Op-ed Commentary: Chris Devonshire-Ellis
Nov. 1 – Getting a handle on budgets for China businesses in 2012 is proving to be a headache this year, as so much is hanging in the balance. In emerging markets such as China, it is difficult enough already to cater for the inevitable bumps along the road, preparing for the forthcoming year is as difficult as I ever remember it – and I’ve managed Dezan Shira & Associates through the Asian Financial Crisis (1997), SARS (2003) and now the Global Financial Crisis (2008). Note the time spread – something difficult occurs in China on average once every five years.
2012 will also see some monumental changes in China in its own right. Huge changes at the very top of the Chinese Communist Party are taking place, with not just the retirement of Hu Jintao and Wen Jiabao, but also a clear out at the very top of many Chinese Ministries. Minister level positions in China must retire at 65, and this has already led last week to replacements being installed at each of China’s financial regulators – there are new chairmen at the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission. At a fell swoop, the most senior personnel directing the nation’s very purse strings – and controlling the future investment decisions concerning China’s wealth – have been replaced.
China 2012 then will be run by a completely new set of senior leaders, and at a younger age than the men that went before. How this will impact on new policies remains unclear, except to say that the current 12th Five Year Plan is already underway, and that any new regime is unlikely in its early stages to introduce any unexpected legislature. Politics then, are unlikely to impact on planning for 2012, although how the new team – in place for the next decade – eventually work things out in China is presumptuous to even suggest.
On top of this, there remain the rumbling uncertainties of the Global Financial Crisis, with China seemingly out of the woods, yet still reliant on overseas markets for export sales. That said, while Europe remains dangerously close to fracturing, a worsening of the situation there would seriously dent any chances of global recovery and probably be sufficient to ensure that consumption in China flattens even more. If Europe does get into further trouble, that could mean additional declines in China with many citizens already stretched with mortgage payments and barely-surviving businesses. With property values coming down, negative equity may rear its head for some, and China knows it will need to head off dissent. Additional injections of huge sums of money to support the Chinese economy may be required, and cannot be ruled out – which is why the Chinese government is unlikely to be significantly involved in any deals to save the Euro. China-based businesses here have an advantage though – an appreciating RMB is adding value to profit margins measured in other currencies, and especially the U.S. dollar. This trend is likely to continue and may be worth a significant amount by the year end.
Other trends revolve around the uncertainty of the widening spread of China’s social welfare system. China’s population is ageing, and the country’s pension funds simply do not have enough in them to cater for increased numbers of retirees – another reason for China not to be lending huge amounts overseas. Consequently, the safety net is being extended to cover more people, and with higher contributions being demanded. That cash is expected to come from China-based businesses that appear to have been targeted as the main contributors.
The changes affect two groups of people. Firstly, expatriates in China – and their employers – must now start to pay mandatory social welfare to China. I was quoted about this here last week in the London Daily Telegraph and we have written about it extensively here and here on China Briefing. Clearly, these amounts now need to be built into budgets, and the amounts due and how to calculate them have been identified by us in the links above (please contact us at email@example.com if you’re still not sure how to total this liability up).
While the additional costs of employing expatriates are now well known and can be planned for, the removal of caps on social welfare payments in China is another potential issue concerning social welfare, and there is no clear direction concerning how this will pan out. This affects all employees in China, both local and expatriate. Currently, in most cities, contributions to the social welfare fund that need to be made by employers are capped at a percentage of average local salary. These caps typically differ from city to city, but have the effect of maintaining a ceiling on the maximum amount employers have to contribute for any single employee to generally around RMB4,000 per month. This means that regardless of how much an employee earns, the social welfare contributions will not impose a large burden on the employer.
However, Dalian has recently announced that it has (at least temporarily) removed its cap, and that social welfare payments payable by employers would now be a standard 31.3 percent of any individual employee’s monthly salary. The more the employee earns, the more welfare is paid by the employer (although the cap still remains in place for the employee). A difficult planning point for 2012 then is the question over whether this will be rolled out on a national basis or not. There are already rumors that certain key Chinese cities are planning to introduce a cap-free social welfare security system. If that happens, operating costs for businesses employing higher paid Chinese and expatriate personnel will see their mandatory welfare contributions shoot up. We discussed the issues also on China Briefing here and the uncertainty this causes 2012 budgeting issues here.
The impact these are expected to have could be wide ranging. We would expect to see the following:
Expatriates in China
The social welfare demands now expected from expatriate employees and their employers will almost certainly result in a decline of expatriates working in the country. Official statistics put the number at some 660,000, of which 250,000 are registered for tax. Non-essential expatriates will be relocated, simply have their contracts terminated, or asked to work in China while on business or tourist visas to keep them off the welfare and tax payroll. The latter also means many will not legally be compliant. It remains to be seen how far China will go in limiting the issuance of business or tourist visas to one individual on a regular basis. Localization of many roles previously held by expatriates will occur. Come the New Year, we expect to see a drop in the numbers of expatriate faces – people here today but who will have left China.
If being passed over in China for 2012, what can the expatriate do? Most we suspect will find it hard to gain new employment in China, at least legally. The bad news is that back home in Europe or North America the economy isn’t doing so great either. The good news is Australia is booming, as are other parts of Asia.
Income taxes are low in many other Asian countries and most do not apply social welfare to foreigners. Markets such as Vietnam and India, and businesses within them, are crying out for seasoned China expatriates who know their way around supply chains, factory management, and related services. We’ve written about a brain drain to India, with a complimentary expatriate manager’s introduction to India here, and detailed why Asia is a good bet for 2012 here. As one door closes, another opens.
Uncapping social welfare
This is a huge potential issue, and will massively increase operating costs in China. It remains at present only a possibility, however it does not require any new legislation to enact as the decision on whether to do so or not lies at a local government level. Some governments may feel their corporate businesses can sustain such an increase; by definition these would be cities where investment has no choice other than to remain extant, with any move out of the question. Other local governments may wish to retain the advantage of keeping a cap on welfare payments in order to attract investment. The possibility that the central government puts pressure from above on certain cities to remove the cap cannot be dismissed.
Until there is any official policy – and there may not be – the risk is difficult to determine. However, for 2012 budgeting issues and assuming the worst position, I would recommend working out the potential cost factor and including it as a cost factor in first tier city locations in China. If it’s not implemented, you have cash on hand, and if it is, you’ve covered for the potential costs.
The bottom line from me is this – I do expect social welfare to be uncapped. The signs are already there, and unless there is a mass revolt in Dalian against the collection of this from businesses, I expect it to be implemented. It will almost certainly be collected initially from cities who feel their investors are unlikely to relocate as a result, which means first tier and possibly some second tier locations. Other cities may delay implementation. The only question in my mind is timing, and which cities will uncap. I anticipate some uncapping during 2012, hence the advice to budget for the extra cost.
Outsourcing from China to India, Vietnam and Emerging Asia
Should an uncapping of social welfare across China (or in key cities) occur as mentioned, a huge additional burden will be placed on businesses in China. If that occurs, businesses can only be expected to respond by outsourcing part or all of their production from China elsewhere. This extends from manufacturing to the service industry – Dezan Shira & Associates is already making plans to outsource some of its China accounting work to its India offices. We’ve also written about this issue, and a 25-page, complimentary issue of China Briefing titled “Developing Your Business from China to India, Vietnam and Emerging Asia” is also available for immediate download from the Asia Briefing Bookstore.
The fundamental dynamics of China’s economy look positive, as we have pointed out, yet during these uncertain times, budgets for 2012 we suggest are best prepared in a conservative manner with additional allowances made for the increased costs of hiring expatriates. Additional sums being set aside in the budget for catering for any further uncapping of China’s social welfare contributions should also be factored in. The overarching feel I have towards China at the present is that it is set on a fundamentally different course than was the case 10 years ago, and that priorities have changed.
Under Jiang Zemin and Zhu Rongji, the main aim was to attract foreign investment into China, and have it join the WTO. Under Hu Jintao and Wen Jiabao, the aim has been to further stabilize China internally, and to use the money it has earned from WTO admission to provide a solid and more transparent social platform on a national basis. The upcoming new leadership has to cater for a different set of dynamics – and that is, quite simply, the task of dealing with an aging China. It is no surprise that social welfare costs are now a major factor in keeping China’s population secure.
The implications of all this – China becoming increasingly expensive – are a byproduct of these demographics, and should not be viewed as any retreat from favoring foreign direct investment. However, as China moves along its development path, new challenges arise, both for its government and for the businesses based here. The time is now ripe to expand beyond China, and look at emerging markets elsewhere in Asia for similar growth patterns that have been experienced for the past 20 years. That total China focus era is passing, which is why the simple act of budgeting for China, this year especially, is that much more difficult.
Yet opportunities exist. As we have pointed out many times before, the ripple effect of China’s emergence has spread across Asia. India has now come to the fore and provides a middle class of similar size to China. Cheaper manufacturing options exist right across Asia, not least in Vietnam. The future of China investments – and budgets – are now, for the first time, irretrievably linked to Asia. I described the three-pronged trident Asia strategy yesterday.
Increasingly, as China moves up the value chain, budgeting for Asia investments will also become part of the annual fiscal and planning cycle at this time of year. China’s increasing demands for security and a rise in national income levels will both encourage such changes to the savvy investor, and longer term, a more stable market for the sale of imported products into China at a higher purchase value. The China game has changed, but for the better, and is now not so Asia exclusive as alternative destinations such as India come on-stream.
The issue is not just one of factoring in increased China business costs, it is also of examining which other locations are capable of providing the growth that, to date, China has given. With that advantage being whittled away, 2012 budgets would be wise to include the increased China costs I have described, in addition to research and development costs for adding subsidiaries elsewhere in Asia.
Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, and the publisher of China Briefing, India Briefing, Vietnam Briefing and the emerging Asia web site 2point6billion.com. Dezan Shira & Associates was founded in China in 1992, and provides corporate establishment, tax, accounting and business advisory services for multinational and small-medium clients in the country. The firm has expanded in recent years into emerging Asia, and in total has 11 offices in China, 5 in India, 2 in Vietnam and one each in Hong Kong and Singapore. Please email the practice at firstname.lastname@example.org for business advisory or other services throughout Asia, or visit the firm’s web site at www.dezshira.com. A weekly subscription to the best of Asia Briefing news can be obtained free of charge from our subscriptions page.
Doing Business in China
Our 156-page definitive guide to the fastest growing economy in the world, providing a thorough and in-depth analysis of China, its history, key demographics and overviews of the major cities, provinces and autonomous regions highlighting business opportunities and infrastructure in place in each region. A comprehensive guide to investing in the country is also included with information on FDI trends, business establishment procedures, economic zone information, and labor and tax considerations.
India Briefing Guide to Doing Business in India
This book aims to provide a basic overview of all topics related to doing business in India – history, business etiquette and culture, and how to invest into the country, in addition to a detailed, state-by-state demographic and geographic overview and a comparison with China.
Establishing Business in Vietnam
In this issue of Vietnam Briefing, we focus on establishing a business in Vietnam, from the corporate and personal income tax regime, to the various registration procedures investors must go through to establish a legal entity in the country.
India Briefing News
Our magazine and regular news service about doing business in India. We cover topics relating to the Indian economy, the market in India, as well as foreign direct investment and Indian tax and legal issues.
Our magazine and regular news service about doing business in Vietnam. We cover topics relating to the Vietnamese economy, the market in Vietnam, as well as foreign direct investment and Vietnamese tax and legal issues.
Our popular emerging Asia website and commentary dealing with China, India and other regional multilateral development, trade, culture, investment and politics.
Previous Article « China Lifts Tax-free Thresholds for Business Tax and VAT Collection
Next Article China Renewable Energy Industry Report: Nov. 2 »
Dezan Shira & Associates´ brochure offers a comprehensive overview of the services provided by the firm. With its team of lawyers, tax experts, auditors and...
As a legitimate tool for reasonable tax planning and cost saving, tax incentives play an important role. Companies also use tax incentives as a useful...
A firm understanding of China’s laws and regulations related to human resources and payroll management is absolutely necessary for foreign businesses in...
Over the last few months, China has been quickly expanding the pilot program on electronic special value-added tax (VAT) fapiao (hereafter special VAT...
An Introduction to Doing Business in Hong Kong 2021 is designed to introduce the fundamentals of investing in Hong Kong. Compiled by the professionals at Dezan...
Since the formulation of the GBA Initiative in 2017, business communities have placed high expectation on the coordinated development among GBA cities, as the...
Dezan Shira & Associates helps
businesses establish, maintain,
and grow their operations.
Update on Expat Welfare: We are now recommending businesses in China employing expatriate personnel include these amounts into 2012 budgets from January 1st. Local governments may not immediately request payment, but when they do, you can expect it to be retrospective to the beginning of the year. Dezan Shira & Associates are catering for this in this manner also. – Chris
Comments are closed.
Stay Ahead of the curve in Emerging Asia. Our subscription service offers regular regulatory updates,
including the most recent legal, tax and accounting changes that affect your business.