increase.

The bathroom fixtures Seagull makes are on the list of US$200 billion worth of Chinese products on which the US imposed a 10 per cent duty starting on September 24, and which is set to rise to 25 per cent on January 1 if Beijing does not make trade concessions.

“Many of us have to work rotating [12-hour] shifts from 8pm to 8am or 8am to 8pm each day,” said a migrant worker in his forties, who declined to be named. He and his colleagues were having a late lunch, costing 12 yuan (US$1.70) each, in a small restaurant outside the factory on the outskirts of Guangzhou, the capital of south China’s Guangdong province.

Analysts have said the practice by Chinese exporters of accelerating production and shipment now to avoid the upcoming tariff increase – or “front-loading” orders – is one probable reason behind China’s strong export performance since Washington started to levy its first round of tariffs on Chinese imports in early July.

The practice may be widespread, because Chinese exports of chemicals, non-ferrous metals, plastics and special industrial machinery were the fastest-growing Chinese export categories in September, according to Chinese customs data, despite all of them being included on US tariff lists.

But fulfilling next year’s orders so far in advance could lead to a significant slowdown in future sales if US clients reduce their next orders accordingly. China’s official purchasing manager’s index has shown new export orders have been contracting since June.

A tactic that works – for now

Ding Shuang, the chief China economist at Standard Chartered bank, who has just visited exporters in the eastern province of Zhejiang, said many companies were doing the same as Seagull and the production frenzy could last the rest of the year.

“Increased demand for shipments has pushed up shipping rates and some exporters are even having trouble finding any space on cargo ships,” Ding said. But the situation could quickly turn bad next year, he warned, as exporters face a double blow from fewer new orders and a sharp depletion of existing orders.

So far, the trade war has not had any significant impact on China’s trade and broad economy. Manufacturers’ front-loading may be partly responsible.

China’s exports rose 14.5 per cent in September from a year earlier, accelerating from a 9.8 per cent rise in August. Meanwhile, its trade surplus with the US, its biggest export market, widened to a record US$34 billion last month.

In Guangdong, China’s export manufacturing hub, the economy expanded 6.9 per cent during the first three quarters of 2018 from a year ago, or slightly higher than the nationwide growth rate of 6.7 per cent for the period.

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Guangdong’s exports posted a modest rise of 0.4 per cent in the first nine months of the year, rebounding from a 3.3 per cent decline in the first half, implying strong third-quarter gains.

The stronger exports figure was supported by activity at factories like Seagull’s. The question is what will these factories do once those orders have been completed, particularly if US clients reduce or even stop orders because of the extra tariff costs.

An exit strategy?

Listed on the Shenzhen Stock Exchange, Guangzhou Seagull is one of a few Chinese listed companies to have disclosed the possible impact on their operations from the US tariffs.

The maker of high-end kitchen and bath plumbing products and bathroom furnishings for brands in the US, Europe and Asia said in a statement that its tap components, the main product line it exports to the US, were on the new tariff list.

The company’s US sales exceeded 372 million yuan in the first half of this year, accounting for about half of its export revenue and more than 35 per cent of its total revenue.

Seagull said it was working with its US clients to apply for a one-year exemption from the tariffs.

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If this does not work, its US clients will have to raise sales prices. Some of its US clients have asked Seagull to “shoulder part of the extra costs”, but the company said it was trying to avoid that.

It said it had started talking to some US clients about moving production out of China. “We will proactively explore the proposal of setting up factories abroad to maintain relations with US clients,” it said in a statement.

Its investor relations office declined to comment further on its plans for managing the impact of the trade war. It also declined to reveal information about its internal production arrangement.

Ground shifts beneath Chinese firms

Guangzhou Seagull was set up in 1998, backed by Taiwanese businesspeople, with China’s labour-intensive export-oriented manufacturing industry thriving thanks to cheap labour and high demand from the United States, Europe and Hong Kong.

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Mainland officials rolled out red carpets for investors from Taiwan and Hong Kong to build factories. A local worker in Guangzhou cost 400 to 500 yuan a month, whereas a skilled Hong Kong worker made 20 times that at the time.

The business grew quickly in the 2000s by making products mainly for the US and Europe, but the fundamentals that made it successful have changed since. Labour, rent and raw material costs have soared, eating up profits and making Chinese products less competitive. Tariffs have only made things worse.

One consequence is a growing number of Chinese manufacturers speeding up relocation of factories to other countries in Southeast Asia, where costs are lower and US tariffs do not apply. Overseas customers are increasingly ordering from such factories, rather than the mainland, to reduce costs.

Huida, another leading Chinese bathware manufacturer, said its export revenue fell almost 13 per cent year on year in the first six months to 373 million yuan.

“We’ve lost a lot of overseas orders, and other companies in the industry are looking for ways to minimise the losses,” chief executive Wang Yanqing was quoted as saying last week at the Canton Fair in Guangzhou.

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Huaji Dengyu Auto-Parts, meanwhile, warned in a corporate filing on the Shenzhen Stock Exchange that tariffs would hit its business because its engine valves are covered by them.

Sales of US$21 million in the US in 2017 accounted for almost 80 per cent of its export revenue and more than 41 per cent of its total revenue.

Workers fear for future 

The full impact of the trade war, however, will only begin to show later this year, industry watchers said.

“The impact of US tariffs on Chinese exports could show as early as October, and the main pressure will be reflected in the export volume in the first quarter of next year,” Hua Chuang Securities analysts wrote in a recent research report.

There is little sign of the US and China de-escalating tensions, with US President Donald Trump threatening to put tariffs on all Chinese imports.

Zhao Xijun, an economist from the School of Finance at the Renmin University of China, said Chinese manufacturers needed to understand that the international trade environment had changed, and be prepared for heavy duties to last for some time.

“Chinese enterprises also need to speed up the diversification of their sales, to countries other than the US, to make up for a decline in US orders,” he said.

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Although Beijing is trying to play down the impact of tariffs, the impact on those reliant on sales to the US could be severely affected.

Workers at Guangzhou Seagull said they could make about 6,000 yuan a month, including overtime from their extended shifts – more than workers at smaller factories nearby. “But it’s still a low pay because we are overloaded with work,” one said.

“It seems the company has no plan to hire new workers. There could even be lay-offs next year if existing orders are filled and there is a lack of new orders.”

Another said he had been working at the factory for many years to support his family.

“Our workers really had no idea what the so-called trade war was all about, but now that we are starting to feel its effects, we are starting to worry,” he said.