China's agreement with the US on its commitments for joining the WTO has been hailed as a landmark in the country's development and integration with the global economy. In the next few weeks the EU and China will undertake to close their negotiations on a parallel agreement of equal importance.
For foreign investors in China, the US-China agreement lists the tariff, regulatory and policy changes for specific industries. It also provides a blueprint for economic reform across industries. Although the final terms of China's entry into WTO will not be set until the remaining bilateral agreements are completed, the most important of which is the agreement with the EU, foreign companies are beginning to assess how the landscape for doing business in China will change as greater advances are made in gaining direct access to the China market.
Tariff reductions will have the most immediate impact. The US-China agreement covers 6,600 industrial items, with tariff reductions that may take place immediately upon accession or be phased in up to five years, depending on the product. On average, tariff levels will fall to 9.4 percent by 2005. Importantly, China has agreed that tariff reductions will be binding on China – there is no turning back after entry into WTO.
At the same time, all industrial quotas and other types of quantitative restrictions are to be phased out. Many of these restrictions will be eliminated upon China's accession to WTO; other items, such as import quotas for autos, will be phased out by 2005. Import licences will also be eliminated upon accession or phased out in tandem with the relevant import quota. Some of the mystery related to import permissions should be eliminated as well ?the US-China agreement is reported to include a list of about 200 products for which import quotas are identified and a plan is agreed for elimination or phasing out. If a product is not on the list, China will not be allowed to use or introduce an import quota.
As tariffs are reduced and quantitative restrictions are removed, foreign companies are considering what will be the most effective way to get their products into the China market.
Up until now, foreign companies have been severely restricted in the trading and distribution activities that they may undertake with respect to imported products as well as products produced by their own joint ventures in China. Apart from certain pilot projects, foreign companies have generally not been allowed to setup import-export companies; nor have foreign-invested enterprises (I.1Es) been allowed to import products or parts not used in their own manufacturing process. In many cases, HEs have not been allowed to distribute their own products in China, but must entrust domestic sales to a Chinese distributor.
Negotiators for a number of WTO member countries recognise that bringing down tariffs and reducing import restrictions are only part of the job of establishing access to China's domestic market. Foreign companies must be able to get their products through the distribution and sales channels to their customers. Eliminating the middleman – or at least allowing foreign companies to joint venture with him – has been the object of several WTO negotiating sessions.
Under the US-China agreement, China has agreed to provide trading and distribution rights that will be progressively phased in over three years. We understand that under the agreement only two permanent exceptions will remain to the granting of trading and distribution rights: tobacco and salt. However, it appears that significant exceptions, although not permanent ones, will remain for crude oil, petroleum, silk and chemical fertilisers. Many of these products, such as tobacco and silk, represent key areas for European companies, and it is hoped that EU negotiators will be able to make some additional progress in these areas.
In the area of distribution rights at the wholesale level, Beijing has agreed that foreign companies with existing investments in China will be able to distribute their domestically-made products with a Chinese partner immediately upon China's accession to WTO. Other foreign companies will be permitted to set up distribution joint ventures one year after accession, taking a minority stake initially. Majority stakes will be permitted two years after accession.
Such restrictions, along with the geographic restrictions previously established under PRC regulations, will be eliminated three years from accession. However, this progressive approach to wholesale rights will not be used for sensitive products, such as publications, pharmaceuticals and pesticides where no wholesaling rights are to be permitted initially. Instead, full rights are to be granted three years from China's accession. Similarly, in the areas of chemical fertilisers and petroleum, full rights are to be in place five years from accession.
New distribution channels
The raison d'etre of most joint ventures and wholly foreign-owned enterprises (WFOEs) has been access to the China market. Establishing a plant in China has often been necessary when the imported product would encounter tariffs in excess of 40-50 percent and a host of import barriers, such as licensing and foreign exchange restrictions. How-ever, even with several joint ventures and WFOEs strategically placed for production of several products, foreign companies often feel that they are developing their domestic market in slow motion. Introducing a new product may mean obtaining consent of the Chinese partner and perhaps government approvals as well.
Foreign companies will therefore welcome the new channels for doing business in China that will come with China's entry into WTO. However, these new channels are likely to be used in co-ordination with existing foreign investments in China to supplement product lines or offer related after-sales services. In some cases, China's commitments may offer explicit advantages to foreign companies with existing investments, such as in the case of distribution rights.
Foreign investors will need to start preparing their strategies now if they are to react quickly when these new opportunities become reality. There will be more than a few bureaucratic hurdles for foreign companies to clear as China implements newly liberalised policy and regulations for its entry into WTO. Seasoned China investors will not find this unexpected, and will be ready with the solutions.
Freshfields 1999. Freshfields is an international law firm. For further details, contact Lucille Barale in Hong Kong (tel: +852 2846 3400) or by e-mail (firstname.lastname@example.org) or Matthew Cosans in London (tel: +44 171 936 4000) or by e-mail (email@example.com).