China's paper industry: entering the WTO era: despite its unique challenges, China's paper industry is ready for development and growth.

China entered the world Trade Organization (WTO) in December 2001. This secured foreign investment protection for China and has already resulted in increased direct investments from abroad. Several Nordic paper companies--including Stora Enso--have started deeper evaluations of their paper and board project plans. At the end of 2002, UPM-Kymmene announced an expansion of its Changshu mill. Several domestic and international board makers have started major expansion projects, such as four new machines at the Nine Dragons mill. In 2001, Chinese paper and board demand increased by 5.3%, reaching 38 million metric tons, and production surpassed 33 million metric tons. In 2002, the country passed the 40 million benchmark for demand.

The Chinese environment is challenging for foreign papermakers due to the scarcity of wood raw material, the current foreign exchange of the Chinese yuan (CNY), and the country's priority on domestic production. Demand in China for paper and board will no doubt continue to increase for decades, and the continuous investments in domestic paper and board capacity make this country a real challenge for international papermakers.

HUGE RESOURCES

With 1.27 billion inhabitants, the People's Republic of China is the most populous country in the world. An average Chinese citizen consumes 30 kg/year of paper and board for a national consumption of 38.2 million metric tons in the year 2001. This 30 kg is less than one-tenth that consumed by the 282 million inhabitants of the United States, whose total demand of 88 million metric tons averages 325 kg/year of paper and board per citizen. If the Chinese would consume as much as Americans, paper and board demand in China would increase to more than 410 million metric tons!

The Chinese built 12 million metric tons of new paper and board capacity between 1995 and 2002. Assuming that a ton of capacity costs US$ 1200, spending on paper and board mills has been as high as US$ 14.4 billion, not including raw material preparation, for a yearly average of US$ 1.8 billion dollars (CNY 15 billion). Annual raw material preparation investments should cost an additional US$ 1 billion, or CNY 8 billion, to cover international costs. For that money, the Chinese could finance half their current pulp and paper and board imports. If China did not invest in domestic production, pulp and paper imports would become intolerably expensive.

New, magnificent buildings in Shanghai, Guagzhou, Beijing, Tianjin, Tsingtao, and the downtown of every large city attest to China's continued growth and prosperity. This prosperity also brings an easier lifestyle, with shorter working hours and less mental stress.

The growth of gross domestic product (GDP) shown in Figure 1 that occurred at the end of the Cultural Revolution in 1976 was the result of decisive action. Deng Xiaoping, a minister and advisor to Mao Tsedong, designed a "Socialist Market Economy" by gradually softening state controls. The first amendment involved rural production by restructuring into a more capitalist model that benefited the self interest of farmers. This policy, along with the dismantling of the cooperative agricultural system, has secured the Chinese food supply. During the recent decade, food has not been scarce in China. The land belongs to the state, but responsibilities and decisions for farming belong to farmers and their families.

[FIGURE 1 OMITTED]

Today, 70% of the population still lives in the countryside working in agriculture and primary industries. However, increasing numbers of people are unemployed and willing to move to cities, hoping for better lives. Productive farming continues to be the cornerstone of China, although growth comes from trades, industry, and services. Although the economy still involves central planning--at least in the minds of state officials--the reality resembles "restricted capitalism," with increased private company ownership and investment financing. This works well despite occasional inefficiencies and bankruptcies, but statistical biases may exist.

MAINTAINING GROWTH

Economic growth in China faced challenges during the period from 1997 to 2001. The government invested heavily during low growth years. This helped maintain high GDP growth, but slow development in paper and board demand during those years hints at reality.

The Chinese government chose to enter the WTO to maintain the high foreign investment volume that traditionally produces more exports and helps total economic growth. In 2002, China enjoyed 8.0-8.2% GDP growth. China has implemented new technologies and production methods to meet its needs for increased competitiveness. These efforts should also boost domestic development.

WTO participation means that imports will receive equal treatment with domestic production in China. This has been the trend. In recent years, Chinese paper and board import duty protection has been approximately 15%-25%. Since the beginning of 2002, duties have dropped to 5%-10% except for certain domestically important grades such as copy papers, which have 16% protection. Pulp imports face minimal protection.

China has committed to further reduce import duties within two years, when paper and board duties will reach approximately 5%. Today, the protection offered by import duties and practical import restrictions is already very low. The more important barriers dwelling in the minds of traders and consumers are cultural barriers.

China continues its practice of special economic zones. In the early 1980s, China established special economic zones in Shenzhen, Zhuhai, and Shantou in Guangdong Province; Xiamen in Fujian Province; and the entire province of Hainan. In 1984, China opened 14 coastal cities--Dalian, Qinhuangdao, Tianjin, Yantai, Qingdao, Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangzhou, Zhanjiang and Beihai--to overseas investment. Beginning in 1985, the state decided to expand open coastal areas. This extended the open economic zones of the Yangtze River Delta, Pearl River Delta, Xiamen-Zhangzhou-Quanzhou Triangle in south Fujian, Shandong Peninsula, Liaodong Peninsula, Hebei, and Guangxi into an open coastal belt. In 1990, the state established Pudong New Zone in Shanghai. More cities in the Yangtze River valley received similar rights.

In addition, China has established 15 free trade zones, 32 state-level economic and technological development zones, and 53 new- and high-technology industrial development zones in large- and medium-sized cities. This system offers benefits for foreign-Chinese joint ventures, such as a two-year exemption in national income tax beginning in the first profitable year followed by three annual 50% reductions. Numerous additional benefits exist for export-oriented, high-technology production joint ventures. In the forestry sector, additional ten-year tax reductions are possible. This support system will continue to operate, emphasizing locations in developing areas of China--especially in the Western and Central regions.

Joining the WTO will not bring major change to China's economic or political development. The country will respect international practices and rules because it is beneficial to do so. WTO membership has brought the Chinese economy a wider, more panoptic worldview through follow-up from the WTO organization and its member countries that do business in China. Membership deepens foreign participation in Chinese businesses and Chinese participation in foreign businesses due to reduced risks.

China will continue to control its economy as before and practice its own independent economic policies. These policies reflect the unique character of the Chinese political system, which China expects other countries to respect. China has promised to open its banking and financial system to international players within a suitable time and has promised to reduce import barriers and duties. The country is also on the road to a free currency exchange. The timeframe depends on the economic situation and political decisions, but the date will certainly not be very soon.

CHINESE CURRENCY EXCHANGE

One important issue preventing the free convertibility of Yuan is the Chinese price level. Table 1, developed from the national accounting, illustrates this. Buying a U.S. dollar requires 8.28 units of Chinese yuan. The information in the table shows that the gap between the Chinese nominal GDP in U.S. dollars and the price-adjusted GDP--adjusted using purchasing power parity--is rather wide as is customary in developing countries. This is true because domestic prices are lower than international prices due to quality and availability. For the Chinese, international prices are 4.7 times higher than domestic prices! This means that the international value of the yuan is lower than its real value. This discourages imports and favors domestic consumption and export. While this is common in developing countries, it naturally favors domestic production.

Free convertibility should narrow the gap between domestic and international prices. It will also accelerate domestic inflation during the transition--which will likely last for decades. Chinese exports currently total approximately US$ 300 billion. This reflects a solid 30% share of the GDP, but it is less than 10% from the price adjusted GDP. If inflation narrows the gap from 4.7 times to 2.35 times, domestic prices would increase by 100%. Economic planners do not desire such a development.

RAPIDLY CHANGING HABITS

Today, newspapers sold in major cities in China carry multi-colored pictures and advertisements. While newspapers are still posted on public wallboards, the habit is gradually disappearing. China consumed 1.87 million metric tons of newsprint in the year 2001 partly due to increased supply from new production lines built in Nanping, Qiqihaer, Guangzhou, and Jilin. Some fine paper suppliers occasionally ran newsprint, resulting in 1.73 million metric tons of total production.

Ten years ago, newsprint consumption and production was only 0.5 million metric tons. Only 4.9% of Chinese paper and board is newsprint; globally, newsprint averages 11%-12% of demand. (That figure is 11.8% in the United States.) China will continue to rapidly increase the share of total paper and board demand for newsprint.

China's literacy rate is more than 80%. The Chinese need 3000 characters to communicate everyday matters. A sophisticated person may master ten times as many characters. The Chinese Lexicon (eight volumes published in 1986-1990) contains 56,000 characters. Printing these characters requires a smoother paper surface than traditional newsprint. The Japanese usually surface size or pigment their newsprint to prevent linting and reduce pressroom breaks. This is not common in China where many conventional techniques could still improve newsprint quality but one can easily guess that there will be the same need over time.

Paper and board growth has been vigorous. Demand has been growing by 8%-9% annually over the past 30 years, as Figure 2 shows. Imports grew quickly in the 1990s--especially for coated paper and board and containerboard grades. Predictions for the coming decades are still high. The period from 2000-2010 should see an increase of 30 million metric tons to 68 million--an average 6.3% annual growth. Low income levels in China justify similarly high expectations for the following decade. Figure 3 compares projected Chinese demand with that of the United States, Japan and European Union.

[FIGURE 2-3 OMITTED]

RAW MATERIALS CHALLENGE

Chinese raw material service is complex. Nonwood pulp varieties have provided a solution in the past. Their quality does not always meet current requirements as Chinese papermakers strive to increase product quality. Many companies try to maximize the use of nonwood fiber pulp as a furnish component to minimize production costs.

China's papermaking industry lacks wood fiber. Domestic wood contributes only 10% of papermaking fiber. More than half that amount is already maximized through high yield mechanical and semichemical pulping methods. According to the Global Fiber Supply Model of FAO, the country has 134 million ha of forests or 14% of the total land area. Chinese projections say there are 159 million ha of forests or 16.6% of the land. Globally, forests cover 29% of the land. China has roughly the same land area as the USA, but its growing stock is 5 billion cubic meters ([m.sup.3]), while the USA has 14 billion [m.sup.3] of timber in its forests. As a result, China imports about 30 to 40 million cubic [m.sup.3] annually, 40% of that from Russia.

China already has 45 million ha of plantations totaling 4.8% of the land or 27% of all forests. Bamboo forests account for 3 million ha. Planted bamboo adds 1.3 million ha. Roundwood production was approximately 290 million [m.sup.3]/year in the 1990s, but the share of industrial roundwood has increased to 100 million [m.sup.3]/year. At the same time, consumption of fuel wood has decreased from 200 million [m.sup.3]/year to 190 million [m.sup.3]/year.

Use of wood for pulping doubled during the 1990s, from 1.7 million metric tons of pulp in the early 1990s to the current 3.7 million metric tons of pulp. This is only 10% of all industrial roundwood. In comparison, the papermaking industry in the Nordic countries uses approximately 40% of the wood supply.

The forest cover in China is increasing by 1%-1.2% a year. In all of Asia, forests are decreasing by 0.05% annually. Globally, the reduction is approximately 0.24%. Plantations will continue to increase forest cover in China. The Chinese paper industry plants 1.2 million ha/year of forest. Current plantations include 29% pine, 36% larch and other coniferous species, 3% eucalyptus, and 0.3% acacia. Fast-growing poplar and aspen are common species throughout the country. The chemi-thermo-mechanical pulp mills use aspen, poplar, and larch. One promising trend is the development of hybrid poplar at Beijing Forest University. This wood grows as fast in Shandong as eucalyptus in Guangxi, is bright and has a rather long fiber. It is a suitable component for fine paper production as CTMP pulp.

Reforestation could make the 55 million ha of unproductive forests productive again and reduce the use of the wood for energy. The Chinese government has plantation programs and strongly supports papermaking investments that include forestry operations. Plans call for an additional 5.9 million ha of pulpwood plantations under government coordination by 2010. This plan proposes planting Caribbean and Masson pine in the South; red pine, Masson pine, aspen, and poplar in central China; and aspen, white pine, red pine, larch, and poplar in the North. Already, the government has allocated 3.1 million ha to companies. This should at least triple wood pulping capacity from current levels.

THE CURRENT REALITY

Cao Zhenlei, president of the China National Research Institute, Beijing, is not concerned about raw material availability, even though current plans cannot meet requirements and China will have to import larger quantities of pulp. He has noticed that Japan, South Korea, and many other Asian countries lack fiber but still have developed strong papermaking industries. He thinks that "the market will take care of the raw material issue" in one way or another. Plantations will help, and imports of wood and wood chips will increase. The Chinese will also invest in foreign pulping facilities, such as the Marga Buana Bumi Mulia 600,000 metric tons/year pulp mill project in Indonesia.

Cao welcomes international investors to Chinese papermaking. Several European and Asian companies are already involved, and some American companies are discussing opportunities. Although 100% foreign ownership of papermaking enterprises is possible, Cao recommends joint ventures to make the experience smoother by easing communication and providing knowledge of the Chinese environment. Potential pulp operations should consider a local partner for more effective raw material management or forestry operations. Papermaking investors with raw materials available elsewhere have a stronger position than those relying on the fiber supply from the markets. Cao feels that the foreign investments are necessary and very welcome.

CHALLENGES AHEAD

The paper industry in China faces several challenges. One is product quality; another is scale. China already has technology and knowledge. Continuing development through continuous, low risk investment in medium scale machinery will be important. Cao wants to see paper quality maintained by suitable furnish, primarily wood, although non-wood is still a viable alternative.

Recently, Chinese paper machines have set speed records. In August, APP Suzhou's PM1, a 7.2-m wide fine paper machine supplied by MHI, ran at 1530 m/min. The 10.7m wide fine paper PM1 at APP's Goldeast Paper Dagang Mill ran at 1524 m/min in July, and the 5.3m wide newsprint PM6 at Nanping has reached 1610 m/min and run at an average speed of 1439 m/min during 2001.

Cao Zhenlei confirms that strong activity will continue in China, especially in packaging paper and board. Sun Paper in Shandong has several capacity expansion projects. Sinar Mas (APP) Ningbo is planning an additional board making line under the name of Ning Shing Development with an 8.8/8.2 m, 700,000 metric tons/year folding boxboard (FBB) machine. Nine Dragons is planning to build four more machines: an FBB machine (450,000 metric tons/year) and a liner/fluting machine (400,000 metric tons/year) at the Dongguan mill, which currently has four new machines with a total capacity of 1 million metric tons. Nine Dragons will also build a 450,000 metric tons/year linerboard machine and another 550,000 ktpy liner/fluting machine at Taichang, Jiangshu Province, close to Shanghai. Two of these machines (FBB at Guangdong and the linerboard machine at Taichang) have been ordered already and should be running by the end of 2004; the two additional machines should start up in 2005.

APP's Hainan Pulp Mill project is also on the official list of projects, but has not yet begun. UPM-Kymmene will build an additional fine paper machine at its site in Changshu with a capacity of 450,000 metric tons/year Store Enso has a similar plan, and the company is studying the feasibility of building a pulp mill with eucalyptus plantations in Guangxi province in southern China.

In addition, Lee & Man Paper Company, Guangdong, has ordered a 400,000 metric tons/yr linerboard machine (PM5), which will start up in December this year.

Restructuring continues. Small mills below 10,000 metric tons/year will gradually close due to their inefficient use of machinery and inability to pay for environmental investments. China hosts approximately 5000-5500 paper and board mills. Today, the strongest companies such as Chenming Group are taking the leadership from other medium-sized companies such as Jiangxi Paper, which failed in its newsprint investment.

The unique characteristics of the Chinese market make it challenging. It currently comprises 12% of global paper and board production. The government wants to develop domestic production of pulp and paper. Market forces will make the decisions based on costs. Investment will continue as the market continues to grow.

Table 1: How China compares

Chinese share of the global markets: 75% of the global nominal GDP
and P&B markets

        Population   Nominal   PPP * adjusted    P&B Con-     P&B Pro-
                 %    GDP %             GDP %   sumption %   duction %

China      20.8        3.4          11.1           12.0        10.5
Japan       2.1       14.4           7.7            9.6         9.7
EU          6.2       27.1          20.0           24.1        25.8
USA         4.7       30.7          21.6           27.5        25.4
World     100.0      100.0         100.0          100.0       100.0

        PPP adjusted GDP/
             Nominal GDP

China        4.66
Japan        0.76
EU           1.05
USA          1.00
World        1.42

* Purchasing power parity

Source: World Bank, PPI, China Paper Association

RELATED ARTICLE: Facts and figures for People's Repunlic of China.

Population

* 1.27 billion, with growth of 0.9%/year.

* 30% live in the urban areas

* 26% are below 14 years and 7% are over 65 years

* 20.9% of the world

Economy

* In 2001, GDP US$ 890 per capita

* Total GDP US$ 1140 billion

* 35% of the world markets: price adjusted GDP 11%

Forestry

* China has a forest cover of 159 million ha--16.6% of the entire country.

* The paper industry has access to 10% of that wood.

Paper & Board

* China produced 33.2 million metric tons P&B and consumed 38.2 million metric tons

* In the 1990s, the average market growth was 9.2%.

* Prospects are 6.3% a year during the 2000s.

* In 2001, Chinese production was 10.5% of the global, and consumption was 12%.

* China is the 3rd largest market after the United States and European Union.

Ethnic groups

* 91.9% Han people and 8.1% comprised of 55 ethnic groups. Largest of these are Zhuang, Uygur, Hui, Yi, Tibetan, Miao, Manchu, Mongol, Buyi, and Korean.

* Most ethnic groups are in the southwestern and western part of China.

Literacy

* 82%. Languages: Standard Chinese = Mandarin (Putonghua-Beijing dialect), Yue (Cantonese), Wu (Shanghaiese), Minbei (Fuzhou), Minnan (Hokkien-Taiwanese), Xiang, Gan, and Hakka dialects.

* Almost all minority groups have their own languages except Hui and Manchu. Local languages are the main language in primary schools.

Religions

* Taoism (combined occasionally with Shamanism), Buddhism, Islam, Christianity, Eastern Orthodox Christianity, Dongba. Han people are Taos, Buddhists, or Christians.

* Islamists are Hui, Uygur, Kazak, Kirgiz, Tatar, Ozbek, Tajik, Dongxiang, Solar, and Bonan.

* Buddhists are Tibetan, Mongolian, Lhoba, Moinba, To, Yugur, Bai, Blang, and Deang.

IN THIS ARTICLE, YOU WILL LEARN:

* How WTO membership will affect the paper industry in China.

* How the fiber situation in China compares with other countries.

* What new projects loom for Chinese pulp and paper companies

ADDITIONAL RESOURCES:

* Visit the World Trade Organization's home page at www.wto.org

* For information about the China Paper Conference in Shanghai next month, go to www.ejkrause.com/chinapapershanghai/

About the authors: Hannu Oinonen (top photo) is an economist, engineer, and independent market and technology researcher based in Finland. He has carried out extensive research in Asia and is the co-author of several reports on the Asian paper industry. He can be reached at [e-mail].

Nie Xiaorong, Ph.D, is an assistant professor at Nanchang University in Jiangxi province. She completed her post-graduate degree at the University of Helsinki.