The central government of Mainland China has introduced a new administrative system upon outward processing trade since October 1999, under which processing trade is categorized in terms of both products and enterprises, subject to different Guarantee Shadow Margin Account (GSMA) requirements. When enterprises subsumed under the Category C import goods or Category B enterprises import goods on the Restricted lists, they should deposit an amount equivalent to tariffs and Value Added Tax (VAT) with the Bank of Chinese, as a pledge requested by the Customs. Earlier this year, the Government has put forward Implementation Guideline to permit settling the GSMA with non-cash methods, e.g., Guarantee Letter, and more recently, the guarantee deposit required for Category B enterprises has been cut down by a half. However, it is unavoidable that most Processing Trade Enterprises (PTEs) are now facing increased cost of imported inputs and some of them are running into financial problems, as the GSMA is now taking up a considerable part of their working capital or credit quota available. Under this circumstance, more and more PTEs have begun to look to domestic suppliers for raw materials and parts.

In recent years, Mainland-made raw materials and components have been making great improvements, in terms of both production capacity and product variety. By adopting local materials, PTEs can benefit from shorter delivery time, reduced transportation costs, and better communications with suppliers. On the other hand, domestic materials are subject to easier control and simpler official formalities, and are free from the GSMA schemes. Moreover, the VATs on domestic inputs are deductible, providing users a substantial advantage in costing. In principle, Hong Kong manufacturers would feel fairly comfortable to accept Mainland materials, and most of them have, to a more or less extent, gained experience in this regard. In fact, some Hong Kong companies have been using domestic inputs on a large scale for pretty long time, as can be seen form a survey conducted by the CMA recently, which revealed that 56.5% of the respondents had employed Mainland materials, while another 39.1% had shown interest. 

However, it should be admitted that some realistic problems remain. For instance, the quality of domestic raw materials and parts is often not stable enough, falling short of international standards as well as the specifications designated by overseas clients. Mainland suppliers are generally relatively weak in quality awareness, and some of them have poor track record in keeping delivery schedule and providing after-sale services, such as goods responsibility guarantee. In some cases, the use of local materials is limited by the obligations imposed by foreign buyers, who insist on a certain portion of imported contents.

On the other hand, the Inter-factory Carry-over procedures are much complicated when domestic materials are used in outward processing trade. It is also a reality that payment by credit has not yet well received in Mainland and most local suppliers are reluctant to offer favorable terms on settlement, such as Distant Letter of Credit. Moreover, due to tax refund, suppliers' enthusiasm in pursuing export performance and other reasons, some domestic materials are available at a lower price in Hong Kong as compared to Mainland per se. Such abnormal phenomenon is also a disincentive for PTEs' to procure directly in the locality.

The CMA suggests that materials producers in Mainland China should step up their improvements in respect of quality, delivery period, pricing and services, so as to develop better synergy and partnership with PTEs. At the same time, it is worthwhile for the Government to consider the following stimulating measures: First, review the prevailing policies on imports & exports, customs clearing, as well as taxation, in an attempt to reduce red tape and institutional barricades; second, speed up the process of VAT refund and raise the rebate rate for domestic materials, thus gearing towards the ultimate target of "full refund" or "zero VAT"; third, assist domestic suppliers in establishing business connections with PTEs, through various channels such as organizing seminars, disseminating information, enhancing liaisons with industrial guilds, and matching on Internet, etc.; and fourth, encourage financial institutions to increase supports to both domestic suppliers and PTEs. Last but not the least, for materials and parts whose substitutes are not available or qualified domestically, the government should consider duly relaxing the GSMA requirement or even withdrawing such items from the Restricted list, so as to secure the smooth operation of Process Trade Enterprises.