Company Level Strategy to Deal with the Yuan Appreication

July 21, 2005 was a very busy day for all of us at JJ Wellesley Group: the phones in our Los Angeles office kept ringing. Clients, prospects, partners, and many others were calling us and they all wanted to talk about one thing, i.e. the news from Beijing: the Chinese governement

finally abandoned its decade-old policy of pegging the country's currency, renminbi yuan (or RMB or yuan for short) to the US dollar. From now on, the yuan will be linked to a basket of currencies, possibly including the US dollar, Euro, and the Japanese yen. Effectively, the dollar-yuan exchange rate moved from 8.28 to 8.11, a 2.1% appreciation for the Chinese currency. While it may be premature for anyone to predict the long term economical and political impacts of Beijing's move, we feel it would be appropriate to for us to share some of our observations on the micro level issues that Western companies may now face in conducting business with/in China.

To study the issue, it is useful to separate the companies mainly buying Chinese produced goods/services from those who primarily sell goods/services to/in China . Even for those companies that do both buying and selling, it is still helpful to first examine the buying and selling activities separately. Our comments are published in two parts. Part One covers the issues from a buyer's standpoint. Part Two addresses sellers' concerns.

Read Part One-Buyers' Perspectives
Read Part Two-Sellers' Perspectives

China-ASEAN Free Trade Pact Offers New Opportunities*

2005 marks the beginning of the China- ASEAN Free Trade Area. On July 1, most tariff rates will be reduced and eventually removed throughout the region. China and the ASEAN 6 of Brunei, Indonesia , Malaysia , the Philippines , Singapore and Thailand will have the majority of tariffs removed by 2010 while the remaining countries of Vietnam , Cambodia , Laos , and Myanmar will remove rates by 2015. The importance of this agreement and the potential investment opportunities it can create should not be underestimated.

Already, the ASEAN nations constitute China's fifth largest trading partner. While China heavily exports labor-intensive products to the US and European Union and imports capital equipment from South Korea and Japan , the trade relationship with the ASEAN members is more complimentary. China's processing industries have an insatiable appetite for resources which the ASEAN countries posses in abundance. Five areas have been marked for special consideration: agriculture, information and communications technology (ICT), human resource development (HRD), Mekong River Basin development, and two-way investment.

For investors, the new trade area offers many new opportunities. Southeast Asia is a source of natural resources, a market for Chinese products, an area of investment in Chinese companies and a place for Chinese companies to invest. For foreign companies already in the region, the lower tariffs offer a chance to expand their trade. For foreign companies looking to invest, entry into one country now gains greater access throughout the region.

Border trade should rise dramatically. Currently, infrastructure between Vietnam, Laos, Myanmar and China is relatively undeveloped. Large investments in these areas should be forthcoming over the next few years. The Southern provinces of Yunnan, Guangdong, and Guangxi are especially poised to make gains in expanded ASEAN trade. Nanning, capital of Guangxi, has been chosen as the annual host of the China- ASEAN Expo and Investment Summit giving investors an opportunity to network throughout the area.

*The author of this article is Mr. Andrew Grady, Project Consultant, Investment Promotion Bureau, Administrative Commisssion, Nanning High-Tech Industrial Development Zone. The article is published on this website through a special arrangement of JJ Wellesley Pro Bono Consulting Program.

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More Outsourcing Contracts Will Land in China

China is the mother of all outsourcing activities if one includes the countless number of manufacturing orders Chinese factories receive from overseas every year. However, in the Western business literature for the past several years, the word outsourcing often refers to the activities in customer service (call centers), business processes management (BPM), and software development. In these areas, India is currently the undisputed leader.

English proficiency and superb college-level IT education programs have often been cited as the key success factors leading to India's climb to the top spot. And most recently, the scale of some of the largest Indian outsourcing contractors had achieved further solidified the country's leadership position. Theoretically speaking, China has no structural difficulty to overcome in order to catch up with India's IT education level. But the Chinese population's lack of English proficiency is a problem that may not be solved in the near term.

What does this mean? Does this mean China will remain as a cheap manufacturing base and has limited opportunities to attract outsourcing contracts outside of the area of manufacturing? Interestingly enough, many experts do not believe so. As a matter of fact, some researchers even predict that by 2006 China's total software export would catch up with that of India. So what kind of activities are overseas companies most likely to outsource to China? And why?

JJ Wellesley Group believes that a couple of key trends in and around China will drive more outsourcing business to the country.

First, China is rapidly becoming one of the world's largest single-country market for many consumer and industrial products. For overseas companies, increased sales in the Chinese domestic market have two important implications. First, manufacturing volumes would increase to accommodate the domestic market growth. And more importantly, a large domestic market could also create new outsourcing opportunities for activities further upstream or downstream along the value chain. For example, in the consumer electronics industry, a sizeable domestic market, may create outsourcing opportunities for the manufacturing of certain key components (which may have been mostly done overseas) as well as the designing of the final products.

Second, the economy in the greater China area (mainland, Hong Kong/Macao, and Taiwan) is getting more integrated. Even in Taiwan, where there has been some evidence that the pro-independence government of Chen Shu-bian had recently intensified their efforts to move towards a formal independence, most corporate leaders, attracted by both the supply of low cost labor and a rapidly expanding market, clearly want to integrate their businesses more with the mainland. Meanwhile, China's business relationships with Japan, South Korea, and ASEAN countries are also getting more interdependent. Countries such as Malaysia and Japan are pushing for an expansive East Asia economic community that would include China, Japan, S. Korea and the ASEAN countries. Given the cultural and lingistic similarities China has with its East Asian neigbhors, the Chinese general population's lack of English profeciency may actually be less of an issue in their every day business dealings within the East Asia region. Some large Hong Kong banks have already outsourced a large chunk of their back-office activities to contractors in the neighboring Guangdong Province. Some Japanese and South Korean companies have also shipped their customer service and software development functions to companies based in northeast China. And it appears that the Chinese workers (with proper training) do not have as much difficulty to work effectively with the Japanese and Korean customers.

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