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Chinese Chemical Market Is Appealing, But The Risks Are High • Enthusiastic foreign investors must remain cautious in a market with great potential but subject to uncertain politics Jean-François Tremblay, C&EN Hong Kong or the past few years, U.S. and European chemical firms have made a steady stream of investments in China. Almost every week, some household-name chemical company acquires a facility, builds a plant, or enters into a manufacturing joint venture in China. Enthusiasm is high. In the minds of international corporate planners, China is the place to be. But the risks and uncertainties are hair-raising. China's constantly changing regulatory framework leaves much to be desired. Infrastructure is inadequate. Perhaps more serious, a review of 20thcentury China hardly provides a reassuring model of political stability. The country has gone through three revolutions. It experienced a humiliating period of semicolonialism under Japan and other world powers in the 1920s and '30s—the so-called international settlements—and later carried a heavy burden of suffering before and during World War II (1931-45) when it lost countless millions of its population. And it endured the "Great Leap Forward," the 1957-58 economic and social policy that resulted in famine and an unknown number of deaths. Many Chinese still bitterly recall their country being referred to as "the sick man of Asia," a past they hope is finally behind them. Since 1976, politics have been relatively stable, but it is very unclear what will happen once ailing and barely lucid patriarch 91year-old Deng Xiaoping dies. At present, China's breakneck pace
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of development translates into constant nese economic liberalization is the need change. Rules and their enforcement to earn foreign exchange to finance seem to be different from day to day, food imports and facilitate improvefrom city to city. New roads, railways, ments in agricultural productivity, says Business Monitor International (BMI). and airports are springing up. Environmental protection is inching Besides, to preserve stability, jobs must its way up the national agenda, and it's be found, if not for all these people, at not clear what the result will be in terms least for a majority of them. In 1996, BMI of new regulations. To qualify for mem- expects that the Chinese economy will bership in the new World Trade Organi- grow about 11%, and that it will slow to about 9% the following year. zation (WTO), authorities are In about five years, BMI says, paying more attention to China "may be the single copyrights and compliance largest buyer of new cars, with international standards. computers, and other highIt all adds up to a complex technology products, a major and rapidly evolving picture. purchaser of power generaOr as was wisely pointed out tion, transport, and construcby an experienced chemical tion equipment, and ... one company executive in Hong of the biggest importers of Kong: "If you think you begin grain." Not bad for a country to understand something with a per capita income of about China, you don't un$470 in 1994. derstand anything yet." All of which is music to the China's gross domestic ears of international chemical product (GDP) grew 13.4% in executives. "The chemical in1993 and 11.8% in 1994. From dustry always plays an im1980 to 1992, GDP growth avportant role in any developeraged 9.2% per year. This is ing economy," comments four times the U.S. growth for Eastman Chemical's Regg the same period. This year, as Bonnevie, Hong Kong-based a result of the fight against indirector for China, Hong flation, economic growth is Kong, and Taiwan. "You can expected to slow down to look at that through history. about 10%. But even at the And that's not going to be slower pace, China is still one any different in China. of the world's fastest Chinese Chemical As the quality of life ingrowing economies. creases for more and Industry Will it continue? Unmore people in China, less a catastrophe hapthey prosper. It's going to create a growpens, probably so. The Chinese governing consumer demand for higher quality ment has little choice but to continue to liberalize the economy and maintain the products and more variety of products, growth momentum. Already the and that's what the chemical industry world's most populous country with thrives on." Since the People's Republic of Chiabout 1.2 billion people, China's population is still growing rapidly in absolute na's first five-year plan in 1953, the numbers. According to the World Bank, chemical industry has been one of the China's population will reach at least key sectors in state planning. At the 1.35 billion by 2010, an average annual time, the emphasis was on fertilizers to boost agriculture. Currently, for the increase of about 10 million people. One of the main rationales for Chi- five years through 2000, the Chinese NOVEMBER 20,1995 C&EN
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Internationalfirmsawait resumption of Chinese imports China's booming economy and lack of production capacity for basic chemicals make it obvious that the country needs to import large quantities of chemicals to support its manufacturing sector, and that it will need to do so for years to come. But Chinese buying is far from steady, and international manufacturers have come to expect roller-coaster rides from quarter to quarter. The current year is proving to be particularly eventful. Until June, China was importing chemicals as if there were no tomorrow, pulling world commodity chemical prices up to record levels. Then, imports abruptly decreased, if not altogether stopping for many categories. This fall, Chinese buyers have been cautiously returning to the market, keeping many on edge. "When will China resume buying again?" asks Janet Yang, an Asian chemical industry analyst at Merrill Lynch in Hong Kong. In the summer, many analysts in Asia predicted that heavy Chinese buying would resume this fall. Chinese buying has picked up, but it has not been as strong as expected. Current prices for acrylonitrile-butadiene-styrene (ABS) and polystyrene in the Asia-Pacific region are still off 60% from their peak in the first part of the year. The head of the liaison office of an international manufacturer in Beijing recalls the hectic times: "The phones were continually ringing. We used to have trouble just filling out orders, handling all the incoming calls. We were so busy before May. Then, it stopped entirely." Reflecting on the frenzied period, this executive indicates that feverish speculation, and perhaps a bit of shortsightedness, played a strong role. "When prices were going up last spring, this encouraged local Chinese buyers to go with the trend, and to buy in the hope of selling for more later." That sentiment is echoed time and again by chemical company marketing personnel around Hong Kong. Says one: "At the beginning of the year, we
Ministry of Chemical Industry envisages yearly production growth of 9 to 10% in the chemical sector. More specific numbers provide an idea of the momentous changes ahead. Following 18 months of research, Japan's Martech Corp., a Mitsubishi subsidiary, this June released a report on China's petrochemical industry. The report says that from 1995 to 2000, using 24
NOVEMBER 20,1995 C&EN
had tremendous buying and overbuying. The market was oversupplied, everybody was trying to buy as much as possible. It was mainly traders and import-export companies. They were taking positions." The mortal blow to this speculative run came from Beijing's far-reaching anticorruption campaign last spring. The witch-hunt—and the witches were numerous and real—sent shock waves through the rank and file of the Chinese government. At the top in Beijing, a member of the Politburo was expelled from the Communist Party and his assistant shot himself for accepting realestate-related bribes. Down the ranks, customs officials at China's largest ports were moved to other locations, tried for taking kickbacks, demoted, and in some cases executed. Douglas H. Moorhead, a retired Exxon Chemical Asia manager who is now executive director of Hong Kong's Association of International Chemical Manufacturers, comments: "It would be a brave man who would [now] go around the import regulations. It's a serious business." What the campaign did was to halt wholesale smuggling, or close off the "flexible import channels," to use a Hong Kong expression. Before the latest crackdown, there was a strong incentive for flexible channel importers to get together with customs officials and establish mutually beneficial arrangements. This is because Chinese "preferential" import duties, a category under which most basic chemicals come into the country, can be as high as 30%. Huge amounts were smuggled, making it difficult to estimate the current level of inventories in China. Insisting on strict anonymity, a seasoned local executive for an international chemical firm estimates that more than 50% of Chinese chemical imports went through the very accommodating port of Shantou in the south of China. When Shantou finally came under close scrutiny
either domestic or foreign capital, at least 18 ethylene construction or expansion projects are being considered, raising annual capacity by about 4 million metric tons. Some of these projects are already under construction. Should all these projects be completed, they would result in tripling ethylene capacity over the end-of-1993 figure of 2.2 million metric tons. Chinese govern-
Moorhead: regulations now taken seriously this spring, "customers immediately asked to have their orders diverted to other locations in Asia," he says. Beijing now keeps Shantou on a tight leash. For the record, executives at large international firms deny getting involved in the nitty-gritty of developing flexible channels. "We'd be out of a job if we did," said one. Nonetheless, at a time when world prices were so high and flexible channel operators were accounting for such an important share of the Chinese chemical market, the flexible channel operators must have looked very attractive to a lot of marketing managers. One European chemical firm, for example, typically does not keep a low profile in China where it is one of the largest foreign investors. However, the smuggling issue is so sensitive that the company refused to be interviewed for this story, lest the word "smuggling" be associated by some with the company name. When pressed, a division manager in Hong Kong would go only as far as confirming that the firm is not in control of all distribution channels until products reach end users in China. The division manager could neither confirm nor deny that some of the company's
ment projections are generally for an ethylene production capacity figure of 5 million metric tons in 2000, says Martech. By 1997, demand is expected to reach 5.8 million metric tons, still significantly greater than the projected capacity at that time of about 3.7 million metric tons, according to Martech. Capacity is particularly short for resins. Martech estimates that in 1993,
output has gone through questionable channels. Though the slump in Chinese imports can be traced back to the anticorruption campaign, it was only a trigger that allowed more fundamental factors to kick in. Severe cash pressures top the list. These cash pressures were themselves the result of a series of factors. First, a campaign started last year to slow down runaway inflation, which exceeded 25%, gathered momentum and turned into a painful cash crunch. A clampdown on loans has made it more difficult or costly for firms to get the working capital to finance imports of raw materials. Beijing has pledged to keep the money tight, even though inflation has declined to about 10% now. Second, there is the question of valueadded tax (VAT) rebates. A 17% VAT was introduced last year. Originally, exporters were told that they could claim a full 17% rebate for the materials going into their products and that they would be reimbursed within weeks. However, it has since emerged that this rebate policy has led to a fiscal disaster in Beijing. The government was put into a position where it had to pay out more in rebates than it was collecting from VAT because many firms took advantage of loopholes in the rules. Moreover, VAT introduction created a cottage industry in fraudulent tax claims, a felony now punishable by life imprisonment or death. New China News Agency (Xinhua) reported on Nov. 13 that three men found guilty of forging tax documents had been executed. To address its mounting VAT rebates liabilities, Beijing is expected to soon announce a reduction in the rebates from the original 17% to perhaps 9%. Moreover, the central government has decided to delay payout of rebates. Chinese exporters will have to wait up to two years to get their expected rebates instead of the few weeks originally scheduled. These nonforthcoming rebates, strict collection of VAT, and the
more than half of China's resin requirements of 7 million metric tons were met through imports. The country is the world's largest importer of synthetic resins, a situation that likely will continue for some time. Assuming demand growth of 13% per year, Martech projects that China will require 11.5 million metric tons of synthetic resins by 1997, and that domestic production
anti-inflationary credit tightening have curtailed Chinese firms' ability to pay for chemicals from abroad. VAT woes and tight credit do not necessarily mean that overall consumption of chemicals has been reduced. Though the cash crunch has slowed down inflation and cooled the economy, it has not killed it. Eastman Chemical's Hong Kong representative, Regg Bonnevie, says: "It slowed down economic growth, but it slowed it down to maybe 10 or 11% or 8 to 9% instead of 15 or 16%." Many executives hold the view that final effective demand for raw material chemicals within China has not slowed down at all, even in June and July. Demand has been feeding off the inventories built up during the frenzied buying that preceded. "All these imports have not been used up," comments an official at a Sinochem market research subsidiary. "They are still in the warehouses. Many companies still have inventories." Citing Chinese government sources, Merrill Lynch in Hong Kong reported at the end of October that Chinese consumption of chemicals increased 16% from January through the end of September, compared with the same period last year. Stricter collection of taxes and customs duties has added a huge premium to the sales price of foreign supplies, says a foreign executive in Beijing. In his view, demand from China will rise as inventories dry up. But for the time being, the obverse of the phenomenon observed in the spring has not entirely run its course, he says. Some speculators in China are still dumping their stocks on the domestic market in fear of having to sell at a lower price later on. For foreign companies, this has created a situation where they are competing against their own products shipped to China months earlier. Currently, the big question is, How large are Chinese inventories by family
of chemical products? No one seems to have that information. Other than fundamental factors, such as the availability of working capital, trying to get the best possible price on the world market still plays a role in the Chinese import picture. Says Moorhead: "China has more ability [than other countries] to turn the tap on and off. They know that they are the largest buyers and they affect prices. Sinochem therefore can directly affect world prices." Sinochem recently spun off its International Information Corp., an entity whose traditional responsibilities included advising Sinochem on factors affecting world prices. Researchers interviewed at the unit in Beijing confirmed that they are closely monitoring the behavior of global markets. Sinochem, China's largest chemical import-export company, imported more than $3 billion worth of oil and chemicals last year. The pulse of Chinese imports is best felt in Hong Kong, where most Chinese importers place their orders. Chinese laws prevent most foreign companies from operating sales offices in China. Liaison offices in China typically engage in most aspects of marketing, short of executing orders. Since October, Chinese orders have been coming back in and are said to be accelerating. The consensus is that Chinese orders will be progressively increasing, though the hysteria of the spring is not expected to return any time soon. Researchers at Sinochem's International Information Corp. believe that by the end of this year China will have imported about the same quantity of chemicals as in 1994. Citing Chinese government sources, Merrill Lynch says China's next five-year plan calls for higher levels of imports. A marketing manager at a large European firm in Hong Kong says in his company's experience, China "starts its five-year plans with a bang." The next plan, approved in October, will begin implementation in the first quarter of 1996.
will have increased to 7.3 million metric tons by then. One problem endemic in China's chemical industry is old, small plants. These were typically dispersed all over China, mostly for political reasons. Says Bonnevie: "Basically, most of the industries in China are very fragmented, and just about any industry that you look at, there's a lot of capacity out
there. But in many cases, it's out-ofdate technology—it could be old equipment, underutilized. Hydroquinone and derivatives is an example of one of the businesses that Eastman is in. There are maybe four or five producers of hydroquinone in the world, like Eastman, Rhône-Poulenc, and others. But when you look at that segment of the industry in China, there's maybe NOVEMBER 20,1995 C&EN
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rive already in place in other countries. The association is organizing a second Responsible Care conference in Beijing in September 1996. The first conference was held in Hong Kong in May. For all the talk of liberalization, government involvement in China's chemical industry is massive and complex. At the top, it is simple. One way or another, all Chinese chemical organizations report to the State Council headed by Premier Li Peng. Below the State Council, administration of the chemical industry splits off into an unusual structure. The Ministry of Chemical Industry (MCI) theoretically has overall supervision of China's chemical industry. It appears to play an important role in setting the targets of five-year plans. As noted in the Martech report, commenting on China's unpublished ninth five-year plan (1996-2000), Minister Gu Xiulian said that the plan would target chemical exports of $10 billion per year by 2000, total foreign investment in China of $10 billion, and the establishment of 100 export-oriented groups. MCI operates some successful companies such as Jilin Chemical and Beijing Chemical Industrial. Generally speaking, however, MCI-related companies are not in a strong financial condition, reports Martech. The ministry does not effectively have authority over all of China's chemical industry. In practice, the director of China Petrochemical Corp. (Sinopec) is on the same hierarchical level as the minister of chemical industry. Both officials report directly to the State Council. Established in 1983, Sinopec is now a huge industrial group employing 850,000 people. Its 1993 sales were 183 billion yuan ($22 billion), according to Martech. Under its wing are more than 80 subsidiaries including petrochemical firms, refineries, schools, and research institutes. It controls about 90% of China's oil refining capacity. Of the 20 largest Chinese chemical companies in terms of sales, 17 are in the Sinopec group. Shanghai Petrochemical, whose stock is listed on both the New York and Hong Kong Stock Exchanges, belongs to Sinopec. Sinopec has established more than 50 joint ventures with foreign firms for a total value of about $6 billion. In September 1994, says Martech, Sinopec unveiled a plan under which Chinese crude oil processing capacity would expand to 200 million metric tons per year. Currently, Sinopec's own refining capacity is about 150 million metric tons per year.
LEGAL NOTICE U.S. POSTAL SERVICE STATEMENT OF OWNERSHIP, MANAGEMENT, AND CIRCULATION (Required by 39 U.S.C. 3685)
1.
Publication Title: Chemical & Engineering News 2. Publication No.: 0009-2347 3. Filing Date: October 2, 1995 4. Issue Frequency: Weekly except for last week in December 5. No. of Issues Published Annually: 51 6. Annual Subscription Price: $120.00 7. Complete Mailing Address of Known Office of Publication: 1155 16th Street, N.W. Washington, D.C. 20036 8. Complete Mailing Address of Headquarters of General Business Office of Publisher: 1155 16th Street, N.W. Washington, D.C. 20036 9A. Publisher: American Chemical Society 1155 16th Street, N.W. Washington, D.C. 20036 9B. Editor: Ms. Madeleine Jacobs American Chemical Society 1155 16th Street, N.W. Washington, D.C. 20036 10. Owner: American Chemical Society 1155 16th Street, N.W. Washington, D.C. 20036 11. There are no known bondholders, mortgagees, or other security holders owning or holding 1 percent or more of total amount of bonds, mortgages, or other securities. 12. The purpose, function, and nonprofit status of this organization and the exempt status for federal income tax purposes have not changed during preceding 12 months. 13. Publication Name: Chemical & Engineering News 14. Issue Date for Circulation Data Below: October 2, 1995 15. Extent and Nature of Circulation: Actual No. Average No. Copies of Copies Each Single Issue Issue During Published Nearest to Preceding Filing Date 12 Months
Total No. Copies 144,039 Paid and/or Requested Circulation (1) Sales Through — Dealers and Carriers, Street Vendors, and Counter Sales (2) Paid or 138,161 Requested Mail Subscriptions Total Paid and/or 138,161 Requested Circulation Free Distribution 3,419 by Mail Free Distribution Outside the Mail Total Free 3,419 Distribution Total Distribution 141,580 Copies Not Distributed (1) Office Use, 2,459 Leftovers, Spoiled (2) Return from News Agents I. Total 144,039 Percent Paid and/or 97.6% Requested Circulation
139,653
134,356 134,356
2,476
2,476 136,832 2,821
139,653 98.2%
I certify that all information furnished on this form is true and complete. Robert H. Marks Director, Publications Division
China National Chemicals Import & Export Corp. (Sinochem) is a firm well known to international traders, since it handles a large proportion of China's chemical imports and exports. It is overseen by the Ministry of Foreign Trade & Economic Cooperation. This ministry, in turn, reports to the State Council. For all practical purposes, Sinochem operates as a private firm and is considering a listing on a stock exchange outside China. Reporting sales of nearly $15 billion in 1994, Sinochem now aims to become an international trading house with interests going beyond its traditional focus on the chemical trade. Foreign firms planning to make large investments in China can expect a complex approval process. Depending on the project, government units that might get involved include the State Planning Commission (which looks at the macroeconomic impact of large projects), the State Economic & Trade Commission, MCI, Sinopec, provincial authorities, municipal governments—and the list goes on. Fortunately, Martech says, some smaller projects can sometimes be approved directly by local authorities or by the Chinese joint-venture partner. Foreign companies with Chinese interests often describe China as a constantly changing business framework with a certain unevenness in the way rules are applied, depending on time and place. Says Damon Warmack, general manager for Eastman Chemical's Hong Kong and China operations: "A uniform enforcement would help us to structure distribution strategies and channels based on more traditional business considerations like sales, service, and all the other things as opposed to business being dictated by what guy has the best import channels/' The situation could get worse before it gets better. Some major issues for foreign investors are on the horizon for next year, according to Eddie Ng, general manager for Hong Kong and China for National Starch. First, duty-free status of manufacturing equipment used in making products for export could be phased out. Moreover, a 17% value-added tax will have to paid on raw materials. On top of that, the import tax will also have to be paid on raw materials from overseas sources, even if those materials are to be incorporated into products for export. These changes will put pressure on working capital, Ng says. He believes that the Chinese government has not ful-
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