China's adjustment of its processing trade policy, reduction in export rebate rate, and tightening of regulations and enforcement with regard to clean production and environmental protection have made a certain impact on the processing trade business of Hong Kong companies on the mainland. In this connection, the Hong Kong Trade Development Council (HKTDC) conducted a questionnaire survey during October-November 2007 on Hong Kong enterprises engaged in processing trade in the Pearl River Delta (PRD) region. A total of 337 valid responses were received, representing an effective response rate of 20.6%. The major findings are as follows:

• 75.1% of the respondents reckon that the adjustment of the processing trade policy on the mainland has affected their business.
  These effects include:
  - the policy adjustment has led to a rise in the purchasing price of raw materials/ semi-manufactures
  - after the policy adjustment, they have to pay customs duty deposit for their raw materials/semi-manufactures imports
  - the policy adjustment has affected the production of their suppliers and has in turn affected their materials supplies
  
  
• 76.3% of the respondents indicate that they are worried about the possible impacts or have already felt the impact on their production brought about by the gradual tightening of regulations on the mainland with regard to clean production and environmental protection.
  These impacts include:
  - they have to pay higher fees for sewage discharge
  - they have to increase investment in their mainland factory production facilities in the coming years
  
  
• 78.3% of the respondents express that they would not consider relocating their production activities from the PRD.
  Their reasons, in descending order, include:
  - the costs of relocation are too high
  - their business in the PRD is still profitable
  - they are worried that by relocating to other places their competitiveness would be weakened
  
  
• 21.7% of the respondents indicate that they would consider relocating to other regions:
  - among them, half are considering relocating to other provinces such as Jiangxi, Guangxi, Hubei, Hunan and Zhejiang
  - 24.7% are considering relocating from the Chinese mainland
  - 23.3% are considering relocating to other less developed areas in Guangdong (e.g. northern Guangdong) outside the PRD
  - 17.8% are considering relocating to eco parks in the PRD
  
  
• 93.8% of the respondents would not consider moving their production activities back to Hong Kong:
  - among them, 44.8% point out that relocating their production activities back to Hong Kong is commercially not viable
  - 6.2% indicate that they might consider relocating part of their production activities back to Hong Kong

If Guangdong builds new industrial parks, provides comprehensive sewage treatment facilities/central sewage treatment system, and offers processing trade bonding arrangements, 29.8% of the surveyed companies express that they would consider relocating to these industrial parks, 37.5% indicate that they have not made any decision, while the majority of the remaining respondents say they would not consider relocating.

Looking to the future, about 65% of the respondents reckon their processing trade business on the mainland would remain unchanged (25.6%) or continue to grow (39.0%) in the next one to two years. In other words, they remain optimistic in the short term. However, the percentage of this optimism in the medium term (three to five years) drops to 53.4%. This somewhat reflects the worry of Hong Kong companies about the development of their processing trade business on the mainland.

In order to meet the challenges mentioned above, most Hong Kong companies adopt proactive measures to cope with the changing processing trade environment on the mainland. Their development strategies include:

- to develop or increase domestic sale on the mainland (42.4%)
- to develop or increase sourcing raw materials and parts on the mainland (42.1%)
- to convert their existing processing enterprise into foreign-invested company (34.7%)
- to increase capital investment in production (22.8%)
- to increase investment in green production (16.3%)

1. Survey Background

In a move to promote the "transformation and upgrade" of the processing trade and to contain the production activities of "high energy consumption, high pollution and resource consumption" industries, the mainland has strengthened its control of the processing trade and adjusted relevant regulations since the second half of 2006. Measures taken include lowering and lifting the export tax rebate rate of certain products, and expanding the catalogue of products under the prohibited category and restricted category in processing trade. In addition to implementing dynamic adjustment of the processing trade product catalogue, the mainland has also tightened regulations and enforcement with regard to clean production and environmental protection, and has established an access mechanism for processing trade enterprises.

The change in processing trade policy and the tightening of environmental protection requirements have made a certain impact on Hong Kong companies' processing trade business on the mainland. In a move to gauge the impact on Hong Kong companies made by the processing trade policy adjustment, the Greater PRD Business Council commissioned the HKTDC to conduct a questionnaire survey between February and March 2007. The survey results were announced on the website of the Greater PRD Business Council in the form of a report in June 2007 (http://www.cmab.gov.hk/doc/ProcessingTradeJune_chi.pdf).

After the questionnaire survey was completed, in April 2007 the Ministry of Commerce issued its new catalogue of products under the prohibited category in processing trade and requested the commerce departments in all localities to strengthen and improve the access control of processing trade enterprises. In July, the new catalogue of products under the restricted category in processing trade was published and newly established enterprises in the eastern region are banned from engaging in the processing trade of products under the restricted category, while Category A and Category B enterprises in the central and western regions are allowed to make "nominal payment" of customs duty deposit. Then in September, it was announced that processing trade enterprises may pay customs duty deposit by means of letter of guarantee (L/G). In view of the new impact brought about by the latest policy changes on Hong Kong companies, the HKTDC's Research Department decided to conduct a new round of questionnaire survey in order to better understand the operations of Hong Kong companies in the PRD under the latest processing trade environment and the development strategies adopted by them in response to the policy changes.

2. Methodology and Targets

The new round of questionnaire survey was conducted during the period from end-October to November 2007. The targets are the 1,635 enterprises which had responded to the last survey who were engaged in processing trade in the PRD region. By the end of November 2007, a total of 337 valid, completed questionnaires were received by the Research Department. The effective response rate is 20.6%.

According to the valid questionnaires received, the surveyed companies are mainly engaged in processing trade involving the production of garments and textiles (23.4%), electronics/electrical appliances (19.3%), gifts and premiums (17.2%), plastic products and plastic raw materials (17.2%), metals, machinery and related parts and components (12.8%).

Most of the respondents are small and medium-sized enterprises. 76% of the surveyed companies indicate that the number of workers employed by their factories in the PRD is 500 or less. Large processing enterprises employing more than 2,000 workers only account for 5.6% of all respondents.

3. Survey Findings

Impact of Processing Trade and Environmental Protection Policy Adjustment on Hong Kong Companies

75% of the respondents point out that the processing trade policy adjustment on the mainland has affected their production activities in the PRD. About 45% of the respondents indicate that the policy change has led to a rise in the purchasing price of their raw materials/semi-manufactures. 30% of the respondents have to pay customs duty deposit for their raw materials/parts imports. The policy adjustment has also affected the production activities of the suppliers of 25% of the respondents, which has in turn affected the materials supplies of these respondents.

While only 26.4% of the surveyed companies indicate that they have been affected by the gradual tightening of regulations and enforcement on the mainland with regard to clean production and environmental protection, half of the respondents are worried that these measures may affect their factories on the mainland in the future. Only 23.7% of the respondents express that they have not been affected at all.

Among all the respondents, 14.2% indicate that following the implementation of the environmental protection measures by the mainland, they have to pay higher fees for the sewage discharged by their processing factories in the PRD. Another 11.6% of the respondents point out that, in order to meet environmental requirements, they have to increase investment in the production facilities in their mainland factories. On average, each company has to increase their investment by HK$2.33 million additionally.

Considerations of Relocating Production Activities from PRD

Although the policy change in processing trade and the strengthening of regulations with regard to clean production and environmental protection on the mainland have affected the PRD production activities of the majority of the respondents, a high percentage (78.3%) of the respondents indicate that they would not consider relocating their production activities from the PRD. The reasons given are: the costs of relocation are too high (40.9%), their business in the PRD is still profitable (19.3%), they are worried that by relocating to other places their competitiveness would be weakened (16.6%). However, there are also respondents who would not consider relocating because they have no idea what other options are available (17.5%).

Only 21.7% of the respondents would consider relocating to other regions. Among these companies, half (accounting for 10.4% of all respondents) are considering relocating to other mainland provinces, such as Jiangxi, Guangxi, Hubei, Hunan and Zhejiang; 23.3% are considering relocating to other less developed regions in Guangdong (such as northern Guangdong) outside the PRD; 17.8% are considering relocating to eco parks in the PRD; and 24.7% indicate that they would consider relocating to places outside the Chinese mainland (accounting for 5.3% of all respondents).

When asked whether they would consider relocating their production activities back to Hong Kong, 93.8% of the respondents answer in the negative. Among them, 44.8% point out that moving their production activities back to Hong Kong is commercially not viable. Another 49% indicate they do not have any plans of moving back to Hong Kong. Only 6.2% of the respondents express that they would consider relocating part of their production activities back to Hong Kong.

However, if Guangdong builds new industrial parks, provides comprehensive sewage treatment facilities/central sewage treatment system, and offers processing trade bonding arrangements, 29.8% of the surveyed companies express that they would consider relocating to these industrial parks, 37.5% indicate that they have not made any decision, while 27.1% say they would not consider relocating.

4. Hong Kong Companies' Views of Processing Trade Development

The adjustment of the processing trade policy on the mainland has affected the processing trade production activities carried out by Hong Kong companies in the PRD region. Nevertheless, in the near term, Hong Kong companies remain optimistic about the prospects of their processing trade business. According to this survey, 39% of the respondents reckon their processing trade business on the mainland would grow moderately or rapidly in the next one to two years, while 25.6% reckon their business would remain unchanged. In other words, about 65% of the respondents are optimistic about the future.

In the medium term, the percentage of respondents who reckon their processing trade business on the mainland would grow moderately or rapidly in the next three to five years rises slightly to 40.6%, but the percentage of those who reckon their business would remain unchanged drops to 12.8%. Overall, the percentage of respondents holding an optimistic view drops to 53.4%. This somewhat reflects the worry of Hong Kong companies about the prospects of their processing trade business on the mainland.

In the face of the challenges, most Hong Kong companies adopt proactive measures to cope with the changing processing trade environment on the mainland. Over 40% of the respondents indicate that they would develop or increase domestic sale (42.4%). Another 42.1% express that they would develop or increase the sourcing of raw materials and parts on the mainland. 34.7% plan to convert their existing processing enterprises into foreign-invested companies (wholly foreign-owned enterprises). There are also respondents who indicate that they would increase capital investment in production (22.8%) and increase investment in green production (16.3%) in a bid to enhance the quality of production.

This new report is available at TDC's Retail Outlets. It can also be purchased through the TDC Bookshop section in the TDC's trade portal: info.hktdc.com.