MIXED IMPACT AND INDUSTRY SKEPTICS FOR CHINA'S FOREST

UNCLAS BEIJING 003123 STATE PASS USTR FOR R. SMITH E.O. 12958: N/A TAGS: SENV ETRD KSCA CH SUBJECT: MIXED IMPACT AND INDUSTRY SKEPTICS FOR CHINA'S FOREST INDUSTRY STIMULUS PLAN REF: BEIJING 3052 SUMMARY -------------- ¶1. (U) On October 29, five Chinese central government agencies (State Forestry Administration (SFA),National Development and Reform Commission (NDRC),Ministry of Commerce (MOFCOM),Ministry of Finance (MOF),and the State Administration of Taxation (SAT)jointly issued a "Forestry Industry Development Plan (2010-2012),designed to bolster China's timber processing and forest products industry during the current worldwide economic downturn, a downturn, which according to the Plan, has resulted in over 3 million job losses within the sector in major timber processing areas. Because increasing numbers of migrant workers previously-employed in the sector are now returning to more rural areas, major components of the Plan are targeted toward rural development. The Plan's primary goals are to "maintain growth (12% annual target growth rate for sector; overall output increased from USD 210 billion in 2008 to USD 330 billion by 2012),protect livelihoods (employing 57 million people by 2012, up from 45 million in 2008),and maintain stability" through a variety of policy measures, the combined economic impact of which is likely to be mixed. Chinese timber industry contacts remain skeptical that the Plan will be implemented in any meaningful way without a lasting revision in the current value-added tax (VAT) rebate rate on exports of timber products. END SUMMARY. ECONOMIC STIMULUS--ENVIRONMENTAL IMPACT UNCERTAIN -------------- --- ¶1. (SBU) The Forestry Industry Stimulus Plan released on October 29 has the potential to be far-reaching, with links to trade, employment, R&D support, industry restructuring, new financing mechanisms, forest tenure reform, climate change accounting, and quite significantly, the utilization of forest resources in other countries on which China's timber processors rely for sourcing raw timber. (NOTE: The "forest industry" in this context encompasses not only traditional products like timber, bamboo, wood panels, and wood pulp, but also other products like woody grains and oils, edible fungi, flowers, silkworms, medicinal herbs, and forest-based eco-tourism. END NOTE) Key components of the plan are detailed below. ¶2. (U) INCREASING DEMAND: The Plan seeks to expand market demand by increasing domestic consumption of forest products, stabilizing ;"traditional" export markets (U.S., EU, Japan),and opening new international markets (Middle East, Russia, Africa, Central Asia, South America, and other emerging markets). Domestically, demand would be driven by new construction in rural areas, post-disaster reconstruction, and conversion of squatter settlements. By 2012, targeted overall trade volume in forest products will be USD 90 billion, with exports making up at least USD 50 billion of that trade volume. ¶3. (U) The Plan calls for promoting growth in international end markets for Chinese-processed timber products "in line with WTO rules," including adjustment of tariffs on (imported) forest products and favorable tax incentives for export-oriented timber processing firms that create jobs. The government also plans to fund a loan program with discounted interest rates for which companies engaged in animal husbandry, timber processing, plantation forests, biofuels, nurseries, nature reserves, and eco-tourism would be eligible to apply. (NOTE: A similar expansion in government support mechanisms within the agricultural sector, targeted toward specific sub-industries and linked to rural development, was announced in early 2009 (REFTEL). END NOTE) ¶4. (U) INNOVATION AND R&D: The Plan encourages innovation and the use of advanced technologies to make Chinese timber processing more efficient. This includes support for additional R&D domestically, and also to "introduce, digest, and absorb" foreign advanced technology and equipment for use by processing plants in reducing energy use and minimizing pollution. Domestic R&D would focus on enhanced timber processing equipment, reforestation, pest control, and reducing threats from forest fires. To offset potential investment risk, tax incentives and government funding would support these efforts. ¶5. (U) MODERNIZED PROCESSES: The Plan encourages processors to "capitalize on current weak demand and lower prices" to procure advanced processing equipment imported from abroad, instituting possibly "relaxed trade barriers" and tax incentives for operations that upgrade technology used. Specific technologies encouraged include thermal center heating, sewage treatment, low-formaldehyde adhesives, continuous press wood-panel production technologies, and energy saving/pollution control equipment. The Plan also seeks to promote sustainable forestry and chain of custody certification processes, to "strengthen the commercial environment," and to "improve product quality." ¶6. (U) CONSUMER CONFIDENCE AND BRAND RECOGNITION: The Plan calls for "enhancing" the competitiveness of Chinese processors by increasing the quality of Chinese timber products and strengthening brand recognition in both domestic and international markets. At the same time, the Plan recognizes the need to improve mechanisms for granting business permits, safety supervision, and testing to ensure product quality and safety, i.e., use of anti-corrosion and/or flame-retardant materials. Low efficiency, highly-polluting operations will be discouraged, including quantities of formaldehyde used in production processes. ¶7. (U) INDUSTRY CONSOLIDATION AND RISK MANAGEMENT: The Plan also provides incentives for the industry to restructure and realign itself, with the most competitive companies becoming stronger, while creating a secondary market for small and medium-sized enterprises (SMEs),which would distribute the risk within the industry. Policy tools employed would include allowing for forest products companies to raise capital through newly-created investment funds, and to establish an insurance system to insulate companies further from risk. ¶8. (U) ELEVATE DOMESTIC OUTPUT CAPACITY: The stimulus plan seeks to increase the capacity of plantation forests, the development of biomass energy, production of woody oils, and the establishment of more eco-tourism opportunities. The Plan stipulates that this action would not only enhance China's energy and food security, but also increase opportunities for economic and rural development. Growth in production is to be led by wood panels, packaging, and other construction materials, but also includes tea-oil, olive, walnut, and other high-yielding oil-producing plantations, specifically in Hunan, Jiangxi, Sichuan, and Yunnan Provinces; plantations for use in biofuel production; cultivating rarer species like oak and mulberry; and continued development of "fast-growing" timber plantations. On the eco-tourism side, the Plan stipulates increased investment in infrastructure development at 300 scenic spots, which would generate income and create jobs locally, ultimately creating a "brand" for Chinese eco-tourism. ¶9. (U) Linked to this push to increase domestic capacity, the Plan provides guidance for attracting additional foreign direct investment in developing or upgrading timber processing operations in line with the government's "Industrial Foreign Investment Catalogue." The Plan also targets Central and Western regions, as well as Heilongjiang and Inner Mongolia, where proximity to the Russian border would provide continued easy access to timber, wood pulp, and paper. ¶10. (U) INTEGRATE FOREST TENURE REFORM WITH STIMULUS: The Plan emphasizes the need to continue with China's ongoing collective forest tenure reform process. This would include expanding the direct economic benefits to those living near forested areas and encouraging a shift from "traditional" to "modern" forestry. For those qualified to purchase forest tenure rights, a mortgage loan program would be established to facilitate such purchases, and the government will create guaranteed micro-credit loans for individual foresters and small and medium enterprises. (NOTE: This ongoing reform effort of forestry rights only applies to economic activity associated with the trees; the land itself will still remain "collectively" owned. END NOTE) ¶11. (U) FOREIGN TIMBER RESOURCES: Ensure a "stable" supply of imported raw timber and paper products from foreign sources, maintaining the volume at or above 160 million cubic meters. Specific objectives include "accelerating" the development of Russia's forest resources, "properly handling the international problem of illegal logging." The Plan also encourages the export of wood panel processing equipment to intended "new markets" (Africa, Southeast Asia, and Russia) to co-locate Chinese processing operations with the sources of raw timber. At the same time, it would support "qualified" Chinese companies in efforts to establish overseas operations through cross-border mergers and acquisitions, but in accordance with the government-issued but voluntarily applied 2007 "A Guide on Sustainable Overseas Silviculture by Chinese Enterprises." ¶12. (U) IMPLEMENTING GUIDELINES: As the State Forestry Administration and other government entities implement these policies, the Plan specifically calls for an "earnest strengthening of macro controls," to improve the management and institution-building of the forest industry. The Plan also cautions that R&D investment should be carefully coordinated and advances properly safeguarded under binding contracts. At the same time, further development in the forest industry should be carried out mindful of "local conditions," coordinated at all levels to avoid redundancy, and allocated based on greatest development needs as well as market principles. Finally, the government pledges in the Plan to include domestic industry associations in most if not all aspects of this stimulus process, including "responding to industry concerns of anti-dumping, countervailing duties, and other international trade frictions in a timely manner." CHINESE INDUSTRY THINKS PLAN LACKS MEANINGFUL CHANGES -------------- -------------- ¶13. (U) Chinese industry contacts doubted the Plan will accomplish the GOC's expectation because there are no new "solid" support policy/measures. Post contacted Mr. ZHU Guangqian, President of the China Timber Trade Distribution Association, Mr. WU Shengfu, Director of China Forestry Industry Association, and Mr. LI Wei, a large wood trader to ask their views. They unanimously expressed skepticism that the plan would be implemented in a meaningful way. They noted that China's wood processing sectors are very market-oriented; about 90% of the wood processing factories are privately owned. Thus, industry believes tax policies would be one of the few ways to influence directly China's wood processing sector. The industry leaders noted that, while the Plan may impact production of wood products from domestic sources, the industry heavily relies on exports of finished products and imports of raw materials. This trade is impacted by the Value Added Tax (VAT) rebate on exported timber products more than any other policy. The government "means business" when the VAT rebate is changed. ¶14. (U) This current Plan was originally released in May 2009 and designed to urge financial institutions to provide support for forestry development. However, mandatory contributions by large processors to a centralized "cultivation fund," managed by the timber associations to funnel to the State Forestry Administration, has been reduced to 10% of wood sales since July 2009, from 20%. Industry voiced the opinion that China's wood processing sector has passed the most difficult time and that both domestic and export markets are going up. Representatives further noted that while an increase in mergers and acquisitions within the industry is one of the goals of the Plan, this has been accomplished by the bearish market in 2008 and 2009 rather than by government encouragement. Nonetheless, industry likes the fact that the Plan "encourages large-scale businesses, supporting mergers and acquisitions of leading companies." Industry believes the Plan may be able to offer substantial financial incentives and policy support offered to increase M&A. COMMENT -------------- ¶15. (SBU) COMMENT: Industry experts believe China's 2010-2012 Forestry Industry Stimulus Plan will have a limited impact on the global environment. On the one hand, upgrades in technology, energy saving measures, and pollution controls will reduce emissions of carbon and other pollutants, which could contribute to China's stated goals for reductions in energy and carbon intensity. Additional trees planted in the creation of new plantation forests also may be environmentally beneficial. The stated intent to increase the use of forest certification schemes would inject greater transparency into the chain of custody into and out of China. Moreover, measures to address product safety concerns would benefit consumers if adequately enforced. However, these positive measures are still geared largely toward improving environmental conditions domestically, with seemingly little regard for impact on forest areas outside of China's borders. For example, it is troubling that that the Plan specifically calls for increased logging and timber processing activity to take place in key producer areas like Russia, Southeast Asia, and Africa, and identifies incentives to facilitate the export of Chinese processing equipment to those zones. It appears that in this economic downturn, and despite (or due to) the upcoming climate change negotiations in Copenhagen, where forest-based mitigation will be a key feature, China appears to have every intent to strengthen its timber industry and China's access to carbon credits, even if it comes at the expense of forest-rich developing countries elsewhere. ¶16. (SBU) The skepticism about the impact of the Plan is not only limited to the lack of consideration of foreign resources. Chinese business is particularly skeptical of the Plan because there is no real money behind it. The forest products industry is overwhelmingly privately-owned and small. This type of enterprise is reactive to the market, particularly overseas demand. Small players tend not to listen or take heed of broad "Plans" from the government. Second, the lever that moves the forestry industry more than any other is the VAT rebate for exported products, of which the Plan makes no mention. Industry believes that the government will "get serious" only when the VAT rebate is increased or decreased to promote or discourage exports, respectively. Thus, this forestry plan probably lacks meaningful policy tools to impact significantly either the processing of wood products in China or the harvest of resources in third countries that fuel the industry's growth. END COMMENT HUNTSMAN