China FDI: A Bit of Good News.

Qingdao China

In the wake of the Rio Tinto and Google cases in China, many commentators have suggested China is becoming hostile to foreign investment. Sitting here in Qingdao, I am not seeing any change China’s attitude towards foreign investment. China remains remarkably open to foreign investment and shows every sign of planning to continue with that open policy for the future. It is true, however, that due to the effects of the international financial crisis, foreign investment in China leveled off in 2009. In response, the State Council recently issued the Opinion on Taking Additional Steps in the Work Improving the Utilization of Foreign Investment.

This Opinion [in Chinese only) and the various research reports issued with it confirm China will not be changing the approach to foreign investment it has followed since 2006. The idea behind This Opinion is to refine and expand, rather than to make any radical changes. As with most such documents, the text is long on general policy pronouncements and short on concrete details. For those of us who work on China FDI matters on the ground, here are the important matters from this Opinion.

1. Continuing to promote “quality over quantity” in foreign investment.
The Opinion repeats China’s basic policy of promoting “quality rather than quantity” that was first promulgated in 2006. In keeping with this policy, the following five investment areas will be encouraged: high-end manufacturing, high-tech, modern service industry , new energy industry and energy-efficient and environmentally clean industries. On the other hand, high pollution, high energy usage and raw materials intensive industries will be discouraged. Low tech, low value added industries and industries already in overcapacity will also be discouraged.

For the most part, detail on how the favored industries will be encouraged is lacking. The Opinion does state, however, that foreign investment in the encouraged category will have preferred access to acquisition of land and will be permitted to pay 70% of the minimum price for land rights.

2. Promotion of foreign investment in the Central and Western regions.
The PRC has developed an interesting strategy for developing the Central and Western regions. Early on, development in the coastal regions was promoted through a combination of tax breaks and support for low tech, labor intensive, light manufacturing industries. Tax breaks have been pretty much eliminated in the coastal regions and the “official” policy is that low tech manufacturing is to be discouraged. However, the policies are now available to encourage investment in the Central and Western regions. Tax breaks are available and low tech manufacturing is now formally encouraged for this region. The notion apparently is that what worked for the coastal regions should also work in the Center and the West.

3. Changes in the administration of foreign investment.
A major trend that began in 2006 was an attempt to centralize the approval process for foreign investment. The Opinion marks a turn away from that trend, by allowing much greater scope for local approval of foreign invested projects. Under the old rules, all projects with an investment amount over $100 million were required to be approved in Beijing. Under the Opinion, this number has been raised to $300 million. In addition, the Opinion provides that the applicable ministries in Beijing have the right to grant approval rights to local governments in most areas under their jurisdiction. Since approval in Beijing is always a major impediment to speedy review and approval of investment projects, this change should have an immediate positive impact.

4. Creating an improved investment environment. 
Under this heading, the Opinion proposes improving the foreign exchange system for foreign invested enterprises and allowing foreign investors to delay full capitalization in cases of financial difficulty. Foreign exchange hassles are a big headache for foreign invested enterprises and improvements in this area will be welcome. Unfortunately, the Opinion provides no concrete guidance on what will actually be done to improve the situation.

5. Expanding the scope of vehicles for foreign investment.
The most interesting feature of the Opinion is its proposal to expand the available vehicles for foreign investment. Currently, the only generally available vehicles for foreign investment are the financially unsophisticated measures of simple stock investment in a WFOE (Wholly Foreign Owned Entity) or a JV (Joint Venture). The Opinion proposes to add the following new avenues for investment:

(a) Foreign participation in the reform and restructuring of domestic enterprises through equity participation and M&A will be encouraged.

(b) A-share listed companies in China will be encouraged to allow investment from both domestic and foreign strategic investors.

(c) The plan to allow foreign investment for credit guarantee companies that would provide services to small and medium enterprises will continue.

(d) The creation of venture capital companies using foreign investment will be encouraged.

(e) Exit mechanisms for private equity investment funds will be improved.

(f) Qualified foreign-invested enterprises will be encouraged to list on the domestic A-share market and to issue corporate bonds and medium-term notes.

The State Council explains these proposals as part of China’s having come to generally recognize the utility of the securities and private investment markets in developing enterprises, especially in the advanced areas that China seeks to encourage. All of these proposals would result in huge changes in the current rather unsophisticated and underdeveloped investment environment. However, implementation will require major changes in the Chinese system. and as of yet, there has been no hint of any legislative or regulatory change that would implement any of these dramatic new proposals.

Though this Opinion is overall quite favorable for foreign investment in China, what it really says is that China is receptive to foreign investment that benefits China if and only if foreign investors strictly adhere to the rules.

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