Fiscal or Monetary Pressure? China Considers to Cut VAT Rebates

Manufacturers and trading companies throughout China are concerned about plans from the Central Government to lower the size of value-added tax (VAT) rebates.

VAT is a form of sales tax levied on the value added at the manufacturing process, but in order to boost exports, significant rebates were introduced: Currently, manufacturers are charged 13, 15 or 17 percent depending on the goods but rebates between 5 to 17 percent are granted on all products exported outside of China’s mainland.

But this may change now.

As Chinese exports have strongly increased during the last years, the rebate has become a severe fiscal burden on the Central Government. According to the Ministry of Finance, the amount needed for the rebates has been rising at an annual rate of 36.3 percent recently, more than twice the growth rate of the Central Government’s fiscal revenue.

It is estimated, that the back payments of the government against exporters have already piled up to as much as RMB250 billion (US$30.2 bn.) at the end of 2002 and the amount of unpaid rebates is expected to reach RMB300 billion (US$36.2 bn.) at the end of this year – a great amount in times where the government’s fiscal belt is tightening.

According to the proposal, the average rebate rate will thus be lowered from 15 percent to 11 percent, saving the Central government around RMB50 billion (US$6 bn.) annually.

On the other hand, the announcement comes amid growing pressure from the United States, demanding to appreciate the Chinese currency. The US trade deficit with China reached an all time high in 2002, and US manufacturers, especially those from the textile industry, fear that China will grab an even bigger share from the Western markets once the remaining trade quotas are deleted at the end of 2004.

In terms of bilateral trade, a cut of the VAT rebates is similar to a Renminbi appreciation. Unwilling to let the Renminbi flow freely, the Central Government might hope to kill two birds with one stone: Solving the fiscal and the monetary problems.

If the new rebate scheme comes into effect, this would have a strong influence on domestic manufacturers producing for export… and for Western companies buying from them. Suppliers producing for export use the VAT refund to lower their prices. Profit margins are already small and in some cases, the manufacturers sell their products even below cost, getting profitable with VAT refund only. Those manufacturers will undoubtedly pass along the rising costs to their suppliers and their customers.

In the last two months all manufacturers have started to discuss with their customers that they need the right to increase prices. All Western companies buying from China should prepare for negotiations with their suppliers and customers.

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