 hina's foreign direct investment (FDI) inflows surpassed those of the United States in 2002, making China the world's leading destination for foreign funds; China should continue to attract significant levels of FDI in 2003 from existing and new investors alike. The 2002 annual increases in both contracted and utilized FDI, of 20 percent and 12 percent, respectively, were particularly striking in light of the fact that overall world FDI flows declined in 2002 for the second consecutive year. (Global FDI fell 50 percent in 2001 and an estimated 25 percent in 2002).
Western analysts anticipate a 10 percent rise in utilized FDI in China in 2003. As in 2002, the manufacturing sector is expected to account for the majority of incoming FDI, although investment in services should pick up with further World Trade Organization (WTO)-related market liberalization and with local governments seeking to entice foreign companies. Portfolio investment in Chinese firms declined in 2002 because the continued slump in global capital markets discouraged Chinese overseas initial public offerings (IPOs). The few companies that did list last year, notably China Telecom, raised significantly less money than they anticipated. Portfolio investment is expected to pick up in 2003, with a number of overseas IPOs planned in the insurance, telecom, retail, and distribution sectors. The average level of funds raised through IPOs is expected to be more modest than in recent years. On the upside, mergers and acquisitions by foreign companies of Chinese enterprises may also increase. FDI: The Year in Review China's strong FDI inflows reflected new market openings tied to China's WTO entry, new opportunities related to preparations for the 2008 Beijing Olympics, and the government's push to build up the nation's infrastructure (see Table 1). Investors also expanded existing production facilities in 2002 and moved facilities from other Asian countries to China. China also experienced an influx of suppliers of intermediary goods.
WFOE remains vehicle of choice Preference for wholly foreign-owned enterprise (WFOE) ventures continued for the sixth straight year. As in 2001, new WFOEs outpaced equity joint ventures (EJVs) at a rate of more than 2 to 1. Contracted FDI for EJVs bounced back from a precipitous slide in 2001, no doubt because of WTO-induced market openings in services, where foreign investors must take on Chinese partners (see Table 2).
Investment in manufacturing dominates More than two-thirds of China's incoming FDI flowed into manufacturing investments. A larger proportion flowed into higher value-added sectors such as semiconductors than in past years, though most investors continue to resist transferring their highest value-added operations to China. Investment increased most strongly in the electronics, telecom equipment, and chemicals sectors. Foreign investment in the production of raw materials and intermediate inputs picked up in 2002 compared with 2001, as foreign component suppliers moved into the market. With this trend comes the emergence of FDI-led integrated supply chains in certain regions of the country, particularly in and around Shanghai and Shenzhen. Another contributor to the rise in manu-facturing investments has been the relocation to China of production facilities from Japan, Taiwan, South Korea, and other parts of Asia. Products made by these relocated facilities include clothing, furniture, and light electronics. Japanese companies alone moved 22 facilities in 2002 from Japan and other parts of Asia to China. R&D centers move beyond traditional boundaries Foreign companies established more than a dozen research and development (R&D) centers last year. To date, 110 of the Fortune 500 companies active in China have established R&D centers there but they are not alone--Indian, South Korean, and Japanese companies are also stepping up their investment in R&D facilities. The scope, source, and locations of such centers are expanding. Most new R&D facilities are still concentrated in the telecom and software sectors, but companies are also investing in auto- and food-related R&D projects. And more facilities are popping up outside of the traditional Beijing-Shanghai corridor, in Chengdu, Sichuan, and in Shenzhen. Regional headquarters, purchasing centers on the rise As of year-end 2002, Shanghai was home to 70 regional headquarters and 37 international purchasing centers of foreign companies. Preferential policies have prompted some of these moves. In Shanghai, transnational procurement or logistics centers set up by regional headquarters are eligible to trade internationally and those with R&D functions are eligible for preferential treatment designated for the high-technology sector. Shenzhen and Beijing are also witnessing a boost in foreign companies' regional headquarters and purchasing and logistics centers. New investment in services ventures China's WTO commitments allow foreign investment in service sectors, such as securities brokerage, and have expanded foreign participation in others, such as legal services. But high capital and prudential requirements have kept the numbers lower than foreign service providers would like, particularly in the telecom sector. Approvals granted in 2002 for banking and finance-related ventures included four for fund management joint ventures, one for a securities joint venture, and several insurance licenses (see Foreign Participation in China's Financial Sector). Nearly a dozen law firms won approval in December to establish a second China office, based on regulations that took effect in September 2002. Foreign investment in environmental and engineering services also increased in 2002 over 2001. Last year also marked the approval of printing and publications distribution ventures under WTO liberalization. A rule that took effect in August permitted foreign-invested logistics joint ventures for wholesale and commission agent business for most imported and domestic products. Hong Kong, Virgin Islands top list of FDI sources As in years past, Hong Kong, the Virgin Islands, the United States, Japan, and Taiwan were the top sources of FDI to China (see Table 3). Third-quarter 2002 statistics show a sizeable increase in US investment in China as the number of new contracts, the value of new contracts, and utilized investments were up 28.3 percent, 33.1 percent, and 14.8 percent, respectively. After shrinking in 2001, EU contracted and utilized investment rose 16 and nearly 22 percent, respectively.
New investments from South Korea, India, and Thailand were also notable. South Korean firms invested more in China than in the United States for the first time. Roughly 84 percent of South Korean investment was injected into manufacturing ventures, mainly in South China (Guangdong and Fujian), but South Korean investment is rising in Shanghai, Tianjin, and Shandong as well. Some of this investment reflects the relocation of some manufacturing facilities from South Korea to China. Expansion and restructuring Among the higher-profile expansions of existing foreign investments in 2002 were Eastman Kodak Co.'s move to increase its number of photo outlets in China; the formation of a chemical holding company by Japan's Kao Co.; Toshiba Corp.'s buyout of its partner's remaining stake to establish a WFOE; and Exxon Mobil Corp.'s refinery expansion in South China. Mergers and acquisitions Foreign participation in mergers with, and acquisitions of, Chinese entities accounted for only about 5 percent of all foreign investment in the 1990s. But China overtook Japan to become the most active mergers-and-acquisition (M&A) market in Asia in 2002. Foreign companies spent $13.9 billion through November 2002 purchasing Chinese firms, up 180 percent over the $4.9 billion spent in 2001. HSBC's $600 million stake in Ping An Insurance Co. contributed to the final figure. Several foreign companies also purchased shares in Chinese banks. New regulations, WTO implementation, and "rectification" An array of new rules governing foreign investment emerged in 2002. Many were WTO-driven, while others were intended to curtail local protectionism and corruption, improve workplace safety, protect the environment, and promote innovation in science and technology. Other notable new policy moves included revisions to the Catalogue Guiding Foreign Investment in Industry; efforts to improve the court system, particularly related to intellectual property rights cases; new tax incentives and an effort to eliminate WTO-inconsistent tax policies; and moves to encourage M&A activity (see Appendix: Regulatory Round-up). WTO-prompted adjustments to the country's regulatory framework had a mixed impact on foreign companies. While some of the new regulations, particularly in the service sectors, provide--for the first time--the basic framework for foreign investment, they fail to lay out clear approval processes and set high capital and prudential requirements that limit qualifying foreign companies and their Chinese partners. The government also continued its three-year-old rectification campaign in 2002 by targeting foreign companies operating outside the boundaries of permitted investments. In the retail sector France's Carrefour SA was forced to sell stakes in about dozen China stores that exceeded the legal maximum of 65 percent for foreign investors. Representative offices' activities also received scrutiny from government authorities. Chief representatives of financial company representative offices--specifically those of banks, credit card businesses, and financial services companies--had to meet requirements that on balance were more stringent than before. The Beijing government also audited the individual income tax payments of local foreign representative offices' foreign employees. Cities, provinces compete for FDI In vying for investment, localities are looking for ways to minimize business costs for potential investors. Shanghai and Shenzhen have been particularly aggressive on this front. Shenzhen issued new regulations to improve the efficiency of foreign-invested enterprise (FIE) registration procedures, including reducing required paperwork, reducing the timeframe for issuing a business license from 10 to 5 days, and providing bilingual guidebooks. And as noted earlier, Shanghai has offered incentives for firms to establish regional headquarters, global procurement and logistics ventures, and R&D facilities. Beijing has sought to remain competitive as well, revising its residency and work permit systems and reducing real estate taxes by half for qualifying companies establishing R&D institutions in Beijing.
Moving investment inland Beijing has continued to encourage foreign investment in China's interior, introducing more tax incentives in May. And the China Export & Credit Insurance Corp. signed cooperative agreements with the World Bank and the International Union of Credit and Investment Insurers (Berne Union) to provide guarantees for overseas investors considering projects in China's western regions. But foreign investments in the interior have been few, with the 12 western provinces traditionally accounting for 5 percent, and the central provinces typically securing 9 percent, of China's total FDI inflows. In 2002 a few companies nevertheless made some high-profile investments--General Motors purchased SAIC-Wuling in Guangxi Zhuang Autonomous Region, an Australian mining company invested in Qinghai, and the Bank of East Asia opened an office in Shaanxi. Issues to Watch in 2003 Western analysts predict a 10 percent increase in China's utilized investment this year and a more modest growth rate of roughly 7 percent in 2004. Among the issues likely to affect FDI inflows in China in 2003, and perhaps beyond, are: Government investment priorities: infrastructure, Olympics, and high tech China's ongoing infrastructure build-out is likely to continue in 2003, though at a slower pace and with closer scrutiny of proposals. The Ministry of Railways is drafting a series of investment policies and will recommend some profitable railway construction projects for global bidding in early 2003. But less clear is the fate of nearly a dozen planned subway lines across China. The State Council imposed a freeze on the projects in October 2002 pending the outcome of a three-month study now under State Council review. The impact on the government's budget deficit and the cost of imported equipment reportedly prompted the review. Olympics-related projects remain a focal point for municipal and central officials alike. The first bidding round for projects for the Beijing Olympics closed on time in late December for site ownership, construction, and operating rights for roughly eight facilities and the operation of the national swimming center. About 10 qualified companies/consortia will be short-listed by the end of February and allowed to bid in the final round. Winners will be named at the end of July 2003. The action plan also calls for public transportation improvements, particularly in rail, and improvements in air and water quality through better environmental protection measures and more forest coverage in and around the city. Beijing remains committed to boosting high-tech investment. Following in the footsteps of a September 2001 State Economic and Trade Commission (SETC) plan, the Ministry of Science and Technology released in August 2002 a general plan for scientific development through 2010. The plan stresses a science-directed venture capital investment mechanism, along with scientific breakthroughs in population studies, natural resources, and environmental protection; and the development of scientific standards, production technologies, and a research and management talent pool. In September 2002, the State Council Informatization Office released a software action plan detailing measures to develop the software industry, which among other things includes enhancing support for software exports; investment or financing policies to increase investment in the software industry; and preferential tax policies. Other priority sectors include environmental technologies, particularly wastewater treatment facilities, and research and development (various localities offer tax breaks for investors and are streamlining approvals procedures). Rising costs Foreign companies will have to cope with rising costs in some of China's most popular manufacturing centers. Urban wages are rising, though the national average holds steady. Per capita income in Shanghai is higher than in Thailand, the Philippines, or Indonesia. And with a shortage of skilled managers and technicians, retention often depends on offering more attractive compensation packages. Another round of government restructuring Recent press reports suggest another wave of central government restructuring that would affect the role of agencies involved in foreign investment approvals and administration oversight in various sectors. Among the agencies most likely to be affected are the State Development Planning Commission, which will likely expand, and SETC, which is likely to be disbanded. The Ministry of Foreign Trade and Economic Cooperation may assume some SETC responsibilities and become a Ministry of Commerce. New regulatory commissions in the banking, state asset management, energy, transportation, and telecommunications sectors reportedly are also under consideration (see Chinese Politics). Interest in portfolio investment Over the past three years, Chinese companies' interest has grown in securing funds through foreign investment in their overseas IPOs. This year will be a tough one for IPOs, especially after investors in Asia markets in 2002 got burned when issues fell below offering prices. Though information technology has traditionally surpassed all other sectors in raising funds on overseas capital markets, insurance and power companies also figure prominently in the lineup for 2003. The average size of listings will be smaller, likely in the $100-$300 million range. Among Chinese companies gearing up for listings in Hong Kong are Lianhua Supermarket Co., Sinotrans Ltd., China Netcom Corp. Ltd., People's Insurance Co. of China, and Ping'An Insurance Co. Property rights Although the status of private property was upgraded in 1999, legal protection for private property in China has never been clearly defined. Near the end of 2002, senior PRC leaders stepped up rhetoric regarding improved private property protection. Now a draft of China's first civil procedure law reportedly includes provisions regarding the protection of personal deposits, investments, and profits, and when passed could enable the sale and purchase of state-owned property by private and foreign investors without legal restrictions. Whether such regulatory developments will affect several cases in which local governments had expropriated land being used by foreign companies in recent years remains uncertain. Standards--an alternative trade barrier? Foreign investors are concerned that China's new technical standards and conformity assessment requirements are emerging as an alternative method to protect domestic industry. US companies' concerns can generally be divided into those linked to the China Compulsory Certification mark process and China's standards-setting process at the central, provincial, and industry levels. To comply with WTO national treatment requirements, China unified its two different certification systems for foreign and domestic products in 2002, though the old marks remain valid until May 1, 2003. Under this new system, companies are reporting more difficulties at port, drawn out certification processes, duplicative testing requirements, and new exemption requirements. In addition, China's standards-setting committees do not, with few exceptions, afford foreign companies a voice in drafting and approving technical standards related to their products. Tax incentives revised China issued a number of tax-related regulations in 2002, including one that altered, and in some cases eliminated, tariff and tax rebates for FIE-imported equipment and raw materials used in FIEs' production facilities in China. The continuation of special treatment for export-oriented enterprises appears to conflict with China's WTO commitments to remove all benefits based on export performance. In other cases, new tax incentives were introduced for specific sectors, reflecting China's shift toward sector-based incentives. Finance and tax officials recently issued rules that give more tax breaks to the integrated circuit industry, including value-added and income tax rebates if the rebates are used in the manufacturing, research, and development of IC products. Industrial policies reconsidered PRC authorities in the automotive and publishing sectors have stated their intention to introduce revised automotive and new publishing industrial policies in the near future. The revisions to China's 1994 Industrial Policy on Automobiles, which China had committed to complete by December 2000, are expected to remove WTO-inconsistent provisions regarding preferential import tariffs based on local content and export performance, among other things. In the case of publishing, China reported in January plans to formulate its first industrial policy aimed at liberalizing, and increasing competition in, the PRC publishing sector. Although central authorities have proclaimed that the publishing policy will go beyond China's WTO commitments, early indications suggest that liberalization remains focused on printing and distribution activities. Publication management rules could be revised before June. More WTO openings Beijing has yet to introduce a number of regulations that reflect its year-two WTO commitments, including those on trading and distribution rights and auto financing. Such regulations provide the roadmap for foreign companies' requirements to set up shop. Among the new regulations expected in 2003 are those on franchising, foreign-invested commercial enterprises, venture capital, and M&A. Appendix: PRC Investment Regulatory Round-upI. 2002 Catalogue
Guiding Foreign Investment in Industry New MOFTEC
Investment Approval Requirements
Copyright 1996-2008 by the US-China Business Council Last Updated: 23-May-03 |
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