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1. Government Attitude Toward Foreign Private Investment; Introduction and General Overview Since 1978, China has actively sought foreign direct investment (FDI) and technology to promote its modernization efforts and accelerate its export trade capabilities. Austerity measures in 1988-89 and the political tensions following the 1989 Tiananmen incident led to a temporary deterioration of the investment environment. However, with looser credit and new calls for reform and opening following Deng Xiaoping's celebrated trip to south China in early 1992, a number of new cities and sectors were opened to foreign investors. In fact, the period in between 1992 and 1996 was the heyday of American investor decisions to commit to and enter the China market, according to a recent survey of U.S. investment in China done by the U.S. Embassy. Since 1992, China has progressively expanded the areas of its economy which are open to foreign investment, including opening a number of more sensitive sectors, including those in the services industry, on an "experimental" and limited basis. China has also introduced new incentives designed to attract more foreign investment in high technology areas. For the past six years, China has been the second largest recipient of FDI in the world, after the United States. According to Chinese statistics, actual FDI in China since 1979 reached a cumulative total of just over $267 billion by the end of 1998, with over $45 billion last year, roughly the same amount as in 1997. There are signs, however, that the rapidly increasing FDI inflows of recent years may be slowing. The total value of newly pledged foreign investment contracts dropped in the first half of 1999; actual FDI inflows decreased as well. The number of new projects has also declined significantly although this has been partially offset by the increase in the size of new ventures. The Asian financial crisis is partly responsible for the slowdown, as investment from other Asian countries and overseas Chinese has fallen. Investment will probably not be affected by the Chinese demonstrations against the U.S. in May in the aftermath of the tragic mistaken bombing of the PRC mission in Belgrade, with most U.S. businesses viewing the demonstrations and the anti-American rhetoric as a "blip" in our larger economic relationship and citing accession to the WTO as the key to China's success in attracting investment in the future. 2. Encouraged vs. Restricted vs. Prohibited Investment China places great emphasis on guiding new foreign investment towards "encouraged" industries. Over the past four years, China has implemented new policies introducing further incentives for investments in high-tech industries and in the central and western parts of the country in order to stimulate development in these less developed areas. However, U.S. investors in the Southwest have been troubled this past year by the failure of local authorities in a number of instances to fulfill their contractual obligations. In December 1997, China published revised lists (originally promulgated in July 1995) of sectors in which foreign investment would be encouraged (i.e. basic infrastructure and high-technology industries), restricted or prohibited. The regulations relating to the "encouraged sectors" were designed to direct FDI to areas in which China could benefit from foreign assistance and/or technology; the policies relating to the restricted and prohibited sectors were designed to protect domestic industries for political, economic or national security reasons -- particularly with regards to the service and general infrastructure industries. Nevertheless, in order to better prepare for the increased foreign competition which would result from its eventual accession to the World Trade Organization (WTO), China has been gradually relaxing some restrictions on areas of restricted investment. Since 1992, for example, new service sectors, including retailing, foreign trade, insurance, finance and tourism, have been opened and expanded on a pilot project basis, with limits on number and location. Furthermore, in March 1998, Premier Zhu Rongji announced plans to reform the state-owned enterprise system by restructuring and/or eliminating most of China's 270,000 SOEs within the next 3-5 years. Even though it is unlikely that China will be able to do more than cut back a bit on the actual number of SOEs, Zhu's public policy is a clear signal regarding China's intent to reform SOE's and make them responsible for debts incurred. Zhu also indicated that he would welcome foreign participation in the restructuring process, though largely in non-sensitive sectors. Despite Zhu's announcement, concerns about inflation and social instability have constrained implementation of SOE reforms. 3. Foreign Exchange and Convertibility On December 1, 1996, China announced full convertibility of its currency on the current account and instituted new, more liberal regulations allowing foreign-invested and domestic enterprises to freely convert currencies for current account transactions (e.g., trade transactions and profit repatriation). In 1998, however, China began tightening up on the scrutiny of underlying documentation to prevent rampant fraud, creating difficulties for many foreign and domestic companies requiring access to hard currency to complete transactions (see section A.2). In 1996, foreign bank branches in the Pudong area of Shanghai were first allowed to engage in local currency business, though this was mainly limited to providing services to foreign-invested enterprises (FIEs). In 1998, China expanded the Pudong rules for local currency business to foreign banks in Shenzhen. To date, about a dozen foreign bank branches have been authorized to engage in this limited local currency business. 4. Taxes and Tax Incentives As of June 1999, China's trade performance was still showing a marked weakness as a result of the lingering effects of the regional economic slowdown and the declining EURO. For these reasons, the Chinese government continued the VAT rebate system in an effort to maintain the profit margins of exporters, particularly those in the SOE sector. State Taxation Administration officials plan to eventually phase out the rebates in an effort to modernize the current two-tier tax system for domestic and foreign enterprises. Discrepancies between central government, provincial and local tax regulations hamper foreign investment, particularly in remote and impoverished areas. The complicated tax incentive system has proven difficult to implement. The Tax Administration is currently at work on a planned unification of the two enterprise income tax laws for foreign and domestic enterprises. State Taxation Administration officials do not anticipate that this revision will be completed in calendar 1999 but some important first steps have been taken. Collection efforts have been centralized and the responsibility for assessment and filing of returns will be shifted to the taxed enterprise by the end of 1999. A standardized reporting and payment procedure will be implemented nationwide to reduce overpayments and loopholes. The State Taxation Administration is currently working on the simplification of the VAT rebate system. The goal is to standardize, as much as possible, both the VAT tax charged and rebate received. The intention is to eliminate situations where similar products produced by different industries are taxed at different rates. One formulation under consideration would result in all products with a 17 percent VAT tax rate having their rate lowered to 14 percent with a 5 percent rebate and all products taxed at 13 percent would have their rate reduced to nine percent with no rebate. There is also some consideration being given to reinstating a zero VAT and rebate system for the processing trade. Currently, FIEs and domestic enterprises pay either VAT or business taxes, depending on the nature of their business and the type of products involved. VAT applies to enterprises engaged in importation, production, distribution or retailing activities. The general VAT rate is 17% but necessities, such as agricultural and utility items, are taxed at 13%. Certain limited categories of goods are exempt from VAT. Enterprises regarded as small businesses (annual production sales of less than RMB 1 million or annual wholesale or retail sales of less than RMB 1.8 million) are subject to VAT at the rate of 6%. Unlike other VAT payers, small businesses are not entitled to claim input tax credits for the VAT paid on their purchases. Different standards apply regarding VAT rebates. The applicable rebate method is a function of the establishment date of the enterprise.
Regulations and periodic updates on China's investment projects and conditions can be found on MOFTEC's website: www.moftec.com. The 1979 "Law on Chinese-Foreign Equity Joint Ventures" is the fundamental piece of legislation dealing with foreign investment in China. Implementing regulations issued in 1983 -- which, like the joint venture law, have subsequently been amended -- detailed the form and organization of equity joint ventures, ways of contributing investment, and rules on the organization of the board of directors and management. Provisions also covered acquisition of technology, the right to use land, taxes, foreign exchange control, financial affairs, and hiring and firing of workers. Other implementing regulations providing similarly detailed rules on "wholly-foreign owned enterprises" and "contractual joint ventures" were promulgated in 1986, 1988, 1990 and 1995. Another important central government decree was the October 1986 "Provisions of the State Council Encouraging Foreign Investment" (commonly referred to as the "22 Articles"). Certain parts of this legislation dealt with tax treatment, hiring practices, and guarantees of autonomy from government interference. In June 1995 the Chinese government issued new investment guidelines in the form of two documents, "Interim Regulations Guiding Foreign Investment" and the "Industrial Catalogue Guiding Foreign Investment." The guidelines did not break new policy ground but instead clarified existing practices by the Government and, for the first time, listed the sectors in which the Chinese Government encouraged, restricted or prohibited foreign investment. The Government's stated intention in promulgating the guidelines was to better channel foreign investment into infrastructure-building and basic industries, especially into those involving advanced technologies and high value-added export-oriented products. A revised "Industrial Catalogue Guiding Foreign Investment" was reissued in December 1997 and included a number of additions and deletions in all three categories of "encouraged" "restricted" and "prohibited" areas for foreign investment. The Chinese government has also issued a steady stream of "administrative opinions" and "provisional measures" to address specific, and often technical, issues related to approval of foreign investments. For example, in November 1996, MOFTEC issued a document entitled "Opinion on the Examination and Approval of Foreign Investment Enterprises." The "Opinion" provided additional clarification on requirements for foreign investment in a number of specific sectors, including road transport, commercial retailing, translation services, hotels, ports, real estate and railroads. The opinion also provided guidance to supplement laws and regulations related to the establishment of certain types of FIEs, such as share companies and holding companies. 6. Contract Law In March 1999, in an effort to standardize business practices, the NPC passed a unified contract code, covering all forms of economic and civil agreements. The Contract Law, which is more comprehensive, more detailed, and possibly easier to enforce than the current fragmented system, will govern all contracts, public and private, and will have a major impact on how Chinese and foreign companies meet their obligations in the China market. The law's stated purpose is to protect the legal rights of all parties while allowing them to determine their own remedies for dispute resolution and breach of contract; to promote foreign investment; and to allow the people's courts to "clearly and decisively" try economic cases as stipulated by the law. While the law is viewed as a step in the right direction with regard to transparency and enforcement, chapters related to technology remain problematic. The Contract Law will enter into force on October 1, 1999. 7. Securities Law The new Securities Law, scheduled to go into effect on July 1, 1999, codifies and strengthens previous administrative regulations governing the underwriting and trading of corporate shares, as well as the activities of China's stock exchanges (currently in Shanghai an Shenzhen). As currently written, the law does not apply to the underwriting or trading of foreign currency shares ("B" shares). These are subject to separate administrative regulations and are for sale only to foreign legal persons. June 1999 press reports suggested that "private" or non-state-owned companies would be allowed to freely list "B" shares. Few non-state-owned firms are allowed to sell "A" shares. 8. Government Procurement Concerns over the WTO consistency of the draft tendering law led the National People's Congress (NPC) on April 9 to make a surprise announcement that it had decided to break out key sections relating to government procurement into a separate law. Sources at the State Development and Planning Commission (SDPC) and the NPC confirmed that while the tendering law (which will now govern only state administered capital construction and infrastructure projects) is still expected to be finalized during the summer of 1999, the new government procurement law is not expected to be implemented for another three and one half years. The Chinese government has estimated that it could save over $9.6 billion annually by requiring government purchases over a certain size to be conducted by tender. Sources say that the main reason it has decided to delay implementation is to allow more time for the key state-owned enterprise (SOE) sector to complete its ongoing reform. In many cases, SOEs have been required to make purchases through certain approved suppliers or operate on a long term contract basis. Chinese officials say that changing these arrangements would, in the short term, disrupt both the SOEs and their supporting industries. 9. Forms of Foreign Ownership In those sectors where foreign investment has been allowed, FIEs can exist as holding companies, wholly foreign-owned enterprises, equity joint ventures, contractual (or cooperative) joint ventures or foreign-invested companies limited by shares. Under China's company law, foreign firms can now also open branches in China. A partnership enterprises law promulgated by China in February 1997 is unclear on whether foreign persons or entities can establish partnerships under the law. 10. Investment Screening Procedures Potential
investment projects usually go through a The
approval process for projects over $30 million China is currently reviewing proposals to streamline approvals by simplifying licensing procedures and by raising the threshold requiring central government approval from USD 30 million to USD 100 million. 11. Investment Incentives China's
complex system of investment incentives has Foreign
investors sometimes may have to negotiate China encourages reinvestment of profits. A foreign investor may obtain a refund of 40 percent of taxes paid on its share of income, if the profit is reinvested in China for at least five years. Where profits are reinvested in high-technology or export-oriented enterprises, the foreign investor may receive a full refund. Many foreign companies invested in China have adopted a strategic plan which requires reinvestment of profits for growth and expansion. 12. Export and Import Policy China has begun to reform its highly-controlled trade regime to reflect its growing role as a major trading nation and to advance its case for membership in the World Trade Organization (WTO). Although China, for the most part, limits the right to import and export goods to certain Chinese companies, it has greatly expanded the number of companies authorized to do so. In 1996, China began allowing a very limited number of foreign companies to form foreign trade joint ventures with Chinese partners in the Pudong area of Shanghai. In 1999, China announced that it would soften the terms for establishing foreign trade joint ventures and expand the scope and number of pilot projects. Under WTO, with few exceptions, China will grant trading rights to foreign companies. The first and largest of the duty free import/export zones is in Pudong's Waigaoqiao free trade district which can approve projects up to USD 30 million. The zone administration has established four commodity VAT markets to provide the VAT invoices necessary for sale of goods into the domestic market. In
October 1992, the U.S. and China signed a --
to phase out non-tariff import barriers including --
to publicize all laws related to trade and refrain --
to reduce tariffs on a range of goods and eliminate In
addition, China adopted the Harmonized System for Examples of the barriers include: -- The Chinese Government has banned the import of nine generic medicines. In addition, in late 1998 it implemented price caps on pharmaceuticals, claiming it was doing so to contain health care costs. The regulations may drive some multinationals and bulk pharmaceutical exporters out of the USD12 billion Chinese pharmaceutical market and push others into the red. Over the past 5 years, foreign drug companies have invested nearly USD500 million in almost 1,500 joint ventures in China. Foreign and joint-venture sales account for up to 80 percent of the market in some of China's larger cities. Instead of fixing permitted prices, the new caps specify profit margins. Companies must open their books for inspection and will be allowed profit margins ranging from 8 percent for ordinary medicines to as much as 25 percent for new drugs that cannot be made in China. The problem is that the new margins are based on each drug's production costs, ignoring research spending and other shared overheads, which far exceed the manufacturing outlay for new medicines. The new regulations also fix a 25 percent marketing overhead. --For manufactured goods, China requires quality licenses before granting import approval, with testing based on standards and specifications often unknown or unavailable to foreigners and not applied equally to domestic products. In the Market Access MOU, China committed to applying the same standards and testing requirements to both foreign and domestic nonagricultural products. These standards would have to conform to WTO requirements upon China's accession to the international trading organization. --China abolished direct subsidies for exports on January 1, 1991. Nonetheless, many of China's manufactured exports receive indirect subsidies through guaranteed provision of energy, raw materials or labor supplies. Other indirect subsidies are also available such as bank loans that need not be repaid or enjoy lengthy or preferential terms. Tax rebates are available for exporters as are duty exemptions on imported inputs for export production. 13. National Treatment Article 6 of the May 1994 Foreign Trade Law provides for extension of national treatment, on a reciprocal basis, to contracting parties of international treaties to which China is also a party. Article 23 of this law provides for extension of market access and national treatment in services under similar conditions. In practice, however, China's restrictive foreign trade and investment regulations deny foreign companies national treatment in almost all service and most industrial sectors. Eventually, China will have to grant unconditional national treatment as part of its accession to the WTO. 14. Acquisition and Takeovers This
concept, as understood in the West, is rarely 15. Government-Financed Research and Development A significant amount of research and development funding is allocated through the "Torch" program of the State Science and Technology Commission. The "Torch" program is a Chinese Government initiative aimed at promoting commercial application of the products of science and technology research. China encourages foreign joint ventures (but not wholly foreign-owned companies) to participate in Torch programs as a way of introducing high technology. An August 1998 report on the "Torch" program noted that fifty-three new national high technology industrial zones were created in the early part of the 1990's, bringing the total number of high-tech industrial zones to over 110. Statistics from the end of 1997 recorded 13,7000 enterprises in the various zones. The same August 1998 report indicated that enterprises in the five Science and Technology parks (Beijing, Suzhou, Hefei, Xian, and Yantai) were officially open to members of ASEAN countries to promote internationalization of China's high and new technology industry under the auspices of the "Torch" program. These same parks may be included into a broader program opening them for cooperation with APEC members, extending the cooperation beyond ASEAN and eventually offering access for U.S.-invested companies to Chinese government-sponsored non-military projects.
In periods when foreign currency was relatively scarce in China, profits that were not generated in foreign exchange could only be repatriated with great difficulty. Since 1994, however, China's foreign reserves have grown rapidly (exceeding $146 billion by mid-1999), and FIEs have generally enjoyed liberal access to foreign exchange. China announced full convertibility in the current account in December 1996 and implemented new, liberal measures that allow foreign investors to freely convert currencies for trade and profit-repatriation transactions. Capital account transactions remain controlled. In October 1997, China issued "Provisions on the Administration of Foreign Exchange Accounts in China" that established new procedures for setting up and maintaining foreign exchange accounts held by FIEs and foreign individuals. While all FIEs are entitled to open and maintain a foreign exchange account for current account transactions, the enterprise must first apply to China's State Administration of Foreign Exchange (SAFE) for permission. SAFE grants permission for the account and establishes a limit, based on an enterprise's anticipated foreign exchange operational needs, beyond which foreign exchange must be converted to local currency. Foreign representative offices and individuals may also open such accounts. No limits are placed on the amount such accounts can hold, though reports for transactions involving more than U.S. $10,000 must be filed by the bank. In general, the restrictions on FIE accounts are less onerous than for wholly Chinese-owned firms. The Provisions also set up procedures for establishing foreign exchange accounts for capital account transactions, which involve more complex reporting and qualification requirements. In the case of foreign exchange accounts for both current and capital account transactions, the final onus for compliance has been shifted to the financial institutions. A parallel regulation covering qualification and approval for the establishment of overseas foreign exchange accounts by foreign-invested and Chinese enterprises was also issued in October 1997. Most joint-venture contracts still require that FIEs balance their foreign exchange (forex) receipts and expenditures, though this requirement is ignored in practice. SAFE officials stress that their policy is clear and that such contract provisions will not be enforced by SAFE if China's foreign exchange reserves begin to decline. While the new, liberal regulations on forex conversion did away with the need for each foreign exchange transaction to be approved, FIEs are still required to submit to annual reviews to determine if they comply with all Chinese laws and regulations, as well as the contract provisions. The reviews could conceivably be used to enforce the forex balancing provisions in FIE contracts. In the summer of 1998, SAFE began to crack down hard on the practice of submitting false or "padded" documents in an effort to skirt the regulations on capital account transactions. SAFE also began to enforce rigorously the rules requiring each investment contract to receive a clean bill of health from the tax and customs authorities. The crackdown seems to have affected trade more than investment, but local attorneys report a slowdown in receiving clearances for some transactions because of nervousness and uncertainty on the part of Chinese bankers. SAFE has set up a hotline and internet web site to respond to complaints from traders and investors and has pledged to intervene with its local officers if there is a dispute. C. Expropriation and Compensation There
have been no cases of expropriation of Nevertheless,
there have been investment dispute A number of cases remain outstanding. A U.S. company which invested in Henan found its joint venture partner apparently shifting its profits from the joint venture to the partner's trading company and establishing a separate factory in China to produce items identical to those produced and sold under the joint venture trademark. In another case, a U.S. firm's assets in its joint venture in Hubei Province were stripped, pursuant to a local court ruling about which the U.S. company received no advance notice; the U.S. company has appealed this case to Hubei provincial as well as to national authorities for several years, thus far without satisfactory result. It seems likely that as the number of investors increases in China, such examples will also increase. D. Dispute Settlement Although
China is a member of the International Investment
contracts often stipulate arbitration in One problem is that even when a foreign company wins in arbitration, the People's Intermediate Court in the locality where the foreign venture is situated may choose not to enforce the decision. 1. China's Legal System The supreme legislative authority in China rests in the NPC and its Standing Committee, which works primarily through the Legislative Affairs Committee. In accordance with the 1982 Constitution, the State Council and the People's Congresses at the provincial and municipal level each have the authority to formulate administrative regulations and local legislation that are not inconsistent with national law. China's formal legal system consists of the People's Courts, the People's Procuratorate, and the Public Security Bureau. In cooperation with the NPC, the Supreme Court interprets new laws and then passes its guidance down to lower courts. Party and officials in other government departments sometime interfere in court decisions. China's top leaders undoubtedly play a major role in deciding sensitive political cases. China's legal system is a mixture of common law and continental legal systems, but it places relatively less emphasis on legal precedents. The 1979 Organic Law of the People's Courts of the People's Republic of China authorized the establishment of economic courts at China's National Supreme Court and three levels of provincial courts. The economic courts are given jurisdiction over contract and commercial disputes between Chinese entities; trade, maritime, and insurance; other business disputes involving foreign parties; and various economic crimes including theft, bribery, and tax evasion. China has also established a special Intellectual Property Rights Division in the State Council and in many intermediate level courts. In 1994, the lowest level of provincial courts started to try economic cases involving foreign parties. Foreign lawyers cannot act as attorneys in Chinese courts, but may be present informally. During the past year, the U.S. has been working with China on projects relating to commercial and economic law under the umbrella of the U.S.-China Joint Committee on Commerce and Trade as a part of President Clinton's Initiative on the Rule of Law. 2. Mortgages/Secured Interests in Property Under Chinese law, the land is owned by the "people" and cannot be privately owned. However, enterprises, including FIEs, can obtain long-term leasehold rights to use the land. Moreover, individuals and enterprises can own and dispose of buildings and other forms of property. In
October 1995, China put into effect a new "Guarantee (Security) Law"
-- the first national legislation 3. Bankruptcy China's
bankruptcy law, passed in December 1986, Nevertheless,
even Chinese officials contemplating China
continues to work on additional legislation
1. Export Requirements Export
requirements, while not formally required by 2. Local Content Chinese
regulations grant foreign-funded Nonetheless,
Chinese officials strongly encourage Under
China's current automotive industrial 3. Technology Transfer Most
joint ventures involve the transfer of 4. Employment Of Host-Country Nationals Rules
for hiring Chinese nationals depend on the The
amended Chinese-foreign equity joint venture While
FIEs are free to recruit employees directly 5. Enforcement Procedures for Performance Requirements Article
13 of the same joint ventures law provides Membership in the WTO would require China to sharply restrict the use of three commonly used trade-related investment measures (TRIMS): local content requirements, contractual obligations requiring imports be balanced against exports, and foreign exchange controls.
In China's partially-reformed economy, there are numerous restrictions placed on the establishment of business enterprises for both the Chinese and foreign investor. With regard to the Chinese investor, 1999 amendments to the Chinese Constitution elevated the status of private enterprise in China. Although not aimed at foreign entrepreneurs, these provisions may have a favorable impact on the investment climate by raising the comfort level of foreign businessmen accustomed to a private enterprise-based economy. With regard to foreign investors, Investment Guidelines published in June 1995, and revised in December 1997, attempt to channel foreign investment into various encouraged sectors and limit or block foreign investment in certain restricted and prohibited sectors. Major sectors of the Chinese economy -- particularly in services and infrastructure -- remain largely or completely closed to foreign investment. In part to better prepare for increased foreign competition which would result from its eventual accession to the World Trade Organization (WTO), China has been gradually relaxing some restrictions on ownership and establishment. Since 1992, for example, new service sectors, including retailing, foreign trade, insurance, finance and tourism, have been opened and expanded on an experimental basis, with limits on number and location. -- China has currently approved 17 retail joint ventures -- in 11 cities and SEZs -- on a single-store basis and two on a chain-store basis. It has recently announced plans to expand both the number and locations of these pilot projects. Foreign investment in such joint ventures is limited to a minority stake over thirty years. In addition, investment in specialty retailing is allowed only if all the products sold in the stores are produced in Chinese factories owned by the foreign investor. -- To date, thirteen foreign insurance companies have been approved to do limited business in Shanghai, including one American firm with licenses to operate in both Shanghai and Guangzhou. (A total of four American firms now have licenses in China.) All of the firms are limited in the products they can offer and the customers they can solicit. Discussions to open additional cities to foreign insurers are currently underway. -- In 1999, China announced that foreign travel agencies would be allowed to open joint-venture travel agencies in China and that it would remove geographic restrictions on foreign financial institutions (of which there are about a dozen) and law firms. China
is also encouraging, on a limited basis,
Chinese law provides that all land is owned by "the public," and individuals cannot own land. . However, consistent with the policies of reform and opening to the outside, individuals, including foreigners, can hold long-term leases for land use. They can also own buildings, apartments, and other structures on land, as well as own personal property. H. Transparency of the Regulatory System Although
more than 150 major laws and regulations I. Capital Markets and Portfolio Investment The development of China's domestic capital markets has not kept pace with the needs of the economy, but two stock exchanges have been established in Shanghai (in November 1990) and the city of Shenzhen in southern China's booming Guangdong Province (July 1991). Other regional "securities exchange centers" have had their ups and downs and were recently closed by the newly established China Securities Regulatory Commission (CSRC). After five years of debate, a Securities Law was finally passed in late 1998 (to be implemented in 1999). Despite the tougher penalties for insider trading and other forms of fraud, the CSRC's lack of experienced personnel and the need for China to adopt and enforce international accounting standards remain major problems. Although in theory FIE's may apply for permission to raise capital directly on China's stock and bond markets, the approval process is not transparent and permission is practically impossible to obtain. (Capital costs tend to be higher in China than elsewhere, so many FIE's prefer to use offshore funding sources.) With one exception, foreign brokerages are barred from underwriting local currency shares (A shares), and all foreign-invested brokerages must restrict their trading activities to foreign currency shares (B shares) that make up a tiny fraction of the market. On a case by case basis, foreign legal persons are allowed to purchase unlisted shares in domestic firms. 1. Banking China's capital markets are dominated by a state banking sector that generally channels funds to state-owned enterprises on the basis of public policy rather than market considerations. Other domestic firms must find different sources of financing, including direct investment, gray-market sales of stock, and borrowing from other firms or non-bank institutions. Foreign firms that need working capital, whether foreign exchange or local currency, may obtain short-term loans from China's state-owned commercial banks. However, priority lending is often given to investments which bring in advanced technology or produce goods for export. In general, foreign-invested firms, which can keep forex accounts in commercial banks, borrow funds from abroad, registering all foreign loans with the State Administration for Foreign Exchange (SAFE). Along with the People's Bank of China, SAFE regulates the flow of foreign exchange into and out of China. With the creation of three policy banks in 1994 -- the Import-Export Bank of China, the China Development Bank (formerly the State Development Bank of China), and the Agricultural Development Bank -- China attempted to make a clear division between policy banking and commercial banking. The government has encouraged banks to target non-SOEs. In Shanghai, for example, banks are clearly scrutinizing small and medium-size enterprises and have provided credit guarantees to small -- including private -- enterprises. Nevertheless, China's mostly state-owned commercial banks continue to carry a heavy percentage of non-performing assets (some observers say more than 30 percent of the total). The People's Bank of China (China's central bank) reorganized its regulatory structure in 1998, and announced plans to set-up asset-management companies to take over the bad loans and help the commercial banks meet international capital adequacy standards. Most observers, however, believe it will take many years for China to re-capitalize its banks along international lines. 2. Restrictions On Debt-Equity Ratios According to regulations promulgated in March 1987, the Chinese Government restricts the debt-to-equity ratio of foreign-funded firms and sets minimum equity requirements. For investments under USD 3 million, debt cannot exceed 30 percent of the total investment. The debt/capital ratio for investments in the USD 3-10 million, USD 10 - 30 million, and over USD 30 million ranges cannot exceed 50, 60, and 70 percent respectively. Debt for investments over USD 60 million is limited to two-thirds of the total value of the investment.
Corruption, layoffs from state-run enterprises, the growing gap between coastal regions and the interior, and economic disparities between rural and urban areas have at one time or another contributed to dissatisfaction among the Chinese populace. As China continued to push forward in 1998 and 1999 with the restructuring of state-owned enterprises, unemployment and other social pressures have been on the rise. As a result, there have been a growing number of local labor actions. Declining rural incomes have contributed to a similar increase in protests by farmers in the countryside. To date, local authorities have generally dealt with these protests in a peaceful manner and have not resorted to violence. In early 1999, however, there were a number of isolated violent actions by disgruntled individuals who -- in some cases motivated by personal, not political reasons -- exploded bombs on public buses, in markets, and along railroad tracks. In May 1999, there were also acts of violence directed against U.S. diplomatic facilities in China, and some American fast-food franchises, because of NATO's mistaken bombing of China's Belgrade embassy. This violence lasted several days after which business quickly returned to normal. In other parts of China, the northwest has been troubled by occasional unrest among minority ethnic and religious groups. China has not encountered widespread political activity since the student demonstrations of 1989, both because the government has worked to minimize tensions and because most people recognize that Beijing is able and willing to forcibly repress any sizeable anti-government protests. K. Corruption Despite a high-profile Government effort to combat official corruption, and the existence of harsh penalties for those convicted of corruption, the practice remains widespread in China. According to Chinese Government statistics, nationwide in 1998, three Ministerial-level officials and hundreds of other senior officials were charged with corruption. The former head of the Central Government's Anti-Corruption Bureau was himself disciplined for involvement in corruption. Banking and finance are among the sectors most afflicted by corruption, as are government procurement and construction projects. Premier Zhu Rongji has targeted corruption in the construction industry because of the safety hazards created by shoddy construction. Offering and receiving bribes are both crimes under Chinese law, but it is unclear if giving a bribe to a foreign official in another country is a crime. Bribes cannot be deducted from taxes. Based on surveys reported in the Western media, including one done by the U.S. Embassy, and on general views expressed by foreign business people and lawyers in China, it is clear that U.S. firms consider corruption in China a hindrance to FDI. Those convicted of corruption can be sentenced to lengthy prison terms or, in particularly serious cases, death. The Government can also impose administrative penalties against those who participate in corruption. These penalties range from official warnings to dismissal from the civil service. Three different Government bodies and one Communist Party organ are responsible for combating corruption in China: the Supreme People's Procuratorate, the Ministry of Supervision, the Ministry of Public Security, and the Communist Party Committee for Discipline Inspection. The Procuratorate and the Ministry of Public Security are responsible for investigating criminal violations of China's anti-corruption laws, while the Ministry of Supervision and the Party Discipline Inspection Committee enforce Government ethics and Party discipline. The U.S. Department of State has been working with China's Ministry of Supervision on an exchange to address issues of corruption and good government practices. The State Department's Inspector General visited China in mid-1997. In June 1998, a delegation from the Ministry of Supervision reciprocated the Inspector General's trip by visiting Washington for discussions with the State Department's Office of the Inspector General and other U.S. Government
agencies responsible for fighting corruption.
The
U.S. does not have a bilateral investment China
has entered into bilateral investment
In
the past, OPIC had a very active program in Although
OPIC may remain unavailable for the
1. Labor Availability FIEs can take over a joint venture partner's work force, hire through a local labor bureau or job fair, advertise in newspapers, or rely on word of mouth. As described in the above section on performance requirements, however, representative offices, for the most part, must hire their local employees through a labor services agency. Skilled managers are often in short supply, although many companies have found an abundance of recent university graduates who are talented and highly motivated; they can command salaries almost on a par with expatriates, which does not make localization any less expensive for many companies. Shortages can be especially acute in south China, which has far fewer institutions for higher education than exist in the north. While engineers and technicians can sometimes be difficult to find, finding -- and keeping -- managers and those with marketing skills is especially difficult. Foreign ventures often find workers move rapidly from job to job within the foreign-invested and growing private sectors. 2. Compensation Workers are paid a salary, hourly wages, or piece-work wages. The provision of subsidized services, such as housing and medical care, is common, and compensation beyond the basic wage constitutes a large portion of a venture's labor expenses. With recent moves by China to reform the housing system and promote home purchases through a mortgage system, however, employer-provided housing is decreasing. Investors should check whether they will have to provide housing and other incentives in the locality in which they establish. Local governments also tax enterprises and workers to support social security and unemployment insurance funds. Tax rates for social security may run as high as twenty percent of an enterprise's total wage bill. Individuals must also contribute four percent of their salary. In general, foreign ventures are free to pay whatever wage rates they want above a locally designated minimum wage. Chinese income-tax laws often make it desirable to provide greater subsidies and services rather than higher wage rates. Such decisions are often taken after observing local practice. China's national labor law specifies rates for payment of overtime compensation under various circumstances. 3. Termination of Employment The ability to terminate workers varies widely based on location, type, and size of enterprise. Terminating individual workers for cause is legally possible but may require prior notification/consultation with the local union. In general, it is easier to fire in south China than in the north China, and in smaller enterprises than in larger ones. Large-scale layoffs, especially in north China, can arouse opposition from the local government and from the workers themselves. Where workers are hired by short-term contracts or agreements, it is generally relatively easy to let them go at the end of the contract period. 4. Worker Rights The Joint Venture Law and China's 1994 Labor Law, effective January 1995, require joint ventures to allow union recruitment, but do not require a joint venture actually to set up the union (as management does in state enterprises). China's labor law provides for the establishment of collective labor contracts to specify wage levels, working hours, working conditions, and insurance and welfare. In recent years, most coastal provinces have passed stricter regulations that require unions in all FIEs. Beginning in 1996, the All-China Federation of Trade Unions (ACFTU) launched a drive to conduct collective negotiations in at least 90 percent of FIE's, and official Chinese newspapers have claimed that this target has been reached. However, anecdotal evidence suggests that this claim is far from accurate. Foreign ventures should be aware that according to Chinese law it is illegal to oppose efforts to establish officially-sanctioned unions. Most collective negotiations, however, appear to be pro-forma in nature. Although China is a signatory to a number of ILO conventions, it has signed no key ILO conventions on freedom of association or forced labor.
China's principal duty-free import/export zones are located in Dalian, Tianjin, Shanghai, Guangzhou, and Hainan. In addition to these officially-designated zones, many other free trade zones offering similar privileges exist and are incorporated into SEZs and open cities throughout China. However, restrictions and charges often apply and can affect venture operations and business in the latter zones. To
make progress toward a consistent national trade Considerable
attention was placed on the status of
FIEs in China are acknowledged as the most efficient part of the Chinese economy and play a particularly significant role in China's trade, accounting for 55 percent of China's imports and 44 percent of exports in 1998. Among the 324,620 FIEs approved, a total of 250,000 are operational, employing 18 million people -- the equivalent of approximately 11 percent of China's non-agricultural population. FIEs approved in 1998 are expected to generate an additional 1 to 1.5 million jobs over the next 2 years. In 1998, China's foreign-related tax revenues increased 26 percent to USD 14.9 billion, accounting for 14 percent of the nation's tax revenues from industry and commerce (Note: Tax revenue from wholly foreign-owned enterprises accounts for more than 95 percent of foreign-related tax revenue.) The industrial output of FIEs reached USD 188 billion, accounting for 27 percent of China's total industrial output. Foreign
investment stock in China is difficult to Major U.S. Investors In China A
large number of U.S. companies have established and Q. U.S. Embassy Survey Of American Investors In December 1998, the U.S. Embassy in Beijing, with the assistance of the Gallup Organization, undertook a survey of American investors in China. The Embassy received a total of 286 valid questionnaires, representing a margin of error of 4.8 percent. The major findings are highlighted below: -- The lure of the China market -- with its 1.2 billion potential customs, increasingly sophisticated middle class, growing industrial base and explosion of retail stores -- stands out as the primary reason why U.S. companies invest in China, according to a new U.S. Embassy mail survey conducted with the assistance of the Gallup Organization. -- Only ten percent of American investors indicated that they were using China primarily as an export platform base. -- Most U.S. companies import more than they export; they have not been contributing to America's trade deficit with China -- Fifty-two percent of respondents reported that they had achieved a positive return on their initial investment; fifty-seven percent report that they are currently earning a profit. -- Fifty-seven percent of reporting firms have reinvested in the current venture; a smaller portion have reinvested in other ventures that support the original venture or in new ventures not associated with the original venture. -- Nearly half of 108 firms that currently are not profitable have reinvested in the current venture in anticipation of a future profit. -- U.S. business is, on the whole, frustrated with many aspects of the business environment in China. The biggest problems: transparency of laws and regulations (62 percent of those reporting), cost of doing business (59 percent), customs procedures/export procedures (58 percent) and foreign exchange regulations/exchange rate risk (54 percent). -- Companies rated almost equally the impact of U.S. trade sanctions, U.S.-China relations, the economic slowdown in Asia, the U.S. annual Most Favored Nation debate and China's accession to the World Trade Organization on their operations in the PRC (over 50 percent characterized the impact as "major" or "moderate"). Nineteen percent said the Asian crisis had a significant impact on them, with 52 percent saying the impact was minimal. -- Thirty-seven percent of respondents rated the China market as good or very good, 44 percent rated it average and 19 percent called it bad or very bad -- Half of the respondents are cautiously optimistic about their investment prospects over the next 12 months, and they plan to expand their operations in China slowly over the next five years. -- Fifty-five percent of respondents said that they would definitely invest in China if they had to make this decision over again; 31 percent indicated that they probably would make the same decision.
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