The hefty increase in processing trade export cost is going to have a great impact on Hong Kong companies operating in the Pearl River Delta (PRD) and Yangtze River Delta (YRD) regions, according to the Ministry of Commerce (MOFCOM). 

Enterprises in YRD have invested considerable resources in proprietary R&D and pollution control in recent years. As a result, many have diversified from the business model of total reliance on processing trade. Compared with their counterparts in PRD, YRD enterprises are in a better position to adapt to policy changes. 

For the many processing trade enterprises operating in PRD and YRD, 23 August 2007 was an important deadline. Under Announcement No.44 issued by MOFCOM, with effect from that date, the 1,800-plus items listed in the new Catalogue of Products under the Restricted Category in Processing Trade are subject to "actual payment" of customs duty deposit. At the same time, no new processing trade activities involving products under the restricted category will be approved in the eastern region.

How significant are the impacts of these two new measures, i.e. implementation of "actual payment" of customs duty deposit and banning of new processing projects involving the 1,800-plus restricted products in eastern China?

First, processing trade enterprises may encounter cash flow problems. Prior to the new rule, most of the law-abiding processing trade enterprises did not have to make "actual payment" of customs duty deposit, i.e. only "nominal payment" of customs duty deposit was made.

Under the new policy, starting from 23 August 2007, processing trade activities involving products under the restricted category are subject to "actual payment" of customs duty deposit. Although the deposit plus interest will be paid back to the enterprise eventually, the whole process starting from the import of raw materials to the export of finished goods may take as long as one year, as in the case of textiles processing enterprises, which means the deposit money will be locked for one whole year. Some people in the industry estimate export costs could go up by 30% as a result. For instance, processing trade enterprises in the textiles, garment, footwear and bags industries alone are expected to pay a total of Rmb20 billion in customs duty deposit. 

According to the Shanghai Cotton Spinning and Weaving Industry Association, the impact will ripple through the whole industry chain affecting upstream and downstream enterprises. For instance, in garment processing, upstream industries such as cotton spinning are affected, while in plastic, metal and other raw materials processing, downstream activities such as electronics manufacturing are impacted.

Moreover, the new policy may affect the employment situation. A study conducted by the Association of Taiwanese-invested Enterprises in Guangzhou has found that production cost will rise dramatically under the dual effect of lower export tax rebate rate and changes in processing trade policy. Under normal circusmtances, enterprises would raise their export price to offset production cost increase. However, right now, only about 20% of the processing trade enterprises are in the position to do so. Others have to cease operation or undergo transformation. This will result in many workers losing their job. 

Indeed, PRD is not the only region facing these challenges, YRD is also hard hit. According to Ge Hua, director of the foreign trade management department under the Suzhou foreign trade and economic cooperation bureau, more than 650 enterprises in Suzhou alone have been affected. "The total sum of customs duty deposit to be locked is estimated at Rmb6 billion," said Ge. In Ningbo, Zhejiang, 370 enterprises have also been hit by the new processing trade policy, affecting close to US$1 billion worth of exports.

The latest change in processing trade policy has triggered a flurry of concerns in PRD. Hong Kong companies found the new policy too harsh and the transition period too short. According to the latest study by Hong Kong's Greater Pearl River Delta Business Council, more than 10,000 Hong Kong-invested enterprises in PRD may have to cease or scale down their operation under the new policy. To help alleviate the pressure faced by Hong Kong companies concerned, different groups from Hong Kong are lobbying hard on this issue.

A task force was set up by the HKSAR Government and Guangdong authorities at the first meeting of the processing trade working group. The task force will assist Hong Kong-invested enterprises in seeking transformation and upgrade, as well as negotiate with the Hong Kong Association of Banks to lobby support from Hong Kong banks in assisting Hong Kong companies. At the same time, the task force will do its best to identify locations in the central and western regions on the mainland suitable for setting up factories and assist Hong Kong enterprises in relocating.

Unlike PRD where the impact of the new policy is strongly felt, YRD seems largely unscathed. So far, no industry association from the YRD region has made any public statement about the "damage" done by the new policy, and no government authorities are doing any liaison work. The impact of the new policy is less significant on YRD.

This is attributable to the differences between PRD and YRD in terms of the nature of their manufacturing activities and industry mix. In general, PRD is more reliant on processing trade and is heavily oriented towards export processing trade orders. As for YRD, although there are a large number of processing trade enterprises operating in the region, their contribution to the local economy is relatively less significant due to the strong presence of large-scale, heavy industry enterprises. 

Moreover, many YRD enterprises which used to deal in foreign trade have diversified into domestic sale. Hence, they are less affected by the new export-oriented processing trade policy.

According to MOFCOM, Announcement No.44 has two major objectives: first, to guide the eastern region in industrial restructuring; and second, to relocate processing trade activities involving low value-added, high pollution and high energy consumption products to the central and western regions. In a nutshell, transformation and upgrade are the key objectives.

Meanwhile, with the emergence of the Bohai Rim economic region, revitalisation the old industrial base in the northeast, and further development of the central and western regions, other regions in China are beginning to attract the attention of foreign investors. In fact, quite a number of Taiwanese-invested enterprises in YRD relocated northward around year 2005. During the present round of policy change, Hunan province was the first to announce that incentives will be offered to processing trade enterprises relocating there from PRD. Attracted by preferential policies, processing trade enterprises may very well relocate to areas offering the right incentives.