Carmaker BYD vs. China's Farmland Laws

BYD, China's fastest-growing major automaker, will be a test case for whether the government values corn and wheat over industry. China's Land & Resources Ministry says that BYD, maker of China's top-selling compact car, the F3, unlawfully built seven factories on 112 acres of farmland it agreed to buy in Xi'an from a local economic development agency. The government said it will decide by Sept. 30 whether to punish the company, which is 10 percent owned by Warren Buffett's Berkshire Hathaway (BRK.A). Penalties could include big fines or an order to demolish the plants. China's land ministry this year already has ordered demolition or jail time in five cases of businesses that illegally built golf courses and housing developments or dug mines on farmland.

China is struggling to balance its pursuit of economic growth with its need to preserve enough farmland to feed its 1.4 billion people. The amount of land used illegally in the first six months of this year rose by 14 percent from a year earlier, to 77.9 million square meters (19,254 acres), the ministry said. Chinese companies seeking to expand sometimes start construction before securing government approvals, says Johnny Wong, an analyst at Yuanta Securities. One reason: The approval process to begin construction can take years to wind through China's bureaucracy.

Local officials, eager to meet development goals, often look the other way or even sell government-owned farmland to builders of new plants. China's Communist Party evaluates local officials using benchmarks that include economic growth, residents' income and education, and environmental protection, according to the assessment system distributed by the Central Organization Dept. High marks are needed for career promotion, prompting many officials to pursue economic growth over land protection, says Dang Guoying, a researcher at the Rural Development Institute of the Chinese Academy of Social Sciences in Beijing. In July, China's land ministry said that local government officials deemed complicit in five cases where building was improperly allowed to proceed on farmland have received administrative punishments.

"The illegal usage of land has been quite common," says Wang Liusheng, an analyst with China Merchants Securities in Shenzhen. "Companies, especially those developing on a fast track, were forced to do so in order to catch market opportunities." Paul Lin, a spokesman for Shenzen-based BYD, declined to discuss the possible impact on the company. "Let's see the conclusion, and we'll prepare for that," he said.

Because of BYD's size and importance in one of China's key industries, its predicament has drawn attention. "A lot of companies are watching the case closely, and it will set an example," said Zhang Xin, an auto analyst with Guotai Junan Securities in Beijing. "If the government lets BYD off the hook easily, the illegal usage of land won't be effectively controlled."

China, which consumes one-fourth of the world's grain, needs at least 297 million acres of arable land to grow enough food to feed its people, the land ministry said. Economic and social development from 1997 to 2007 reduced farmland by 83 billion square meters to about 1.22 trillion square meters. That's about 1.4 percent above the minimum requirement for arable land, says the ministry. "The ministry will severely punish violators of land-safeguarding laws and regulations, and we should dare to tackle tough cases," says Li Jianqin, head of the ministry's law enforcement and supervision division.

The ministry says BYD built its new factories even though 92 percent of the land they occupied in Shaanxi province was zoned for agriculture. The province produced 4.84 million tons of corn and 3.92 million tons of wheat in 2008. BYD's Xi'an factory, built in 2005, can assemble 300,000 cars a year. The carmaker planned to invest 5 billion yuan ($735 million) in a second factory complex in Xi'an with the same capacity. Construction started earlier this year and was expected to be finished by the second half of 2011, BYD's Lin says.

Although analysts don't expect BYD managers to receive prison time, there is financial risk for the carmaker. "If the government really means to play tough, they will order BYD to tear down whatever they have built on the land," auto analyst Zhang says. "All the other companies will really draw lessons from BYD's case and won't dare to use land illegally."

The bottom line: China is taking action against companies that have built on land zoned for farming. The BYD case is being closely watched.

By Tian Ying and Liza Lin, with Andrew Frye, Yidi Zhao, and Chua Baizhe

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