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Luxury tax Swiss watch exporters take long view of China

China is the third-largest market for Swiss timepieces

(Keystone)

Last summer, Switzerland became the second European country to sign a free-trade agreement with China, following Iceland’s lead. On July 1, the pact came into force.

For Switzerland’s watchmakers, among the drivers of the export industry, the deal is good news. The rapid growth of the Chinese economy and the penchant of its expanding middle class for western luxury goods has helped boost the value of Swiss watch exports to China from CHF45 million ($49 million) in 2000 to CHF1.45 billion in 2013. That makes China the third-largest market for Swiss timepieces, according to figures from the Federation of the Swiss Watch Industry (FH).

As far as the industry is concerned, the main advantages of the deal, which took more than three years to negotiate, are a reduction in Chinese import tariffs and greater protection for intellectual property, says Jean-Daniel Pasche, president of the FH.

“The deal will give a clear framework for bilateral commercial relations, with concrete improvements, such as the reduction of tariffs, and greater protection of the ‘Swiss-made’ label in China,” he says. “That is very positive.”

Under the terms of the deal, Chinese customs duties on automatic watches and quartz watches with non-digital displays - which between them account for 90 per cent of Swiss watch exports by value - will drop from their current level of between 11 and 12.5 per cent to between 4.4 and 5 per cent over a period of five to 10 years.

Customs duties on other watchmaking products, such as alarm clocks, movements and exterior components, will also be cut by varying amounts. The only products that will not benefit from lower duties are watch bracelets manufactured from precious metals and exported separately. But these account for just 0.05 per cent of Swiss watch exports by value, according to the FH.

While the reduction of trade barriers is certainly a positive step for Swiss-Chinese relations, the impact on Swiss watch exports to China is not likely to be that large, say analysts.

A watch bought in mainland China can be as much as 30 or 40 per cent more expensive than if it had been bought elsewhere, according to René Weber, an analyst at Bank Vontobel in Zurich.

The price difference is particularly marked for watches that cost more than Rmb10,000 ($1,600), as these are subject not just to import duties, but also to a 20 per cent luxury tax, which the free trade deal will leave in place.

The upshot is that, while plenty of Chinese buy expensive watches outside the country - typically in Hong Kong, but also in European countries such as Switzerland, the UK and France - relatively few choose to buy them in China. As a result, most of the Swiss watches bought in China tend to be at the cheaper end of the spectrum. The average export price of the Swiss mechanical watches sold to China was CHF616 last year, far lower than the global average of CHF2,143, says Mr Weber.

Given that average prices are already so low, and because the tariff reductions will be phased in over a period of years, Mr Weber does not expect them to translate into meaningful reductions in the prices of watches in China. Moreover, Swiss watchmakers have little incentive to cut prices in the country because their cost base there is rising fast, says Jon Cox, head of Swiss equities at Kepler Cheuvreux, a Europe-wide financial services company.

“At the moment China is not a particularly profitable market. This is partly because of taxes. But it is also because rents in the main shopping locations are very high, and staff costs are relatively high, even though they are not selling as much as staff elsewhere,” he says.

“I assume that the [Swiss] watchmakers probably aren’t going to pass on much of this change to final retail, and as a result, the profitability of the Chinese market will go up for the watchmakers.”

John Guy, luxury analyst at Berenberg Bank, takes a similar line. “The luxury goods industry does not tend to cut prices, and I don’t think the impact of this tariff reduction will be big enough to change that,” he says. “As a result, I don’t think we will see a big jump in Swiss watch exports to China.”

Mr Pasche at the FH acknowledges that the luxury tax will remain a significant brake on sales of fine watches in China. However, he points out that with the signing of the free trade agreement a working group was set up to discuss further bilateral arrangements between the Swiss and Chinese watch industries. One of the topics for debate will be the luxury tax, he says.

If all goes to plan, Mr Pasche says the deal’s impact could go far beyond the Swiss-Chinese trade balance.

“We would like to do deals with the other Bric countries - with Brazil, with India, with Russia,” he says. “That obviously depends on them too. If this deal works well, perhaps it will increase their interest in a deal of their own.”

‘Watchmakers probably aren’t going to pass on much of this change’

Copyright The Financial Times Limited 2014

for the Financial Times

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