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Breaking News: China Changes Foreign Investment (FDI) Rules

China lawyer

Last week, China’s National Development and Reform Commission announced the issuance of a new and substantially revised Catalog for the Guidance of Foreign Invested Enterprises (Revised 2007) 外商投资产业指导目录(2007 年修订). The Chinese version can be found here [link no longer exists]. The NRDC’s English language website is strangely silent on the issue and we are not aware of any English language translations of the new catalog. The press release issued by the China Daily has been written strictly for foreign consumption and should not be relied upon.

The Catalog provides the basic guidance for foreign investment in China. It divides investments into “encouraged,” “restricted” and “prohibited” categories. In the 2007 catalog, the encouraged section is more than twice the length of the 2004 Catalog. The restricted and prohibited categories are not substantially changed, but do contain some surprises. The major changes to note in the 2007 Catalog are the following:

  • There has been a substantial restriction on foreign investment in real estate and real estate brokerage firms. Construction and operation of luxury hotels, villas, office buildings and conference centers has been placed in the restricted category. In this context, this means an absolute prohibition. This is a surprising move since this business seems to have little impact on the domestic Chinese real estate market.
  • Continued restriction and prohibition of participation in publishing, media, market research and social research. In recognition of the influence of the Internet as an alternative publishing source, various Internet based businesses have been added to the prohibited category. This denial of access for media and publishing is a hot button for the United States and the Chinese do not seem willing to budge a bit on this.
  • Opening of the service area to logistics and service outsourcing by placing these in the encouraged category. The service area continues to be opened to foreign investment. The addition of outsourcing to the encouraged category is important. China is trying to catch up with India as an outsourcing center. Dalian in particular is being pushed as a location for such businesses.
  • The new policy discourages or prohibits foreign investment in businesses solely devoted to export (a 180 degree reversal of prior policy). The new policy restricts or prohibits investment in industries China has already mastered (like toys, furniture, shoes, clothing) or in industries with high usage of resources or energy (like steel, aluminum, paper, cement, other basic industries). This is another 180 reversal of prior policy. The message is that there will be no more dumping of outmoded or wasteful production in China. Whether China can successfully implement this policy at the local level remains an open question.

The 2007 Catalog can only be understood in light of the policies it implements. It embodies the decision at the highest levels of the PRC to make substantial changes in China’s approach towards foreign investment. This approach was stated in detail by the National Development and Reform Commission in the 11th Five Year Plan on Foreign Capital Utilization 利用外资“十一五”规划, issued in November of 2006. That Plan states China will move from emphasizing the quantity of foreign direct investment (FDI) to emphasizing the quality of that investment.
This new approach will involve the following:

  • Shifting from using foreign capital to make up for a shortage of investment funding and foreign exchange to using foreign capital to introduce advanced technology, management experience and high quality talent to China.
  • Focusing on ecology, environmental protection, conservation and the comprehensively utilizing its resources.
  • Combining the use of foreign capital with the upgrading of domestic industry and technology.

The 2007 catalog is another step in Beijing’s plan to reform the environment for foreign investment in China. It is consistent with other measures which eliminated the tax break for foreign invested enterprises, limited foreign M&A activity, and eliminated many supports for export oriented enterprises. It appears China is serious about making this change and foreign investors need to become familiar with this new system. As one official told me: “China intends to use foreign investment rather than be used by foreign investors.”

It is a new world and foreign investors must understand that the system is undergoing a dramatic change.

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