By Juliane von Reppert-Bismarck and Doug Palmer
BRUSSELS/WASHINGTON (Reuters) - China broke international law when it curbed exports of coveted raw materials, the World Trade Organization ruled Tuesday, in a landmark case threatening Beijing's defense for similar export brakes on rare earths.
A WTO legal panel dismissed China's claim that its system of export duties and quotas on raw materials -- used in the production of steel, electronics and medicines -- served to protect its environment and scarce resources.
China struck a defiant note in response to the ruling, which it is expected to appeal.
The WTO said in a statement, "The panel found that China's export duties were inconsistent with the commitments that China had agreed to in its protocol of accession."
"The panel also found that export quotas imposed by China on some of the raw materials were inconsistent with WTO rules," it added.
The ruling hands a victory to the United States, the EU and Mexico, which took China to the WTO in 2009 saying export restrictions on raw materials including coke, bauxite and magnesium discriminated against foreign manufacturers and give an unfair advantage to domestic producers.
It coincides with growing anxiety among markets and policymakers about a trend among resource-rich countries to rein in exports of commodities -- from wheat to iron ore -- as supplies fall behind global demand.
The WTO issued an unusually stark warning about such export policies last month, saying they risked creating serious shortages.
The case is of particular importance to the EU, whose raw materials purchases from abroad make up 10 percent of its total imports, and which are used in production and manufacturing processes it says employ 30 million Europeans.
More important than the potential for providing easier access to the eight raw materials in question, the ruling sets a potential precedent in favor of the free circulation of raw materials, particularly of rare earth minerals used to make high-tech goods. China produces 97 percent of the world's supplies of the crucial industrial inputs, and has begun cutting exports to the dismay of importers.
The United States and EU's top trade negotiators as well as industry groups said the ruling should serve to pressure China and other states into dropping such restrictions.
U.S. Trade Representative Ron Kirk hailed the "significant victory" on Tuesday, but warned that "China's extensive use of export restraints for protectionist economic gain is deeply troubling."
EU Trade Commissioner Karel De Gucht called for a negotiated peace with Beijing to avoid a full-fledged trade war, and vowed to address the issue during a visit to Beijing next week.
But he insisted the EU, United States and Mexico could still opt for legal action if China failed to cooperate.
"What is important about this judgment is that it sets the rules for the future and that it will become an important element in discussions with every country" that restricts raw material exports, De Gucht told Reuters before addressing EU lawmakers in Strasbourg, France.
"What I hope is that we can come to a solution through discussions so we don't have to litigate anymore," he said.
Europe's main industry lobby, BusinessEurope, said the ruling paved the way "for freer trade in raw materials globally," while U.S. Senate Finance Committee Chairman Max Baucus urged China to drop the export curbs "immediately."
"These WTO findings are crystal clear -- China is manipulating the raw materials market at the expense of American businesses," Baucus said.
CHINA REGRETS RULING
China said it regretted the WTO's decision, insisting its export policies are based on environmental and resource protection -- a justification likely to resonate with nations such as Russia, Ukraine and India that are also reining in their resource sales.
"China takes the view that although these measures have a certain impact on domestic and international users, they are in line with the objective of sustainable development promoted by the WTO and they help to induce the resource industry toward healthy development," the Chinese government said in a statement from its embassy in Geneva, where the WTO is based.
The statement reinforced the widely held expectation that Beijing will appeal the ruling, a move that could delay any amendments to duties and quotas by several years and create pressure for a negotiated peace.
An appeal could also overturn part of Tuesday's ruling, and trade observers said they expected Washington, Brussels and Mexico City to hold off any new legal claims until the strength of China's appeal became clearer.
"The verdict in this suggests it will be very difficult for China to win a rare earths case in the WTO," said James Bacchus, a former chairman of the WTO appellate body who now works for the Greenberg Taurig law firm in Washington.
But with an appeal likely, the United States and others may be waiting for that decision before filing a complaint in the rare earths dispute, Bacchus said.
(Additional reporting by Gilbert Reilhac in Strasbourg, Alysha Love in Brussels; Editing by Rex Merrifield and Peter Cooney)