4 Reasons Sourcing from China will be More Expensive in 2008

China has been trying to stem an ever growing trade surplus, manage domestic inflation, move development from the coastal areas to the inland areas and decrease its dependence on heavily polluting industries.

Because of these objectives, manufacturing in China is becoming more expensive as China adds in hidden (and sometimes not so hidden) costs into the sourcing equation.

Here are the top 4 reasons you can expect costs to continue to rise in 2008:

1. Reduced VAT Refund

When Chinese manufacturers purchase goods domestically for use in manufacturing, they pay a VAT (value added tax). For people in the United States or others who are not familiar with the term VAT, it’s essentially a sales tax. Historically, the Chinese government allowed for generous VAT refunds if the final manufactured product is for export. However, as of July 1, 2007, China has changed its refund formula. Many products have had their VAT refunds completely eliminated and many others have been reduced. Since Chinese factories typically take these VAT rebates into account when calculating profit margins, the reduction or elimination of them is likely to… raise prices (or drastically shrink profit margins).

There is an excellent set of PDF files created by mfg.com which detail exactly the products that have had VAT changes as well as those that are duty free altogether. They have all been translated into English. Since these are PDF files, they may load slowly depending on your internet connection.

Please find them here:

• Overview of Affected Products,
• Products with LOWERED Rebates
• Products with CANCELLED Rebates
• Products that are DUTY FREE

2. RMB Currency Appreciation vs USD

Until mid-2005, China maintained a peg on the RMB to the USD at 8.27. This provided an element of stability and took the currency risk out of the sourcing equation. However, over the past year and a half, China has begun appreciating the RMB against the dollar. As of this blog article, the current conversion is 7.26. Furthermore, many experts are estimating the rate to dip well into the 6’s over the next year.

Here is a chart from Yahoo Finance showing the USD vs. RMB trend:

Chart Yahoo Finance USD vs RMB

While nobody knows for sure what the ‘final’ trading range will be, there are a few interesting commentaries out there. This article from Bloomberg quotes Jim Rogers, chairman of Beeland Interests Inc. and a former partner of George Soros, saying the RMB may quadruple in the next decade.

“The currency has advanced 10.5 percent since the government scrapped a peg to the dollar in July 2005, gains that U.S. officials say are insufficient to reduce a trade surplus that swelled to $23.9 billion in September. Jim Rogers, chairman of Beeland Interests Inc. and a former partner of George Soros, said yesterday the yuan may quadruple in the next decade.

The yuan is “the best currency to buy right now,” Rogers told investors in Amsterdam, adding that he is shifting all his assets out of the dollar and into yuan. China is “going to be the most important country in the 21st century.”

The currency climbed 0.16 percent to 7.4926 per dollar as of the 5:30 p.m. close in Shanghai, according to data compiled by Bloomberg. Non-deliverable forward contracts show traders are betting the yuan will reach 7.0070 in 12 months, a gain of 6.9 percent from the spot rate, and 6.95 by the end of 2008.”

On a side note, if you’re importing to Europe, the Euro has actually been appreciating against the RMB, so for now you guys are ok! Check out a recent Yahoo Finance chart showing the Euro vs RMB trend.

Yahoo Finance Chart Euro vs RMB

3. Increased Costs Associated with Importing Raw Materials

China said on July 23rd, 2007 that it would begin requiring that exporters put down a deposit for half the amount they spend importing 1,853 raw materials. A quote from this People’s Daily article summarizes the policy.

“Enterprises which are engaged in the production of these products are required to have guarantee deposits in the Bank of China, the designated bank of China Customs, for a contracted period of time, according to the statement jointly released by the Ministry of Commerce (MOC) and China Customs.

If these enterprises fail to sell their products within the time scale dictated by the contracts, the customs will ask the bank to keep their deposits and interest for taxation.

“We are striving to improve the development of China’s processing trade in a bid to promote trade balance and reduce trade surplus,” said Wei Jianguo, vice minister of commerce.”

These new regulations will require a larger cash outlay for large contracts by Chinese factories. Therefore, it’s more likely that they will need to borrow money to meet this requirement. Borrowing money costs money and that cost is likely to be passed along.

4. Labor Costs Continue to Rise

Labor, once assumed to be endless in China, has been ‘drying up’ for a number of years now. China’s factories depend on a constant supply of new migrant laborers coming from the countryside. Typically every Chinese New Year, as many people return to their home town as can afford to do so. And each year, some old and many new laborers come to the cities in search of work after the holidays.

However, as villages have become more prosperous, with more family members making and sending money back home, this endless supply of new labor, has began to shrink. Because of this and other factors, labor costs continue to rise. China’s National Bureau of Statistics reported that in the first half of 2007 wages were up 18.5% compared to the year earlier period alone!

In addition, China as of January 1, 2008 enacted new labor laws that allow for much more worker protection, but of course at a cost. Global Labor Strategies has an article with many links to other blogs and newspaper articles discussing the reaction worldwide to the new law.

SourceJuice is here to provide you with on the ground information from China, relevant to your sourcing and product development needs. Please visit our website and join our RSS feed or mailing list to keep updated with the latest trends in sourcing.

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2 Responses to “4 Reasons Sourcing from China will be More Expensive in 2008”
Silk Road International Blog » The Price of Rice in China Says:
January 23rd, 2008 at 4:03 am
[…] This week, the folks from Sourcejuice via China Success Stories (two good sites for people trying to source from China) listed out 4 price-increase issues in more detail with updates for 2008. Check it out here. […]

China Sourcing Service Says:
January 25th, 2008 at 11:26 pm
Your article is spot on – we are already warning new prospects that their costs are most likely going to rise for the very reasons you have cited in your article. Thanks for publishing it as we will use it to refer our prospects and customers so they are able to see another source agrees with our predictions.

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