Since China joined the World
Trade organization (WTO),
China's investment environment
has greatly improved. Many
multinational and
international companies have
considerably increased their
investments in China over the
past years. This trend of
increased Foreign Direct
Investment (FDI) is in
contrast to the global FDI
which is falling. From 2000 to
2003, annual FDI dropped from
US$ 1,388 billion to US$ 560
billion, whereas over the same
period China grew from US$ 40
billion in 2000 to US$ 53
billion in 2003. In 2004 the
figure reached US$ 61 billion,
rising 13 percent over 2003.
In 2005 FDI continued to flow
strongly and even though some
figures this year indicated a
drop, it is likely to at least
meet last years figures.
Foreign Invested Enterprises
(FIE) have not only given a
boost to the development of
many industries, but in
addition FIE's export and
import account for more than
half of the nations total, the
taxes they pay make up to 20%
of the total and they employ
around 22 million workers.
Source of FDI The biggest
source of FDI for 2004 was
still from Asia, at the top
led by investors from Hong
Kong or international
companies through their Hong
Kong entities: In the last
couple of years, the flow of
FDI has started to not only go
into the traditional
manufacturing ventures but
also increasingly into the
equipment manufacturing,
electronic machinery, high
tech, entertainment, retail
and financial services. The
reason for the growth in China
is not only because of the
preferential policies the
Chinese government granted
while opening the market to
foreign investors, but also
because China has developed
into a key export base.
Attractions for FDI In
addition to its low industrial
wages, China's manufacturing
sector has made substantial
productivity gains (improved
infrastructure, increased
automation) and shows a higher
product sophistication being
achieved by a better trained
workforce and imported
technology. Another
precondition is the trend from
'made in¡K' to 'made by¡K' -
The company label is getting
more important than the
product's local origin,
enabling Western companies to
move production to contract
manufacturers in low cost
countries. The pioneers of
this development were sport
shoes, garment manufacturers,
and the computer industry,
which are all supported by
contract manufacturers (local
and foreign owned).
Preferential Treatments still
exist for Foreign owned
companies in China, in order
to attract FDI. It is
advisable to examine the exact
plans of the China entity and
which benefits can be found.
For example, a manufacturing
company that is exporting 100%
of their goods overseas should
consider establishing in a
Free Trade Zone or the Export
Processing Zone due to the
facilities and services on
offer. As the company is not
selling onto the local market
but is using China as a
manufacturing base, components
can be imported duty free,
then processed. The China
components can be added on
duty free and then re-exported
while claiming VAT back on the
China-sourced components.
Problems for FIE's Of course,
an investment into a Foreign
Country, and especially China,
does not come without problems.
Once overcome cross culture
differences and governance
issues, one of the main
concern in China has become
labor shortages. In the early
stages of China's economic
growth, Guangdong was the top
job provider for rural
migrants who headed for the
booming urban centers.
Guangdong and the Pearl River
Delta is now facing a labor
shortage of at least two
million workers as migrant
labor moves to better paying
jobs in the Yangtze River
Delta. The Pearl Delta is
therefore not only in need of
middle-level management and
technical staff, but also
factory assembly labor.
Peasants from the poor central
and western provinces are
diverting to the Yangtze
region after hearing from
relatives that wages and
working conditions are better
than in Guangdong. For example
most shoe and garment makers
and electronic plants
currently depend heavily on
cheap labor. These
labor-intensive factories
might either have to move to
inland regions for a long term
strategy or close under
intensified competition in the
future. Power shortages have
challenged tight production
schedules in the last few
years, and are expected to
continue for the near future.
Despite efforts of increasing
supply, peak demand remains up
and is likely to continue to
outweigh supply. Another top
concern for companies
investing and or operating in
China is the protection of
intellectual property rights (IPR).
The Chinese government has
started to battle the problem
by drafting new legislation in
order to protect the rights of
intellectual property owners
but so far it seems to have
not eased FIE's frustration.
These challenges, together
with benefits of the 'Go West"
initiative of the government,
have prompted Foreign
investors to explore the
opportunities in the Western
and less developed Provinces
rather than tier cities. Hong
Kong as Base for the
investment As seen in the 2004
figures, Hong Kong companies
are still the main investors
into China. Hong Kong is still
used by many international
companies as a base or
headquarter for their China
operation. The reason for this
are easier set up procedures,
liability and tax incentives.
These are some of the benefits
of a Hong Kong company: 1) The
Hong Kong Holding Company is
fully liable for the China
investment and protects your
existing company from all
liability. 2) Dividends
received by the Hong Kong
Holding Company are tax free
and can be used for further
investment. 3) Royalties,
license fees, rent etc.
received by the Hong Kong
Holding Company are tax free.
4) Manufacturing Profits: If
the China company is a
manufacturing operation and
the goods are invoiced and
sold through the Hong Kong
Holding Company, only 50% of
the profits are assessed as
sourced in Hong Kong and
therefore taxable. Profits
from the sale of goods build
up in the Hong Kong company
and can be used for
re-investment. Further
Opportunities in New Markets
After the rules for trading
and distribution rights
changed for FIE's in 2004, the
implementations of the rules
and the establishment
procedures have delayed and
proven to take longer and
therefore delayed and
frustrated many investors. As
the next step for the
commitments China made with
its entry into the World Trade
Organization, the following
sectors will open for foreign
investors on December 11,
2005: - Advertising:
establishment of Wholly
Foreign Owned Enterprises will
be possible for media channels
- Banking: foreign companies
will be able to provide
renminbi (RMB) services in
further cities - Insurance:
the minimum assets level to
obtain an insurance brokerage
license will be reduced -
Courier services and freight
forwarding: establishment of
Wholly Foreign Owned
Enterprises will be possible -
Hotels: establishment of
Wholly Foreign Owned
Enterprises will be possible
Mergers & Acquisitions: New
regulations last year enabled
easier process for Mergers &
Acquisition activities.
Instead of establishing new
joint ventures or wholly
foreign owned enterprises,
investors may now acquire
Chinese firms or shares in
Chinese firms. The Future Due
to the changes in regulations
over the previous years, FIE's
will continue to explore new
directions and opportunities.
FDI, even though expected to
continue to flow into the
export and manufacturing
sectors, will also include
newly opened markets and
possibilities. Competition
from China within the
international as well as
domestic Chinese market from
not only local but also
established FIE's, will
redefine the strategies of
Multinational cooperation for
their China Investments.
by Klaus Koehler, Managing
Director, Klako Group
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