US embassy cable - 05ROME1150

UNCLAS  ROME 001150 
 
SIPDIS 
 
 
DEPT FOR EUR/WE, EUR/ERA, EB/TPP 
DEPT FOR EAP/CM (GOLDBERG) 
STATE PASS USTR 
GENEVA FOR USTR 
USDOC FOR 4212/ITA/MAC/OEURA/CPD/DDEFALCO 
 
E.O. 12958:  N/A 
TAGS: ETRD, ECON, ELAB, IT, CH, EXPORT CONTROLS 
SUBJECT: ITALY'S TRADE AND INVESTMENT RELATIONS WITH CHINA: 
THREAT OR OPPORTUNITY? 
 
Refs: A) Florence 13;  B) 2004 Beijing 19943 
 
Summary 
------- 
 
1. There are divided views in Italy on trade and investment 
in China and whether China is a threat or an opportunity. 
Although Italian exports to China have increased recently, 
they pale compared to the sharp increase of Chinese imports 
into Italy.  Italy's direct investment in China remains 
quite small.  Those GOI officials and Italian manufacturers 
that view China as a threat point primarily to China's 
unmatchably low labor costs, the strength of the Euro, 
Italy's weak economy, and the lack of strong Italian 
investment in China as root causes of their anxiety.  This 
fear of China has caused some Italian manufacturers to push 
for protectionist actions against Chinese products, 
especially after the recent expiration of the WTO Agreement 
on Textiles and Clothing.  Alongside such concerns, other 
Italian companies believe China's growing economy represents 
an important opportunity to expand trade and investment. 
Chinese competition may not pose a significant threat to 
most Italian companies, but in several/regions (for example, 
textiles in Tuscany), the effects of Chinese competition are 
significant and it has fostered a sense of crisis within the 
business community.  More broadly, certain Italian SMEs will 
suffer from Chinese competition if they do not adapt to an 
increasingly competitive international market.  Because of 
Italy's electoral timetable over the next year, politicians 
will continue to generate a lot of noise and smoke about the 
"China threat," but this will translate into little action, 
given the constraints of Italy's EU obligations.  End 
summary. 
 
Italy-China Trade -- The GOI's Dueling Views 
-------------------------------------------- 
 
2. In recent months, the Italian Government has ratcheted up 
its attention to Italy's trade relationship with China as 
never before, most publicly with the visit of President 
Ciampi to China in December 2004. Accompanied by Foreign 
Minister Fini, Finance Minister Siniscalco, and Productive 
Activities Minister Marzano, Ciampi emphasized commercial 
opportunities for Italian firms during the visit, as 
strongly evidenced by some 200 Italian business 
representatives that accompanied him. During his visit, 
Ciampi signed eight commercial accords with Chinese 
President Hu Jintao, including agreements on restriction- 
free exports of Italian processed meats to China; the 
proclamation of 2006 as the "Year of Italy in China;" and 
joint cooperation in preparation for the 2006 Winter Olympic 
Games in Turin (Ref B).  China reportedly had never before 
recognized a foreign Olympic committee as a viable partner 
for cooperation in preparation for the Olympic games. 
Ciampi's visit came towards the end of the yearlong "Marco 
Polo Project," a calendar of events organized by Italian 
trade officials to promote greater Italian investment in 
China in 2004. 
 
3. China was also the focus of the Second National Foreign 
Trade Conference, on February 26, 2005, which featured Prime 
Minister Berlusconi, along with Fini, Marzano, Foreign Trade 
Vice Minister Urso, and other leading government and 
business figures. In contrast to Ciampi's emphasis on China 
as an opportunity for Italian business seeking trade and 
investment abroad (and thus a means to help bolster Italy's 
lackluster economy), the February trade conference focused 
more on the potential threat China poses to Italy's export- 
dependent economy, especially in the textile sector. Several 
speakers noted that China's reputation as a golden 
opportunity for foreign investors was overstated; and the 
prevailing view among the many Italian manufacturers present 
was that, in the near to medium term, China represented more 
of a threat to them than an opportunity. Just one week after 
the conference, Marzano and Urso announced that the GOI 
would ask the European Commission to impose safeguard 
measures, including antidumping duties, to counter the 
"predatory invasion" of Chinese textiles into Italy in 
recent months. 
 
4. Italian industry views of China vary as much as those 
 
 
within the GOI. Some Italian SMEs express concern that 
Chinese goods flooding both domestic and foreign markets 
will displace Italian goods.  At the same time, many Italian 
firms, including some that worry about Chinese exports, wish 
to reap the benefits of the ever-growing Chinese economy. 
Italy's export finance company (SACE, akin to the QS. 
Export-Import Bank) lies firmly in the pro-opportunity-in- 
China camp. 
 
Italy-China Trade and Investment Figures 
---------------------------------------- 
 
5. Italy's exports to China in 2004 were valued at Euro 4.4 
billion, placing Italy third within the EU, after Germany 
and France.  More than half of Italian exports to China are 
machinery-based, and the remainder includes high technology 
medical equipment, iron, and steel.  In terms of imports, 
Italy is China's fourth largest market in the EU (Euro 11.8 
billion in 2004).  Italy's principal imports from China 
include textiles, household equipment, and machinery parts. 
Italy's 2004 trade deficit with China equaled 7.4 billion 
Euro.  Although Italian exports have increased in all but 
one of the last six years, Chinese imports have risen by 
much higher percentages during this same period. 
 
Italy's Foreign Trade with China (billions of Euro) 
 
      Imports     Exports    Balance 
1999      5.0         1.8       -3.2 
2000      7.0         2.4       -4.6 
2001      7.5         3.3       -4.2 
2002      8.3         4.0       -4.3 
2003      9.6         3.9       -5.7 
2004     11.8         4.4       -7.4 
 
 
6. Recent statistics on Italian exports to China could be 
viewed positively, especially given the rise of the euro 
against the Chinese yuan. However, many companies, 
especially the small-to-medium-sized manufacturers that 
constitute roughly 90 percent of all Italian enterprises, 
are blaming China for their loss of market share in both 
Italy and abroad in recent years. In 2003, Italy's export- 
dependent economy weathered a 3.9 percent decline in all 
exports, though exports rebounded in 2004 with a 5.7 percent 
increase.  Despite this positive 2004 data, the sectors of 
textiles and clothing, furniture, leather and footwear 
registered significant decreases in exports during the year. 
 
7. In terms of foreign direct investment, Italy is currently 
ranked fifth among European countries and 19th among all 
foreign investors.  According to the latest statistics, 
Italy's cumulative investment in China was about USD 230 
million as of September 2003, amounting to only 0.3% of 
worldwide investment in China. Most  investment during 2003 
was in the automobile, textile, mechanical equipment, and 
pharmaceutical sectors. 
 
Euro's Strength Versus the Dollar and the Yuan 
--------------------------------------------- - 
 
8. The strong euro gives Chinese companies a key advantage 
over Italian firms when exporting to foreign markets, 
especially the United States. Italian government 
representatives believe Italy's unfavorable exchange rate 
vis--vis the yuan (which is pegged to the dollar) has led 
to growing Chinese competition in the foreign export sector 
(Ref A).  Some experts calculate that certain Italian export 
sectors suffered as much as 20 percent from 2003-2004, due 
solely to the euro's strength against the yuan. 
 
 
Promoting Labels of Origin/"Made in Italy" Brand 
--------------------------------------------- --- 
 
9. In response to anxiety over Chinese exports flooding 
global markets, more Italian SMEs are working together to 
strengthen the competitiveness of Italian goods.  One idea 
advocated by some Italian SMEs, and backed by Italian trade 
officials, would require all nations to label the origin on 
the textiles they produce.  This information would 
 
 
theoretically encourage consumers to buy Italian products 
due to their high quality reputation, compared to those of 
other nations, including China.  In addition, there is a 
campaign within Italy to promote the "Made in Italy" brand 
by placing it on more Italian products, again relying on the 
reputation of high-quality Italian goods to increase Italian 
exports. This emphasis on labeling is also a reflection of 
widespread Italian views that Chinese exports are pirated, 
and thus unfair competition. 
 
WTO Agreement's Demise Raises Strong Concerns 
--------------------------------------------- 
 
10. No single recent event has preoccupied Italian exporters 
and trade officials more than the termination of the 
multilateral WTO Agreement on Textiles and Clothing (which 
replaced the earlier Multifiber Arrangement ending in 1994). 
This termination is widely believed to pose a serious threat 
to Italian manufacturers. Rossano Soldini, president of the 
Italian footwear manufacturers' association, recently 
claimed that footwear imports from China rose 45 percent in 
the past three years and reached 150 million pairs in 2004. 
He predicts a further increase to 300 million pairs this 
year. 
 
11. Textile manufacturers are equally worried, particularly 
in Tuscany, where the province of Prato is Italy's largest 
producer of fabrics.  In the last ten years, the district 
has lost 30 percent of its manufacturing companies, while 
imports of fabrics and apparel from China increased six 
times, increasing in value from euro 23 million in 1994 to 
122 million in 2003.  According to the Prato manufacturers' 
association and Chamber of Commerce, large illegal imports 
of counterfeited textile products from China also add to the 
industry's problems.  As a consequence, Prato's per capita 
income, in real terms, declined 0.4 percent each year 
between 1996 and 2003 (though there was some increase in the 
city's population at the same time, mostly due to 
immigration).  A recent study of the University of Florence 
predicts a further 25 percent decline in the number of local 
textile manufacturers in the next two/three years. 
 
12. The Italian textile and footwear industries believe that 
the only way to compete with Chinese manufacturers is to 
continue to rely on the reputation and quality of Italian 
brand-name products.  SACE's chief economist, Alessandra 
Lanza, believes Italian SMEs can maintain superior quality 
through consolidation, allowing several SMEs to use their 
combined resources to make joint investments in product 
research.  Similarly, Francesco Pensabene, economic expert 
at the Asia-Oceania desk of the "Istituto Nazionale per il 
Commercio Estero" (ICE: Italy's foreign trade promotion 
agency, roughly equivalent to the U.S. Foreign Commercial 
Service), told us that simply maintaining current quality 
standards is not sufficient for Italy's exports to maintain 
or increase their current levels.  Rather, Italian companies 
need to invest in more research and development to create 
higher quality products. 
 
.But Not All Italian Companies Fear China. 
------------------------------------------ 
 
13. Despite strong concerns about Chinese competition and 
the lack of Italian investment in China, many Italian 
companies are trying to take advantage of China's growing 
economy by promoting their products in China.  As discussed 
above, some hope promoting the "Made in Italy" brand could 
increase Italian market share in China beyond textiles and 
machinery into other sectors, such as high technology 
equipment.  ICE's Pensabene notes that Italian firms could 
benefit very much by taking advantage of the growing 
consumer awareness of the Chinese middle class.  This group, 
he maintains, views Italy as a nation of cultural and 
manufacturing excellence, and desires many Italian products, 
including furniture, kitchenware, fashion, food, and 
products featuring Italian design. Pensabene also believes 
the Italian tourist sector is poised to attract much larger 
numbers of Chinese tourists in the near future. According to 
some polls, 70 percent of Chinese who want to come to Europe 
would choose Italy as their destination.  Chinese tourism 
should bring a significant increase in direct revenue to the 
 
 
Italian economy, while further stimulating the Chinese 
desire for Italian exports. 
 
Italian Investment in China - A Weak Relationship 
--------------------------------------------- ---- 
 
14. Pensabene believes Italians have so far been unwilling 
to take the risk of large investments and that Italy's 
relative lack of investment in China could have lasting 
repercussions on Italy's economy.  Pensabene identified two 
obstacles to Italian investment in China:(a) lack of 
financial resources, and (b) an "export-only" mentality that 
keeps Italian firms from creating sales and service networks 
abroad. 
 
Lack of Financial Resources 
--------------------------- 
 
15. Pensabene told us that Italian SMEs find it difficult to 
acquire capital to invest in China for two reasons. First, 
Italian SMEs, many of which are family-owned, tend to be 
reluctant to seek outside financing for fear of giving up 
control of their companies. Second, many Italian banks are 
overly risk-averse, thus unwilling to extend credit for 
investment in China where success appears uncertain. 
(According to SACE's Lanza, Italian SMEs prefer to invest in 
small markets close to home, such as Eastern Europe, an area 
also considered less risky than China.  These SMEs do not 
have to consolidate to invest in Eastern Europe and do not 
need as much initial capital to start a business there.) 
 
16. Despite this difficulty, SIMEST (the Italian government 
agency that lends to Italian companies wishing to invest 
abroad, similar to the U.S. OPIC) helps Italian companies in 
every step of setting up business in China, from making 
equity investments to developing industrial relations with 
foreign partners. SIMEST Director of Area Participation and 
Finance, Gerardo Stigliani, told us that the agency 
currently ranks China as its number one priority in terms of 
investment aid to companies.  SIMEST gives out more than 40 
million euro yearly for projects in China, mostly for 
engineering, construction, and clothing projects. 
 
"Export-only" Mentality 
----------------------- 
 
17. Pensabene argues that Italian companies should make long- 
term investments abroad and not rely merely on quality and 
brand recognition to increase market share.  He noted 
Italian firms do not always appreciate the need for 
investment to support exports.  For example, a Chinese Fiat 
owner, Pensabene maintained, often must wait weeks for parts 
to arrive from Turin because the Italian car maker has not 
built a sufficient parts and service network in China. Fiat 
and other Italian firms are also hampered in international 
markets, including China, by a reluctance to transform 
research and development into new technologies, he said. 
Note: we understand Fiat's truck division is doing well in 
China, but its auto sector is in trouble (not unlike the 
company's situation in Europe). End Note. 
 
Two Success Stories 
------------------- 
 
18. There are close to 500 Italian companies in China, 
excluding those in Hong Kong.  Many are Italian/Chinese 
joint ventures, mostly in the areas of telecommunications 
(nineteen percent), automotive products (sixteen percent), 
and chemicals and petrochemicals (nine percent).  Two 
examples of Italian companies that have been quite 
successful in opening manufacturing facilities in China are 
Geox (footwear manufacturer) and De Longhi (manufacturer of 
small appliances and heating systems).  Both have opened 
factories in China, with De Longhi also closing down several 
factories in Italy to relocate production in China - but at 
the cost of more than 650 Italian jobs and several labor 
protests in 2004. 
 
Comment 
------- 
 
 
19. China's rise as a global economic power, based on low- 
cost manufacturing capabilities, has provoked considerable 
hand-wringing in Italy.  Much of this concern, however, can 
be attributed to a widespread anxiety here that Italy is in 
economic decline.  The World Economic Forum's 2004 
Competitiveness Report, for example, ranks Italy a dismal 
47th globally, the lowest by far of the G7 economies.  Under 
the Berlusconi government, in office since mid-2001, Italy's 
annual GDP growth rate has been only 0.9 percent. 
Contrasted with China's booming economy, Italy's economic 
malaise appears all the more pronounced. 
 
20. Looked at dispassionately, however, there is little 
evidence to suggest that China poses a direct threat to the 
vast majority of Italian businesses, especially those whose 
success has been built upon the high-quality and high-brand 
recognition products for which Italy is famous. However, 
those businesses that compete more upon price than quality - 
such as the lower ends of the textile, apparel and shoe 
industries -- will likely continue to suffer.  Moreover, 
Italian family-owned SMEs in such sectors may have a 
particularly difficult time adapting to new market 
realities. 
 
21. The GOI's ability to react against the "China threat," 
even in those limited areas where it actually exists, is of 
course severely constrained by Italy's obligations within 
the European Union.  This, however, will not prevent Italian 
politicians from continuing to make a great deal of noise on 
this issue, given the country's electoral calendar: 
regional election take place in early April; national 
elections loom in the first half of 2006.  The Northern 
League party, a junior partner in the governing coalition, 
for example has seized upon the Chinese threat to Italy's 
textile sector as a prime vote-attracting issue (the League 
is strongest in the commercial heartland of northern Italy). 
In the end, however, we anticipate such polemics will amount 
to just that:  much smoke and noise, but little action.  End 
comment. 
 
22. This message was drafted by Embassy Rome Intern Jessica 
Alvarez. 
 
 
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 2005ROME01150 - Classification: UNCLASSIFIED