China Smuggling Crackdown Hurts Tobacco Cos. (fwd)

[Robert Weissman <rob@essential.org>]

                         August 5, 1998
 China's Crackdown on
 Smuggling
 Threatens Multinationals' Sales

 By CRAIG S. SMITH and WAYNE ARNOLD 
 Staff Reporters of THE WALL STREET JOURNAL

 SHANGHAI, China -- China's current campaign to
 crack down on smuggling across its borders is likely to
 hurt a surprising constituency: multinational companies.

 While Western firms trumpet support for the move,
 kicked off by President Jiang Zemin earlier this month,
 many are quietly assessing the damage that an end to the
 illegal duty-free trade will have on their businesses, said
 executives. Companies as diverse as Eastman Kodak
 Co., International Business Machines Corp., Philip
 Morris Cos. and major oil companies benefit from what
 are politely called "gray market" channels, through which
 independent traders ship their products into the country.

 Kodak, IBM, Philip Morris and other companies
 acknowledge that this trade exists but say they don't
 support it. "Kodak is not involved in smuggling," said a
 Kodak spokeswoman in Hong Kong. "If there are some
 distributors or dealers doing this, we don't know about
 it." Kodak executives have conceded, however, that
 much of the roll film sold in the country is imported
 through independent gray-market channels. The
 smuggling crackdown would shut down much of the
 trade. "Closing off unofficial imports will increase China's
 revenue, but at the same time limit imports into the
 country," said Norman Givant, a lawyer with more than
 a decade's experience in China.

 Increasing Protection

 Western companies have been championing the rule of
 law in China for years, but many have at the same time
 benefited from the gray market, which circumvents
 China's high duties and 17% value-added tax on most
 imports. An end to China's smuggling would increase
 protection of the country's state-owned industries and
 highlight the high duties and other taxes that some
 Western critics call barriers to free trade. As it is, many
 multinationals' already weak Asian sales could suffer,
 while the sales of their mainland Chinese competitors
 likely will get a boost.

 "The net effect will be greater restrictions on market
 access, exacerbating the country's trade imbalance with
 the West," said Mr. Givant.

 Typically, foreign companies sell China-bound goods to
 offshore distributors, sometimes called "converters," who
 deliver shipments to the mainland without paying full --
 or any -- duty. Multinationals turn a blind eye, but most
 are aware that much of the trade is illegal.

 The antismuggling campaign already has damped Asian
 demand for diesel fuel and other refined oil products.
 China's military, singled out in the crackdown by
 President Jiang, is believed to be a major smuggler of oil
 into the country. Stopping the smuggling would force
 Chinese users to buy from domestic refineries, which are
 operating far below capacity because they can't compete
 with smuggled oil. Without the Chinese demand
 facilitated by the smuggling, regional oil-product prices
 could drop as much as 10% in the coming months,
 estimated Alex Conroy, an analyst at ING Barings in
 Shanghai. "Anybody who sells oil products through
 Singapore will get hurt," she said.

 Remaining Competitive

 Western companies complain publicly that the gray
 market hurts their ability to control mainland Chinese
 distribution. Yet the trade continues because
 multinationals would have to pay full duty if they
 imported the goods themselves, making many Western
 products too expensive for China's consumers. The
 duties range from 20% for personal computers to as high
 as 150% for automobiles.

 For some products, like cigarettes, smuggling is the
 only major way into the country. Because Chinese
 tobacco imports and sales are officially controlled by a
 state monopoly, the central government estimates that
 smuggling accounts for more than 90% of foreign
 cigarettes sold here -- an estimated $100 million per
 year of them from Philip Morris alone. A spokesman for
 Philip Morris in Hong Kong said that while the company
 may be aware of the smuggling, it doesn't know of
 specific instances, and won't comment on the potential
 impact the crackdown might have on the company's
 sales.

 Some Western companies that manufacture in China
 even ship their mainland-made products to Hong Kong,
 Singapore or Taiwan for sale to independent distributors
 who then smuggle the goods back into China, say
 Western executives. Despite the rigamarole,
 manufacturing in China gives Western companies
 distribution and after-sales-service privileges they would
 otherwise be denied. Exporting their products allows
 them to avoid paying duty on imported components or
 raw materials (duties are waived on imports destined for
 re-export) and to get a partial rebate on the value-added
 tax paid on components and raw materials.

 Importing IBM Exports

 The PC industry is a case in point. IBM's PC factory in
 Shenzhen, for example, has a license to sell 80% of its
 output "onshore," meaning it can accept local currency
 and deliver the PCs in China. But in practice, said IBM's
 China general manager, Richmond Lo, only about 50%
 of the output stays in China. IBM quite legitimately ships
 the other half to Hong Kong, where they are bought by
 distributors paying U.S. dollars.

 Once the PCs are in Hong Kong, said Mr. Lo, the
 distributors pick them up and ship them right back into
 China, a move that should cost them 20% in import
 duties and 17% in value-added tax. Do they pay this? "I
 have no idea," said Mr. Lo, adding, "I don't deal with
 those people."

 Most distributors duck the duty and the value-added
 tax, said Western executives, allowing the distributors to
 sell IBM machines at prices competitive with domestic
 Chinese brands. China's market for PCs is one of the
 fastest-growing in the world and one of the most
 competitive. Smuggled PCs from as far away as the
 U.S. and Kuwait end up on Chinese shelves, having
 evaded duties and taxes, coming by truck, by boat and
 over the mountains from Vietnam, said Western
 executives. No one seems to know just how large the
 market for gray PCs is, but smuggling has been so rife
 that legitimate imports simply haven't been able to
 compete, they said. Before the crackdown, "there was
 no legitimate channel" for importing PCs, because
 smuggling was so widely accepted, said a Hong
 Kong-based distributor who handles merchandise made
 by Compaq Computer Corp. and IBM.

 Help From China's Navy

 How is the smuggling done? Faking accounts for
 customs so inventory is undervalued or undercounted is
 one popular ploy, said the distributor. But using the
 military to escort goods into the country tax-free is
 another. Before the crackdown, distributors from Hong
 Kong could arrange for the Chinese navy to meet them
 offshore and ship the computers into a naval base,
 according to a PC-industry veteran. The northeast port
 of Dalian was a particularly popular point of entry for
 PCs, he added.

 The extent to which smugglers influence China's PC
 market is already apparent. Although the crackdown
 was announced only this month, banks are already more
 reluctant to issue U.S. dollar-denominated letters of
 credit to distributors for PC purchases, and many
 distributors are reluctant to ask for them for fear of
 inviting scrutiny by authorities. IBM's Mr. Lo said more
 of his business lately is conducted in yuan, indicating that
 fewer distributors are taking delivery of PCs in Hong
 Kong in the wake of the smuggling crackdown.

 Market researchers at IDC Asia/Pacific Ltd. in
 Singapore estimate that second-quarter growth in
 China's PC market almost halved from a year earlier as
 talk of a crackdown spread. Even legitimate sales are
 being hurt, according to Ken Koo, general manager of
 Hewlett-Packard's PC and printer business in China.
 "Distributors have stopped taking shipments," he said,
 adding, "Everybody's taking a wait-and-see attitude."





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