Corporate Finance

China shakes out the welcome mat

Multinational corporations in China have long complained that they are hobbled by red tape, rising costs and a Byzantine legal system. Although foreign direct investment growth is slowing, recent reforms suggest the Mainland will not necessarily lose its lustre. George W. Russell reports

By George W Russell

E-Mart, a large South Korean supermarket chain, announced its withdrawal from the Chinese market on 15 September, citing high costs, including wages, and lower-than-expected revenues. The retailer joins compatriots Lotte Shopping, British retailer Marks & Spencer and Japanese construction materials group Mitsubishi Cement as the latest multinational corporations to pull out of the Mainland.

The latest casualties had their own reasons: Mitsubishi Cement complained of an oversupply of cement and tighter environmental regulations. Marks & Spencer blamed “low brand awareness.” Lotte suffered from a boycott of Korean products due to a dispute between Seoul and Beijing over a missile-defence system.

What they had in common was confirmation of the perception that China is less open to foreign corporations than in the past. “Protectionist policies, unclear regulations, policies that favour domestic companies, stalled reforms and what some termed selective enforcement of laws against foreign companies have made many United States companies feel unwelcome in China,” says Michael Enright, Professor of International Business at the University of Hong Kong.

A survey by the American Chamber of Commerce in China (AmCham) indicated that one in four U.S. member businesses had shut down its China operations or planned to do so. This year’s China Business Climate Survey Report, which surveyed 462 U.S. companies, reported that 81 percent of companies surveyed believed foreign businesses are less welcome in China, up from 77 percent in 2016.

It’s not just U.S. companies. Japanese investment in China fell 50 percent between 2012 and 2016 due to slower growth in both countries and rising Mainland wages. Under the previous administration of Hu Jintao, Beijing lured Japan’s big manufacturers with tax breaks and other sweeteners. But the present government of Xi Jinping has narrowed incentives to focus on high-end technology and services.

Respondents to the survey also reported that their main disincentives were increasing costs and protectionism, although profit repatriation was also cited as a concern. In April, executives from two U.S. giants, IBM Corporation and Visa Inc. – as well as Japan’s Sony Corporation and Germany’s BMW – met with Pan Gongsheng, Deputy Governor of the People’s Bank of China and Director of the State Administration of Foreign Exchange, about tackling fund transfer difficulties.

Official data seem to reflect the world’s wilting enthusiasm. Inbound foreign direct investment (FDI) fell by 0.1 percent year-on-year to 441.5 billion yuan (US$66 billion) in the first half of 2017, according to the Ministry of Commerce. China attracted US$133.7 billion in FDI during all of 2016, 1 percent lower than 2015, after years of strong growth.

New imperatives

It is unclear if the slower growth is indicative of a long-term trend, or a signal of a maturing economy. “China is still an attractive investment destination,” says Tony Tsang, Greater China Transaction Support Leader at EY in Shanghai and a Hong Kong Institute of CPAs member, who sees two factors at work.

“One is that a lot of multinational corporations have been established in China for more than 10 years,” he says. “They have reached their expected capacity and have sufficient scale.” Even though overall FDI is flat, Tsang cites AmCham Shanghai data that show 73.5 percent of U.S. member companies recorded revenue growth in 2016 as well as growth in operating margins.

The second factor, says Tsang, is China’s policy of rebalancing the overall economy to put more emphasis on services and consumption. Over the past 10 years, he notes, the appreciating yuan and increasing wages have caused many multinational corporations, especially manufacturers, to balance their portfolio by expanding to Southeast Asia and other countries.

The government appears to recognize that China is perceived as less friendly than it was to FDI. “The inflow of foreign capital has been pivotal for China to maintain a relatively quick growth rate” Premier Li Keqiang acknowledged at the World Economic Forum in Dalian in June. “We must send a strong message of welcome to foreign investment.”

In January, the State Council released the Circular of Several Measures for the Expansion of Opening-up and the Active Use of Foreign Investments, which relaxed restrictions on foreign investment in several sectors, including services, manufacturing and mining.

Then on 16 June, the State Council issued the Special Administrative Measures of Pilot Free Trade Zone for Admittance of Foreign Investments (Negative List) (2017). The negative list, updated for the first time since 2015, specifies sectors in which foreign investment is prohibited or restricted in the country’s 11 free trade zones. The list reduces the number of prohibited and restricted areas to 137, compared with 172 in the 2015 version.

In contrast with its crackdown on outbound acquisitions by Chinese companies to halt capital flight, the Ministry of Commerce says foreign takeovers and mergers with Chinese companies will be easier. “We have recently further simplified regulation procedures for merger and acquisition deals,” says Gao Feng, the ministry’s Deputy Director-General. “Investors from around the world… are welcome to invest in China through M&A.”

Cutting red tape

The disappearance of low-end manufacturing has caused few ripples in the Chinese government, but some pullouts have raised alarm. Last year, Seagate, a technology company based in Silicon Valley, closed its plant near Suzhou and made more than 2,000 employees redundant. The company blamed not only thinner profit margins and sagging global demand for its hard drives, but its ballooning Chinese tax obligations.

William Zarit, AmCham Chairman, told a briefing that a demand for 400 million yuan in “additional tax” might have been the last straw for the company. “The tax situation makes it very difficult for Seagate, who made a business decision to leave Suzhou,” he said at the time. “As far as I know, the company felt the need to undo its tax burden.”

Last month, China announced further reforms, saying market access for foreign investment would be widened in the banking and securities sectors as well as insurance, renewable-energy-powered vehicles, marine, architecture and design, aircraft maintenance and petroleum retailing.

While specific new guidelines on foreign investment procedures have yet to be issued, China Daily reported last month that the new system would be finalized by the end of September. Some streamlining initiatives include allowing foreign investment applications to be uploaded electronically instead of a paper filing, removing government pre-approvals from more sectors and reducing registration procedure delays, the English-language daily reported. The government said it would also expedite work permit application procedures for skilled foreigners and extend visas.

“Foreign investors are now taking a more nuanced and consumer-centric approach [to China],” says Mukund Narayanamurti, Chief Executive Officer of Asialink Business, a Melbourne-based consultancy that helps Australian companies establish or expand in the Asia-Pacific region. “In the past, they were often attracted by cheap land and labour. But now, many are increasingly focused on new and emerging sectors.”

Narayanamurti said the reforms announced in August, if implemented, should help open up China’s economy more widely to foreign investors and provide greater clarity and certainty. “Australian companies should look to take advantage of these reforms by stepping up their presence on the ground in China, and by assessing the many new opportunities with China that are emerging.”

Australia, he added, was a country that had greatly broadened its trade and investment relationship with China over the years, “from an original focus on mining, energy and bulk agricultural commodities, to professional services, creative industries, premium food, university-industry collaboration, and biotechnology.”

Widening scope

The new guidelines are likely to create opportunities linked to the Belt and Road Initiative, which seeks to connect over 60 countries through US$900 billion in spending, mostly on infrastructure, to create a land route, the Silk Road Economic Belt, and a sea link, the 21st-century Maritime Silk Road, from Asia to Europe and beyond.

The January circular’s reforms also include helping foreign-invested industries to relocate to the economically depressed north-eastern “rust belt” of China, Dongbei, comprising the provinces of Liaoning, Jilin and Heilongjiang.

Investment in China’s Western region is also encouraged, especially in underdeveloped services such as banking and finance. “We want to attract accounting, law and rating agencies to build a cross-border financial services platform,” says Fan Ruiping, Secretary of the Chengdu Municipal Party Committee.

Fan says Chengdu, the capital of Sichuan province, has launched a five-pronged foreign investment development plan focusing on economics, finance, technology, culture and innovation. Chengdu officials see the city’s key location as a starting point of the historic Southern Silk Road – connecting Sichuan and Yunnan provinces with Myanmar, India and Central Asia – as an international opportunity.

It is more important than ever before for foreign companies to make the case for the benefits they bring to China, Enright of the University of Hong Kong, argues in a recent report, The Impact of U.S. Foreign investment and U.S. Companies on China’s Economy, urging a focus on economic impact.

“Economic impact analysis gives a much more complete picture of the benefits of foreign enterprises than FDI flows,” he says. “The economic impact of … foreign affiliates in China in a given year has been as much as 180 times the investment flow.”

Narayanamurti, the Australian business consultant, agrees, saying it is up to foreign investors to take advantage of China’s apparent opening up. “For their part, many Australian businesses will need to develop and refine their cultural understanding of China, their awareness of the business environment and their level of market and consumer insight, in order to best seize these opportunities.”

This article was originally published in the September 2017 issue of A Plus.