Since early this year, foreign banks and insurance firms in China have had a busy time. HSBC and Citibank were given licences to do foreign-currency business with Chinese customers. The banks' top guns flew in for the inauguration of the business, speaking confidently about China's great potential.
Half a dozen leading insurance companies meanwhile have set up joint ventures with Mainland partners, to do what they had been waiting for years: offering insurance services to local Chinese.
These financial institutions are among the first group of foreign firms to benefit immediately from China's new foreign-investment regime, as outlined in its accord with the World Trade Organisation (WTO) last November.
After years of negotiations, China has finally agreed to open up previously highly restricted or closed sectors to foreigners. These sectors include distribution, telecommunications, securities, banking, trading and tourism. In some sectors such as management consulting, advertising and real-estate services, foreign firms will be allowed to set up wholly foreign-owned enterprises (WFOEs) a few years from now. With some 'strategic' sectors, such as telecoms and securities, a ceiling of 49 percent for foreign ownership remains.
The world has greeted China's greater market opening with enthusiasm. In a survey of 680 companies in Asia conducted last November, the accounting firm Deloitte Touche Tohmatsu found that nine in 10 foreign companies already operating in China plan to expand their business. Other surveys indicate the same sentiment.
Even before China's formal accession to the WTO, foreign investors parked in Hong Kong billions of dollars whose final destination was the Mainland. In 2000, the inflow of capital to Hong Kong increased year-on-year by a record 44 percent to US$64bn, making the territory the largest recipient of FDI in Asia. As these 'parking funds' headed back to the Mainland, China's utilised foreign direct investment (FDI) grew a year-on-year 15 percent to US$46.8bn in 2001. The volume could reach US$65bn by 2003, predicts investment bank Lehman Brothers.
China is already the third largest recipient of FDI in the world, after the US and UK. Its rise is partly at the expense of the rest of Asia. Southeast Asia's share of total FDI in developing Asia has shrunk, from more than 30 percent in the mid-1990s to 10 percent in 2000, noted the United Nations Conference on Trade and Development (UNCTAD). FDI flows into other parts of Asia have been falling since 1997, with the continent's nine least developed countries receiving in total less than US$500m in 2000.
This massive capital inflow has provided a shot in the arm to China's sagging economy. In recent years, the Chinese government has had a hard time achieving its target 7-8 percent growth in GDP. It has printed a record volume of treasury bills to finance infrastructure, as a way to spur growth. Consumers, however, refuse to follow the government's example and do not spend, leaving factories with stockpiles of goods.
Even foreign investors seemed to have lost faith in China. In 1999 and 2000, utilised FDI fell for the first time, from US$45.8bn in 1998 to around US$40bn each year. Suddenly, China had bad press. Foreign firms complained about not making money in China. A few, notably breweries and food processing firms, pulled out of the market, selling their investments to their Chinese rivals.
Improved business environment
But thanks to WTO accession, China has become the darling of foreign investors again. Foreign investors are aware that problems such as red tape and corruption will persist, but Beijing has made enough promises to raise hope for an improved rules-based business environment. As a WTO member, China is bound to observe the three basic principles of the organisation: non-discrimination, national treatment to all companies and a transparent legal system.
To this end, China has already amended dozens of laws and rules to make it WTO compliant. The national government said it would need to formulate 26 new regulations and amend 140 national laws and regulations. At the provincial and municipal-government level, a similar exercise is going on to change locally applied, vaguely phrased 'administrative' measures that make life difficult for many foreign businessmen.
The most important amendments were made to the three laws that regulate the types of investment vehicles for foreign firms in China – equity and co-operative joint ventures, and WFOEs. In recent months, the National People's Congress has removed from these laws four important restrictions imposed on foreign-funded enterprises: the need to balance foreign exchange, source raw materials in China, export a certain ratio of their products and use advanced technology. In practice, many foreign firms in China have not met these criteria and used various ways to bypass them. But the official removal of these restrictions will help firms to operate freely.
Important amendments have also been made to the three major laws on intellectual property rights. The revised Patent Law, Copyright Law and Trademark Law offer more protection and compensation to victims of IPR infringements.
The State Council and its ministries have also issued since late last year other regulations that formally allow foreign firms to enter into the newly opened areas of financial leasing, foreign exchange services to local Chinese, fund management, insurance, telecoms and venture capital. Revisions to the regulations in other sectors such as franchising and distribution are next in line.
As a result of all these changes, three investment trends are likely to emerge:
1.) Conversion from joint ventures to WFOEs. With the lifting of a ban on 100 percent foreign ownership in certain sectors, foreign firms will establish WFOEs to replace their existing joint ventures with Chinese partners. WFOEs have become increasingly popular because they offer greater freedom in management. In 2001, 15,640 new WFOEs were set up, with the investors pledging to invest a total of US$42.98bn. By contrast, only 8,895 joint ventures were set up, with a utilised value of US$17.5bn last year.
2.) More joint stock limited companies. With the passage of various regulations, both Chinese and foreign investors have found it attractive to set up their business on the Mainland as limited companies. This vehicle carries limited liabilities and a clearer ownership structure with voting rights based on the number of shares held by each partner. With joint ventures, Chinese partners could sometimes veto management decisions even though they were minority shareholders. A joint stock company is also easier for transfer of assets and eventual listing on the stock market.
3.) Mergers and acquisitions. More domestic and foreign investors in China, domestic and foreign ones, are expected to merge or acquire existing foreign-funded enterprises and local firms, rather than making greenfield investments. There are many good reasons to do so: to acquire well-known brands, take over market shares of rivals or make use of established distribution channels. Tsingtao Brewery, for example, has used such a strategy to quickly expand its market share nationwide in recent years. HSBC Holdings, meanwhile, has recently acquired 8 percent of Bank of Shanghai. Other foreign banks may follow suit, in a bid to cement alliances for strong local banks.
In the more liberal and diversified investment environment, the government continues to have its own investment agenda, promoting projects with long-gestation periods and export potential. Last September, for example, the State Development Planning Commission produced a list of 228 'priority' projects. These projects are mainly in petrochemicals, chemicals, infrastructure and other heavy industry sectors and many of them are located in the backward west of the country.
The visible hand is most evident in the revised Regulations Guiding the Direction of Foreign Investment, which came into effect from April this year. The document is a comprehensive guide on the kind of projects China favours or prohibits foreigners from investing in (see page 31).
The government also continues to spend much energy to promote its Western Development Strategy, which was first launched in 1998. It calls on foreign investors to invest in the 10 western areas of Sichuan, Guizhou, Yunnan, Shaanxi, Gansu, Qinghai, Tibet, Ningxia, Xinjiang and Chongqing. It promises investors that they will continue to enjoy tax holidays and other concessions in western China, even though it is removing such preferential treatment elsewhere in the country.
Foreign investors, however, remain lukewarm. By end-2000, 86 percent of China's actual FDI was in the eastern provinces, while the west accounted for a mere 5.4 percent, or US$18.8bn. The region's remote location, poor infrastructure and limited local purchasing power continue to be major drawbacks to foreign firms. As one foreign analyst notes, the Go West strategy is more like a political campaign than a commercial proposition to investors.
Foreign investment continues to concentrate in the two delta regions of the Yangtze and Pearl rivers. Jiangsu, the eastern coastal province with a strong light-industrial base, accounted for 13 percent of all utilised FDI by end-2000, while Shanghai took up another 8 percent. Shanghai recently has been able to attract more capital and technology-intensive projects, with many multinational firms setting up semi-conductor factories and research centres in the new business district area of Pudong.
Guangdong continues to lead the country with a 28 percent share of the country's actual FDI. For many years, Hong Kong's small to medium-sized firms were the biggest investor in the province. Since the early 1990s, Taiwan firms have grown in numbers and in influence, with about 16,000 of them in the province. In particular, Dongguan, a city two hours by car from Hong Kong, has emerged as the biggest industrial base for them in China. The 5,000 Taiwanese firms there produce computer products, toys, plastic, furniture, shoes, cable wires and furniture, helping the small town to generate exports of US$15bn last year.