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Discordant trade relations with the United States are only making Asia stronger, not weaker.
Abe De Ramos, CFO Asia
April 26, 2004
It was a week of stark contrasts in the changing fortunes of East and West. On February 16, Robert Zoellick, the mustachioed chief trade negotiator of the United States, landed in dusty New Delhi with a mission—to convince India to break down its barriers so that more American goods could compete in the local market. The following day, Praveen Kadle, the affable CFO of Tata Motors, hopped on a flight from Bombay to Seoul to complete the acquisition of a South Korean company. After days of preaching the virtues of free trade, Zoellick left India empty-handed and perhaps a little embarrassed. Kadle, meanwhile, returned with a deal that gives India's largest automaker a 26 percent share in the Korean heavy trucks market.
Seemingly unrelated, the two events are in fact key indicators of a power shift in the subtle game of global trade. By all appearances, US trade negotiators have lost their footing. Fretting over a record trade deficit of US$542 billion, they call for Asian governments to remove trade barriers. At the same time, Congress introduces protectionist policies at home. Treasury Secretary John Snow presses Beijing's leaders to revalue the yuan. Yet the Bush administration relies on China and Asia to finance its budget deficit by snatching up US Treasury bills, mass investments that keep interest rates soothingly low. In sum, the US needs Asia more than ever before, but its leverage is diminishing and its policies are all over the map.
Compare this to the emerging concordance on trade all over Asia. The entry of an Indian company into Korea, one of the first investments in that direction, is the latest example of a trend that came into full bloom only in the last two years: Asian countries are trading more with each other and becoming more integrated. This is fuelled as much by an intricate regional supply chain as it is by their growing domestic economies. As Ifzal Ali, chief economist of the Asian Development Bank, notes: "If these trends continue and regional economies remain focused on policies to achieve faster growth on domestic demand, Asia's outlook should become less dependent on developments in the major industrial countries."
What this means for CFOs is that Asia is entering a new era of economic stability that bodes well for business, one that is built on a strong foundation. Donald Hanna, chief Asia Pacific economist for Citigroup in Hong Kong, says the trend has been going on for the last ten years with the formation of international production and distribution networks in East Asia. "The rise in intra-regional trade should strengthen the independence, but the independence in some sense was already there," says Hanna. Rob Subbaraman, Asia economist at Lehman Brothers, agrees. "There are two things driving intra-regional trade: the elaborate production network, and strengthening domestic demand," he says. "In a way the region is more in control of its own destiny."
In short, while the United States has got itself in a position where it needs to correct its trade relationships with Asia to help protect its economic growth, Asian economies are finding that demand from within the region (notably China) is replacing the role of the US as a source of growth. "That does not mean that over the medium term, what happens in the export markets of Japan, Europe, and the United States will not matter very much," says Ali. "But if there is a misstep in these economies, the impact of a downturn there would be less now as well as in the future than has been in the past."
Standing Up to Uncle Sam
Numbers suggest that change is afoot. Intra-regional trade rose from 38 percent of Asia's total imports and exports in 2000 to 47 percent last year, according to Citigroup. Asia's trade with Japan, a longstanding partner, stagnated around 15 percent, while trade with the rest of the world slid from 45 percent to 38 percent. Yet, the growth of Asian economies has remained robust. The GDP growth rate of the region steadily improved from 4.1 percent in 2001, 5.6 percent in 2002, and 5.7 percent last year. All this happened while the US suffered a bust in the tech sector that triggered a recession from which it is still recovering. This year, Asia's GDP will improve by 6.2 percent, driven equally by consumption, investments, and exports.
Could this be the reason why Asia has been so skillfully fencing with the West in the trade ring? Headlines show the growing audacity of Asian trade policies. Following Zoellick's visit last February, Indian Commerce Minister Arun Jaitley rejected calls to reduce India's tariffs on agriculture, even as the US made a thinly-veiled threat that it would ban federal jobs from being outsourced to India if it did not. "It is strange that on the one hand people are talking about opening of markets, and on the other banning business process outsourcing," Jaitley told Indian media on the day of Zoellick's arrival. "Our agriculture is fragile as it is not subsidized like in the US."
China, meanwhile, practically runs a mill that issues statements every other day on why it will not budge from its position of keeping the renminbi peg (allowing only a narrow trading band of between 8.276 to 8.28 to the dollar) despite consecutive moves by Washington late last year to raise tariffs and quotas on Chinese-made televisions and a range of garments and furniture (see "Not Just Yet," at the end of this article).
None of this saber-rattling has bothered Asian companies in affected industries. Indian outsourcing companies, confident of their role in boosting the profitability — and productivity — of their American clients, haven't stopped expanding. In the last six months alone, Infosys Technologies added 5,000 new IT brains to its workforce. Nor are Chinese companies backing down. Quite the contrary, they are more expansive than ever, as is the case of TV-maker TCL International, which may do justice to its name with the imminent acquisition of two foreign brands, Thomson in Europe and RCA in the US.
And thanks to Asia's better economy and good demographics — half of all Asians are under 25, which means there will be a huge number of income earners for generations — the region is once again a growth area for many companies, even those that have previously shunned it. For example, Esprit Holdings, a US$1-billion-a-year Hong Kong company that retails trendy clothes largely in Europe, is looking at Asian expansion this year. Currently, Asia accounts for only 9 percent of its revenues. Some analysts estimate it will go up to 20 percent in 2004.
In 2002, Esprit Holdings bought the Esprit brand in the US (until then, the group was unconsolidated). With an aim to increase its revenues from that market (currently at 3 percent of total), Esprit will begin to sell its clothes not just from department stores as it already does, but through standalone shops. It will open its first on Fifth Avenue in August, and hopes to bring the number in New York to ten. Even as the clothes Esprit will export to the US will come from its sources in China, CEO Heinz Krogner isn't bothered a bit by the growing protectionism. "It will hurt American companies more than me," he says, "because they rely on imports from Asia."
Looking at the broader picture, trade relations between Asia and the US are likely to remain nervy in the future. To be sure, the US is on a protectionist mode; just look at the focus of debates between President George W Bush and Senator John Kerry, his likely opponent in the November election. On the one hand, Kerry lashes out at Bush for the loss of some 2.3 million American jobs, thanks supposedly to the outsourcing of manufacturing and IT jobs to China and India. The Bush administration, on the other, has gone beyond rhetoric, introducing bills and slapping quotas and tariffs against imports from Asia; openly defying a World Trade Organization ruling that its assistance to industries affected by dumping is illegal; and maintaining massive farm subsidies.
Although it's easy to dismiss these as being politically driven, Stephen Roach, chief economist of Morgan Stanley, says there is no doubt that America is going through a simple equation that has been proven correct in the past: the greater the pressures on job and income security, the greater the risk of protectionist responses by the high-labor-cost nations of the industrial world. As such, unless employment and incomes improve, a more protectionist US, he says, is "a risk that can no longer be taken lightly as politics comes face-to-face with the stresses and strains of globalization."
Against this backdrop, Asia's strokes have been too bold and too frequent not to be recognized as instances of daring confidence. First came the rejection of the US and European agenda in the WTO talks in Cancun last September, a rebellion led by Asian governments. Then came the victory in November of steel exporters against the controversial US tariffs; China had been especially aggressive, threatening to retaliate with levies on imports of US commodities if the steel tariffs weren't lifted. And from computer chip makers in South Korea to shrimp farmers in Vietnam, more Asian companies are becoming litigious, prodding their governments to raise more disputes with the WTO than ever before (see "Punch, Counterpunch," at the end of this article).
Bilateral deals with non-Asian countries are also sprouting, as Asians, says Ali, try to diversify or to find "buffers" for their import sources and export destinations — such as Japan with Mexico, Korea with Chile, and Singapore with Australia. Since Cancun, Asia has also been pushing for broader regional free-trade deals. The Association of Southeast Asian Nations for one is in advanced talks on forming an Asean-China free trade area. India and Pakistan created last January a South Asian FTA, and to complete the bridge that will connect these regions, India and Thailand, two of the world's largest exporters of auto components, will activate their FTA agreement in July.
In short, while trade relations between Asia and the US are likely to remain rancorous, it shouldn't prevent Asian businesses from flourishing. In fact, the greater integration in the region, coupled with growing domestic demand, presents opportunities for CFOs like never before. Nowhere is this more evident than in the role China plays. "The PRC has emerged as a major growth engine for intra-regional trade," says Ali. As China's domestic demand grows, its Asian neighbors are only too willing to supply it with goods. Over the last two years, exports from East, Southeast and South Asia to China have surged between 35 and 65 percent a year. Last year, Korean exports to China exceeded those to the US for the first time.
In China We Trust
No doubt, some of these exports to China are put together or added on to products that go to a final destination, including the US. "What China is doing is importing a lot more from Asia, and exporting more to the US," says KC Kwok, chief Asia economist at Standard Chartered Bank in Hong Kong. "Effectively, China is now the intermediary between the rest of East Asia and the US."
But with investments and consumption in China rising faster than fireworks, the portion that stays in the mainland is on the rise. One indication is the growing imports by domestic enterprises. Previously, the majority of imports from Asia were for foreign-invested enterprises. Now, they're roughly equal, says Subbaraman of Lehman Brothers. "Another way of looking at it is by breaking them down into processing and ordinary imports; processing imports being goods for producing exports, while ordinary imports cater to the domestic economy," he says. "Again, the figure is roughly half-half."
Indeed, one of the reasons why Tata Motors, which makes passenger and commercial vehicles, acquired Daewoo Commercial Vehicle of Korea is to break into the Chinese market. "About 60 percent of Daewoo's total exports goes to China, and it is already working with a company there to make trucks in China for the local market," says CFO Praveen Kadle. "So we would use Daewoo as a leverage to strengthen our position in the Chinese market."
Soon, this may just be supplemental to an all-out China strategy. In the next six months, the US$2.9-billion-a-year Tata Motors is expected to announce a plan to penetrate the market. "We're looking at [whether] to export the vehicles to China, or to have joint ventures," says Kadle. "With the Daewoo acquisition, we need to re-look at our Chinese strategy, but these options are still open."
Tata Motors already exports and assembles trucks in South Asia, Africa, and the Middle East. The Daewoo operation, says Morgan Stanley analyst Satish Jain, will be its platform to expand in Southeast Asia, as well as expand its product range in its existing markets — including India. Until now, Tata Motors' commercial vehicle technology is focused on the lower end of heavy trucks, going up to only 210 horsepower. Daewoo, which Tata bought for US$120 million, already makes trucks between 210 to 450 hp. "If you want to be a global player in this segment, you need to manufacture trucks of up to 450 hp; not just the engine, but the whole configuration," says Kadle.
Currently, Daewoo Commercial Vehicle, which was spun off from the bankrupt Korean chaebol, runs at only 25 percent capacity utilization, producing 5,000 heavy trucks a year, of which 10 percent goes to export markets. Kadle says Tata expects to ramp up the utilization to 60 percent in two to three years, and increase the volume for export. That certainly bodes well for Tata's revenues, which as of financial year ending March 2003, relied heavily (95 percent) on sales in India. Including its output from Daewoo — and potentially China — Tata Motors expects to generate 20 percent of revenues from non-India sales in the next three years.
Kadle has grand visions. The Korean acquisition and the opportunities it represents has just made it easier for an Indian company to have a multinational presence, which until now is almost non-existent. "Clearly, Indian companies, having restructured themselves in the last couple of years and enjoying buoyant domestic economy and liberalization, are being encouraged to improve their global presence," says Kadle.
And Tata Motors is just one of the companies in the Tata Group, India's largest conglomerate, to go overseas. Tata Consultancy Services, the largest outsourcing provider in India, is a fully global operation. Tata Steel, meanwhile, is looking at acquiring assets in South Africa, Eastern Europe, and China.
A Virtuous Cycle
How Tata Motors has got this far runs in parallel with the recovery of Asian economies after the 1997-1998 financial crisis. On the corporate side, companies restructured their businesses, cutting back investment spending and paying back debt to clean up their balance sheets. (Tata Motors itself is now debt-free, says Kadle, having sold non-core assets and paid as much as 40 billion rupees in debt since 1997.) The same holds true for Asian governments, repaying some of their foreign currency debt (even getting out of IMF-sponsored programs), fixing their banking sectors, and improving their investment rules.
"For the region as a whole, balance-of-payments positions are now quite solid, and foreign currency reserves have been built up," says Kwok of Standard Chartered. "And as this process continues, we're now seeing that consumer confidence is gradually coming back." With the return of consumer demand, companies have started investing again — and with that comes rising incomes and greater employment. "Now we are entering a period of a virtuous spiral — consumers driving the economy, and the economy driving consumer sentiment," adds Kwok.
This bout of fiscal sobriety has gradually given Asian governments a weapon of influence in its trade relations with the US. Asian central banks have since the crisis maintained a policy of buying dollars to keep their currencies weaker, which consequently boosts their export competitiveness. Since most of these dollar purchases are in the form of US Treasuries — Asia now holds US$1.3 trillion worth of Treasuries, an all-time high — the region is essentially financing the US current account deficit.
This huge and constant purchase of Treasuries is cited by economists as the main reason that US interest rates have remained so low, putting the US in a double bind. US officials seek to reduce America's dependency on exports by pressuring Asia's governments, while at the same time relying on those central banks to keep the cost of money at historical lows in an election year.
To be sure, Asian governments risk shooting themselves in the foot, economists warn. Eventually, they say, the US would have to address its deficit to assure a "stable depreciation" of the dollar against Asian currencies. Otherwise, it may run the risk of a disorderly depreciation, which could have disastrous effects on global trade. "At some point, you run into a period when people will say, enough is enough," says Hanna of Citigroup. There are other reasons that Asia's funding of the US deficit remains a liability. "Excessive reserves could be accumulated at the cost of foregone imports and investment opportunities," says Ali.
And so the fierce fencing match between the US and its Asian trade partners continues. While the US addresses the issue via a new stage of aggressive trade negotiations, Zoellick's India visit proves this tactic can hardly be constructive.
One of the more important statements to emerge from recent G7 meetings, according to Hanna, addresses just this issue of the global trade imbalance. Explains Hanna: "That statement is essentially an argument that says, 'The easiest, least-cost way for the world to deal with the US current account deficit is for everybody else to grow faster.' " Greater all-around growth, the argument implies, would mean greater demand for US goods, which would help tame its troubling deficit.
Asia's role in this can't be underestimated. "The world economy has been too dependent on US demand for growth and as a result, you've got big global imbalances," says Subbaraman. "Asia, playing a bigger role in global demand, will help ease these." But as the US plays protectionist hardball against Asia, Asian governments quite understandably may be dissuaded from further opening up their markets to American goods — especially now that the region is gradually becoming more integrated and its economies are diversifying their markets.
Amid the parry and thrust of global trade wars, Asian governments — and Asian companies — are vying with more confidence than ever before.
Abe De Ramos is executive editor of CFO Asia in Hong Kong.
Got the tariff slap? Here's what CFOs can do.
When Vincent Yan heard the news in November that the United States was imposing tariffs of up to 78 percent on color TV imports from China, accusing its manufacturers of selling their products below cost, his shock quickly turned into consternation. "It's ridiculous," says the CFO of TCL International, China's largest TV maker. "There are no TV manufacturers in the US anymore; I wonder who they're trying to protect." Asked if he agrees with popular opinion that the anti-dumping measure was politically driven, Yan promptly shakes his head. "This is pure old-fashioned thinking."
His disdain quickly turned into action. In less than a week since the move, the four targeted Chinese companies gathered to build a legal team to counterattack. Their argument: the Commerce Department used Indian cost structures to determine the fair price for Chinese televisions, "so it turns out a lot higher than the selling price," says Yan. The group maintains that the Chinese manufacturers' costs are much lower, given their cheap cost of labor and the savings they get from the scale of their parts purchases.
Legal talks are in progress, and while a preliminary judgment had ruled that there was dumping, Yan is determined to engage in battle, especially since TCL is in dogged pursuit of a larger outsourcing business from American brands. "We see our revenue constantly growing in the US market," he says, "which offers a lot of opportunities for us because we have lower manufacturing costs." Like many manufacturers, TCL is also spreading its factory presence to other countries, both as a strategic move and to take advantage of those countries' free-trade status with the US, among other considerations. "If our joint venture (with Thomson of France) is successful, we will have Thai and Mexican factories," says Yan.
The confidence of the Chinese TV manufacturers is only a slice of the bigger picture of Asian assertiveness over trade issues. Ahn Duk Geun, director for WTO and Trade Strategy Center at the Korean Development Institute in Seoul, says that since 1995, Asia has legally challenged their trade partners more often than ever before. That was the year when the World Trade Organization took over from GATT, and the doors of a stronger dispute settlement body opened. "Developing countries traditionally were not active parties in dispute settlements," says Ahn. Now, they're much more active in asserting their legal rights "to defend the economic interests of major industries." In other words, they're behaving more like the West.
As of end-July, East Asia plus India had 56 cases pending as complainant and 49 as defendant — most of them related to dumping, and against the US and the European Union. Many more cases do not reach litigation before the WTO, says Ahn, as countries choose to settle as a first resort. Of those that have been resolved in the past — such as the anti-dumping duty the US imposed on Korean memory chips in 1998 — Asians have had a victory ratio above 90 percent. "Asian countries don't take these disputes lightly; only when they're sure to win do they bring the case to the WTO," says Ahn.
But first, the biggest obstacle is getting government attention on a case that largely affects private companies. "The WTO [dispute settlement] agreement was prepared to protect the member countries' private parties...but it is still a government playground," says Ahn. "Even if a company is on the brink of bankruptcy, it could be too minor to rattle diplomatic relations." Governments can put in place procedures "to link private economic interests to the WTO" more easily, which could mean companies can force an investigation that may lead to formal complaints. Interestingly, only China has this procedure in Asia, despite its late accession to the WTO.
But a victory doesn't guarantee the losing party will comply with the WTO ruling. That remains to be the case with the Byrd Amendment of the United States. In January 2003, the WTO ruled against the law that allowed the government to distribute to US private companies anti-dumping duties it has collected from foreign exporters. (Prior to 2000, those collections went straight to the US Treasury.) Washington has so far paid more than US$700 million to companies that have filed anti-dumping and countervailing duties petitions, says the lobby group Consuming Industries Trade Action Coalition.
The WTO gave the United States until last December to comply. But Congress didn't repeal the amendment as politicians see it as protection for US companies hit by unfair trade, even as several countries, from the European Union to Thailand, together petitioned the WTO to allow them to impose countervailing tariffs on US imports. "When the losing party does not comply, it tries to provide compensation by liberalizing other areas, but this is rarely adopted," says Ahn. "If the losing party has serious issues with compliance, say politically or economically, it can just say, 'Hit me.' "
In the meantime, nothing beats risk management, such as diversification of manufacturing locations, and good old financial best practice. When Nisshin Steel was hit "by growing protectionism in the United States and other countries" at a time of weak domestic demand, says CEO Toshihiko Ono, the company went on a "thorough, no-holds-barred revision of all costs...implementing policies including emergency measures" from outsourcing and attrition to reduced depreciation through selective investments. CFOs in sensitive industries may need to start practicing similar steps.
Not Just Yet
Revaluation of the renminbi may be imminent, but CFOs can buy time.
CFO David Howell is not exactly looking forward to a stronger renminbi. His company, Radica Games, which makes toys for its own brands as well as for others, last year moved some of its 500 employees in Hong Kong to join the 3,500 it already has in China, in a bid to reduce overhead at headquarters. But how much savings Howell gets will surely be diminished if, or when, the Chinese currency is revalued. Most economists expect the renminbi to appreciate against the dollar in a revaluation.
"The ongoing risk that it will be revalued is more and more likely to come to fruition," says Howell, "in which case, the cost of manufacturing, labor, and services is going to go up in dollar terms." That, in turn, may impact Radica's pricing structure — and for that matter, those of other manufacturers in China. "Most things that people buy come from China, so if the underlying cost is going to go up, we will see an increase in cost of goods all over the world," Howell adds.
To be sure, some China-based manufacturers will be able to maintain their margins (since their imports could get cheaper once the yuan gets stronger) and not need to adjust their prices. But those like Radica with little or no revenues from China may have to resort to price increases — or tightening operations even more. "The majority of the materials we purchase, we buy in US dollars," says Howell. Radica spends 6 to 10 percent of product cost on labor, and only about 20 percent of its raw materials are sourced from China. The rest — somewhere from 50 to 80 percent — come from Taiwan, Thailand, and other places.
The impact could be the same for some of the world's largest electronics manufacturing services (EMS) companies that rely on China for production and overseas markets for revenues. These include Flextronics, which has 30 percent of its total manufacturing floor space in China; Jabil Circuit with 28 percent; and Solectron with 13 percent. "A predominant portion of EMS business is conducted in US dollars, which makes this group more vulnerable to higher translated costs," writes Steven Fox, analyst at Merrill Lynch in New York, in a report. "For example, Solectron generates only 23 percent of sales from non-US dollar currencies, which does not likely allow enough of a 'natural hedge' that balances revenues and costs by currency."
CFOs have anywhere from six to 12 months to manage the risk, depending on whose forecast you buy. Merrill Lynch expects the yuan to appreciate 12 percent — from 8.32 renminbi per dollar to 7.32 renminbi — in the December quarter, and slightly further in 2005. On the other hand, Stephen Jen of Morgan Stanley in London wrote in February that a yuan float is "very unlikely" in the second half of the year and "a meaningful risk in 2005". "Whatever happens, USD/RMB will not move much in the coming year," he says. And there are those who think that the risk may not be meaningful at all. "The Chinese yuan is unlikely to appreciate by any significant extent, if at all," says KC Kwok, chief Asia economist at Standard Chartered Bank in Hong Kong.
Kwok points to China's rising trade deficit as an indicator that the currency may not be undervalued. In the first two months of the year, China recorded a trade gap of US$7.9 billion, as imports grew 42 percent while exports jumped only 29 percent. "China's trade surplus has been on a downtrend for a while, so the whole argument that it needs to revalue the currency is not particularly convincing," says Kwok. Tim Condon, chief Asia economist at ING Financial Markets in Hong Kong, agrees, pointing to a surging fixed-asset investment in China — 55 percent in the first two months of the year alone — that hints of economic overheating. "We believe the [renminbi's] undervaluation will be eliminated by rising inflation," he says.
These trends only add to the more fundamental reason why a revaluation is not exactly called for: China's banking system, which suffers from massive and seemingly incurable non-performing loans. A stronger yuan, says Kwok, will only further delay the industry's recovery. "If revaluation of the currency hits the profitability of exports, or negatively affects the competitiveness of Chinese enterprises in general, then it's going to hit the banking sector," he says. "We still believe that there is room for China to liberalize its foreign exchange regime, but liberalizing it will take a long time."
In short, as Beijing has said time and again, China will liberalize its currency, but not just yet.