* Harbour Ring says Christmas demand indications not encouraging
* Sees Chinese consumers becoming more cautious
* Sudden changes in Chinese regulations the biggest problem
By Susan Fenton
HONG KONG, Nov 16 (Reuters) - Hong Kong-based toy manufacturer Harbour Ring Crown Ace, which counts Mattel and Hasbro among its clients, is bracing itself for a tough Christmas season and an even worse outlook in 2009 which will be worse than a recession.
"Everyone is just holding their breath to see how the Christmas season goes. The signs so far are not very encouraging, people are talking about more than a serious recession," Richard Ellert, Harbour Ring's chief executive officer, told Reuters in an interview on Sunday.
The company, one of the world's biggest toy makers on an original equipment manufacturing basis, has cut output and is currently employing only 3,500 staff at its factory in Dongguan in Guangdong province, southern China's manufacturing belt, compared with 4,400 this time last year. In peak season in June to September it employed 8,000.
It shipped most of its Christmas goods by the end of September but fears retailers could end up with leftover stock if Christmas demand is weak, prompting them to slash orders early next year.
"If there is a downturn in the toy industry it will become very evident the day after Thanksgiving," Ellert said, referring to the day after the U.S. Thanksgiving holiday late this month, which traditionally marks the start of the Christmas shopping season.
"What discretionary spending is available after Christmas (and in 2009), we just don't know."
In a sign that Christmas demand could disappoint, air cargo out of Hong Kong, a trading hub for the shipment of Chinese goods to the rest of the world, fell 9.8 percent in October from a year ago, according to data from Hong Kong Air Cargo Terminals Ltd.
Harbour Ring -- which was recently bought by private Italian promotional toy company PEA -- relies on the United States for up to 40 percent of sales and Europe for 30-35 percent of sales.
"PERFECT STORM"
Ellert says business is not being helped by indications that consumers in China -- the biggest untapped market for Western toy makers that could in theory help offset weakening demand in the United States and Europe -- are starting to rein in spending.
"The China market is down for sure," said Ellert. "The Chinese are much more cautious about spending money than the West. The (Chinese) economy is slowing and the Chinese generally are reacting a lot faster than the West: they don't wait for things to get bad before they start saving."
As exporters have been hit by the global downturn, China's annual economic growth eased to 9 percent in the third quarter, from 11.9 percent for all of 2007. Economists see it falling below 8 percent, the pace considered necessary to create enough jobs.
Ellert says capacity in the global toy industry, most of it in China, has shrunk 20-40 percent since mid-2007. In southern China, tens of thousands of toy factories have closed this year.
"The numbers are staggering," he said.
Sudden changes in regulations in China, including the repeal of VAT rebates to exporters last year, and the government's push to shift low-end manufacturing up the value chain or move it to less-developed parts of the country inland in the West, have posed big problems for toy makers in China.
"The changes were so sudden and so massive that the industry was not able to react and cope," said Ellert. "China would offer incentives for factories to move inland without realising that the supply chain was not there to support (the industry)."
"The fact that raw material prices went through the roof as well, and labour costs increased, all these factors created the perfect storm for the toy industry," he said.
The minimum wage in Guangdong province has risen 11.5 percent this year while raw material prices have surged 20 percent, and the introduction of a new labour law in January, which makes it harder to employ temporary staff, has added another 8 percent to Harbour Ring's labour costs.
China has reintroduced VAT rebates recently and provided assistance for SMEs to obtain loans.
Premier Wen Jiabao, visiting Harbour Ring's factory in Dongguan last week, said more support for industry would be forthcoming but did not give any details, Ellert said.
He says more toy factory closures next year are inevitable. However, as manufacturing capacity continues to shrink, Harbour Ring sees a chance to win market share and expand capacity by up to 15 percent, a strategy it hopes will get it through 2009.
"Anyone who survives next year will be fine going forward," he said. (Reporting by Susan Fenton, Editing by Hans Peters)