7/2017 DFTZ – boom or bane for our local SMEs?
by Tan Thiam Hock
Saturday, 25 March 2017
I NEVER got to know my grandfather. All I know about him was from stories told by my dad. During the fight between the Communist Party and Kuomintang (KMT) from 1927-1949, many Chinese migrated to South-East Asia in search of a new life.
And when the Communist Party under Mao Ze Dong defeated and pushed KMT to Taiwan in 1949, the exodus of people mainly from southern China intensified.
My grandfather had migrated to Singapore where he ran a lucrative business housing the immigrants and sending them over to Malaya at that time. He had four wives, two in China and two more in Singapore. My grandmother who was the first wife was finally brought over from China when my dad was 10 years old. This must have been around the 1930s and my grandmother and dad was subsequently sent to Paloh, Johor where my dad’s elder sister had settled down with her family. My grandfather eventually passed away as an opium addict in Singapore.
After my mom passed away in 1992, I decided to accompany my dad back to his birth place in Yongchun, Fujian. Malaysia Airlines had a twice weekly direct flight to Xiamen and we had a taxi ride on a long and winding journey to our hillside village which took us a good four hours to reach. This road has now been replaced by a super highway which I understand had cut travelling time to under two hours.
We visited the once grand mansion that my grandfather had left behind. It had more than 20 rooms with a courtyard in the middle. One of my cousins and his family was occupying the rundown mansion and half the rooms was used to rear ducks, chickens and pigs. Another cousin stayed in the town centre where he had built a three-storey modern house where the ground floor was used as a warehouse to store goods. He had prospered in supplying apparels and knitwear to Hong Kong companies for re-export to US and Europe.
When Deng Xiaopeng became the paramount leader of the Communist Party in 1976 after Mao’s death, he started to reform China by introducing socialism and opening China to the world’s market. After 15 years of fighting with his Maoist compatriots, Deng finally won the ideology war and in the early 1990s introduced the concept of a socialist market economy.
This was the era of an export driven economy. China through their state enterprises initially went into manufactured goods and subsequently private entrepreneurs were encouraged to join the economic industrial revolution. China had become the largest factory in the world supplying all kinds of manufactured goods to retailers like Walmart in the US and many other retailers in Europe. Middleman like Li & Fung from Hong Kong was the main beneficiary, acting as a go between for the customers in the West and the factories in China, getting a 6% commission fee for being a quality assurance broker. Just imagine Li & Fung handling US$100bil worth of exports from China.
With the earnings from the exports, China then started a major internal modernisation reform, building massive infrastructure of roads, bridges, railway lines, airports etc. Property development projects were massive in size and many modern malls were built. Our own Parkson department stores saw the opportunity and expanded swiftly in China culminating in a lucrative listing in Hong Kong.
By 2013, China had built massive production capacity in almost every industry. Not only has China built excess production capacity in manufactured goods, the high growth years has resulted in the formation of colossal companies in construction, property development, railways, banking etc.
In September 2013, the current supreme leader Xi Jinping announced the One Belt, One Road development strategy which basically competes with the Trans Pacific Partnership (TPP) in integrating the region into a cohesive economic area through building infrastructure and broadening trade. To fund this expansionary project, China led the formation of Asian Infrastructure Investment Bank. With a slowing domestic economy, China had to export its excess production capacity in construction, railways, property development etc.
As we have witnessed in the last three-four years, many Chinese companies have invested in Malaysia. From ports in Kuantan and Malacca to massive property development projects in Johor, Malacca etc to securing railway contracts for the East Coast Railway and possibly the high speed railway to Singapore. The contractors have brought their own workers, imported China-made sanitary wares and even nails for their own construction projects. Their property development companies like Country Garden have reclaimed four islands in the southern tip of Johor and building almost 20,000 apartments, hotels, schools and medical facilities and this is only like 30% completion. About 90% of the sales have been to Chinese buyers and it looks like Country Garden have built a mini-city for the potential migration of 400,000 Chinese residents.
On the commerce retail business in China, the surprise success of Alibaba has been well recorded. For financial year ending March 2016, Top line gross merchandise sale for Alibaba’s group was US$485bil. Alibaba and its companies enjoy a revenue of US$15.7bil which is 3.2% commission margin on sales of US$485bil that was done through their digital marketplace. Alibaba is now the largest retailer in the world if compared to Walmart’s sales of US$482bil. Amazon which trades strictly through their e-commerce website had clocked in at US$100bil in sales revenue.
Jack Ma the founder of Alibaba is now the face of China’s push for global free trade through his Electronic World Trade Program. This is in contrast to the new protectionist policies of the Trump administration with the planned introduction of border tax for imports into US.
With its low cost production base, China’s manufactured goods have been successfully exported through the traditional distribution channels over the last 30 years. Local importers have sourced from China, importing through our ports, paying relevant import duties as charged by our customs, now selling with an additional GST 6% added to the cost of goods. The importers then sell to wholesalers and retailers creating a value chain of margins to support the distribution channel.
Digital Free Trade Zone (DFTZ)
Credit must be given to our Prime Minister and Malaysia Digital Economy Corp (MDEC) for its efficiency in getting Alibaba to invest in an e-commerce and logistics hub in DFTZ, the first outside China. Located in our former LCCT, it will be Alibaba’s regional warehousing and fulfillment facility for Malaysia and the region. The e-hub with centralised customs clearance is expected to create top line gross merchandise sales of US$65bil by 2025.
In a statement on Feb 19, our Second International Trade and Industry Minister Datuk Seri Ong Ka Chuan announced that purchase of goods via the Internet or e-commerce worth RM1,200 and below will be exempted from paying tax in the DFTZ. This would mean that Malaysian consumers do not have to pay import duties, if any, or 6% GST. As a free trade zone, manufactured or semi finished goods can be imported into the DFTZ without payment of import duties or GST. This will facilitate re-export to other countries in the region.
Who benefits from DFTZ?
Malaysian consumers who purchased via e-commerce companies situated in DFTZ as any purchases bought below RM1,200 will be tax free. No import duty and no GST.
Malaysia Airports or MAHB as they have finally found a tenant for LCCT, a white elephant since Air Asia moved to KLIA2.
Malaysian Inland Revenue for potential tax revenue assuming the Alibaba company in DFTZ is a locally incorporated company but might miss out for some years if pioneer status is given. But if the Alibaba company is incorporated in other countries, then it will be difficult for our tax authorities to collect income tax as foreign incorporated companies is outside its jurisdiction. The same philosophy applies to including the sales value of USD 65 billion into our national GDP numbers. Only statistics from our local companies are included as GDP output.
Logistic companies, freight forwarders and Malaysian Airlines assuming Cainiao Network, Alibaba’s logistic arm leases cargo planes from MAS. But then again, Cainiao like Amazon might decide to buy its own cargo planes.
Malaysian youths as the DFTZ project is expected to provide 60,000 new jobs.
Local SME’s increasing their exports via the DFTZ e-commerce gateway. That is assuming our manufactured goods are relevant and cost competitive vs the manufactured goods from China. Most unlikely. Currently, production cost in China is at least 20-30% lower. In addition, can our local companies claim back the GST portion when they sell to Alibaba DFTZ? If not, our Malaysian products will have a 6% tax disadvantage vs the tax free imported Chinese products.
Alibaba DFTZ as they have an open freeway to disrupt the local distribution channels of wholesalers and retailers via tax free advantages. For B2C e-commerce, purchases in Malaysia is less than RM500 per transaction which suits Tao Bao (Alibaba B2C) just fine. In addition, Alibaba runs a B2B marketplace where the tax free threshold of RM1,200 per transaction is more applicable. A big order can be divided into smaller transactions to ensure tax free purchases. Alibaba is a sure winner with this unparalleled tax free advantage.
Losers from DFTZ?
Depending on the manufactured products brought in from China, our importers, wholesalers, retailers, manufacturers and e-commerce SME’s will be badly disrupted due to lower cost products and tax free, GST free imports. It definitely will be an uneven playing field for our local SME’s. Our authorities should note that we have 200,000 retail outlets in Malaysia and the retail industry hires 1.2 million workers. Even if the DFTZ model disrupts 30% of our commerce retail business, we will lose 360,000 jobs and close down 60,000 outlets. And that is not counting the disrupted manufacturing industry.
Customs Revenue. Assuming 30% of the US$65bil DFTZ sales is imported into Malaysia. Collection of GST alone will be lower by US$1.2bil or RM5bil a year. Not counting those items that still attract import duties.
Our National GDP will actually shrink as the whole market will trade on lower prices.
DFTZ – entrepreneur beware!
Comparable advantage in production cost have been a zero sum game for competing nations. With so much excess capacity for almost any product in the world right now, the nation that has the lowest cost of production will always win. And the nation that is least competitive will lose market share. In world trade, most nations that are nor competitive will adopt a protectionist stance in defense of its local industries.
The Malaysian authorities should weigh the cost benefits of the DFTZ carefully and ensure that it does not create an irreversible uneven playing field for our local SMEs. Be realistic and pragmatic as you review the capabilities of our SME against the factory of the world. Much as I like and admire Jack Ma for his brilliance in e-commerce Initiatives, I am wary that this could be a Chinese conspiracy to dump their excess manufacturing capacity on our doorsteps.
Local entrepreneurs are advised to go on high alert when more details on DFTZ becomes available. Study the proposals carefully and try to figure out if any advantages given to DFTZ players will affect your livelihood. If it does, start looking for alternative businesses that will not be disrupted.
Chinese winter is coming. Stay warm always.