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Foreign Investment After falling precipitously in 1999, foreign direct investment (FDI) inflows to China rebounded in 2000 and should accelerate after China joins the World Trade Organization (WTO). The value of new investment contracts rose by more than 50 percent, to $62.66 billion (see Table 1). Reflecting the steep drop in contracted investment in 1999, utilized investment increased only slightly, to $40.77 billion. For the first time, fundraising on capital markets rivaled FDI as a source of foreign capital: PRC enterprises raised a record $39 billion on domestic and international capital markets in 2000.
FDI: THE YEAR IN REVIEW The late-1999 improvement in investor confidence continued through 2000, as China's economy began to recover and the country's WTO negotiations approached their conclusion. Resurgent investment from the United States, Japan, South Korea, and Taiwan stabilized China's FDI inflows in 2000. New contracts up The value of new contracts rose by just over 50 percent to $62.66 billion, compared to the year-earlier period. The number of contracts increased in tandem, by almost 30 percent. This large percentage jump in contracted investment reflects both the low basis of comparison with 1999 investment levels and a number of large deals closed in 2000 by BASF, BP Plc, DaimlerChrysler, IBM Corp., Motorola Inc., Royal Dutch/Shell Group, and two groups of Taiwan-led investors in China's semiconductor industry, among others. The value of realized investment in 2000, in contrast, was virtually unchanged from 1999. WFOEs most popular vehicle, again For the fourth consecutive year, wholly foreign-owned enterprises (WFOEs) were the most popular vehicle for foreign investment in terms both of value of new contracts and number of projects. Over 40 percent more WFOE contracts than joint venture contracts were signed, and the value of contracted investment in WFOEs was 70 percent more than that in joint ventures (see Table 2).
US investors outpace Europeans The number of new US foreign investment contracts and the value of those contracts increased by almost 29 percent and 33 percent, respectively, over 1999. A single Motorola investment of $1.9 billion accounted for most of the growth, however. US utilized investment increased by a modest 4 percent. FDI from the United States accounted for almost 13 percent of China's total contracted FDI, and almost 11 percent of total utilized investment, in 2000. Meanwhile, thanks to a mid-year boost from BASF's $2.6 billion joint-venture agreement with Sinopec and Royal Dutch/Shell Group's record-breaking joint venture of $4.1 billion, contracted investment from the European Union increased by 116 percent in 2000. EU utilized investment remained stable, reflecting the steep decline in contracted investment in 1999. Asian countries split Contracted investment from Asia rebounded in 2000, up over 25 percent. Japan and Hong Kong invested heavily, though investment from Singapore and Thailand fell 18 and 37 percent, respectively, compared with 1999. Investment from Taiwan was considerably less than other economies, with its contracted investment increasing only 20 percent, while utilized investment fell almost 12 percent. However, a large percentage of the investment from the so-called free ports is actually Taiwan capital being invested through offshore channels to avoid Taiwan's restrictions on investment on the mainland. And in contrast to other regions, contracted FDI from all Asian countries increased by only 25 percent and utilized FDI was down in 2000 by more than 5%. Further, Asian investment, while still composing the bulk of China's FDI inflows, fell below 50% of total FDI for the first time in 2000, continuing a falling trend that has continued since the onset of the Asian crisis in 1997. Free ports' FDI share on the rise Investment from tax havens such as the British Virgin Islands and the Cayman Islands grew significantly through the third quarter of 2000, to almost 6 percent of total FDI projects, 17 percent of contracted FDI, and just under 11 percent of utilized FDI. Free ports sponsored more than 1,300 projects and contributed $4.46 billion in utilized investment, an increase of 46%. INVESTMENT TRENDS Economic recovery China's economy regained its footing in 2000, alone a major improvement in the investment climate (see China's Economy). Strong export growth, a modest rise in domestic demand, and the government's more than two-year-old spending spree have been largely responsible. The economy still faces deflationary pressures, however, both from wary consumers skeptical of the outcome of ongoing economic reforms and from the stagnating rural economy. Information technology investment surge Investment poured into China's electronics and telecommunications sectors in 2000. The amount of contracted investment in these sectors rose 188 percent over 1999, reaching $11.4 billion, or almost one-fifth of total contracted FDI. Utilized investment increased by almost 50 percent to $4.6 billion, or one-tenth of the total. China plans to develop semiconductor manufacturing bases in Shanghai and Beijing by 2010, at a total cost of more than $15 billion. To spur further development of China's computer software and semiconductor industries, the State Council issued Several Policies Encouraging the Development of the Software and Integrated Circuit Industries in June 2000, which detail tax breaks and other incentives for domestic enterprises. Though the surge in information technology (IT) investment is evidence of China's commitment to attracting and developing the sector, foreign IT companies encountered restrictive standards and licensing practices by Chinese regulators throughout the year. Companies are concerned that regulators may continue to use such practices to control or exclude foreign participation in IT even after China enters the WTO. Revising investment procedures to prepare for WTO PRC officials responsible for managing the country's foreign trade and investment regimes engaged in a frenetic effort during the second half of 2000 to bring these regimes into compliance with WTO rules and practices. Many of the new laws and frameworks for investment, which PRC officials are increasingly discussing in public, will have a significant impact on US firms investing in China.
Restructuring of existing investments: M&A opportunities US companies continued to reassess China's investment structures in 2000 and worked to identify creative ways to consolidate multiple operations. Some companies bought out all or part of a Chinese partner's stake, sold stakes in ventures that no longer made sense in current domestic and global market conditions, or consolidated investments under a holding company or foreign-invested stock company. China's consolidation of large domestic state-owned enterprises in financial services, petrochemical, steel, telecommunications, and aviation sectors also presented foreign companies with investment and acquisition opportunities. Foreign companies will be paying close attention to how China incorporates WTO investment rights into PRC law. Intellectual property rights (IPR) protection Foreign companies in almost every sector continued to encounter widespread trademark, copyright, patent, and trade-secret infringements in 2000. Many are heavily involved in both individual and collective prevention and enforcement efforts, with mixed results. China has pledged in its WTO negotiations to bring its IPR regime into full compliance with the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) upon accession, and the NPC Standing Committee is reviewing amendments to China's existing IPR laws for passage in 2001. In an encouraging development, the State Council created an interministerial group to combat counterfeiting offenses nationwide. The group launched a three-month offensive in November. The government will need to sustain this effort on a permanent basis to achieve real results, however. The disruptive potential of continued rampant IPR violations in China cannot be overstated. Centralization of tax authority Tax collection continued to be a top concern for both foreign investors and PRC government officials in 2000. (A recent survey of companies by the Beijing Municipal Administration for Industry and Commerce revealed that individual foreign enterprises in Beijing pay on average six times more in taxes than their domestic counterparts.) The State Administration of Taxation announced plans to step up enforcement, broaden the tax base through new taxes, develop a national IT-based tax collection system, and eliminate unnecessary tax exemptions. Meanwhile, foreign trading companies and enterprises in export-processing zones will likely continue to feel the effects of an ongoing government crackdown on enterprises that unlawfully claim value-added tax rebates (VAT) or illegally export products into the PRC. Opening the interior to foreign investment The State Council released its long-awaited list of preferential policies to facilitate western development in October. Under the terms of the new policies, foreign investors will receive an extra three years of concessionary tax rates above the existing concession periods offered in other parts of the country and will be allowed into sectors previously off-limits or saddled with unwieldy investment conditions. Mining (excluding oil and gas), railways, telecommunications, wind power, and aviation, among other infrastructure sectors, will open to foreign investment. However, without serious improvements in basic infrastructure, transparency of government policies, and flexibility in investment terms, new FDI is likely to remain limited to areas where the markets are more developed and policymaking is more transparent. ISSUES TO WATCH IN 2001 WTO accession negotiations Negotiators in the WTO working party on China's accession made significant progress in 2000 in narrowing differences on the terms of China's accession. However, after meeting for a week in January 2001, negotiators returned to their capitals without a final agreement. The key outstanding issues are China's desire to preserve its right as a WTO developing country so that it can offer agricultural subsidies to its farmers; services, including disputes over China's insurance commitments and the definition of chain stores; trading rights; and technical barriers to trade. A March 2001 meeting between MOFTEC Vice Minister Long Yongtu and USTR Robert Zoellick may have helped identify compromise language on agricultural subsidies that will allow the talks to continue. The working party will likely reconvene later in the spring to resolve remaining issues. If China has not acceded to the WTO by June 3, 2001, however, the Bush Administration, Congress, and the business community will face another Normal Trade Relations (NTR) debate and vote. Translation of WTO commitments into law and practice Regardless of progress in Geneva, China appears poised to continue the process of aligning its trade and investment frameworks with WTO rules. The laws and regulations that China revises and adopts--not the text of the WTO accession package itself--will provide the roadmap local officials will use to implement WTO commitments. Foreign companies will monitor China's moves closely--especially regarding the phase-in of China's commitments on trading rights, distribution, and services--and under the WTO Agreement on Trade-Related Investment Measures (TRIMS). Foreign firms will also continue to look out for new government standards and licensing practices which, while WTO compatible on the surface, may discriminate against foreign firms. The narrowing of tax differences between domestic and foreign companies and across zones and localities will occur gradually and will likely gather steam after China's entry into WTO. Tax officials made frequent public statements last year about government plans to phase out preferential tax policies in Economic and Technological Development Zones (ETDZs). The government offices that currently approve foreign investment projects will have to adjust their functions to emphasize registration and licensing, because WTO entry will mean that new foreign investments will receive the same treatment as new domestic deals. Foreign portfolio investment: A permanent feature PRC enterprises in services and high-technology sectors are likely to seek out foreign capital, technology, and managerial expertise in 2001, and especially after WTO entry. China Telecom, China Netcom, China National Offshore Oil Corp., the Bank of China Group, and Shanghai Baosteel are some of the major enterprises expected to launch initial public offerings on foreign markets in 2001. Foreign investors in 2001 will continue to participate in these and other stock offerings by PRC companies in sectors otherwise off limits. Acceleration of capital market reforms In 2000 China introduced measures that pave the way for foreign participation in China's capital markets. For example, China lifted restrictions on the ownership forms of companies that list on China's two exchanges. This raises the possibility that FIEs may be able to list on China's A-share market in the near future, though few firms are currently structured to take advantage of the opportunity. China also issued provisional rules on open-end mutual funds in October 2000, which could eventually enable foreign financial institutions (in joint ventures with PRC firms) to offer such funds to Chinese investors. China's need for capital for economic restructuring will drive financial sector reforms forward in 2001, creating new investment opportunities for foreign companies in banking and other professional services in the process. ONWARD AND UPWARD Assuming that the Hainan island incident is a short-term issue, and there are no immediate or direct consequences on trade relations such as sanctions or rejection of NTR, than investor optimism should continue in 2001, with the predictable effect on FDI inflows. The Chinese leadership's clear commitment to economic restructuring--and the efficiency gains from the government's heavy investment in infrastructure and IT--are likely to enhance China's attractiveness as an FDI destination. In the longer term, more small and medium-sized foreign companies are likely to invest in China, either to supply multinational corporations or customer bases in Asia, or even to fill niches in the China market. This optimism and longer-term expansion could fade, however, if WTO negotiations stall, or if China's implementation efforts falter once accession is complete. After the falloff of the past few years, however, Beijing appears to have recognized the importance of FDI as an engine of growth and is unlikely to backtrack dramatically from its commitments. With China's accession to WTO not expected until mid-year at the earliest, some companies may delay investments until the final accession document is complete and phase-in periods begin. In such a scenario 2002, not 2001, may be the year that witnesses the investment boom that most anticipate after China's WTO entry.
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