China 2012 Budgets – The Uncertainty Factor Creeps Back

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Labor cost evaluations the huge bugbear in planning for 2012

Op-Ed Commentary: Chris Devonshire-Ellis

Oct. 24 – One of the main problems facing businesses in China today remains the uncertainty factor. Getting that out of China’s commercial creed is proving a tough nut to crack, and before he upped sticks from Beijing to become a US Presidential candidate, Jon Huntsman reiterated the same to me a year ago at the Economist China Conference.

With the then-Ambassador Huntsman stating that “China needs to provide security, stability and predictability, and that much remains to be done,” he pretty much nailed the overarching problem with conducting business in China – that of uncertainty. The issue of course is a huge one – it impacts upon a consistently applied rule of law, an independent judiciary, transparency in audit, and the relative certainty over predicting and planning ahead. It’s obviously never an exact science (and when it is, fraud or corruption is usually involved), however China still has a journey to undertake in order to make it easier for commercial activities in the country. It also seems obvious that the Ministry of Commerce has been losing some political clout in the decision-making process as concerns China plc.

Take, for example, the necessary business skill of business planning. 2012 is just around the corner, and all companies in China, foreign-invested and domestic, need to start planning for the financial year ahead – not least because China operates its annual audit system on a calendar fiscal year. January 1st each year means quite literally, turning over not just a page, but beginning a new set of books. The ministry, however, has neither been seen to be in control of, or even understanding of, business interests in China and seems to have lost its way at the forefront of investment policy-making.

Planning for 2012 budgets is consequently going to be difficult. The Ministry of Finance, the Ministry of Commerce, and a number of different Central Government Ministries are all involved in providing clarity of laws and implementing rules that should make it easier for companies to determine their future cost structures, but are failing in this duty. An important cost component, the administration of China’s pension scheme – which now includes expatriate employees in the equation – is seriously lacking in clarity. To date, China still lacks adequate detail within its social security laws to provide a clear legal framework for administration of the public pension throughout the nation. The social insurance law recently implemented in July this year appears to allow local governments a fair degree of discretion regarding its implementation. Each local government is drawing up its own plans for pension reform and applicable contributions, and there seems to be only limited coordination across China concerning the standardization of pension provision.

This is now starting to become a burden on businesses in China – the uncertainty factor – as pensions and social welfare contributions have suddenly become a hot topic in China. The two main uncertainties are as follows:

Expatriate social insurance contributions
The laws concerning the inclusion of expatriates into China’s social welfare scheme have been passed. What haven’t yet been provided are the implementing rules, which determine how and when these amounts are to be collected and in what portions. This is problematic as it appears, and is consistent with the points above, that this will differ on a national basis with each local government determining how this will impact upon expatriate staff.

In the absence of Central Government directives, we only have clues from FESCO Beijing (just one of many regions) about how they anticipate the new laws will be implemented. We wrote about this in some detail last week, but to reiterate, it seems that expatriates and their employers will need to contribute in full backdated to last July, with the full amounts to be paid latest by this December. This means a full six months’ worth of expatriate social welfare will need to be paid in one go. Yet to date, there remains no clarification at a Central Government level. It therefore remains hugely unsettling for companies’ finance departments to know what to allocate and how to budget for 2012, and it creates uncertainty for many expatriates relying on jobs in China that may no longer be viable for their employers to continue after the extra costs are added in. Expats coming into 2012 will have, in many cases, no idea if their company will agree to fund the extra costs, whether their work visas will be allowed to run down, and whether their contracts will be renewed. The reason – flatly because their employers don’t know the situation either. Until this is clarified, it makes China 2012 budgets and planning problematic for many – both companies and expatriates. This is clearly undesirable.

Potential for social welfare cap removal
This could be an even bigger financial blow to employers in China, with huge cost implications. At present in most cities in China, a cap on the amount of social welfare contributions exists to limit these payments beyond a certain amount. The maximum contribution for an employer on behalf of any single employee in each city varies, but it is generally around the RMB4,000 per month mark. This means that regardless of how much salary the employee earns, the social welfare contributions will not impose a large burden on the employer.

However, Dalian announced last month it has abandoned the cap, and the social welfare payments would now be a standard 31.3 percent of the employee’s salary, each month. The increased financial cost is substantial. If this were to be rolled out by other cities across China, the effect would be dramatic, and in many cases would lead to a huge increase in bankruptcies, not to mention the wiping out of profits at countless companies. To date, this remains hypothetical, yet it is another move that could be rolled out next year. It represents risk, and uncertainty. No Chinese Minister has shot down the possibility of it occurring, and no statement has been issued that caters for any answers about the potential of this being enacted nationally. The social insurance law certainly leaves plenty of room for local governments to remove the cap if they want to.

These two factors alone make it highly awkward when planning for business in China next year. It is only 10 weeks away, yet the uncertainty factor has crept back in and this is demonstrative of a China that is far less capitalist in thought than many commentators have had people believe. The government’s stated main aim at present is specifically not commercial; it is the “maintaining of social security.” The fact that it is the financial elements of social security platforms in China that are now causing commercial insecurities should come then as no surprise, but with some considerable concern.

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates. The firm was established in 1992, maintains 12 China offices and provides China legal establishment, tax and business advisory advice across China. For further assistance please contact or visit the practice’s web site here.

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