CHINA'S policy of providing generous tax rebates to exporters may be up for reconsideration as data continue to show a strong recovery in Chinese goods heading overseas.

"China's economy has staged a V-shaped recovery, signaling the point for a policy change," Zhang Yansheng, director of the International Economic Institute under the National Development and Reform Commission, said last week.

China's exports in May surged 48.5 percent from a year earlier, the General Administration of Customs announced yesterday. May 2009 was the low point in the export slump that followed the global financial crisis.

At the height of that crisis, the Chinese government increased rebates for exporters eight times to counter a plunge in overseas demand. That took the rate of rebates up to an average 13.5 percent from 9.8 percent.

That means that an exporter who paid, say, 16 percent in value-added taxes would get a rebate, bringing the effective tax rate down to 9.8 percent. China's export nosedive started to turn last December, when export growth returned to the black after seven months of declines and China overtook Germany to become the world's top exporting nation.

"Export growth seems to be back on a firm footing, so it's time for the government to take another look at the rebate regime," said Liu Kegu, former director of the China Development Bank. "It's one thing to give rebates when that sector was in peril and quite another to continue rebates when no stimulus is needed."

The rebates refund part of the value-added tax companies pay to the government. They also cover some sales taxes paid on certain goods. The amount of VAT and rebates vary according to sectors and goods. Exporters of mechanical and electrical products, for example, now get a full refund of the 17 percent VAT they pay.

Cost cutting

The rebates cover more than 8,000 tariff lines of goods. They were intended, in part, to provide exporters extra funds for research and development to improve product quality and move goods up the value chain as China tried to shake its image as a cheap-goods manufacturer and deflect criticism from trading partners.

But most exporters, especially in low-end goods, such as shoes, toys and textiles, simply use the rebates to lower their prices and woo more buyers.

"The policy is not flawless," said Xue Jun, an analyst at CITIC Securities Co. "Many foreign importers know the rebate policy well and use it to bargain for lower prices."

By drastically reducing or even eliminating the rebates, some Chinese economists argue that producers deprived of price advantage will pay more attention to improving the quality and value of goods. But moving factories up the value chain is no easy feat.

"China is struggling to get its exporters to shift from low-value goods to semi-finished goods that will earn them more profits," said Xue. "Other manufacturers in what were once emerging economies in Asia have gone through it successfully, but it's a slow process. Eliminating rebates will help."

It would also help the government. The rebate policy cuts deep into the pockets of government revenue. In 2009, China returned 648.7 billion yuan (US$94.9 billion) in rebates to exporters.

The rebate policy has come under serious scrutiny in the past. In 2006 the government overhauled the policy, reducing rebates on exports of goods whose manufacture consumed large amounts of energy and were resource-intensive, such as crude oil and steel.

Reducing rebates would ease industrial overproduction, relieve pressure on the yuan and deflect anti-dumping allegations from trade partners, the government said.

There were signs, at that time, that the policy change was indeed forcing some exporters to move away from resource intensive goods toward high-value processed goods. But whatever strides that were under way got dashed by the global economic crisis, the plunge in national exports and a return to heavy rebates.

China has been trying to reduce its dependence on exports and encourage more consumer-led growth.

Industry sources predict the government will scrap the 9 percent rebate for hot-rolled steel and reduce the rebate for cold-rolled steel and galvanized steel to 9 percent from 13 percent. The new policy, they said, may be announced next month.

Some people fret that such a policy shift may throw the export recovery process into reverse. They point to the sovereign debt crisis and possible recession in the European Union, China's largest trading partner.

"We think it's too early to remove the rebates," said Luo Jianping, general manager of Guangzhou Toona Baba Toys Manufacturing Ltd. "The world economy is very fragile and we need more months of positive data to demonstrate that the export recovery is sustainable."

So far the Chinese government seems undeterred. "Will the crisis in Europe become more serious than the former one in America? Obviously not," said the National Development and Reform Commission's Zhang.