Trade Tricks Defy China's Rule of Law Campaign

An analysis by Michael Lelyveld
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A Chinese clerk counts yuan banknotes at a branch of Agricultural Bank of China in Qionghai city, Hainan province, July 15, 2014.
A Chinese clerk counts yuan banknotes at a branch of Agricultural Bank of China in Qionghai city, Hainan province, July 15, 2014.

Illicit trade practices and currency speculation could provide an early challenge to China's "rule of law" campaign.

In October, President Xi Jinping launched his drive for legal reforms and obedience to the ruling Chinese Communist Party (CCP) at the Central Committee's fourth plenary session, vowing to "comprehensively advance the rule of law."

Yet, within days, reports of rampant trade fraud surfaced, citing the familiar ruse of filing fake invoices to hide flows of "hot money" and evade China's currency rules.

The flagrant use of phony export documents may raise doubts about how much has changed and whether the rule of law will extend to lucrative but surreptitious arbitrage deals.

On Oct. 27, Bloomberg News reported obvious signs from September trade figures that speculators had moved large sums of cash into China to profit from exchange rates and the strengthening yuan, reviving a practice that regulators tried to stamp out early last year.

According to Bloomberg, China's official trade figures for the month showed a 34-percent surge in exports to Hong Kong valued at U.S. $37.6 billion (229.9 billion yuan), but Hong Kong's corresponding record of imports rose just 5.5 percent to U.S. $24.1 billion (147.3 billion yuan).

The difference of over U.S. $13 billion (79 billion yuan) is believed to reflect the amount of disguised currency inflows, represented as payments for phantom exports with forged invoices, reported as legitimate trade.

"This is definitely another important piece of evidence of over-invoicing exports to Hong Kong to facilitate money inflow into the mainland," said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, as quoted by Bloomberg.

Investigators from the Ministry of Commerce (MOC) and the General Administration of Customs (GAC) were reportedly sent to southern Guangdong province to probe the huge discrepancy.

But previous crackdowns on bouts of phony invoicing from late 2012 have done little to deter the use of fake documents, which have been openly advertised and sold for years.

"We'll take corresponding regulatory measures, if necessary," a GAC spokesman vowed in April 2013.

"Companies and banks who break the regulations face being fined or closed, and their practices exposed to the public," said the State Administration of Foreign Exchange (SAFE) a month later.

Despite the threats, the profitable practice has persisted, allowing speculators to dodge China's currency controls, while others may claim export tax rebates for goods never sold.

The scam not only fills the pockets of forgers and speculators. It also distorts China's trade figures, giving false readings of the country's economic growth.

China's total exports for September jumped 15.3 percent from a year earlier, their best performance in 19 months, according to official figures.

On Nov. 8, the GAC reported that October exports rose at a slower 11.6-percent rate, but how much invoicing played a part was hard to say.

Campaign goal

The question is whether the rule of law drive will bring an end to such common crimes or whether it will be used primarily to enforce CCP authority and prosecute selected officials for corruption.

Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington, said that past government anti-crime campaigns have had little impact on activities like export fraud.

"There have been lots of 'strike hard' campaigns, corruption crackdowns and the like, and none have ever affected false invoicing," said Scissors.

"False invoicing comes and goes for commercial reasons, not because of the current political theme," he said.

Aside from export reporting, China's leaders have been facing apparent resistance to government authority and party discipline on several fronts.

In the run up to Beijing's showcase Asia-Pacific Economic Cooperation (APEC) summit earlier this month, for example, the Ministry of Environmental Protection (MEP) publicly summoned the mayor of Anyang city in central Henan province for defying cleanup plans.

The official Xinhua news agency said the city, some 500 kilometers (310 miles) from the capital, had failed to implement anti-smog rules for high-polluting cement plants, steel mills and other manufacturers despite MEP monitoring since June.

"Some factories have even secretly discharged pollutants at night," the report said.

In preparation for the APEC summit, Beijing authorities and the central government imposed an expanded list of measures for the city and surrounding region in an effort to improve air quality for the event, including traffic restrictions, enforced "holidays" for workers, factory shutdowns and suspension of construction projects.

The extraordinary steps may have put some of the central government's muscle behind MEP enforcement, which has often been criticized as toothless.

Some 28,000 police officers and 800,000 civilians were mobilized for the event to ensure security and enforce emergency rules, Xinhua said.

But even in Beijing, some of the rules were blatantly disobeyed.

On Nov. 4, the city's environmental protection bureau found 16 cement mixing plants and construction sites were continuing to work as usual despite a ban on activity that was supposed to last through the summit ending on Nov. 11, the official English-language China Daily said.

Construction workers were unhappy with the stoppages because they only receive half-pay when their projects are suspended, the paper reported.

Inspectors also found dozens of enterprises and construction projects in Shijiazhuang, capital of neighboring Hebei province, ignoring the business bans, The New York Times said.

Effect on business

There may be nothing extraordinary about violations of environmental rules, but they may raise questions about whether the rule of law campaign has had any effect on everyday business, even under the spotlight of an international event.

Recent reports on China's steel industry suggest manufacturers are continuing to defy orders to cut production under the government's five-year anti-smog plan announced in 2013, despite the additional threat from the rule of law push.

In October, the China Iron and Steel Association (CISA) said industry output rose to record levels in the first nine months of the year, plunging prices to an 11-year low, Xinhua reported.

Total crude steel production rose 2.3 percent to 618 million metric tons (681 million tons) in the period, accounting for over half the world's output, CISA said.

The overproduction prompted the CPP flagship paper People's Daily to complain that steel is now "almost as cheap by weight as Chinese cabbage," Reuters reported.

On Oct. 20, Xinhua blamed the lack of a rule of law for a host of economic problems, including "overcapacity, real estate bubbles, risks of local government debts and shadow banks."

But whether the government will crack down on industry resistance to its policies under the rule of law remains to be seen.

Although Xinhua cited shadow banking as one of "the pains currently suffered by the Chinese economy," it was also unclear whether the rule of law would be used to close down the avenue of alternative financing offered by China's big banks.

Last month, a report by the Financial Stability Board of the Group of 20 leading industrialized nations said China's shadow banking sector had grown rapidly to become the third-largest in the world.





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