2010 Market Outlook: Recovery to be Slow, But Steady

RECURRING THEMES:

The shape of the recovery. While speakers’ ideas differed on exactly how long before the nation starts climbing its way back up, most said they do not see a W-shaped recovery. In other words, there should be no second leg to the recession. However, most also agreed that the path back up the hill won’t be an easy one—the recovery will take some time in coming.
A caution on unemployment. Since unemployment lags behind other indicators, most speakers pointed out that the joblessness rates have not yet bottomed out. Further pain will be felt before the situation improves.
Capital is king. Most presenters said the companies in the firms they were talking about that have been the most successful in riding out the recession were ones that were able to shore up cash and ensure they had sufficient working capital. Several speakers also pointed out, however, that the lending squeeze is starting to loosen and a few even said it may be time to start looking at wise ways to spend.
The effect of stimulus. Many of the speakers said the stimulus packages, both here and abroad, may play a role in what sectors will see the fastest recovery. In China, for example, the government is pouring money into infrastructure projects. Several speakers, in addressing U.S. stimulus packages, pointed out that because of timing, projects that are already in the design stages or that can be put together quickly, may be affected the most.

You might think that after two years of depressing economic figures, the attendees and speakers at the VMA Market Outlook Workshop, which was held in Chicago August 12 to 14, would have pessimistic attitudes. But this year’s news was not all bad—in fact if a main theme arose it was: we are on the road to recovery.

Speakers differed on what that road would look like and how much it had been washed away from the storm of the last few years. But most said permanent changes may have occurred in the process, such as increased attention on finding new sources of fuel and the need to focus more on what’s happening in the entire world, instead of just domestic markets.

Looking at the short term, the bright spots in industry are the same as last year: energy and power continue to present great opportunity; the water and wastewater markets cannot help but grow going forward because of sheer need; opportunities continue to grow in countries such as China and India. But perhaps most reassuring of all, the long-term outlook has not changed, and that is: the valve and actuator industry has traveled down treacherous economic roads before; and, as before, most companies will arrive on the other side of this recession stronger and more knowledgeable about how to be successful.

Domestic Markets
On its Way, but not at the Station

The good news is that the economic recovery is finally arriving, Alan Beaulieu, economist, Institute for Trend Research, told market outlook attendees. The bad news is that it won’t really get here until some time next year and it won’t look very pretty when it arrives.

“We have more pain to go through. But in terms of falling off a cliff, we’ve almost hit the rocks,” Beaulieu joked. Furthermore, “We will not be impressed with the recovery of 2010, but 2011 will be the good year.”

When Beaulieu spoke at VMA’s Market Outlook Workshop in 2008, the GDP was still above the zero line. Since that time, he has downgraded his own forecast—he had said it would be the worst recession since the 1980s, but now says it’s the worst since post World War II when the GDP fell to about minus 13.

In addition, “We will not begin to grow in terms of industrial production until about 2014,” Beaulieu told a groaning audience.

Some specific issues Beaulieu addressed this year included:

The credit crisis. Beaulieu joked that recently, he was alarmed when he turned on the TV and got both Fox and CNN headlines screaming about the evils of today’s banks. “When those two agree, it’s the end of the world,” he joked. But businesses should want banks to do well, not poorly, and what will happen is that “banks will go back to being banks”—not lending to companies with inadequate balance sheets, he said. “Until toxic assets are disposed of, they [lenders] won’t make loans again.” He also pointed out that the nation’s credit system is at normal recessionary levels, that lending will soon open up, and that interest rates are historically low for those who want to borrow.
Inflation. Beaulieu cautioned the audience not to believe the pundits that say inflation is not coming. Companies need to factor in price increases in the long term for raw materials, he explained, because if they don’t, it “will have a nasty impact in that it will steal purchasing power,” he said.
Taxes. We are now the 13th largest debt-to-GDP nation in the world, and it’s making the rest of the world nervous, Beaulieu said. Congress will have to raise taxes over the coming years, he said. Unless the federal deficit can be brought under control, the nation is creating “an odious situation for our children,” he said.
The stock market. All the leading indicators say the market is rebounding, so “we don’t have to rely on newspapers [to tell us what’s happening],” Beaulieu said. However, don’t expect a return to 2007 levels for some portfolios until the year 2020, he said.
Good places to be. Beaulieu said the industries receiving stimulus money are the ones to invest in this year. Also good are the medical industry (because of the aging population), the food industry, higher education, legal services and global energy.

Finally, he advised people to look into investing in real estate because “you won’t get a better deal in your lifetime,” he said.

He also advised companies to stock up on cash, “but don’t hoard it” and be aggressive in planning. “We have to get over the hunkered-down mindset—differentiate your company by being one of the few who is spending money,” he said. And he left the audience with this positive thought:

“Americans change and adapt more than any other people. We will not only survive, we will learn to thrive,” he said.

FORECAST: Inflation will be up 3% by end of 2010 and will rise to 6% in the year 2011, peak at 7.5% in 2012, then start falling. The nation’s debt service as a percent of total budget outlays will grow to 13% in 2009, 25.5% in 2012 and 34.1% in 2015.

WALL STREET
The Light Shines Brightly

The speaker invited to talk about Wall Street’s perspectives, Michael A. Schneider, CFA, managing director of Robert W. Baird & Co., Inc., said he was delighted to take place in predictions for this year because “today I have the benefit of being the bright bulb in the group.”

Schneider explained that while the U.S. economy had just entered its 21st month of recession (at the time he was speaking), the economic indicators upon which he relies were beginning to look up. For example, the U.S. Purchasing Managers Index (PMI), which measures whether or not the manufacturing sector is contracting or expanding, fell to the 50 mark (flat growth) in August 2008, then bottomed at 32.9 in December only to rebound sharply to 48.9 by July 2009. Also, the New Orders to Inventory ratio leapt to 1.65 by July from a low of 0.58, indicating a degradation in inventory levels, he said.

“Our belief is that the supply chain is there, and we will soon see orders going up,” he said. Add to that the more than $3.1 trillion in stimulus packages that is about to find its way into the global economy, “and you have a nice bounce off the trough,” he said.

As far as specific markets, he said:

Upstream. Oil and gas demand declined significantly in 2009 due to the global recession. In North America, rig counts were down more than 50% this year, but Schneider said they’ve reached bottom. Meanwhile, he pointed out that crude oil prices had risen in the last few months leading up to the workshop to above the $60/barrel level, which bodes well for drilling and exploration projects going forward.
Downstream. While capital expenditures have fallen dramatically, credit markets are beginning to loosen. Since crude oil seems to have found a “home” at about $60 to $70, confidence is returning to the market to release projects planned since last December, Schneider said.
Chemical processing. Schneider labeled this segment “truly not a good industry,” and one that is further burdened because it’s based on consumer spending, which is not expected to revive soon. Plant capacity is currently at about 68% in the U.S. Schneider also said chemical production is migrating away from North America and Western Europe to emerging markets and the Middle East.
Power. Schneider said he was most excited about this industry because of “extremely pent up” demand. “I’m starting to see the dam break on power projects,” Schneider said, and he expects about $13 trillion invested in electricity infrastructure by 2030. Power maintenance work is also starting to rebound.
Water/Wastewater. This is also an exciting segment because of the potential for growth, Schneider said. Many U.S. water systems have reached the end of their useful lives, and globally, the water/wastewater market is growing by about 6% to 8% a year, driven by population growth, rising living standards and industrialization, as well as aging systems. Desalination “is a great opportunity for everyone in this room,” Schneider told attendees.

FORECAST: Upstream oil and gas demand will increase in 2010 and reach 2008 levels by 2010 or 2011, which means upstream production will be brought online to offset depletions. Demand in mature regions will decline modestly through 2013, but be offset by growth in developing regions. Capital expenditures in downstream oil and gas will decline nearly 10% in 2009, but growth will return in 2010 and accelerate through 2013. Global capital expenditures in chemical processing will decline nearly 8% in 2009, but growth will resume in 2010 and ramp up through 2012. Power maintenance work will be strong in 2009 with projects increasing by 48% and spending by 23%.

WATER/WASTEWATER
Pushing Forth Driven by Needs

Although the water/wastewater industry was hit by the fall in new construction of the last few years, the marketplace is still experiencing some growth, according to Tom Decker, vice president, CH2M Hill. This is because, while some projects have stalled or slowed, the need is so great that the industry will grow, he said.

“We are taking this thing ‘One Day at a Time,’” Decker said, referring to the popular TV sitcom that aired from 1975-1984. “We are in a recession so overall construction is down, unemployment is high. But if you look at the water/wastewater industry, you’ll see it’s holding pretty steady,” he said.

The general consensus is that the water/wastewater industry grew by about 4% in 2008 and should grow about the same in 2009, he said. This is despite lessened tapping fees and other revenue drops, less water being used and rising costs. While some cancellations and deferrals of projects have occurred, the trend has not been rampant and has been very specific to geography.

“One reason the market stays so good is the tremendous backlog of work,” Decker said. The nation is now in the process of working off that backlog, and bidding has become extremely aggressive, he added.

“One of the enablers [for that aggressive bidding] is that the prices of materials is holding steady or dropping slightly so [bidders] can sharpen that pencil,” he said.

Add to that fact the reality of need—failing infrastructure and court-ordered consent judgments are pushing utilities forward, for example—and the picture for the industry, while not as bright as the peak in 2005, looks steady.

While wastewater construction is still outpacing drinking water construction, recent research figures from Engineering News Record showed growth in water engineering is far outpacing growth in engineering for wastewater.

That should translate in coming years into increased need for drinking water equipment and construction, he said.

While the stimulus package may affect the industry somewhat (more than $6 million is slated for state revolving funds, for example), the package was put together to get people working and the economy moving. Because of that, the types of projects that will get some funding are those that can meet the very tight design time frames involved. (A quarter of the money that goes into revolving funds has already been distributed, he pointed out).

Fortunately, some agencies and utilities already had big projects in the works, because otherwise, the stimulus package would affect mostly just smaller projects.

A few of the key areas in this industry to keep on eye on include:

The bond and credit markets. Decker said these markets must stabilize before the industry can see significant project growth. He said to watch private dollars and pointed to a new Citigroup program providing loans to municipalities for financing infrastructure projects.
New opportunities. The world currently has only a 90-year supply of phosphorous, and while methods for removing it from wastewater exist, ways to process the results have not been refined. Desalination remains one of the hottest new segments in the industry. Decker said projects in this area are starting to break loose and that the next 1 to 5 years will see a number of U.S. projects built.
Piping. Decker pointed out that in the U.S., we lose 15% to 17% of drinking water through bad pipes (leaks) and in the world, that number is 26%. Nearly half of the pipes that currently exist will reach their life expectancy by the year 2020, he pointed out.

FORECAST: The market for water/wastewater will not contract in 2009 and will see a 4% growth overall. There also will be no contraction in 2010 because of sufficient demand and funding mechanisms, as well as a steady backlog of projects.

U.S. POWER
An Industry Slowly on the Rebound

The U.S. power industry is currently faced with a myriad of challenges, including dealing with the increased cost of capital and shortened loan terms, environmental and regulatory uncertainty, and a drop in overall electricity consumption. However, longer-term market fundamentals point to an improving market picture for industry players, including the valve and pump industry, according to Keith Small, senior marketing manager & proposals of Black & Veatch’s Energy business.

Small said the power generation industry is slowly beginning its rebound following a “trough.” Many power providers are taking steps to preserve liquidity and maintain their overall financial health, he said, and the result has been an increase of plant upgrade and efficiency improvement projects to enhance existing operating fleets.

Small also shared how clients’ focus on sustainability (economic, environmental and community benefits) has exacerbated the power generator’s conundrum—“it’s not just about adding additional megawatts to the grid, but rather what kind of megawatts and at what cost,” Small said.

Power generation technology deployment is changing, he said. “Coal has a difficult road ahead, at least in the short-term,” Small said. Environmental and political opposition have intensified and new coal plants in the U.S. going forward will likely need to be carbon capture ready.

Meanwhile, “Renewable energy is the growth market today,” Small said, as clients embrace alternative fuel sources to meet renewable portfolio standard (RPS) mandates (requiring a percentage of electricity to come from renewable sources). Wind has peaked, but it will rebound; solar is expanding, and interest in biomass (co-firing and new build) is growing.

The Combustion Turbine (CT) market is expected to “begin its revival sometime in 2010” (assuming low to moderate natural gas prices prevail), he said. New CT projects will, at some point, again include baseload facilities (those that go beyond addressing peak power needs and supporting alternative forms of energy).

The solar industry is gaining ground partly because of solar photovoltaic and partly because of integrated solar-combined cycle applications, which introduces low-grade solar-generated steam into the CT cycle, Small said.

The big “elephant in the room” that everyone’s talking about today, according to Small, is CO2 legislation. The proposed American Energy and Security Act of 2009 could provide a comprehensive climate change and energy policy for the U.S., he said. Greenhouse gas reduction levels and timelines, allowable offsets, a Federal RPS and carbon capture provisions, are key focal points under discussion, he said. The Senate will likely vote by the end of 2009.

Small also said that, despite a few early movers, “a wait-and-see attitude” is leading to delays in air-quality control projects. “People want to know what the rules are going to be. Utility CEOs want some form of certainty in place as they plan for their futures,” Small said. He added that: “Nuclear, despite a number of submitted combined operating license applications, is still a ways out.”

Forecast: Recovery in the U.S. power industry is expected in the 2010/2011 timeframe, and those competing for near-term work must be flexible, cost conscious and prudent in risk management practices. The valve and pump industry should expect a smaller volume of opportunities, more renewable applications and a growing number of combustion turbine projects in the short-term. The industry should also begin positioning itself today for a much improved and robust future following market recovery.

NUCLEAR
A Bright Spot in the Energy Sector

“I’m a little bullish on nuclear,” said Gary Wolski, vice president of New Build, Nuclear Group, Curtiss-Wright Flow Control Company, who has been in the industry long enough to remember the days when the issue was how to grow the market, and even before then, how to win its acceptance. He called what’s happening currently the “perfect storm for nuclear” because of the world’s desire for low carbon footprint, as well as the long lives of plants, reliability statistics and most recently, the capability to bring economic benefits and employment to communities.

Fifteen percent of the world’s electricity now comes from nuclear, and in some places, the figures are much higher such as France (75%), Germany (28%) and Japan (25%). Currently, there are 104 plants in 31 of this nation’s states, and people now recognize the greenness of the industry, as well as its very high safety record, Wolski said.

“It’s currently safer to work at a nuclear plant than in a kindergarten classroom,” he joked—eight times safer than electric and 14 times safer than manufacturing.

Although nuclear is affected by the fact the nation is currently seeing a decrease in electricity needs, “we believe that to be short term,” Wolski said. In the meantime, those companies selling to the industry that are currently making money in this market are in the business of upgrades, Wolski reported. However, the world has looked ahead and the general belief is that there will be waves of plants to come, he said.

The biggest challenge currently is the same as what many other industries are facing: the uncertainty of financing, Wolski said.

“When power consumption is going down and you tell a bank, ‘I’d like to build a new plant for $8 billion,’ it’s hard to get the money,” he explained. However, utility and other companies are joining efforts and locating new investors, he said.

Also, while proposed new carbon legislation is negative for some industries, it “could be a real jolt for nuclear,” he said.

Wolski said the next wave of nuclear plant building likely will be modular reactors—smaller plants that can be built partially in a factory. One of the latest of these is the light water reactor, which is only 15 feet in diameter. The advantage of such systems, besides being cheaper than building an entire large plant, is that they can work like a building block system—a utility could buy what it needs now, then add more as the power grid grows, Wolski pointed out.

FORECAST: Once the short-term effects of less electricity consumption passes, the industry will grow in waves with new types of technologies increasing capacity and making smaller units economically viable.

HYDROCARBON PROCESSING
A State of Uncertainties

Mark Peters, vice president/group publisher for Pennwell, says that while some people laughed at former Secretary of Defense Donald Rumsfield’s term, “known unknowns,” that term actually expresses succinctly the state of the hydrocarbon processing industry.

The industry is faced with a multitude of uncertainties, which makes it hard to predict what will happen, but looking back can ensure history doesn’t repeat itself, Peters said. Some of those “known unknowns” include:

Oil prices falling apart. The world is seeing a repeat of history back to when the price of crude oil reached a low of $9.16/barrel in December of 1998. But while the price dipped to $30/barrel last December after a high last year in the $140/barrel range, prices appear to have reached some stability for now at $60 to $70/barrel, Peters said. However, the situation is complicated by other factors, such as:
Environmental concerns. With greenhouse gas emissions on everyone’s minds, nobody really knows what will be required of fuel going forward. In 2004/2005, prices were affected when the government began requiring lower sulphur fuels, then they were affected by the MTBE additive fallout. The issues today that might affect fuel include the world’s upcoming meeting on climate change and by a new administration that supports strengthening environmental regulations.
Global influence. Back in 1998, the biggest concern for the industry was the economic meltdown of Asia. Today, that concern has expanded to include the world’s economy. But the industry is also influenced by increased demand from places such as China and India, as well as stability uncertainties, such as what happened in the Middle East in the 1990s.

Going forward, factors that will shape energy expansion in the world also include:

New sources. Peters said changes in refining have allowed increased use of unconventional heavy oil. LNG will grow as a source both here and in Asia, he said, and new supplies in deep water, in the former Soviet Union and other areas will be tapped. A geologist in 1874 predicted the world only had enough oil to burn kerosene lamps for four more years, and 17 scares have occurred since then, Peters pointed out. But better methods of processing, additives that make fuel burn better and new sources mean “a peak has not been reached in supply,” Peters said.
Changes in fuel use. Peters pointed out that everywhere else in the world, diesel is the fuel of choice. He predicted gas demand going forward will stay flat while diesel demand will grow.

FORECAST: Capital expenditures will fall 15% in 2010 compared to 2009 and may be worse in 2011. Maintenance, repair and operating equipment spending will remain flat. For the long term, many new unconventional liquids will be brought online. By 2010, the world oil consumption will reach 91.5 million barrels per day and by 2025, that number will be 120.8 million barrels/day.

PETROCHEMICALS
Troubles Ahead, but Signs of Movement

Bill Hyde, director of C4 Olefins and Elastomers, CMAI, told market outlook attendees that the global petrochemical supply balance is tightening up due to capacity rationalization (not demand growth, which he said is flat) at the same time the world is on the cusp of exponential growth in new capacity. As a result, the industry is moving towards a possible wreck, or at least some major difficulties, he said.

For highly leveraged companies connected to the industry, this is a time of significant risk, he said.

Hyde explained that the value chain for the industry is pinned between two dominant forces—the energy infrastructure on one end and consumers of finished goods on the other. In between are the related industries such as goods producers, retailers, compounders and base petrochemical producers, which tend to fight over the defined amount of value that exists.

Supply and demand dynamics in the value chain are volatile, influenced by numerous events related to supply interruptions in energy and feedstock values, inventory stocking or destocking, evolving variations in trade patterns and consumer confidence. When the consumer stops moving, however, the gears of the industry cease, he explained. So since the world’s consumers are currently overly indebted and cautious about spending, things have slowed almost to a halt.

However, “We are starting to see signs of consumers rolling forward,” so there is hope that the trends may start back up the other side, Hyde said.

“In our view, the economy is right about at the tipping point. If we haven’t started into slight growth, we will in a short amount of time,” Hyde says. Lower energy prices actually tend to give consumers forward momentum through increased spending ability, and those consumers are also seeing lower food prices, extensions on unemployment benefits and other falling prices. Meanwhile, construction costs have declined, interest rates are historically low, and trillions of dollars are flowing into restarting economies through various stimulus packages.

Still, what has occurred has the potential for longer-term effects because of the places in the world where capacity is being added, Hyde said. Some countries don’t require high rates of return to justify investment. Other locations, like the Middle East, have a significant raw material cost advantage.

“This makes them [the places with those two advantages] competitive anywhere in the world because these are places we can’t export to competitively. So they push themselves into the market, and others deal with the fall out,” he said.

FORECAST: Slow conditions will continue well into 2010 and maybe later. Pricing power will not return until sometime in 2012 or 2013. There will be limited to no new capacity in North America and Western Europe.

OIL & GAS
A Roller Coaster in Pricing

Last year, when John Spears, president of Spears & Associates, addressed the crowd, oil prices were climbing toward $140/barrel. By this year’s workshop, they had fallen to $70, while gas prices fell from about $9 to about $3.

“It’s been quite a year of adjustment in the oil and gas industries,” Spears told this year’s audience.

Demand for oil and gas has decreased, creating an excess inventory that Spears says probably won’t right itself until late in 2010. Industrial use of gas, for example, has fallen 8% for the year, and Spears predicted it would fall another few points by the end of 2009. Also, because of the about 32,000 gas wells (and over 8,000 oil wells) drilled in 2008, the ability to produce has gone up.

“So with consumption down, and ability to produce up, we’re stuck with a lot of inventory,” Spears said.

Natural gas, which drives 75% of drilling activity, is now running at a rate of about 5 excess billion cubic feet (Bcf) feet per day, he said. Total gas inventories were about 550 Bcf higher at the time of this year’s outlook workshop than in 2008, and about 450 Bcf over the 5-year average, he said.

What this all means is that operators are scaling activities to reflect the situation. Less drilling occurred in 2009 (Spears predicted at the workshop that about 12,500 gas wells will be drilled in 2009 and 3,400 deferred until 2010 or beyond), and many rigs are not being used (he said about 30% of new gas wells drilled are currently left uncompleted).

Spears also predicted large scale shuts-ins would take place beginning in September 2009 and last until the current cold season, and “anytime you’ve been shut down, gas prices fall out of bed.”

Also, gas production is likely to decline further going forward; as a result of all these events, prices will remain low probably until sometime in 2011 and maybe longer if LNG imports flood the U.S. market, Spears said.

The type of wells drilled going forward is also likely to change.

“There is tremendous incentive to go off and drill the most productive wells,” Spears pointed out, and since horizontal wells are about four times more productive than vertical wells, they are likely to be favored.

FORECAST: Gas prices will not rise above $6 MBTU until at least late 2010. U.S. gas output is forecast to fall 1% in 2009 and 3% in 2010. Gas well drilling will drop about 60% in 2009 vs. 2008 levels. The gap between supply and demand will close sometime in late 2010 or in 2011.

GLOBAL ECONOMY
Growth Indicators Heading to Positive

While many of the market outlook speakers this year had less than stellar news to report, Farid Abolfathi, managing director, Country Analysis and Forecasting Group, IHS Global Insight, began his talk with good news.

The world’s recession “essentially ended in the second quarter, so the second half should see growth,” he said.

He showed attendees 20 of the indicators he analyzes and of those 20, 11 show the world was moving in the right direction while 9 pointed downward.

One of those indicators, which he called the yield curve, is especially favorable.

“This indicates the financial situation has turned favorable for banks. They can now borrow cheap and lend at higher interest rates so this sector should improve this entire year,” he said.

Another of the indices—the global equity prices index—shows that the stock market, while way below where it was several years ago, started upward in about March of this year.

“Going forward, we will see stock prices rise further in the short term,” he commented.

An index that measures manufacturing confidence shows that while the world is at record lows, some stabilization has occurred recently, and one that measures new orders also shows stabilization and should begin to rise rapidly soon, Abolfathi said. Meanwhile, industrial production has bottomed out and is not yet showing signs of recovery, but Abolfathi said this index lags behind and even if it falters further, should begin to rise rapidly sometime in the next six months.

However, all of the indices indicate that, while the world is not in a depression, this recession “is the worst since 1947,” Abolfathi said.

Abolfathi also said his optimistic short-term outlook is based on recovery drivers that are already in action such as: massive injections of money from government programs, inventory corrections that are winding down and should eventually create demand, and pent-up demand from financial investors who have built up cash for the past two years. He also said that market participants and economists have been wrong about the strength of the recovery—that numbers have exceeded expectations consistently. However, he cautioned that it was the advanced economies of the world that created the crisis (not emerging markets); and unless consumers begin to spend in those advanced economies, the world may see more trouble.

FORECAST: Most countries will see a “V-shaped” economic recovery, but it will take four to five years to get back to peak levels.

CHINA
Weakened, but the Power Remains

The year 2008 was “a year of great change” in China with unbelievable growth and double-digit GDP growth in the first part of the year. By the second half, however, much of that growth “died off completely,” and as a result, many plants shut their doors, according to Bob Tellier, divisional vice president, True Value Company.

Still, China has great potential as well as a government committed to manufacturing and a potential workforce and consumer base not yet fully tapped.

The Chinese economy followed the U.S. in tumbling, and the Chinese yuan’s value followed closely the U.S. dollar. However, the yuan’s value stabilized due to manipulation by the country’s central bank, which saved that country from the fate of some other Asian areas where the economy is not as tightly controlled, Tellier said. Most recently, the credit spigot in China has been reopened, and commodity prices have stabilized.

In the manufacturing sector, one situation that has complicated the picture is a labor law passed in 2007 that went into effect Jan. 1, 2008. The law requires a written contract for all employees, who are usually guaranteed two years of employment. That law put many companies out of business, he said. Another development that has affected manufacturing is VAT rebates, which are essentially sales taxes on raw goods factories buy that are rebated if those goods are used to make products for export. Up until recently, the government has not wielded this tool. But in the last few years, it has started giving more back to encourage industry, Tellier explained.

The country is very aggressive in its buying of raw materials and supplies, especially those related to steel, Tellier said. At the same time, the domestic market for goods is still small, so exporting will remain crucial. And the government is committed to building up its infrastructure, having pledged $560 billion to that sector.

As a result of all these developments, it’s clear China “will be a big part of the supply chain or a very large competitor,” Tellier said.

Those who want to do business there need to be aware that “a lot happens below the radar,” Tellier said. Sourcing in China requires committing to a presence there and learning the business environment, which Tellier said is very-much based on establishing relationships. “As a westerner, you cannot impose your norms on them, you have to react and adapt to their realities,” he said.

FORECAST: The government’s commitment to the manufacturing sector, the stimulus package aimed at improving the infrastructure, manipulation of currency and rebates, and the country’s aggressive acquisition of raw materials and suppliers mean the country will remain a manufacturing powerhouse.

——

Genilee Parente is managing editor and Judy Tibbs is editor-in-chief of Valve Magazine.