""

Required Report - public distribution

**Date:** 5/12/2003

**GAIN Report Number:** CH3057

CH3057

**China, Peoples Republic of**

**Tobacco and Products**

**Annual: Part 1 of 2**

**2003**

**Approved by:**

![](media/image1.wmf)Larry M. Senger

#### U.S. Embassy

**Prepared by:**

Dr. Hu Dinghuan, James Butterworth, Jiang Junyang

**Report Highlights:**

Cigarette retailers no longer need to have a special license to sell
imported cigarettes. Despite measures opening the market, China's
tobacco monopoly remains firmly in control. Planted area is forecast to
decrease 4.9 percent but production is forecast to increase 7.0 percent
in 2003. Cigarette producers had a profitable year in 2002. In 2002
tobacco farmers were paid nearly one-third less for their crop than last
year in order to encourage reduced production. In 2003 China contracted
for the import of U.S. tobacco for the first time in recent memory.

Includes PSD Changes: Yes

Includes Trade Matrix: No

Annual Report

Beijing \[CH1\]

\[CH\]

Table of Contents

[**Executive Summary 3**](#executive-summary)

[Statistical Tables 5](#statistical-tables)

[Table 1. Unmanufactured Tobacco: Production, Supply and Distribution
5](#table-1.-unmanufactured-tobacco-production-supply-and-distribution)

[Table 2. Flue Cured Tobacco: Production, Supply and Distribution
6](#table-2.-flue-cured-tobacco-production-supply-and-distribution)

[Table 3. Burley Tobacco: Production, Supply and Distribution
7](#table-3.-burley-tobacco-production-supply-and-distribution)

[Table 4. Oriental Tobacco: Production, Supply and Distribution
8](#table-4.-oriental-tobacco-production-supply-and-distribution)

[Table 5. Dark Air and Sun Cured Tobacco: Production, Supply and
Distribution
9](#table-5.-dark-air-and-sun-cured-tobacco-production-supply-and-distribution)

[Table 6. Cigarettes: Production, Supply and Distribution
10](#table-6.-cigarettes-production-supply-and-distribution)

[Table 7. Tobacco Production by Province
11](#table-7.-tobacco-production-by-province)

[Table 8. Tobacco Production by Type
12](#table-8.-tobacco-production-by-type)

[Table 9. Procurement Prices for Flue Cured Tobacco (2002)
13](#table-9.-procurement-prices-for-flue-cured-tobacco-2002)

[Table 10. Factory Price for Cigarettes (2002)
14](#table-10.-factory-price-for-cigarettes-2002)

[Production 15](#production)

[Tobacco 15](#tobacco)

[Cigarettes and Cigars 16](#cigarettes-and-cigars)

[Consumption 16](#consumption)

[Trade 18](#trade)

[Tobacco 18](#tobacco-1)

[Cigarettes and Cigars 18](#cigarettes-and-cigars-1)

[Tariffs and Non-Tariff Barriers 18](#tariffs-and-non-tariff-barriers)

[Smuggling 18](#smuggling)

[Stocks 19](#stocks)

[Policy 19](#policy)

[Tobacco 19](#tobacco-2)

[Cigarettes 19](#cigarettes)

[Marketing 20](#marketing)

# Executive Summary

In 2003, planted area is forecast to decrease 4.9 percent but total
tobacco production is forecast to increase approximately 7.0 percent.

In 2002, China's tobacco processing industry had a good year. Total
profits and taxes were RMB 145.63 billion, an increase of 20.5 percent
as compared with the preceding year. Tobacco farmers did not have such a
good year than in 2002. They were paid about one-third less for their
tobacco than in 2001.

The planted area of tobacco in MY02 decreased slightly but production,
which was 2,783.5 TMT, increased by 18.5 percent as compared to MY01.
Planted area in nearly half of the main tobacco producing provinces
decreased. The sharpest reductions occurred in Henan, Shaanxi and
Shandong which are less important tobacco producing provinces. These
reductions were offset by increases in the major tobacco producing
provinces.

Total cigarette production was 34.449 million cases in MY02, which is
0.452 million more cases (1.3 percent) than were produced in 2001. (Each
case contains 10,000 cigarettes.) The wholesale quantity of domestic
cigarettes was 34.782 million cases, which was 3.0 percent higher than
in 2001. The total retail quantity of cigarettes was 33.920 million
cases, which was 3.5 percent higher than in 2001.

At some point in 2003, as part of its WTO accession commitments, China
will eliminate the requirement that retail cigarette outlets obtain a
special license to sell imported cigarettes. Therefore, in future years,
cigarette vendors in China can sell both imported and domestically
produced cigarettes with the same license. This will make it easier for
foreign tobacco companies to set up retail cigarette shops and
distribution networks in China.

The State Tobacco Monopolization Administration (STMA) continues to
reduce the number of small cigarette factories. In 2002 it closed 11
factories, bringing the total down to 124. In 1998 there were 185.

China began importing U.S. tobacco starting with 21 MT. In 2002, total
tobacco imports were 388 TMT, an increase of 584.6 percent as compared
with 2001. Total tobacco exports were 141 TMT as compared to 140 TMT in
2001.

Tobacco stocks continue to decline from their peak in the late 1990s. In
2002, total tobacco stocks were 3,495.9 TMT, 4.4 percent below 2001
stocks of 3,655.6 TMT. Flue-cured tobacco stocks decreased 4.6 percent
from 3,379.5 TMT in 2001 to 3,225.5 TMT in 2002. At the end of 2002,
total cigarette stocks were 2.709 million cases, composed of
approximately 0.705 million cases of industry stock and 2.004 million
cases of commercial stock. In 2002, total cigarette stocks were 14.9
percent below 2001 stocks, which were 3.185 million cases.

In 2002, total imports of cigarettes and cigars were 1,370.728 million
pieces, of which 249.739 million pieces were from the United States.
Total imports were 23.3 percent less than in 2001. Total exports of
cigarettes in 2002 were 1,3874.467 million pieces, only slightly less
than 2001 when they were 1,3875.000 million pieces.

> In 2002, STMA and Ministry of Public Security launched several large
> programs to halt the production and distribution of illegal and
> counterfeit cigarettes. Despite these efforts, illegal activities in
> the tobacco industry persist.

The main policy changes that the China National Tobacco Corporation
(CNTC) is implementing or plans to implement in 2003 are: 1) to change
where tobacco is grown; 2) to reduce total planted area; and, 3) to
reduce purchases of tobacco. New policies to breakdown provincial level
monopolies that restrict inter-provincial movement of cigarettes will be
implemented. The goal is to develop a unified national tobacco market.

> In 2003, the average purchase price of domestic tobacco declined by 36
> percent, as compared with 2002. The price for Grade A declined by 22
> percent, Grade B by 40 percent, and Grades C and D declined by 41
> percent. STMA is planning to make Chinese tobacco more competitive on
> the international market by reducing prices. Some foreign tobacco
> enterprises started to extend their sales network though joint
> ventures.

# Statistical Tables 

## Table 1. Unmanufactured Tobacco: Production, Supply and Distribution

  ------------------ ---------- --------- --------- --------- --------- ---------
  PSD Table                                                             

  Country:           China,                                             
                     Peoples                                            
                     Republic                                           
                     of                                                 

  Commodity:         Tobacco,                                           
                     Unmfg.                                             

                                2001                2002                2003

                     Old        New       Old       New       Old       New

  Market Year Begin             01/2001             01/2002             01/2003

  Area Planted       1339600    1339600   1330408   1327710   1262525   1262525

  Beginning Stocks   4342988    4342988   2204599   3655589   1491627   3495916

  Farm Sales Weight  2349627    2349627   2328978   2783516   2617036   2617036
  Prod                                                                  

  Dry Weight         1997183    1997183   1979632   2365988   2224481   2224481
  Production                                                            

  U.S. Leaf Imports  0          0         60        0         210       210

  Other Foreign      56686      56686     59580     388052    463224    463224
  Imports                                                               

  TOTAL Imports      56686      56686     59640     388052    463434    463434

  TOTAL SUPPLY       6396856    6396856   4243871   6409629   4179542   6183831

  Exports            139918     139918    118929    140809    119688    119688

  Dom. Leaf          2361787    2361787   2573674   2384853   2434120   2434120
  Consumption                                                           

  U.S. Leaf Dom.     0          0         60        0         210       210
  Consum.                                                               

  Other Foreign      56686      56686     59620     388052    463224    463224
  Consump.                                                              

  TOTAL Dom.         2601349    2601349   2633314   2772904   2897554   2897554
  Consumption                                                           

  TOTAL              2741267    2741267   2752244   2913713   3017242   3017242
  Disappearance                                                         

  Ending Stocks      3655589    3655589   1491627   3495916   1232017   3166589

  TOTAL DISTRIBUTION 4945865    4945865   4243871   6409629   4179542   6183831
  ------------------ ---------- --------- --------- --------- --------- ---------

## Table 2. Flue Cured Tobacco: Production, Supply and Distribution

## 

  ------------------- --------- --------- --------- --------- --------- ---------
  Production Table                                                      

  Country:                                                              

  Commodity:          Flue                                              
                      Cured                                             

  Material Ton                  2001                2002                2003

                      Old       New       Old       New       Old       New

  Market Year Begin                                                     

  Area Planted        1180600   1180600   1173263   1191800   1133288   1133288

  Beginning Stocks    2610044   4061035   1928509   3379500   1220521   3225500

  Farm Sales Weight   2045250   2045250   2030812   2472143   2283941   2283941
  Prod                                                                  

  Dry Weight          1738463   1738463   1726190   2101322   1941350   1941350
  Production                                                            

  U.S. Leaf Imports   0         0         40        0         0         0

  Other Foreign       55948     55948     58705     44616     46846     46846
  Imports                                                               

  TOTAL Imports       55948     55948     58745     44616     46846     46846

  TOTAL SUPPLY        4404454   5855445   3713445   5525437   3208717   5213696

  Exports             134055    134055    113947    135136    114866    114866

  Dom. Leaf           2285942   2103067   2320232   2120186   2151989   2151989
  Consumption                                                           

  U.S. Leaf Dom.      0         0         40        0         0         0
  Consum.                                                               

  Other Foreign       55948     55948     58745     44616     46846     46846
  Consump.                                                              

  TOTAL Dom.          2341890   2341890   2378977   2164802   2198835   2198835
  Consumption                                                           

  TOTAL Disappearance 2475945   2475945   2492924   2299938   2313701   2313701

  Ending Stocks       1928509   3379500   1220521   3225500   895016    2899995

  TOTAL DISTRIBUTION  4404454   4404454   3713445   5525437   3208717   5213696
  ------------------- --------- --------- --------- --------- --------- ---------

## Table 3. Burley Tobacco: Production, Supply and Distribution

## 

  ------------------ -------- -------- -------- -------- -------- --------
  Production Table                                                

  Country:                                                        

  Commodity:         Burley                                       

                              2001              2002              2003

  Market Year Begin  Old      New      Old      New      Old      New

  Area Planted       56187    56187    58434    98629    93786    93786

  Beginning Stocks   75837    177023   174091   174091   171600   171255

  Farm Sales Weight  99428    99428    104400   225960   241724   241724
  Prod                                                            

  Dry Weight         84514    84514    88740    192066   205465   205465
  Production                                                      

  U.S. Leaf Imports  0        0        20       0        210      210

  Other Foreign      369      369      460      171718   223023   223023
  Imports                                                         

  TOTAL Imports      369      369      480      171718   223233   223233

  TOTAL SUPPLY       160720   261906   263311   537875   600299   599953

  Exports            2931     2932     2491     2837     2411     2411

  Dom. Leaf          84514    84514    88740    192066   205465   205465
  Consumption                                                     

  U.S. Leaf Dom.     0        0        20       0        210      210
  Consum.                                                         

  Other Foreign      369      369      460      171718   223023   223023
  Consump.                                                        

  TOTAL Dom.         84883    84883    89220    363784   428699   428699
  Consumption                                                     

  TOTAL              87814    87814    91711    366621   431110   431110
  Disappearance                                                   

  Ending Stocks      72906    174091   171600   171255   169189   168843

  TOTAL DISTRIBUTION 160720   261906   263311   537875   600299   599953
  ------------------ -------- -------- -------- -------- -------- --------

## Table 4. Oriental Tobacco: Production, Supply and Distribution

  ------------------- ---------- -------- -------- -------- -------- --------
  Production Table                                                   

  Country:                                                           

  Commodity:          Oriental                                       

                                 2001              2002              2003

  Market Year Begin   Old        New      Old      New      Old      New

  Area Planted        10373      10373    10581    10746    10219    10219

  Beginning Stocks    5100       5100     3341     3341     1846     1639

  Farm Sales Weight   24620      24620    25112    24620    26338    26338
  Prod                                                               

  Dry Weight          20927      20927    21346    20927    22387    22387
  Production                                                         

  U.S. Leaf Imports   0          0        0        0        0        0

  Other Foreign       221        221      265      103031   123637   123637
  Imports                                                            

  TOTAL Imports       221        221      265      103031   123637   123637

  TOTAL SUPPLY        26248      26248    24952    127299   147870   147663

  Exports             1759       1759     1495     1702     1447     1447

  Dom. Leaf           20927      20927    21346    20927    21387    21387
  Consumption                                                        

  U.S. Leaf Dom.      0          0        0        0        0        0
  Consum.                                                            

  Other Foreign       221        221      265      103031   123637   123637
  Consump.                                                           

  TOTAL Dom.          21148      21148    21611    123958   145024   145024
  Consumption                                                        

  TOTAL Disappearance 22907      22907    23106    125660   146471   146471

  Ending Stocks       3341       3341     1846     1639     1399     1192

  TOTAL DISTRIBUTION  26248      26248    24952    127299   147870   147663
  ------------------- ---------- -------- -------- -------- -------- --------

## Table 5. Dark Air and Sun Cured Tobacco: Production, Supply and Distribution

  ------------------- -------- -------- -------- -------- -------- --------
  PSD Table                                                        

  Country:                                                         

  Commodity:          Dark Air                                     
                      & Sun                                        
                      Cured                                        

                               2001              2002              2003

  Market Year Begin   Old      New      Old      New      Old      New

  Area Planted        92440    92440    88130    26535    25232    25232

  Beginning Stocks    99830    99830    98657    98657    97660    97522

  Farm Sales Weight   180329   180329   168654   60793    65034    65034
  Prod                                                             

  Dry Weight          153279   153279   143356   51674    55279    55279
  Production                                                       

  U.S. Leaf Imports   0        0        0        0        0        0

  Other Foreign       148      148      150      68687    69718    69718
  Imports                                                          

  TOTAL Imports       148      148      150      68687    69718    69718

  TOTAL SUPPLY        253257   253257   242163   219018   222656   222519

  Exports             1173     1173     997      1135     964      964

  Dom. Leaf           153279   153279   143356   51674    55279    55279
  Consumption                                                      

  U.S. Leaf Dom.      0        0        0        0        0        0
  Consum.                                                          

  Other Foreign       148      148      150      68687    69718    69718
  Consump.                                                         

  TOTAL Dom.          153427   153427   143506   120361   124996   124996
  Consumption                                                      

  TOTAL Disappearance 154600   154600   144503   121495   125961   125961

  Ending Stocks       98657    98657    97660    97522    166413   96558

  TOTAL DISTRIBUTION  253257   253257   242163   219018   222656   222519
  ------------------- -------- -------- -------- -------- -------- --------

## Table 6. Cigarettes: Production, Supply and Distribution

  ----------------- ------------ ------------ ------------ ------------ ------------ ------------
  PSD Table                                                                          

  Country:          China,                                                           
                    Peoples                                                          
                    Republic of                                                      

  Commodity:        Tobacco,                                                         
                    Mfg.,                                                            
                    Cigarettes                                                       

  1000 pieces                    2001                      2002                      2003

                    Old          New          Old          New          Old          New

  Market Year Begin              01/2000                   01/2001                   01/2002

  Filter Production 1677186000   1677186000   1688991000   1698335700   1714180000   1714180000

  Non\~Filter       33970000     23814000     20514000     24114300     20820000     20820000
  Production                                                                         

  TOTAL Production  1698500000   1701000000   1709505000   1722450000   1735000000   1735000000

  Imports           2088000      1787000      1877000      1371196      1439756      1439756

  TOTAL SUPPLY      1700588000   1702787000   1711382000   1723821196   1736439756   1736439756

  Exports           12811000     13815000     14091000     13814467     14090756     14090756

  Domestic          1687777000   1688972000   1697291000   1697416860   1699962985   1699962985
  Consumption                                                                        

  Total             1700588000   1702787000   1711382000   1711231327   1714053742   1714053742
  Didappearance                                                                      

  TOTAL             1700588000   1702787000   1711382000   1723821196   1736439756   1736439756
  DISTRIBUTION                                                                       
  ----------------- ------------ ------------ ------------ ------------ ------------ ------------

## Table 7. Tobacco Production by Province

  ------------------ ----------------- ---------------- ------------------
  China's Leaf                                          
  Tobacco Production                                    
  **Area** By                                           
  Province                                              

                                       (1,000 HA)       

                     2001              2002             2003

  Province           Revised           Prelim           Forecast

  Yunnan             336               358              345.5

  Guizhou            202               217.3            196

  Henan              174               148.2            144.9

  Hunan              86                93.6             78.6

  Sichuan            70                70.1             75.8

  Hubei              63                60.9             54.9

  Heilongjiang       46                44.7             38.5

  Shandong           47                41.8             45.2

  Chongqing          55                56               49.6

  Shaanxi            42                32.2             29.1

  Fujian             59                65.31            64.8

  Others             158               139.6            139

  TOTAL HA           1340              1327.7           1262.5
  ------------------ ----------------- ---------------- ------------------

  ------------------ ----------------- ---------------- ------------------
  China's Leaf                                          
  Tobacco Production                                    
  **Volume** By                                         
  Province                                              

                                       (1,000 MT)       

                     2001              2002             2003

  Province           Revised           Prelim           Forecast

  Yunnan             614.7             718              718

  Guizhou            288.6             330.2            364.6

  Henan              320               274.9            382.4

  Hunan              162.8             186.4            186.4

  Hubei              122.9             108.2            111.2

  Sichuan            121.7             140.9            157.1

  Shandong           84.4              87.1             123.3

  Heilongjiang       84.2              74.4             66.9

  Chongqing          80.1              87.1             91.4

  Shaanxi            65.5              52.8             50.4

  Fujian             101.5             108.9            115.3

  Others             303.3             277.5            293.8

  TOTAL MT           2349.6            2446.4           2617

  All figures are                                       
  Post estimates                                        
  based on SSB, STMA                                    
  and industry                                          
  figures.                                              
  ------------------ ----------------- ---------------- ------------------

## Table 8. Tobacco Production by Type

+--------------+---------------+------------------+-------------------+
| China's      |               |                  |                   |
| Tobacco      |               |                  |                   |
| Production   |               |                  |                   |
| By Tobacco   |               |                  |                   |
| Type         |               |                  |                   |
| (2001\~2003) |               |                  |                   |
+--------------+---------------+------------------+-------------------+
|              |               |                  |                   |
+--------------+---------------+------------------+-------------------+
|              | Area          |                  |                   |
+--------------+---------------+------------------+-------------------+
|              | (1,000HA)     |                  |                   |
+--------------+---------------+------------------+-------------------+
|              | Revised 2001  | Prelim 2002      | Forecast 2003     |
+--------------+---------------+------------------+-------------------+
| Flue Cured   | 1181          | 1192             | 1133              |
+--------------+---------------+------------------+-------------------+
| Burley       | 56            | 99               | 94                |
+--------------+---------------+------------------+-------------------+
| Oriental     | 10            | 11               | 10                |
+--------------+---------------+------------------+-------------------+
| Dark Air &   | 92            | 27               | 25                |
| Sun Cured    |               |                  |                   |
+--------------+---------------+------------------+-------------------+
| TOTAL        | 1340          | 1328             | 1263              |
+--------------+---------------+------------------+-------------------+
|              |               |                  |                   |
+--------------+---------------+------------------+-------------------+
|              | Production    |                  |                   |
|              |               |                  |                   |
|              | (1,000MT FSW) |                  |                   |
+--------------+---------------+------------------+-------------------+
|              |               |                  |                   |
+--------------+---------------+------------------+-------------------+
|              | Revised 2001  | Prelim 2002      | Forecast 2003     |
+--------------+---------------+------------------+-------------------+
| Flue Cured   | 2045          | 2135             | 2284              |
+--------------+---------------+------------------+-------------------+
| Burley       | 99            | 226              | 242               |
+--------------+---------------+------------------+-------------------+
| Oriental     | 25            | 25               | 26                |
+--------------+---------------+------------------+-------------------+
| Dark Air &   | 180           | 61               | 65                |
| Sun Cured    |               |                  |                   |
+--------------+---------------+------------------+-------------------+
| TOTAL        | 2350          | 2446             | 2617              |
+--------------+---------------+------------------+-------------------+
| All figures  |               |                  |                   |
| are post     |               |                  |                   |
| estimates    |               |                  |                   |
| based on     |               |                  |                   |
| SSB, STMA    |               |                  |                   |
| and industry |               |                  |                   |
| figures.     |               |                  |                   |
+--------------+---------------+------------------+-------------------+

## Table 9. Procurement Prices for Flue Cured Tobacco (2002)

  ---------- ---------- ---------- ---------- ---------- ---------- ----------
  Material                                                          
  Ton/US\$                                                          

             Region 1   Region 2   Region 3   Region 4   Region 5   New Region

  **Class    **1328**   **1230**   **1151**   **1072**   **1021**   **888**
  A**                                                               

  C1F        1700       1589       1485       1384       1313       1140

  C2F        1511       1407       1316       1225       1165       1013

  C3F        1326       1227       1148       1071       1018       897

  C1L        1568       1461       1367       1273       1209       1050

  C2L        1381       1283       1199       1114       1064       912

  B1F        1353       1254       1173       1092       1040       895

  B2F        1147       1054       988        922        879        768

  B1L        1158       1064       996        929        885        774

  B1R        1147       1054       988        922        879        768

  H1F        1191       1098       1027       958        912        794

  X1F        1129       1037       971        906        862        754
  ---------- ---------- ---------- ---------- ---------- ---------- ----------

  ---------- ---------- ---------- ---------- ---------- ---------- ----------
  **Class    **746**    **672**    **579**    **587**    **559**    **500**
  B**                                                               

  C3L        1158       1059       91         924        880        769

  X2F        913        923        773        722        688        604

  C4F        1016       924        865        806        769        672

  C4L        950        860        806        756        719        630

  X3F        727        643        604        567        542        517

  X1L        1045       949        890        832        789        688

  X2L        858        769        722        675        645        571

  B3F        689        604        571        537        512        486

  B4F        427        352        335        318        306        301

  B2L        764        678        638        598        571        537

  B3L        445        369        352        335        318        310

  B2R        979        887        832        776        739        648

  B3R        642        560        529        497        475        453

  H2F        1023       928        870        813        773        677

  X2V        703        621        584        547        523        463

  C3V        1006       914        857        800        763        667

  B2V        821        732        688        645        614        503

  B3V        632        554        520        486        470        293

  S1         558        480        453        426        409        385
  ---------- ---------- ---------- ---------- ---------- ---------- ----------

  ------------ ---------- ---------- ---------- ---------- ---------- ----------
  **ClassC**   172        172        167        161        161        139

  BAL          155        155        150        145        145        125

  X3L          324        324        320        316        316        270

  X4L          180        180        175        170        170        145

  X4F          195        195        190        185        185        159

  S2           224        224        220        216        216        185

  CX1K         180        180        175        170        170        145

  CX2K         126        126        120        114        114        99

  B1K          155        155        150        145        145        125

  B2K          96         96         90         84         84         72

  GY1          81         81         75         69         69         60

  ClassD       44         44         38         32         32         26

  B3K          51         51         45         39         39         30

  GY2          36         36         30         24         24         21
  ------------ ---------- ---------- ---------- ---------- ---------- ----------

## Table 10. Factory Price for Cigarettes (2002)

+--------------------+-------------+---------------+------------------+
| #### Class         | **Price in  | **Price in    | **Share of       |
|                    | RMB**       | USD**         | production for   |
|                    |             |               | 2002**           |
+--------------------+-------------+---------------+------------------+
| Class A            | Greater     | \$926/50,000  | 6.30%            |
|                    | than RMB    | pcs.          |                  |
|                    | 7           |               |                  |
|                    | ,641/50,000 |               |                  |
|                    | pcs.        |               |                  |
+--------------------+-------------+---------------+------------------+
| Class B            | RMB 2,586 - | \$313         | 10.20%           |
|                    | 7           | -926/50,000   |                  |
|                    | ,641/50,000 | pcs.          |                  |
|                    | pcs.        |               |                  |
+--------------------+-------------+---------------+------------------+
| Class C            | RMB 1,247 - | \$151         | 33.70%           |
|                    | 2           | -313/50,000   |                  |
|                    | ,586/50,000 | pcs.          |                  |
|                    | pcs.        |               |                  |
+--------------------+-------------+---------------+------------------+
| Class D/E          | Less than   | Less than \$  | 32.80%           |
|                    | RMB         | 151/ 50,000   |                  |
|                    | 1           | pcs.          |                  |
|                    | ,247/50,000 |               |                  |
|                    | pcs.        |               |                  |
+--------------------+-------------+---------------+------------------+
|                    |             |               | 17.0% for E      |
+--------------------+-------------+---------------+------------------+

# Production

## Tobacco

The total planted area of tobacco in 2003 is forecast to be 4.9 percent
less than in MY02, but the output of tobacco is forecast to increase by
about 7.0 percent. This forecast assumes that CNTC successfully
implements its program for the rational adjustment of production area
and for the increased funding for applied tobacco production research,
and that technology advances result in increased yields.

Tobacco continues to be the most profitable crop for farmers in the
principal tobacco growing provinces. The prices of other crops cannot
compete with tobacco, thereby limiting the effectiveness of any policy
that relies upon reducing the area planted to tobacco to bolster tobacco
prices and farmers' incomes. This was evident in MY02 when planted area
decreased by only 0.89 percent as compared with MY01, even though the
prices farmer were paid for their crop decreased by about one-third.
Sharp reductions occurred in Henan (14.8 percent), Shaanxi (11.7
percent) and Shandong (11.1 percent). But, in Fujian, Hunan, Guizhou and
Yunnan, tobacco planted area increased by 10.7 percent, 8.8 percent, 7.6
percent and 6.6 percent, respectively. Yunnan province, with its
favorable weather conditions, continues to dominate all other tobacco
producing provinces.

In MY02, total tobacco production was 2,783.5 TMT an increase of 18.5
percent compared with MY01. Tobacco production in Yunnan was 718 TMT,
which accounted for roughly 29.4 percent of total national output; the
increase rate between MY01 and MY02 was 14.4 percent. The largest
decrease occurred in Shaanxi province \-- down by 24.1 percent \--
because of a drought. Tobacco production continues to be consolidated in
the major tobacco-producing provinces, such as Yunnan, Henan, Hunan and
Sichuan, with production since 1998 increasing by 25.3 percent, 21.0
percent, and 31.6 percent respectively.

To improve yields and reduce erosion, CNTC officials have implemented a
new policy of moving tobacco production from steep hillsides in
mountainous regions to lower and flatter land. They expect this will
take two or three years to achieve. This plan also aims to consolidate
small-sized farms into large-scale farms. These measures already have
reduced the total authorized tobacco-producing regions to 129 from 139.
At the same time, the number of counties authorized to grow tobacco was
reduced to 544 from 586. These policies have resulted in 288,025 farmers
switching from tobacco to other crops.

The increasing gap between the poor and upper-income consumers in China
is increasing the demand for high-quality and low-quality tobacco, while
the demand for medium-quality tobacco decreases. In 2002, production
these three grades of tobacco was 36.2 percent, 49.0 percent, and 14.8
percent, respectively. In 2002, as compared with 2001, demand for
high-grade and low-grade tobacco increased by 1.5 percent and 0.8
percent, while demand for medium grade tobacco decreased by 2.3 percent.
Demand for high-grade and low-grade tobacco is forecast to continue
increasing in MY03.

Tobacco quality improved significantly last year. A survey and tests on
tobacco quality were conducted in the Fujian, Guangdong, Hunan, Guangxi
and Jiangxi. The results showed that the average qualified rate of
purchased tobacco was 82 percent in 2002 as compared with 2001 when the
rate increased by 11.7 percent. In 2002 the qualified rate for
high-grade tobacco was 77.79 percent; middle-grade tobacco was 77.0
percent, and low-grade tobacco was 85.5 percent.

Despite these improvements in quality, the problem of uneven quality of
domestic tobacco still exists, especially among the different supply
areas. It is difficult for tobacco processing plants to blend tobaccos
from different areas. Some farmers harvest the tobacco before it is
mature. Although it looks good, the aroma is not ideal. It is also
reported that in some areas the genetic quality of tobacco varieties has
declined because farmers harvest and plant hybrid seed rather than
buying new seed.

China's tobacco industry will face several problems in the near future.
The first is how to control the over supply of tobacco. The second is
how to improve the quality of production in order to meet the increasing
demand for high quality tobacco. The third is to prepare China's tobacco
regime for increased competition as a result of China's accession to the
WTO. Lastly, the use of prohibited pesticides on tobacco, and the
residues there from, also continue to be a problem. According to a
government inspection report, in select areas of China, 50 percent of
the pesticides used on tobacco were prohibited.

## Cigarettes and Cigars

In 2002, the retail price of cigarettes remained very stable but profits
increased significantly. According to one report, the gross profit of
cigarette production in 2002 was RMB 17.19 billion, which was 7.0
percent higher than in 2001. Now there are 32 cigarette factories at
provincial level in China. Last year the profit of 17 of these factories
increased by 50 percent compared with MY01.

Total cigarette production was 34.449 million cases in MY02, which was
0.452 million cases more than in 2001. The wholesale quantity of
domestic cigarettes was 34.782 million cases, 3.0 percent higher than
that in 2001. The total retail amount of cigarettes was 33.920 million
cases, 3.5 percent higher than that 2001.

In 2002, the total supply of premium brand cigarettes was 7.740 million
cases compared to 7.746 million cases in 2001. Sales of premium brand
cigarettes were 6.976 million cases, which was 15.6 percent more than
the preceding year. The stock of premium brand cigarettes at the end of
December was 0.728 million cases, which increased by 13.4 percent as
compared with 0.642 million cases at the end of 2001.

Despite STMA's efforts to loosen the grip provincial level tobacco
monopolies have on regional tobacco distribution, the tobacco market in
China remains highly fragmented. Each province has its own brands of
cigarettes and distribution of those brands generally is limited to one
province or the surrounding region.

In order to enlarge the scale of cigarette factories, STMA continued its
policy of consolidating production facilities. In 2002, 11 cigarette
factories discontinued operations. Among them, five were closed, four
merged with other factories, and two went bankrupt. Also, 144 brands
were discontinued because they were unprofitable. The total number of
cigarette factories has fallen to 124 in 2002 from 185 in 1998.

Reducing the content of tar in cigarettes is a priority for domestic
cigarette producers. According to a test of 1,124 cigarette brands from
124 different manufacturers, the average tar content of these samples is
14.7 mg, which is 31.3 percent higher than the international average
level of 11.2 mg. A survey of Beijing cigarette smokers showed that
about 23 percent of those questioned prefer cigarettes with a tar
content of less than 12 mg.

# Consumption

Despite a heightened awareness of the health dangers from smoking,
cigarette consumption in China is increasing steadily. According to a
report from CNTC, total sales of cigarettes in 2002 increased 1.3
percent as compared with MY01 to 34.449 million cases. The graph below
shows that consumption in January, February and September is higher than
in other months. These months correspond with the calendar New Year,
Spring Festival, and Moon Festival.

Chinese consumers are becoming increasingly aware of the heath risks
posed by smoking. According to a survey of cigarette consumption in 48
cities conducted in 2002 by the Association of Chinese Consumers, 82.3
percent of those surveyed considered smoking harmful to their health.
This is a significant increase from 1996, when only 66.0 percent of
those surveyed believed smoking was harmful to their health. The same
survey found that about 73.0 percent generally are opposed to smoking
and 83.4 percent think smoking should be banned in public.

In the largest cities, the percentage of the population that smokes has
started to decline. A recent survey conducted by Capital Medical
University of 3,062 Beijing residents over the age of 15 showed that
28.0 percent of those questioned were smokers, which was down from 31.2
percent in 1996. In the recent survey, among those who smoke, 85 percent
were men and 15 percent were women.

In rural areas and smaller cities, however, the percentage of smokers
continues to increase. This is especially true in the poorest provinces.
A survey conducted of 3,000 residents of Jiangxi Province, a relatively
poor province in central China, showed that in Jiangxi's cities, 61.6
percent of the men and 2.3 percent of the women smoke. In the rural
areas, 68.5 percent of men and 4.8 percent of women smoke. The same
survey showed that the average age when smokers started to smoke was
14.4 years for urban dwellers versus 14.3 for those living in rural
areas.

> The Chinese are starting to smoke at a younger age. A survey of 5,347
> middle school students in a city in South China showed that the
> average percentage of all students between the ages of 13 and 15 years
> old who smoke is 6.1 percent. Among those the percentage of male
> students who smoke is 59.7 percent, while that of the female students
> is 40.3 percent.

![](media/image2.wmf)

Source: Data collected by Dr. Hu.

## 

# Trade

## Tobacco

After many years of effort to address China's quarantine concerns about
U.S. tobacco that culminated two years ago in a tobacco protocol, the
United States exported tobacco to China in 2003 for the first time in
recent memory. STMA has formally signed a contract to import 21 MT of
U.S. tobacco and total exports for 2003 are expected to reach about 300
MT. Price is still one of the most important factors considered by STMA
when they import tobacco from foreign countries. The demand for premium
cigarettes is increasing, but the supply of domestically produced
high-grade tobacco is insufficient to meet that demand, so imports of
premium tobaccos are likely to increase. This may provide an opportunity
for additional import of U.S. tobacco. CNTC, however, is funding several
research projects to develop high-quality tobacco varieties suitable to
China's growing conditions. The results to date reportedly show some
promise. It also plans to dedicate several areas to growing high-grade
tobacco.

In 2002, the total amount of imported tobacco was 388.1 TMT \-- 584.6
percent more than in 2001. The sharp increase is due to the
implementation of China's WTO commitments. Tobacco exports were
relatively unchanged -- 141 TMT in 2002 compared with 140 TMT in 2001.

## Cigarettes and Cigars

In 2002, total imports of cigarettes and cigars were 1,370.728 million
pieces, of which 249.739 million pieces were from the United States. The
total figure was 23.3 percent less than in 2001. In 2002, total exports
of cigarettes were 13,874.467 million pieces, down slightly from
13,875.000 million pieces in 2001.

Imports of cigarettes and cigars have declined gradually since the
1990s. The main reasons are the following: 1) cigarette production
technologies in China continue to improve, as well as the counterfeiting
techniques to produce established Western brands of cigarettes
(Counterfeit cigarettes that employ the latest production technology
have displaced a certain amount of imported cigarette and cigars); 2)
most imported cigarettes are made from blended tobaccos. (Although some
Chinese consumers have come to accept these cigarettes, especially
highly educated female smokers, most Chinese smokers still prefer the
traditional unblended cigarettes); and, 3) although import duties for
foreign tobacco will be reduced from 65 percent to 25 percent in 2004,
foreign cigarettes still are considerably more expensive than Chinese
cigarettes. Generally speaking, one box of popular foreign imported
cigarettes is about US\$0.50 higher than comparable domestic cigarettes.

## Tariffs and Non-Tariff Barriers

China's WTO accession agreement requires the tariff on tobacco to be
reduced from 40 percent to 10 percent by 2004. Tariffs on cigarettes
will be reduced from 65 percent to 25 percent by 2004. It also
eliminates the need for retail cigarette outlets to obtain a special
license to sell imported cigarettes. Cigarette vendors will be able to
sell all kinds of cigarettes regardless of the country of origin. These
changes will make it easier for foreign tobacco companies to set up
retail chains and sales networks in China.

STMA, however, still remains in firm control of the international trade
of tobacco and cigarettes in China.

## Smuggling

Smuggled and counterfeited cigarettes, and related products, continue to
be a major problem that results in the loss of huge amounts of revenue
for central and local governments. A report from China's General Customs
Administration stated that the problem is particularly bad in the
southern provinces of Fujian, Guangxi and Guangdong. Although reliable
figures are difficult to obtain, in the northwestern province of Shanxi
alone it is estimated that an average of 200,000 cases of smuggled and
counterfeited cigarettes enter the market every year. This represents an
estimated loss of tax revenue and profit of RMB 500 million per year for
this relatively poor province.

The most popular ways smugglers transport illicit cigarettes, cigarette
papers, and tobacco include: 1) in fishing boats; 2) on police vans; 3)
in parcels transported on trains; and, 4) through the post office.

In 2002, STMA and the Ministry of Public Security jointly launched
several major crackdowns on illegal cigarette activities. As a result of
these crackdowns, STMA & MPA reportedly inspected 320,000 cases of
suspected illegal cigarettes, confiscated 4.97 billion counterfeit
cigarettes, closed down 2,476 illegal manufacturing operations, seized
1,375 pieces of equipment used in these illegal operations, and arrested
4,075 people. Despite repeated crackdowns such as these, the problem
persists and shows little sign of abating anytime soon.

# Stocks

To avoid a build up of stocks like the one which occurred in the late
1990's, CNTC has imposed restrictions on planting area and the quantity
of tobacco it will purchase on contract from farmers. In 2002, total
tobacco stocks were 3,495.9 TMT as compared with 3,655.6 TMT in 2001 \--
a reduction of 4.4 percent. In 2002, ending stocks of flue-cured tobacco
was 3,225.5 TMT as compared with 3,379.5 TMT in 2001. In 2002, 33
percent of these tobacco stocks were high-grade tobacco, 50 percent were
middle-grade, and 17 percent were low-grade tobacco.

At the end of 2002, total cigarette stocks were 2.709 million cases,
consisting of 0.705 million cases being held by wholesalers and 2.004
million cases by retailers. The total ending stocks of cigarettes in
2002 were 14.9 percent less than the 3.185 million cases in 2001.

# Policy

## Tobacco

The main policies CNTC plans to implement in 2003 affecting tobacco are
as follows: 1) to reduce and reapportion the planting area (This
reapportionment will reduce the planting area in regions where the
natural growing conditions are less favorable and the quality of tobacco
is lower than in more favorable areas, and will increase the planting
area and purchases of tobacco from areas that can grow high-quality
tobacco for which the demand is greater; 2) to reduce tobacco
purchases); 3) to adjust the structure of tobacco production; 4) to
concentrate the production of tobacco in several large producing areas,
and to gradually eliminate tobacco producing areas where production is
less than 15,000 MT; 5) to further develop advanced tobacco planting
technology and tobacco processing techniques; and, 6) to improve the
quality of tobacco in order to increase the international
competitiveness of domestic tobacco.

## Cigarettes

CNTC's new policies for cigarettes are: 1) to establish a unified
national cigarette market by eliminating the barriers that currently
prevent the movement of cigarettes and other tobacco related products
from one province to the next; 2) to improve the efficiency of cigarette
production by consolidating production (CNTC plans to close down
cigarette factories that produce less than 100,000 cases per year. It
also will encourage the merger of factories with a total output of
100,000 to 300,000 cases per year. At the same time, it will increase
the production capacity of medium and large factories to take over the
production capacity lost by closing the smaller factories); 3) to
establish some large scale cigarette processing enterprises that will be
able to compete with the multinational players in the international
market; 4) to adjust the structure of cigarette products, increasing the
output of famous brands and top grade cigarettes; 5) to reduce the tar
content in domestically produced cigarettes to 12 mg; 6) to continue to
crackdown on cigarette smuggling and counterfeiting; and, 7) to
modernize the cigarette distribution network by upgrading information
technology.

# 

# Marketing

> In 2002, the average purchase price of domestically grown tobacco
> decreased by 36.0 percent as compared with 2001. The price of Grade A
> tobacco decreased by 22.0 percent, Grade B by 40.0 percent, and Grades
> C and D by 41.0 percent. STMA is planning to increase the
> international competitiveness of China's domestic tobacco industry by
> reducing tobacco prices.
>
> One of the major trends in China's cigarette market is the
> proliferation of brands of cigarettes and the shortening of the life
> cycle of those new brands. There are about 2,000 brands of cigarettes
> on China's market. Usually a cigarette manufacturer owns dozens of
> brands at the same time. The retail cigarette stores also sell many
> different brands. Cigarette stores in Jiangsu Province, one of the
> richest areas in East China, normally sell more than one hundred
> different brands.
>
> Cigarette prices vary greatly from one grade to the next. The
> highest-grade cigarettes sell for thousands of RMB for 10 cases while
> the lowest grade cigarettes sell for less than 10 RMB for 10 cases.

As one of the first steps in opening China's cigarette market to comply
with its WTO accession commitments, China will abolish the special
license cigarette retailers have had to obtain to sell imported
cigarettes. Each new step in opening the market is bound to pit the
Chinese tobacco monopoly against the multinational tobacco companies.
Some foreign tobacco companies already have gotten a foothold in the
Chinese market and have started to extend their distribution network
though joint ventures with domestic enterprises. A large German tobacco
company joined forces with the Yuqi Hongta Tobacco Group (YHTG) to
develop domestic and international cigarettes and to take advantage of
YHTG's existing distribution network. This is one strategy foreign
enterprises can use to take advantage of China's increasingly
liberalized cigarette market.