A Big Lift from China

Asia's exports to the mainland are soaring--but for how long?

Just a few years back, growth prospects for Philippine Associated Smelting & Refining Corp. looked grim. Its biggest market, Japan, had been ailing for a decade, the rest of Asia was still fragile from the 1997-98 financial crisis, and the U.S. was too far away to be a customer. Then the company, better known as Pasar, landed a contract to supply processed copper sheets to China Minmetals Group, a wholesaler in Beijing--and it hasn't looked back. China now accounts for more than a third of Pasar's revenues, thanks to roaring demand for pure copper used in everything from construction to carmaking to computer manufacturing. Sales to China are expected to jump 70% in 2002, to $80 million, and now the biggest problem is learning to say no to a favored customer. "You don't want to put all your eggs in one basket, but boy, is it tempting," says Carlos G. Dominguez, Pasar's chairman.

Pasar isn't alone in enjoying the boom in Chinese demand. Producers from Seoul to Bangkok are benefiting as insatiable China gobbles up copper, cars, chips, and just about anything else that's for sale. Philippine exports to China nearly doubled in the first half of 2002, Taiwan's exports to the mainland jumped 80%, and China-bound exports from South Korea, Malaysia, and Thailand have all seen double-digit growth this year. Overall, Asian sales to China could increase by between 55% and 85% by 2005, according to Salomon Smith Barney, which could mean an additional $70 billion in goods. "China is providing some of the best opportunities for economies in the region," says Philippine Finance Secretary Jose Isidro N. Camacho.

That's a good thing, because the U.S.--Asia's top export market--has been in the dumps. In the first half of this year, exports from Taiwan, the Philippines, and Japan to the U.S. all dropped by more than 5%. Granted, in some of these countries exports to China still pale in comparison with those to the U.S. The Philippines, for instance, sells 25% of its exported goods to the States, compared with just 3.6% to China. But elsewhere, China is overtaking the U.S. as the locomotive for regional growth. It already has unseated the U.S. as Taiwan's No. 1 export market, and last year it eclipsed Japan as South Korea's second-largest export destination, after the U.S.

So will China completely redraw Asia's trade map, throwing a lifeline to factories from Rayong to Busan? It's more complicated than that. While Japanese, Taiwanese, and South Korean companies can count on growing demand for equipment and high-tech components that China can't produce for itself, labor-intensive manufacturers in Southeast Asia won't likely fare so well over the long haul. Making shoes, clothing, and low-tech electronics such as cheap mobile phones costs 20% to 25% less in China than in Malaysia or Thailand. So the surge in exports could well be a prelude to a painful hollowing out as homegrown companies move to China to cut costs. "Statistics that make you think China is saving the region are an illusion," warns T.J. Bond, Merrill Lynch's chief economist for Asia.

Indeed, even while exports to the mainland surge, suppliers around the region are moving to China to be closer to their customers. Qdos, a circuit-board maker based in Penang, Malaysia, built a plant in the southern city of Guangzhou so it could be near a Motorola Inc. cell-phone factory it supplies. Cal-Comp, a Thai subsidiary of Taiwan's Compal Electronics Inc., is building a plant in Suzhou near a Hewlett-Packard Co. plant that uses its components in inkjet printers. And Hana Microelectronics Co., a Thai producer of printed circuit boards, plans to double its capacity in China because customers such as Fairchild Semiconductor are expanding their own production there. "If China continues to suck in and attract large electronics manufacturers, you will get all the small guys like us clustering around them," says Hana's president, Richard D. Han.

China's growing imports could turn and bite neighboring Asian countries in other ways, too. Some 42% of what China imports is merely bolted together, packaged, and reexported, says Salomon Smith Barney economist Yiping Huang. So falling U.S. and European demand could eventually hurt any company that supplies Chinese manufacturers.

No matter what happens to Asia's factories, though, China will continue to require plenty of raw materials. That's good news for copper smelter Pasar and for resource-rich countries such as Malaysia, with its vast rubber and palm plantations. Palm-oil exports to China from Malaysia soared 59%, to 6 million tons, in the first seven months of 2002. Energy-hungry China has also become a net crude oil importer, which should benefit both Malaysia and Indonesia. Its consumption of industrial chemicals will keep Southeast Asian refineries busy. And China's construction boom will require huge timber imports--again likely to benefit Malaysia.

China's middle class--some 100 million strong and growing--is also doing its part to keep factories across Asia humming. Newly affluent mainlanders are snapping up everything from Philippine pineapples to Japanese sedans. Consider LG Philips LCD. The Seoul joint venture between Royal Philips Electronics and LG Electronics Inc. expects to double its shipments of liquid-crystal-display screens to China next year, to 6 million units. Much of that growth will come from Taiwanese companies that manufacture in China and reexport their products, but more than 10% of the screens will end up in TVs and computers sold to Chinese households.

The trick for Southeast Asia is to find a way to tap into China's growing consumer base. One way is to focus on strengths in such areas as tourism and logistics, which could remain dynamic even if the export boom to China isn't long-lived. Thailand and Malaysia already are seeing a surge in Chinese tourists, while the Philippines is developing its potential as an air-cargo center; both FedEx Corp. and United Parcel Service have set up regional hubs there. "The strategy is how to complement China," says Boonler Somchit, executive director of the Penang Skills Development Center. One option: retrain engineers and technicians for design work rather than pure manufacturing, which Malaysia is doing. Says Joe Adams, vice-president of Malaysian operations for San Diego-based Zip-drive maker Iomega Corp.: "Malaysia has to do what Singapore did 10 years ago--shift its focus to R&D." Sound advice. The question is whether the current export boom to China will give Asia the time it needs for yet another transformation.

By Frederik Balfour in Hong Kong, with Moon Ihlwan in Seoul

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