Environmental Aspects Affecting Foreign Investment in China

While foreign investors may be attracted to China’s many business opportunities, they should be aware of differences in environmental aspects such as the political and cultural landscape. Beyond this, they also need to understand changes in the country’s foreign direct investment (FDI) situation.

The government has blamed the recent lacklustre incoming FDI on the slowdown in global economic growth, prolonged European debt crisis, and rising labour costs, among other factors.

However, some experts expect China to continue attracting FDI due to the growing strength of its domestic market, marked by increasing personal disposable incomes that help to boost demand.

In addition, the view that rising wages in China will encourage many foreign investors to base their operations elsewhere may be challenged if considered from a broader perspective. Foreign direct investment into China is moving away from low-end manufacturing towards industries such as the high-end manufacturing, new energy, services and hi-tech sectors. Furthermore, China’s interior provinces are expected to increasingly attract foreign investors seeking cheaper labour and faster-growing markets. For example, southwest China’s Chongqing recorded FDI totalling US$10.5 billion in 2011, up about 66 per cent year-on-year and almost 10 times the level in 2007.

This article will focus on the main environmental aspects that affect foreign investment in China – economic, legal, financial, cultural as well as information technology and security.

Economic

China’s economy is currently the world’s second-largest and behind only the United States’, recording a 9.2 per cent year-on-year increase in 2011 to RMB47.16 trillion (about US$7.45 trillion).

The GDP of China is reportedly expected to surpass that of the US within the next decade or so. China has already overtaken the US in several areas, such as exports and manufacturing output.

More recently however, China’s economy has slowed due to headwinds from the prolonged European debt crisis. This has prompted authorities to cut interest rates and loosen banks’ reserve requirements to spur lending and boost activity. Yet, at the same time, they are also keeping a close watch on inflation, particularly from climbing food prices.

China established its first Special Economic Zone (SEZ) in Shenzhen in 1980, followed by Zhuhai, Shantou and Xiamen soon after. The entire province of Hainan was also designated an SEZ.

SEZs are areas where market-driven capitalist policies are implemented to entice foreign businesses to invest in the country. Such policies include preferential tax exemptions or new infrastructure projects.

Supported by the State Council, several state-level new areas in China also benefit from preferential policies to attract new developments to boost the local economy. These include Shanghai’s Pudong, Tianjin’s Binhai, Chongqing’s Liangjiang, Guangzhou’s Nansha, Zhoushan Archipelago and Lanzhou New Areas.

Foreign Direct Investment in China grew 9.7 per cent year-on-year to reach US$116 billion in 2011. Over the past 10 years, China’s FDI inflows recorded a compound annual growth rate of over 9 per cent.

Legal

The extent of foreign investment opportunities in China varies according to the level of restrictions imposed by government regulations for each sector.

While wholly foreign-owned enterprises can be established in many industries, restrictions on foreign investment also affect several key sectors, such as agriculture, telecommunications, securities, energy and automobiles.

For example, China has agreed to allow foreign firms to own up to 49 per cent of domestic joint venture securities firms. While this is a significant increase from 33 per cent previously, it is still a minority stake.

Another example is China’s restriction on foreign investment in building and operating refineries with a daily crude oil distillation capacity of less than 200,000 barrels. This is an increase from the previous threshold of 160,000 barrels per day.

However, the government encourages foreign investment in exploration and development of unconventional energy resources such as coal bed methane, shale oil and oil sands.

China allows foreign-invested enterprises (FIEs) to remit their profits, dividends and bonuses out of the country without the need for prior approval from the State Administration of Foreign Exchange. The FIE can directly make the remittance through a bank by presenting the necessary documents such as the tax payment statement.

Financial

The People’s Bank of China (PBOC) is the central bank of China with the power to control monetary policy and regulate financial institutions in the country. However, the PBOC has been cautious in loosening monetary policy for growth as doing so too quickly could stoke inflation, which has the potential to trigger social unrest in the world’s most populous nation.

While China welcomes more foreign capital and economic growth, it has been wary of relaxing property market curbs due to concerns that real estate speculation would drive up housing costs and reignite inflationary pressures.

The PBOC in June 2011 announced a pilot programme to allow yuan-denominated FDI in China. Foreign investors may use yuan-denominated capital to make a variety of investments in China, such as business acquisitions, the establishment of new companies, and stake purchases.

However, the PBOC prohibits yuan-denominated FDI in certain restricted sectors, such as those significantly related to the nation’s macroeconomic management.

It has also clarified several restrictions on yuan-denominated FDI in a notice sent to financial institutions.

One of the restrictions is that capital from foreign investors in yuan start-up accounts cannot be used to bid for land or purchase property.

In addition, yuan in accounts set up after FDI starts cannot be invested in securities, financial derivatives, asset management products, or properties that are not for the foreign investors’ own use.

Foreign investors are also only allowed to set up one start-up account, which must be separated from reinvestment accounts.

China’s banking system has become an increasingly competitive market following financial reforms, with only three banks in the country remaining fully state-owned − the Agricultural Development Bank of China, China Development Bank and Export-Import Bank of China.

However, the central government, through the activities of the finance ministry, the PBOC and China Banking Regulatory Commission, continues to have much influence over how many Chinese banks operate.

Cultural

The western approach of doing business typically focuses on aspects of the deal first, and then expects the relationship to grow later. In Chinese culture however, the ‘guangxi’, or relationship, is paramount. The Chinese believe that proper rapport and relationship should first be established before a commercial transaction will take place. In China, a relationship is usually built over a shared meal during lunch or dinner, and usually takes the form of a banquet.

The Chinese also place much emphasis on courtesy and ‘giving face’, or respect. Showing respect for others is essential to foster strong cooperation or help achieve business success. This not only applies to your partners and customers, but also to local employees supporting your operations in China. Because a strict management method may not suit the cultural mindsets of local staff, foreign investors may find a management system that is more flexible and sensitive to Chinese culture to be more effective.

The use of business seals is a Chinese custom. While this may be an unfamiliar practice to western investors, seals have been used in governmental and commercial transactions since imperial times in China. More information about business seals may be found here.

Information Technology and Security

Next-generation information technology (IT) is one of the seven strategic emerging industries seen as crucial for China’s future economic development in the 12th Five-Year Plan for 2011 to 2015. The other six are clean energy technology, high-end equipment manufacturing, biotechnology, alternative energy, new materials, and clean energy vehicles.

These seven industries are expected to receive significant governmental support, as the government seeks to grow them from 5 per cent of GDP in 2010 to 8 per cent by 2015 and 15 per cent by 2020.

Like other countries that significantly leverage on IT, China also needs to address information security issues. Despite better information security, the country still faces increasing cyber attacks and threats from overseas, according to a report by the National Computer Network Emergency Response Coordination Centre of China, the nation’s primary computer security monitoring network.