Economic Development Policies for Central and Western China

The PRC government has ramped up incentives to develop central and western China—will foreign companies bite?by Nancy Huang, Joie Ma, and Kyle SullivanChina launched two strategies to develop its central and western regions in the last decade. The PRC State Council launched the Western Development Strategy, China’s first comprehensive regional development plan to boost the economies of western provinces, in 2000. Premier Wen Jiabao announced the Rise of Central China Plan, a development strategy to coordinate regional growth in six central provinces, in 2004. To achieve the broad goals outlined in the plans, the PRC government has implemented strategic programs, developed industry-specific plans, created industry-specific catalogues of preferred technologies, and announced new incentives to attract investment to the central and western regions. Though both plans have limitations, they provide important guidance—and specific incentives—for foreign companies looking to expand in China and gain access to potential customers in untapped regions.

Push for regional development plans

Economic development in China’s central and western provinces has lagged far behind progress on the booming coast. PRC data show that China’s gross domestic product (GDP) increased nearly 17 times, and GDP per capita rose 12-fold between 1978 and 2008. Most of this growth was generated by a handful of eastern and southern provinces, however. The average income in central and western China was roughly 77 percent of the national average in 1999, and increased only slightly to 80 percent of the national average by 2008.

The push to develop China’s hinterland has gained more traction within the PRC government in recent years. The composition of China’s industrial structure is undergoing a major transformation in which traditional industries, such as low-end or energy-intensive manufacturing, are losing policy support from the coastal provinces. As a result, central government officials have adopted a different development model that seeks to direct foreign investment to meet specific needs. The PRC government is thus now more focused on promoting the central and western regions. For example, the National Development and Reform Commission (NDRC) in 2008 revised the Catalogue of Encouraged Industries for Foreign Investment in Central and Western China to guide foreign investors to sectors that the government intends to develop: high value-added, environment-friendly, energy-efficient industries that take advantage of local resources, as well as areas in which China lacks the capabilities necessary for development (see Table). The revised catalogue opened to foreign investment sectors that had been previously restricted or prohibited, or that had been restricted in the more developed coastal regions. Examples include auto components manufacturing, value-added telecom services, and natural resource exploration.

Western Development Strategy

Passed in March 1999, the Western Development Strategy was the first central government-directed development program for China’s western region. The strategy calls for the central government to invest in infrastructure development and natural resource exploitation, and set market liberalization policies to create regional economic development centers.

With the first 10-year phase of the Western Development Strategy coming to a close—along with concerns about the damaging effects of the global recession—the central government began to call for a new round of regional development in 2008. The purpose was not only to support ongoing efforts to build basic infrastructure, but also to call attention to the broad industries the central government wanted to prioritize for development. The government added new energy, equipment manufacturing, new materials, biotechnology, pharmaceuticals, aerospace and defense, and information technology (IT) to the list of encouraged industries. These additions joined traditional sectors that had previously dominated economic activity in the western region, such as petrochemicals, energy, mining, and minerals processing.

In addition to revising the catalogue, the PRC government has also designated three economic clusters in western China to spur regional development: the Chengdu-Chongqing Economic Zone, Guangxi-Beibu Gulf Economic Zone, and Guanzhong-Tianshui Economic Zone. Regional plans have been released for two zones—Guangxi-Beibu (2008) and Guanzhong-Tianshui (2009)—and media reports indicate the plan for the Chengdu-Chongqing Economic Zone will be released in late 2010, though no official confirmation has been made. The clusters will encourage economic development in surrounding areas and, over time, will connect to create widespread growth across the western region.

Policymakers intend to allocate certain industries to core areas to match industries with local capabilities and resources. For example, under the Guanzhong-Tianshui plan, Xi’an, Shaanxi, aims to become a national center for science and technology research and development (R&D), as well as a base for high- and new-tech industries and advanced manufacturing. Baoji, Shaanxi, is slated for development as a base for new-materials R&D and production, and as a center for machine-tool manufacturing, heavy-auto manufacturing, non-ferrous metal processing, and retail industries. Shaanxi’s resource-rich cities of Tongchuan and Weinan encourage investment in the energy, coal-to-chemical, and agricultural processing industries. For the province’s remaining areas that are largely rural, government efforts will still focus on basic infrastructure construction to foster urbanization.

From 2000 to 2008, the western region’s GDP grew by an average of 11.7 percent annually. But these robust numbers mask the shortcomings of the Western Development Strategy. From 1999 to 2009, high-volume growth in western China was limited to just three major cities: Chengdu, Sichuan; Chongqing; and Xi’an. Average annual incomes in the western region remain below the national average.

The Rise of Central China Plan

In 2009, the State Council released the Rise of Central China Plan with the clear goal of transforming central China into a production base for four major industrial areas: grain production, energy and raw materials, equipment manufacturing, and high technology. The plan also aims to develop the region into a major transport hub.

To support the 2009 plan, the PRC Ministry of Commerce (MOFCOM) in May 2010 issued the Central China Foreign Investment Promotion Plan (2009-14) and six related provincial sub-plans that cover Anhui, Henan, Hubei, Hunan, Jiangxi, and Shanxi. Each provincial plan contains a foreign-investment promotion strategy that focuses on specific industries. For example, the Henan Promotion Plan encourages foreign investment in chemicals, electronic equipment, equipment manufacturing, high technology—especially IT—and mining.

Industries encouraged in the Central China Foreign Investment Promotion Plan include a mix of traditional and emerging industries, including

• Agricultural products and food production;
• Clothing, food, light industry, electronics, and other labor-intensive industries;
• Electronic information, biotechnology, new energy, new materials, and other high-tech industries;
• Energy and raw materials;
• Farm machinery, vehicles, and shipbuilding;
• Logistics, transportation, and other modern services; and
• Mining, metallurgical, and petrochemical equipment.

The Rise of Central China Plan has a few characteristics that set it apart from the Western Development Strategy. Notably, central China development policies seek to exploit the region’s agricultural advantages and develop industries such as agriculture machinery, food processing, logistics, and petrochemicals.

The Rise of Central China Plan has already shown some positive results. In 2009, the average GDP growth rate of the six central provinces reached 11.6 percent, exceeding the 11.1 percent growth rate of coastal provinces. Industrial value-added and fixed-asset investment in the region also demonstrated robust growth in 2009. Indeed, impressive economic growth in the central region appears to be generating domestic demand and driving policymaking toward the region.

Yet companies have expressed doubts about the business operating environment in central China. Many complain about the region’s poor infrastructure and fragmented logistics networks relative to the coast. Higher transport costs and relative isolation from supply chains may outweigh the benefits of tax breaks and other financial incentives available to foreign-invested enterprises (FIEs) that relocate to central China.

More policies on the horizon

Signs indicate that the PRC government is pushing for further development in the country’s central and western regions. China’s 12th Five-Year Plan (2011-15), which is currently being drafted and is scheduled to be finalized in March 2011, will devote significant attention to developing central and western China. Though details of specific policy initiatives are not yet public, the policies will likely emphasize balanced regional economic growth instead of focusing on generating rapid economic development.

As an indication of a renewed commitment to development in central and western China, the State Council approved in June 2010 a plan to establish the Liangjiang New District in Chongqing. The district was modeled after Shanghai’s Pudong New District and Tianjin’s Binhai Development Zone, offering all the same incentives, including a reduced enterprise income tax (EIT) rate of 15 percent through 2020 to companies that operate in encouraged industries. NDRC Vice Minister Du Ying announced in July that regulators are currently developing the Catalogue of Encouraged Industries in Western China.

Regional development incentives

By offering incentives to foreign companies, the PRC government has emphasized that foreign investment is key to developing the central and western regions. Under current investment schemes, foreign companies that invest in priority industries in these regions can enjoy the same preferences that are offered to industries in the encouraged list of the Catalogue Guiding Foreign Investment in Industry. Incentives are mainly tax related, such as a 10 percent reduction in EIT payments. Current policy allows exemptions until the end of 2010, but the exemption may be extended for emerging industries such as bio-sciences, IT, pharmaceuticals, and renewable energy. The State Council is urging localities to streamline or liberalize investment processes and technology funding to encourage FIEs in eastern China to relocate to the central and western regions.

Incentives in central China

Many tax incentives are available to investors in central China, with the bulk of them offered at the county and city levels. County and city tax incentives include exemptions or reductions in payments of value-added tax (VAT), EIT, import tax, urban land tax, and other tax liabilities. Local governments also offer preferential land-use policies, such as discounted rental fees, rebates, and accelerated approvals for land use. Eligibility for preferential policies depends on the location, industry, and nature of the applying company’s operational activities.

According to a 2007 State Council General Office notice, companies in 26 central China cities are eligible for incentives that were once applied to companies under the Plan for Revitalizing the Old Industrial Base in the Northeast Region. More than 200 counties offer incentives to companies under the Western China Development Strategy. Incentives are primarily related to tax and land use in the following 26 cities:

• Anhui Province  Bengbu, Hefei, Huainan, Ma’anshan, and Wuhu;
• Henan Province  Jiaozuo, Kaifeng, Luoyang, Pingdingshan, and Zhengzhou;
• Hubei Province  Huangshi, Shiyan, Wuhan, and Xiangfan;
• Hunan Province  Changsha, Hengyang, Xiangtan, and Zhuzhou;
• Jiangxi Province  Jingdezhen, Jiujiang, Nanchang, and Pingxiang; and
• Shanxi Province  Changzhi, Datong, Taiyuan, and Yangquan.

Companies operating in the agricultural products and processing, auto, defense, equipment manufacturing, high- and new-technology, metallurgy, petrochemical, and shipping industries may be eligible for rebates on their VAT payments for fixed assets. The rules also apply to organizations that have head offices (zong ji gou) in central China and have purchased fixed assets through their head office. Industrial enterprises can write off 40 percent of the purchase value of fixed assets or intangible assets from their income taxes.

The rules also provide incentives for land use. Any land that is deemed by the land utilization plan as a “transformational project” and that is used for urban construction can be regarded as priority. Transformational projects are those that use land for a different purpose than what it had been used for in the past. Land applications for key infrastructure projects will be given additional priority status.

Incentives in western China

Despite reforms to China’s enterprise tax regime in 2008, preferential tax policies listed in the Circular on Issues Regarding Tax-Related Preferential Policies for Western Development (1999) remain effective, and most of them are likely to be extended past 2010. Tax benefits listed in the circular include:

• Reduced EIT rate of 15 percent for investment that falls under the encouraged category in the Catalogue Guiding Foreign Investment in Industry or the 2008 Catalogue of Priority Industries for Foreign Investment in Central and Western China.
• Local tax deductions or exemptions approved by the provincial government.
• 2+3 tax holidays for new enterprises in the transportation, grid power operation, irrigation works, postal services, and broadcasting industries. Eligible companies receive a two-year exemption on their EIT payments beginning from their first profitable year, and pay a 12.5 percent EIT rate from the third to fifth year. To qualify, companies must derive 70 percent of their annual revenue from services related to their core business and must have been operational for 10 years or more.
• Duty-free imports and exemptions on VAT payments on imported products that are used directly by the importing company, according to the product types listed in the Import Commodities Not Exempt from Duty and Tax for Foreign Investment Projects Catalogue.

Media reports indicate that the State Administration of Taxation has already begun internal discussions on updating the circular, and may include a 3+3 tax holiday for companies that invest in key public infrastructure projects. (A 3+3 tax holiday would be similar to a 2+3 holiday, but would allow an additional year of exemptions on EIT payments.) Statements from the PRC leadership also suggest it will extend the 10-percent reduction in EIT rates.

More options for foreign investors

The push to develop China’s central and western regions will open market segments to foreign investment for years to come. Companies will find greater investment options as previously restricted industries in the interior open to foreign investment and favorable policy incentives become available.

Despite the growing attractiveness of China’s interior as a destination for investment, establishing operations in central and western China brings distinct challenges that companies must account for in their planning. Local officials’ relative lack of experience in facilitating foreign investment may require companies to educate government officials about how their operation supports government policy objectives. Companies should also be aware of the risk of local protectionism, particularly favoritism toward state-owned enterprises.

Policy is just one component of the decision to embark on a major investment. Companies must consider other factors—such as the operating environment, access to a talented labor pool, ease of transportation and logistics, and access to the supply chain—before entering a new market. For now, most cities in central and western China are underdeveloped. But given the speed with which the PRC government aims to grow the economies of interior China, conditions for investment may improve quickly.

[author] Nancy Huang is manager, Business and Policy Research; Joie Ma  is manager, Programs; and Kyle Sullivan is manager, Business Advisory Services, at the US-China Business Council (USCBC) in Shanghai. USCBC is the publisher of CBR. [/author]