The Red Dragon slips its leash

As China steps over the threshold into the WTO, the pulp and paper industry gives a mixed response to the question of what the future holds. For some companies, it means a breath of fresh air regarding the review of rules and regulations. For others, it may spell the end of the road

by Caroline Jewitt

This month will mark an historic event in terms of globalization. The World Trade Organization (WTO) Ministerial Conference in Doha, Qatar, is set to formally adopt an agreement, which will allow China to become a member of the WTO. Arduous negotiations on China's entry into the global organization have been ongoing for almost 15 years, but at last, the nation has made it. From the WTO's point of view, China's accession is a major coup, as "the WTO will take a major step toward becoming a truly world organization", according to Mike Moore, WTO director-general, who spoke at the meeting of the Working Party on China's Accession in September. But not everyone sees the move through rose-tinted spectacles.

Take the pulp and paper industry, for example. According to one financial analyst, "From a domestic viewpoint, entry will increase quality and competition, as well as decreasing tariffs. From a foreign viewpoint, the industry will be more regulated with greater transparency. China will become a more level playing field." On top of that, it is one of the only economies that are still growing in the world at a rate of around 7%. The Asian Development Bank has forecast GDP growth of 7-7.75%/yr in 2001-2003. According to another source, China is expected to show 25% of the world's demand growth in the next 15 years and Asia is expected to show 50%.

These factors may all be true, but there are some observers who remain skeptical as to the benefits for the local pulp and paper industry. Many local producers are already finding it difficult to compete with imports and the modern foreign-owned producers in China in terms of quality and price. It is widely expected that these domestic producers will suffer even more following the country's entry into the WTO when import tariffs will fall from 10-15% to around 5-7%. Chinese producers have already seen what tariff reductions can do to business following the bilateral access agreement between China and the US that was formed in November 1999. The agreement reduces most Chinese paper tariffs to 5-7.5% with the lower rates coming into effect by 2003, according to Paperloop's Asian Pulp & Paper Markets/China report.

Lower tariffs are hailed by many observers as the golden key to increased trading within the Chinese pulp and paper market. But Paul Blamire, paper industry analyst at Nikko Salomon Smith Barney (NSSB), is one of many insiders to take a less positive view, based on the implications for local companies. China is home to hundreds of small, old production sites that simply cannot compete with the modern technology that is installed in the country's larger mills. "China's products are scattered among numerous small operations. There are few world class mills in China in terms of quality and size. This limits the scope for exports," he says. "There will not be a big rush out of China in the form of exports, which knocks the argument for lower tariffs on the head," Blamire comments.

Forcing out the small fry

Looking at trade between China and Japan, for example, one industry analyst says, "The tariffs are not excessive at the moment. The benefit to Japan will be seeing China inside the WTO. Japan will be able to go through the WTO to bash China for dumping [paper]. Japan will welcome the formal processes and bring China to book."

Japanese producers may recoup some losses, but several Chinese companies are worried over the implications. The effect of changes to anti-dumping regulations for newsprint is on the mind of Zhang Yaohui, chief engineer and vice general manager at the Qiqihar mill in China (see separate article). While Zhang is not worried about his own company, as Qiqihar is one of the most modern and competitive newsprint mills in China, he believes that most Chinese newsprint producers may suffer under new anti-dumping rules. At the moment, Chinese newsprint producers are protected by anti-dumping duties of up to 78%. The duties, which were set to run for five years from July 1998, were imposed on Korean and North American newsprint. But the protective shield is about to be lifted, which is sure to hurt smaller, inefficient players.

However, Yang Kuangyu, chairman of the China Newsprint Association also says, "The sliding scale duties on newsprint imports are unlikely to be removed." He explained that since the government has already pumped hundreds of millions of dollars into modernizing state-owned newsprint mills, it is impossible to leave them open to foreign competition in the near term. "I estimate that it will take another 3-5 years for the domestic newsprint mills to reform," Yang adds.

On top of that, the country's highly prized newsprint sector is trying to cope with an oversupply problem. One local producer said recently, "I don't think Asian newsprint markets realize the extent of the oversupply problem."

A wave of newsprint capacity expansion projects in China has already led to a drop in newsprint prices, despite healthy demand levels in the region. Between 2000 and 2001, around 820,000 tonnes/yr of new capacity was added at seven newsprint mills. The Chinese government has subsidized the schemes to make domestic producers more competitive ahead of WTO membership. But the extra capacity has only served to create an oversupply of newsprint in the domestic market where prices have dropped 10-15% from early in the second quarter.

Producers are becoming concerned about the amount of overcapacity, with companies such as Jilin Paper and Wuhan Chenming Hanyang installing swing machines to enable them to produce other printing/writing paper grades if the market is oversupplied.

Metso Paper received the order to supply a LWC/newsprint production line to Jilin Paper. The startup of the line, to be built at Jilin, northern China, is scheduled for late 2002. According to Metso Paper, China has become one of the most important markets for the company. In September, the supplier opened a new service technology center in Jiangsu Province.

Another major equipment supplier in the region says that the WTO is not necessarily the driving force behind any bonuses to come in the future. "Looking at the order trend, we have seen rather rapid acceleration even without the WTO," according to the supplier. "Business has accelerated over the last three years and we have already established an office and business center there. Looking at the past record, figures have climbed drastically over a period of time and can only accelerate further," he continues.

Blamire and his colleague, Peter Cain, at NSSB are familiar with the threat that orders for large new machines pose on the smaller players. "Asia has thousands of small machines producing paper and board, which is simply not of international quality, and usually on a scale that is well below the industry average," they say. "We expect these machines will either be restricted to producing low-margin products for local customers, or they will be forced to stop producing," Blamire and Cain add. The two analysts point out that, on average, Chinese paper mills produce less than 6,000 tonnes/yr, yet the world average is over 60,000 tonnes/yr. In fact, only 40 mills in China produce more than 10,000 tonnes/yr and only a handful of these sites churn out products of international quality, according to NSSB. In comparison, the average production at mills in developed economies is well above 100,000 tonnes/yr.

Bigger and better

One major Japanese company also anticipates a backlash on small Chinese producers coupled with substantial benefits for its own operations. The firm plans to expand in Asia based on the fact that Japan's market growth is estimated to be low compared to China, for example. "Many companies would find it [China's membership] an opportunity as the Chinese paper industry is generally out of date. China's raw materials are poor, so foreign producers have the scope to export more to China, as well as investing in the region," the company says. The end result, according to the Japanese firm, will be the collapse of the small non-competitive papermakers.

For the bigger fish in the sea, China's WTO entry will not have so much of an impact. UPM-Kymmene, for example, says that it is optimistic about the free trade development, which should boost the service sector in China and drive higher demand for quality printing/writing grades. "The move promises to create further value-adding opportunities for Changshu," according to one company source.

Kenneth Nystén, president of Stora Enso (HK), says, "We are unsure as to what will happen yet. We know that duties should be reduced from 10% for board and 15% for fine paper to around 5-7%. That's quite realistic. But when that will happen, nobody knows," he says.

Companies should not expect to see miracles on the day after China joins the WTO. It is widely accepted that it will take years for the region to adapt to the rules and regulations.

On the surface, the move represents a fantastic opportunity for companies that have already made an effort to grow and gain value. But for the others, it seems that the Chinese government has left them high and dry in its eagerness to join the global network. The next 12 months may prove to be the toughest yet, for hundreds of small, local enterprises.