Having just explained how Shantou's gross domestic product is likely to fall this year for the first time in almost two decades, Mayor Li Chunhong was working his way through a statistical release emphasising the municipal economy's few bright spots. He read that during the first 10 months of this year, contracted FDI (foreign direct investment) was up 39.7 per cent, while utilised FDI increased 4.3 per cent. Consumer spending grew 4.2 per cent. Personal savings deposits were up seven per cent and bank loans 3.9 per cent. And by some miracle, electricity consumption increased 10 per cent even as the overall economy shrank. There was, however, a glaring omission - the port city's year-to-date exports, which had been plummeting. As of the end of April, for example, they were down 68 per cent year-on-year. 'They are down more than 50 per cent,' he said candidly, and began flipping through the pages looking for the exact figure. Not finding it, his irritation grew. 'This only talks about the positive points. It doesn't mention anything negative.' He rounded on an aide: 'What is this ghost material you've prepared? This [release] is incomplete.' The aide was sent to get the export figure and came back with it minutes later. Over the first 10 months of the year, he reported, Shantou's exports had fallen 52.6 per cent year-on-year. It is, of course, rare for any politician to go out of his way to dig up an unflattering piece of information. It is rarer still for one to then give a candid explanation of the reasons for it. But that is precisely what Mr Li did. '[The steep fall in exports] is largely due to VAT fraud,' he said. Taking advantage of the Chinese Government's policy of refunding the VAT paid by exporters, in the mid- and late 1990s, tax cheats in and around Shantou claimed to have shipped exports that in fact they had never even manufactured. In this manner they were able to claim fraudulent VAT rebates worth at least 4.2 billion yuan (US$506 million) from the central Government. 'In fact, some of our [reported] exports did not exist. It was a fraud,' Mr Li said. He said that over the past year about 2,000 'exporters' without a single production line among them had been rooted out in eastern Guangdong. 'None of them had production facilities. Their 'exports' were exports in name only,' Mr Li said. This was the first time that a senior Shantou official had openly acknowledged that some of the city's previously reported exports - and hence the foreign exchange earnings supposedly generated by them - were phantom exports. The consequences of this fraud were far-reaching. With an average VAT of 15 per cent, tax cheats had to report US$100 (HK$780) in export earnings for every US$15 in fraudulent VAT rebates they claimed from the Government. To bilk Beijing of 4.2 billion yuan in fraudulent VAT rebates, Shantou-based tax cheats would have had to report US$3.4 billion in fake exports. This scam explains in part why China's foreign exchange reserves, though sizeable, have never increased in line with its massive foreign domestic investments and large trade surpluses.