Wittbecker on Aluminum: Is China's removal of VAT an admission of defeat?

That event is China’s decision to rescind its export VAT (value-added-tax) rebate program.

VAT as a stimulus to exports

China began its export VAT rebate program in 1985. The goal was simple, to enhance the competitiveness of China’s emerging industrial base in foreign markets. It worked well in many sectors and particularly well in the aluminum semi-fabricated and fully fabricated markets.

It should be noted upfront that the VAT rebate program did NOT apply to primary, unwrought aluminum. In addition, China maintains an export duty of 10% on primary aluminum. This should dispel misleading reports in the media (and in some political circles) that China is a massive exporter of “primary” aluminum.

Are there exports of primary metal from China? Yes, undoubtedly there ARE exports of primary. But those exports are nothing compared to what has transpired in semi-fabricated and fully fabricated products.

Unlike primary, Chinese exports of “semis” in the form of sheet, plate, extrusions, and wire/cable have flourished. The most recent monthly data, for December 2024, showed exports of $ 3.41 billion. During calendar year 2023, Chinese aluminum exports topped US$ 34.9 billion, according to data from the United Nations Comtrade database. That’s looking at it by value. In terms of volume, exports of semis peaked at 6.2 million tons in 2024.

Long-term negative consequences of the VAT program

The surge in exports came at a considerable long-term cost. Chinese capital investment (capex) in its mid- and downstream sectors exploded. Massive expansions were made in rolling and extrusions.

Capex in the rolling sector alone created an untenable capacity situation. China added capacity far faster than its internal rate of consumption, pushing it into a bigger and bigger net exportable surplus. Capacity utilization rates in China rarely exceeded 70% and, at their worst, dipped as low as 50%.

This surplus led to some regrettable decisions by some mills to export so-called “fake semis” in the period 2010-2014. These were heavy-gauge, hot-band products that allowed mills to claim VAT rebates and load the mill.

Exports of legitimate rolled products also poured out into the US, Europe, Brazil, and elsewhere. Accusations of dumping came soon after, and trade actions were launched.

China subsequently found itself on the losing end of every trade case prosecuted: common alloy sheet, extrusions, and alloyed aluminum wheels.

Fast forward to Trump 2.0

The election of Donald Trump to a second term was a wake-up call to Beijing that trade relations with the US were likely to worsen. (At this writing, China has now been hit with a second, 10% across-the-board tariff on its goods.)

China, if nothing else, is very pragmatic in its industrial policy. It understood several things had occurred that demonstrated the VAT rebate program had outlived its usefulness.

• 1. Its access to export markets was increasingly restricted by either anti-dumping/countervailing duties or wholesale country of origin tariff barriers.
• 2. Capital investment in semi-fabricated capacity was out of control and needed to be reined in (like what happened in primary aluminum, which led to a 45-million metric-ton cap being implemented).

The continuation of the VAT program would be “throwing good money after bad.” Exports were likely to face increasingly difficult trading conditions. And there definitely was no reason to continue to build more capacity.

The removal of the VAT rebate program was a critical first step to controlling the sector.

What’s next?

Our colleagues at CRU analysis can walk you through the detailed analysis of export economics in a post-VAT rebate environment. Suffice it to say that the removal of the 13% rebate will take the marginal suppliers out of the game.

We would also expect Beijing to borrow a page from its primary aluminum playbook and institute capacity caps into rolling and extrusion. In addition, we expect that they might introduce a licensing system – as in primary. This system would require new entrants in semi-fabricated production to buy operating licenses from incumbents who wanted to quit the business.

The value of those licenses would be set by the effective conversion margins prevailing in the market. If margins were high, the cost of transfer licenses could be high. Conversely, if margins were low, the licenses could be cheap(er). The important thing is that no net new capacity would enter the market.

This system proved quite effective in the primary sector. Older, less efficient operators were happy to sell out to new, more efficient operators willing to buy the licensing rights.

The demise of the VAT rebate system in China might be the most tangible sign that Beijing realizes that its unbridled access to global markets is over. There was no point in continuing a system of financial incentives to the export sector when the tariff headwinds were getting stronger.

Editor’s note

This is an opinion column. The views in this article do not necessarily reflect those of SMU. We welcome you to share your thoughts as well at info@steelmarketupdate.com.