INSIGHT: The US targets China’s VAT-refund policy

22 June 2012 16:40  [Source: ICIS news]

By John Richardson

Concerns over a global trade war resurfacePERTH (ICIS)--When the global economic crisis began, there was great concern that the world would slip in to a 1930s Depression-era level of trade protectionism.

And, indeed, in 2009, when the crisis was at its height, there was a sharp increase in what Simon Evenett, who runs the monitoring service, Global Trade Alert, calls "beggar-thy-neighbour policies".

Fortunately, though, the worst fears of the pessimists were not realised as the global economy rebounded in 2009-2010, largely thanks to China's huge economic stimulus package.

But now, as China slows down and as the eurozone faces a potential implosion, concerns over a global trade war have re-emerged.

"In terms of an increase in formal trade protectionism, which involves antidumping, anti-subsidy and safeguard duties, there have been more cases," said Edmund Sim, partner in the Singapore practice of law firm, Appleton Luff, and an expert in international trade legislation.

"There has also been quite a big increase in informal activity."

Dumping, under international trade law, is defined as when a manufacturer in one country exports a product to another country at a price which is either below the price it charges in its home market or below its cost of production.

Winning anti-subsidy, or countervailing, duties involves proving that an exporter has used a tax break, free land or another type of investment incentive intended to support domestic business.

Safeguard duties are levied at countrywide-levels and are designed to give industries breathing space in order to restructure.  

"Informal measures can take the form of restrictions on imports to a limited number of ports and more rigorous enforcement of standards and testing," added Sim.

"Exports are therefore being held up by the need for results to come back from a testing laboratory.

"I get a sense that people are increasingly worried about these informal measures."

He added that he also got the sense that American companies were becoming less tolerant over long-running problems in China, including intellectual property rights protection and cyber attacks which sometimes result in intellectual property being stolen.

"US companies are also complaining more strongly about being denied access to Chinese markets," he said.

"What the US is finding particularly frustrating is that, despite the tremendous improvement in its energy cost position thanks to shale gas, it still feels it cannot sufficiently penetrate Chinese markets."

A further source of tension is the fall in the value of the yuan against the US dollar by around 1% in 2012, following several years of appreciation. The appreciation, which occurred between 2005 and the start of this year, is also viewed as insufficient by the US.

"We recently had an audience with Mitt Romney's trade adviser in Washington DC," said Sim.

"He confirmed that, yes, on day one of him being President, Romney would declare China as a currency manipulator.

"But this would be a strategy to get China to negotiate rather than a statement of policy. The Obama approach has been to instead ignore the issue.

"How would China react? Pragmatically, it might ignore the rhetoric during the first few days of a Romney administration.

"It might then recognise that, despite the change in government, there was still continuity.

"Some of the officials in a Romney administration would likely have also worked for the second Bush administration. Governments like continuity when dealing with other governments."

And Sim added that US frustration was being tempered by awareness of how, without a strong China, the world economy would struggle, and that China was heavily dependent on exports for its GDP (gross domestic product) growth.

But the elephant now looming large in the corner of the trade policy room is China's practice of subsiding exports through selective value-added (VAT) tax rebates.

These apply to chemicals, polymers, fibre intermediates and other raw materials that are imported to manufacture finished goods for re-export.

In other countries with VAT, exporters receive the full refund of VAT paid on inputs.

In China, however, exporters receive varying amounts of VAT refunds, depending on the products involved. 

Producers of value-added goods tend to get higher VAT rebates, encouraging exports, whereas producers of basic materials get lower VAT rebates, thus discouraging exports. 

The selective rebates were reduced in 2007 as part of China's drive to lower dependence on exports while boosting domestic consumption.

But as the economic crisis worsened, China's rebates were increased for some products.

Evenett, who is also a professor at the University of St Gallen in Switzerland, estimates that 71% of Chinese exports were affected by a change in rebates in 2010, compared with just 4% in 2007.

"Given that China's VAT rates vary between 13% and 17%, and that parts and component imports account for half the value added in many Chinese sectors, even small variations in these rebates can have a big impact on the profitability of exporting," wrote Evenett in an academic paper, which was reported in a 13 June Financial Times article.

In 2010, Beijing paid out the equivalent of a fifth of total annual Chinese government spending in VAT rebates, he added.

"What's more, all of this is World Trade Organisation (WTO) legal,” he said.

In response to China's VAT rebate scheme, the US Department of Commerce announced on 19 June that it had changed how it will calculate antidumping duties.

"The department will now deduct the un-refunded VAT from the export price to the US. This, of course, increases the dumping margin because the net export price is lower," said Sim.

"And in the anti-subsidy duty cases against China, the US claims that raw materials in China, when purchased from state-owned companies, are subsidised by the state, particularly in the case of some polymers and steel,” he added.

"The US Department of Commerce will thus value the amount of subsidy by comparing the Chinese domestic price with the world price for the raw materials.  

"In all of the cases I've seen, the calculated amount of subsidy is large because the Chinese domestic price is lower than the world price,” he said.

“This is the result of the VAT rebate policy discouraging exports of basic raw materials, which increases domestic supply and lowers domestic prices."

This applies to polyvinyl chloride (PVC), where, despite local capacity being well in excess of demand, end-users still import substantial volumes.

"This new US approach effectively targets the VAT refund policy both in dumping and anti-subsidy cases, which can be viewed as double counting,” said Sim.

“At some point, therefore, the US will have to drop one of the approaches if the Chinese go to the WTO."

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: John Richardson
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