China Dials Back VAT Rebates on Certain Exports – No Film at 11
Monday, July 5th, 2010Download this podcast
Length – 6:12
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I am going to start this post out with a warning: in the world of global economic intrigue and gamesmanship, the following ranks rather low on the excitement scale … but on June 22nd, China announced that it would scrap the export tax rebate it gives to China producers of 406 categories of export products. These products include steel, non-ferrous metals, fertilizers, chemicals, plastics, rubber, and glass. This was the first adjustment in the export tax rebate since July 2009, when it was increased as part of China’s stimulus program.
Now I know that, for most of you, the phrase “export tax rebate” doesn’t send a thrilling chill down your spine … and if it DOES, then maybe you need to get out more. But we think that there is something deeper here that is worth exploring just a bit further.
This policy announcement is coming at an interesting time. The communication between the U.S. and China on the global economy and the RMB valuation has had more passive-aggressive subtext than a Midwestern family Thanksgiving – “PLEASE pass the SALT, DEAR!!” – so one rather hoped that any move by China would be attempt to alleviate some of the stress … as in “Please ADJUST your RMB rate, DEAR!!”. However, at first blush, there is not a huge material impact to the trade imbalance as the policy change is not expected to make a major dent in exports, since it affects only $11 billion in exports, or about 1% of the total.
However, we think that the importance of this policy change goes beyond any material impact. We think that China is trying to telegraph some very specific messages to two constituencies: the international community and its own people.
First of all, the Chinese government is signaling to its own domestic manufacturers that it wants them to curb overcapacity, move up the value chain, and turn away from the export-driven model of growth. In this new policy, the government has focused on the environmental benefits of discouraging the production and export of these 406 products, which are highly energy-intensive and polluting, thereby scoring a point with the Greens, both domestic and international. Lower production will save energy and reduce greenhouse emissions, in line with China’s stated promise of reducing energy consumption per unit of GDP by 20% from 2005 to 2010. Again, this move is not going to get China all the way to environmentally friendly heaven, but it’s a step in the right direction.
At the same time, this move is a response to recent global pressures on the RMB and non-tariff trade barriers, trying to get China to be an engine of global recovery, rather than continuing its export-driven model. Europe and the US are trying to export their way to recovery, so someone’s exports have got to go down. By partially eliminating the export rebate, in line with RMB revaluation, China can better claim that it’s pulling its weight globally. Given that this is a partial rollback of the stimulus package, China can also claim that it’s dealing with stimulus-induced preferences for domestic industry, further reducing what some say is over-investment by the Chinese government in their own infrastructure which has led to an over-inflation of China’s GDP growth. So that’s quieting 4 squawking birds of international conscience with one stone of administrative action … not bad at all. The tortured metaphor of that last sentence does not give enough Kudos to China for this move … China is definitely starting to understand that, for its policy changes to have impact, symbolism – properly spun – can have more power than substance in the world of international diplomacy.
However, of the two possible audiences for this move – internal and external – we fall on the side of this being a stronger message to its own domestic producers, an encouragement to move up the value-chain and pursue domestic innovation, not just be the manufacturer for the world. Steel is a good example. 48 of the 406 affected products are made, at least in part, from steel that, until this action, had enjoyed a 9 percent rebate. Steel exports from China have grown 127% year-on-year, and 266% alone just this past May. However, along with this growth have been the installation of new steel-making facilities in China … despite a general ban on adding more capacity, Chinese companies found a way to build 40 new steel plants in this past year. This has resulted in the overproduction of low value-added steel which means that China’s steel industry profits have come almost entirely from the 9% rebate.
But this new ruling makes a fine distinction between the two types of steel products. The rebate on the commodity steel goes away but the higher value-added steel products such as cold-rolled and galvanized steel – which many US buyers are more interested in anyway – still enjoy a 13% export rebate. So, by getting rid of only the rebates on low-valued added products, the government is sending a signal to the domestic industry: “Start moving up the value chain, and stop building so bloody much capacity. Move away from the low-cost export model and start innovating.”
After over 20 years of concerted effort on building their economy through exports, China is going to take awhile to turn this ship around. In other words, China is not going to becoming a domestically-driven (and particularly a consumer-driven) economy any time soon … I don’t even think the next 20 years is going to get them there. But bit by bit, they are moving that direction … and this recent policy change is one of those bits. And keep your eyes and ears open for future policy announcements … more and more you are going to see the double purposes behind policy changes as China navigates the dangerous waters between both the internal and external constituencies most impacted by such changes.