Chinese crackdown on smuggling has limited impact

"China is big and the Emperor is far • away," goes a Chinese saying. \ J Following announcements in Bei­

jing by Chinese President Jiang Zemin and Premier Zhu Rongji (C&EN, July 27, page 26), a highly publicized drive against smugglers began in late July. The new measures so far have had some impact-raising temporarily the prices of chemicals traded within China.

Given the scale of the problem and the size of the country, mounting an effective nationwide crackdown on smuggling is a costly undertaking for central authorities. Alexandra Conroy, a Chinese chemical stock analyst at ING Barings in Shanghai, says it was the "appalling" first-half results that Chinese oil and chemicals companies sent to Beijing in June that prompted ac­tion. The losses, says Conroy, "started to scare the government considerably. And [the situation] was showing no sign of let­ting up. The Koreans were showing no signs of tightening supplies or raising pric­es to anything like a reasonable level. It was getting intolerable."

The Chinese petrochemical market can be thought of as a pie, says regional petro­chemical analyst Samuel S. Webster, at se­curities firm CS First Boston in Taipei. Por­tions of this pie are mostly shared in a zero-sum game by producers in China, Tai­wan, and South Korea. Prior to the crack­down, he says, the Chinese were getting squeezed out of the pie, and this is what led authorities to act. It appeared unfair and abnormal to Chinese authorities that established Chinese producers could not benefit from their home market, that they were suffering at the expense of smuggled foreign products.

The measures adopted since July, Con­roy says, fall into three categories. First, Beijing sternly warned both the People's Liberation Army and customs officials that smuggling had to stop. "Clearly, some­body was letting this stuff go by," she says. The second set of measures was an in­crease in the number of officials at ports throughout China checking whether the correct import duty was being paid on goods entering the country. The third was a blitz by the state media reporting the progress of the crackdown, to scare smug­glers and those aiding them.

No statistics are available, so it's not clear how much smuggling has been re-

duced since the beginning of the crack­down. But it appears the measures have been moderately successful. Chinese polyester producer Yizheng Chemical Fi­bre swung back into the black in the third quarter, and across the Taiwan Straits, competitor Nan Ya Plastics began suffering losses, "for the first time in memory," Webster notes.

The price of polyester filament in­creased 20% in August and almost 12% in September, and that of polyester staple fiber decreased 2.7% in August but in­creased 6.8% the following month. How­ever, on average, Conroy says, prices of the main commodity chemicals are cur­rently back down where they were be­fore the crackdown began. Webster ob­serves that the prices of most chemicals in China have continued to slide, despite the crackdown. But he says prices are now declining at "an arrested pace," rather than free-falling.

In Hong Kong, executives at interna­tional chemical firms report that some orders from China were canceled in the second half of the summer and that busi­ness slowed somewhat. A marketing manager at a large European producer says: "There was, over the past two months, a certain effect in that custom­ers would hesitate to place orders be­cause, whether they smuggled or not, the whole customs clearance procedure was so complicated and time-consuming. So people preferred to wait and see."

Orders for China-bound products have begun to pick up again in Septem­ber. Ryota Hamamoto, managing director of Petrochemical Corp. of Singapore, says demand is coming back, despite the added controls. One way or another, he notes, China needs agricultural film be­fore winter, and domestic producers can­not supply enough. Inventories in China appear to have been depleted over the past few months, he observes.

But the situation is not bright for for­eign suppliers. One marketing executive at a European firm mentioned that he was "trying to save the business" these days. The smuggling crackdown was, for him, not the central issue. Rather, it was the aggressive competition from regional chemical producers, essentially Korean and Japanese. Above all, he was further concerned about China's decelerating

rates of economic activity, which mean customers are generally ordering less.

Moreover, Chinese companies that im­port chemicals are acutely short of cash. One of the reasons is a new measure de­signed to reduce corporate tax evasion. Chinese exporters of manufactured goods are exempted from paying a 17% value-added tax (VAT) on the raw materials (in­cluding chemicals) they need to import from abroad. Many Chinese companies have abused this exemption by importing chemicals VAT-free and then selling them domestically instead of incorporating them into exported products.

Recently, the government—in addi­tion to the smuggling crackdown—has been collecting the VAT upfront on all imports. Bona fide exporters can still ap­ply for tax rebates, but only after they have proven that they have exported goods incorporating imported raw mate­rials. Having to pay the VAT upfront is stressing the companies' cash flows. "Even the people who really import in order to reexport are being put under cash constraint," Conroy explains.

In South Korea, rather than concerns over a smuggling crackdown, there have been hopes that the floods that China expe­rienced over the summer would boost de­mand for polyvinyl chloride, reports analyst Shin Seung-Yong of securities finn Indosuez W. I. Carr. But this extra demand may not materialize, Conroy opines. Acknowledging that the summer floods were the worst in China since 1954, she points out, "China floods every year." As a result, the increase in demand will be "incremental." And given the regional oversupply, the difference will be barely noticeable, she believes.

There is a limit to how much success Chinese authorities can expect to achieve in clamping down on illegal imports. A strin­gent crackdown has the effect of increasing the domestic prices of chemicals in China. Although such a situation helps China's chemical industry, it comes at the expense of downstream users of chemicals, which also are experiencing financial difficulties. They likely will pressure authorities for cheaper raw materials.

And a crackdown-induced widening price differential between China and abroad provides further profit incentive for people to engage in smuggling. If authorities send legions of officials to Chinese harbors to check incoming imports for evidence of un-derinvoicing, detemiined smugglers simply find other ways to bring products into the country. As Conroy says, "There's too much product out there."

Jean-François Tremblay

SEPTEMBER 28, 1998 C&EN 1 7