Mumbai’s sudden ban on Chinese toys was attributed to some political strife surrounding Pakistan or as an aggressive protectionist move disguised as new safety guidelines. Regardless, it hits China as toy factories continue to close in Guangdong Provence at a rapid pace. Whether or not the toy ban could inflict further damage on China-Indian trade relations remains to be seen, but if in fact dealings deteriorate China could feel the economic pain.

India’s imports from China surged by 60% in 2006-07 to reach $17.4 billion from $10.9 billion in 2005-06, according to the Global Network of Exim Banks and Development Finance Institutions (G-NEXID). China is now India’s largest trading partner.

In turn, the past few years have seen China grab 60% of the Indian toy market – displacing domestic manufacturers.

The ban came just a day after the Chinese Ministry of Commerce posted statistics revealing that nearly 1,000 Chinese toy exporting companies in its Guangdong province had closed in 2008. The carnage was caused by a combination of unsafe toys being exported to the U.S. and a rise in raw materials.

Guangdong province cranks out approximately 70% of China’s toy products. According to Chinese customs statistics, 922 toy exporters in Guangdong went out of business in 2008, leaving 2,167 left from the 3,089 toy exporters which were operating in late 2007. Dongguan, the toy manufacturing center in Guangdong, was once hailed as the world’s “toy capital” with more than 4,000 toy factories and nearly 2,000 suppliers.

For investors, the message is loud and clear: China is in for a long slog.

The fresh numbers reinforce our position that investors should look elsewhere in Asia for longer term profit opportunities.

Beijing said that approximately 20 million migrant workers have lost their jobs in China due to the economic downturn. The loss of jobs has prompted 15.3% of workforce in China’s new cities to return home – abandoning the modern urban centers that have come to represent China’s ballyhooed economic miracle.

This new survey was conducted before the Lunar New Year holiday which was celebrated in the last week of January, a holiday during which people returned home. The exodus was caused by a wave of factory closures as exports plunged in the wake of the current global recession.

Beijing admitted that 2009 could be the “toughest year” since the turn of the century for development of the countryside, which has fallen behind as Chinese economic reforms focus on cities.

Despite the gloomy news, the benchmark Shanghai Composite Index gained 9.3% in January 2009 as investors responded favorably to China’s massive economic stimulus package. Still, investors would be wise to consider other regions in Asia for faster gains than mainland China.

Liu Jiwei, an analyst from Pacific Securities, forecast that the growth rate of corporate earnings in China will decline to minus 10% in 2009 from a growth rate of 3% in 2008.”

Overall, 2009 is shaping up as a terrible year for investors with holdings in China.

We recently recommended that investors explore other regions in Asia that have investment potential. The key is to find countries that have cheaper factory labor than China.

We cited South Asia, which includes India, Pakistan and Bangladesh. In addition, parts of Southeast Asia (Cambodia, Laos, Myanmar, Thailand, Vietnam and Malaysia).

The rise of workers rights, coupled with last year’s dramatic inflation, has tarnished China’s reputation as the low-cost provider of manufactured goods. In turn, companies from Asia and industrialized nations are moving to cheaper alternatives such as South and Southeast Asia. In this case, investors would be prudent to follow the money.

This is the beginning of an epic collapse of the Chinese economy… after this summer’s Olympic Games.

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“Asia will not be immune to the global slowdown, neither will it be hostage to it. It remains tied to global activity through traditional trade channels, and increasingly, through its closer integration in international financial markets,” says ADB Chief Economist Ifzal Ali.

Despite government controls, the ADB predicts that inflation will spike to 5.1% in 2008 – possibly hitting a decade-long high – before cooling to 4.6% in 2009. Prices will be highest in central Asia, where inflation will remain in the double digits. China is the country most at risk, as inflation is running at an 11-year high. But economic growth in neighboring countries, such as Vietnam, is also at risk.

The report urges policymakers to tackle the problem at its root.

“For some economies, this may mean a more flexible exchange rate, while in others it may need a scrutiny of fiscal spending and priorities and, in some cases, targeted measures may be warranted to ease supply pressures that are piling on to cost pressures,” the report said.

In an interview with Reuters, Ali took on a stronger tone.

“If this genie gets out of the bottle and inflation becomes ingrained, it could bring the growth process to a grinding halt,” Ali said.

Decelerating Growth

The ADB said that growth in India and China is expected to moderate as their governments tighten policies to control inflation and accommodate “blistering” demand.

India’s economy is expected to expand by 8% and China’s is expected to grow 10%. The slowdowns in the United States, Europe and Japan will hurt China more because it’s more reliant on foreign trade.

East Asia is expected to slow from 9.3% in 2007 to 8.1% in 2008. Southeast Asia will slow from 6.5% last year to 5.7% – among the region’s countries, only Thailand is expected to post higher growth.

Growth in Central Asia is expected to decelerate sharply from double digits last year to 7.5% in 2008 because of weaker expansion in the region’s largest economy, Kazakhstan.

In the Pacific Islands – from Papua New Guinea to Fiji – growth is expected to rebound in 2008.

However, all of the developing Asian countries, collectively and individually, face the task of integrating into the global economy, sharing growth, creating conducive business and investment climates and maintaining macroeconomic stability, Ali said.

“Looking beyond the immediate bumps in the road, Asia’s long-term growth prospects will depend on how successfully countries tackle” those structural constraints facing them, says Mr. Ali.

Headquartered in Manila and financed by 67 countries, the ADB fights poverty with low-interest loans, grants, private sector investments and research about the region that is home to two-thirds of the world’s poor.