By Ana Cicenia
Foreign direct investment (FDI) in China has changed significantly as wages continue to rise and the country’s economy matures from a heavy manufacturing base to one led by consumption and services. Foreign investors are taking a more cautious approach to investing in China than in years past, while Chinese outbound investors have been more bullish.
Naturally, the government has taken notice. Following a slowdown in inbound FDI, and a significant increase in outbound FDI, the government in August released the Notice on Promotion of Foreign Investment Growth (“the Notice”) to ease restrictions on inbound FDI and the Administrative Measures for Outbound Investment by Enterprises to regulate outbound FDI.
These initiatives fit into a larger business reform agenda designed to improve foreign investment options, and they are already reshaping both inbound and outbound FDI. Accordingly, strategic foreign investors with an interest in China are finding that their opportunities are changing, while Chinese investors are finding new incentives to concentrate their outbound investment on specific initiatives.
The Notice on Promotion of Foreign Investment Growth
China experienced a decrease in inbound FDI last year. In 2016, capital inflows fell to US$170 billion compared to US$242 billion in 2015, a 29.7 percent drop. The first half of 2017 also saw a drop in foreign investor sentiment as capital inflows fell by 1.2 percent year-on-year.
In light of this trend, the government has pushed through several new reforms to attract more foreign investors, including the updated Catalogue for the Guidance of Foreign Investment Industries (“the Catalogue”) and Free Trade Zone Negative List (“FTZ Negative List”), simplified company establishment procedures, and revised trademark laws. The Notice is central to this wider effort to encourage FDI and support China’s transforming economy in moving up the global value chain.
On August 8, 2017, the State Council, the chief administrative body in China, set new goals for the expansion of FDI. The Notice has five key measures:
- reduce market entry barriers for foreign investment;
- formulate supporting fiscal policies;
- improve investment environment of national-level development zones;
- facilitate the entry and exit of foreign workers; and
- improve the general business environment.
The first measure, reduce market entry barriers, extends the FTZ Negative List nationwide and relaxes FDI restrictions in sectors such as banking, brokerage, and insurance and adds high tech sectors such as augmented reality to the encouraged category. Foreign investors can expect to see foreign share limits either lowered or removed entirely in these specified industries.
The second measure encourages FDI with supporting fiscal policies. The measure details tax exemptions and preferential treatment for FDI in high tech industries and investment in the western and northeastern economic regions.
The third measure strengthens the investment environment provided by national development zones. The measure promises to speed up administrative approval in national development zones, but this mostly applies to the manufacturing sector.
The fourth measure, facilitating entry and exit of foreign talent, is part of an ongoing effort to improve residence permit rules and attract more foreign talent. However, this is expected to affect mostly foreigners working in domestic firms and not those working in foreign-invested enterprises.
Finally, the fifth measure calls for improving the business environment through free remittance of foreign profits and stronger protection for intellectual property. Whether or not free remittance of foreign dividends and interest will be secured though is yet to be seen, in light of past capital control policies.
Following through on the Notice, the Ministry of Finance announced last Friday new rules that grant foreign investors more access to Chinese banks, insurance and securities companies. Foreign investment ratio limit in securities companies is raised to 51 percent, compared to current ratio of 49 percent, and the limit will be removed completely in three years.
Previously, a single foreign investor could not own more than 20 percent of a Chinese bank, and multiple foreign investors could not hold more than 25 percent. This limit has now removed and foreign investors enjoy domestic treatment. Additionally, foreign investors will be allowed up to a 51 percent stake in insurance companies in three years and the limit will be removed entirely in five years.
The Administrative Measures for Outbound Investment by Enterprises
The government has sought to regulate outbound FDI, publishing the Measures in August. After ambitious spending by several domestic conglomerates in 2016, when outbound FDI reached US$170.1 billion, a 44.1 percent increase from 2015, the Chinese government instituted several new capital controls and is cracking down on “irrational” acquisitions by domestic firms abroad.
Domestic companies like Dalian Wanda Group, HNA Group, and Fosun International dramatically increased their acquisitions abroad in the past few years, most of which was financed through credit lines with state controlled banks. The government is concerned that the spending sprees by these companies signal the emergence of “Grey Rhinos”, and is determined to curtail excessive investment abroad.
In a statement published August 4, 2017, the State Council laid out the new Measures. The Measures categorize outbound investment into three categories, as follows:
- Investments that threaten national security or interests;
- Investments into unauthorized core military technology and products; as well as
- Investments into the gambling and sex industries.
- Investments in countries with which China has no formal diplomatic relationship, are at war, or has agreements with restricting investment; as well as
- Investments into the real estate, hotel, entertainment, and sport industries.
- Investment in One Belt, One Road (OBOR) related projects and infrastructure;
- Investments that advance Chinese manufacturing technology;
- Investment that improve Chinese high-tech and R&D centers abroad;
- Investment that secure supply chains in raw materials and energy sources, such as oil, gas, and minerals;
- Investment in trade, culture, logistic services is encouraged, as well as finance.
These new government directives appear to have already made an impact.
The first 10 months of 2017 have already seen an increase of FDI in high-tech manufacturing, a 22.9 percent rise from last year, at RMB 56.65 billion. Notably, FDI in China’s central region has also seen a dramatic rise, growing 47.9 percent from last year. While much of this occurred prior to the August announcement for the Notice, foreign investors should see these directives as complementary to larger trends within the economy.
Meanwhile, outbound investment has also complemented the Measures. While the capital controls and new restrictions on outbound FDI have effectively stemmed outflows in 2017, with outbound FDI down 40.9 percent from last year, investment in OBOR projects totaled US $11.18 billion, a 4.7 percent jump from last year. With the OBOR initiative added to the Constitution, and regulators offering smooth approval process for OBOR projects, investment into the new Silk Road are expected to increase.
All of this is happening during a pivotal point in the Chinese economy. As GDP growth continues to slow down — reaching 6.2 percent industrial output last month — and wages are rapidly rising, the Chinese economy is evolving, moving farther away from manufacturing-centric economy towards a services and consumption based economy.
Increasing competition from other developing countries, and worry about the security of the RMB after a six percent drop in 2016, has further motivated the government to take action in new ways that reflect this new normal.
China Briefing is published by Asia Briefing, a subsidiary of Dezan Shira & Associates. We produce material for foreign investors throughout Asia, including ASEAN, India, Indonesia, Russia, the Silk Road, and Vietnam. For editorial matters please contact us here, and for a complimentary subscription to our products, please click here.
Dezan Shira & Associates is a full service practice in China, providing business intelligence, due diligence, legal, tax, IT, HR, payroll, and advisory services throughout the China and Asian region. For assistance with China business issues or investments into China, please contact us at firstname.lastname@example.org or visit us at www.dezshira.com
Dezan Shira & Associates is a pan-Asia, multi-disciplinary professional services firm, providing legal, tax and operational advisory to international corporate investors. Operational throughout China, ASEAN and India, our mission is to guide foreign companies through Asia’s complex regulatory environment and assist them with all aspects of establishing, maintaining and growing their business operations in the region. This brochure provides an overview of the services and expertise Dezan Shira & Associates can provide.
This Dezan Shira & Associates 2017 China guide provides a comprehensive background and details of all aspects of setting up and operating an American business in China, including due diligence and compliance issues, IP protection, corporate establishment options, calculating tax liabilities, as well as discussing on-going operational issues such as managing bookkeeping, accounts, banking, HR, Payroll, annual license renewals, audit, FCPA compliance and consolidation with US standards and Head Office reporting.
In this issue of China Briefing magazine, we provide foreign investors with best practices for implementing internal controls in China. We explain what makes China’s internal control environment distinct, and why China-based operations need to prioritize internal control. We then outline how to execute an internal control review to gauge organizational resiliency and identify gaps in control points, and introduce practical internal controls for day-to-day operations. Finally, we explore why ERP systems are becoming increasingly integral to companies’ internal control regimes.