Country Commercial Guide FY 1999

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VII. INVESTMENT CLIMATE NOTE: COMMON ACRONYMS USED THROUGHOUT TEXT FDI = foreign direct investment FIEs = foreign-invested enterprises, including foreign/Chinese equity joint ventures, cooperative or contractual joint ventures, and wholly-foreign-owned companies MOFTEC = Ministry of Foreign Trade and Economic Cooperation SDPC = State Development and Planning Commission (known prior to early 1998 as the State Planning Commission or SPC) SEZs = The five special economic zones of Shenzhen, Zhuhai, Hainan, Xiamen and Shantou. VAT = China's value-added tax, applied at each stage of processing or sale/resale. For most goods, VAT is currently 17 percent of the value of a good added at each stage of production/sale. A. Openness to Foreign Investment Government Attitude toward Foreign Private Investment. 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 the late senior leader Deng Xiaoping's celebrated trip to south China in early 1992, a number of new cities and sectors were opened to foreign investors. Since then, China has progressively expanded the parts of its economy which are open to foreign investment, including opening a number of more sensitive sectors, such as in the services industries, on an "experimental" and limited basis. China has also continued to introduce new incentives to foreign investment designed to attract higher technology investments. As a result, China has achieved remarkable success in attracting foreign investment to many of the sectors in its economy in which it allows FDI, especially in the coastal regions and Special Economic Zones (SEZs). For the past five 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 $222 billion by the end of 1997, with over $45 billion FDI in 1997 alone. There are signs, however, that the rapidly increasing foreign investment in-flows of recent years have been slowing. The total value of new pledged foreign investment contracts has dropped 20-30 percent in each of 1996 and 1997, indicating that growth in future actual foreign investment in-flows soon will likely drop as well. The Asian financial crisis is partly responsible for this development, as investment flows from overseas Chinese investors have declined. In addition, as China tries to move upstream, encouraging high value-added, high-technology investments, newer investments have yet to make up for the decline in labor intensive, low-cost joint ventures. China has placed greater emphasis on ensuring that new foreign investments are in industries that China wants to encourage. Over the past three years China has implemented new policies introducing further incentives for investments in high-tech industries and in inland parts of the country. In December 1997 China published revised lists, originally promulgated in July 1995, of the sectors in which foreign investment would be encouraged (particularly in basic infrastructure and high-technology industries), or in which it would restrict or prohibit foreign investment. In the latter case, the policy has often been designed to protect domestic industries for political, economic or national security reasons. In April 1996 China eliminated duty and value-added tax (VAT) exemptions for the equipment imported as part of a foreign investment, thereby significantly raising the costs of foreign investment in joint venture and wholly-foreign owned manufacturing. However, after receiving complaints about this decision and observing a decline in foreign investment in some of the industries which China hoped to encourage, China reintroduced the duty and VAT exemptions in January 1998. These exemptions were for a range of machinery imported for use in foreign investments which the SDPC would certify as "nationally-encouraged projects." In particular, the incentives were introduced for foreign investments which involved technology transfer and appeared on China's lists of "encouraged" or "restricted category B" investment projects, as well as foreign investments involving loans from foreign governments or foreign financial institutions. In addition, the duty and value-added tax (VAT) exemptions were retroactively extended to cover many investments made during the period in which the incentive had been eliminated. However, the imports of those investments made during that period were not/not covered retroactively. During the past two years, China has continued to introduce reforms in foreign exchange controls, taxation, foreign trade, and state enterprise restructuring which affect foreign investment. In July 1995 and again in January 1996, China reduced rebates of VAT to exporters. The reductions in VAT tax rebates cut into what already were fairly thin profit margins for many exporters (12-15 percent) and had a significant impact on the operations of both foreign-invested and domestic enterprises engaged in exporting goods produced with domestic inputs. However, with signs that the financial crisis in Southeast Asia would soon negatively impact China's exports, China reversed course and increased the VAT rebates for exports of certain products, such as textiles, beginning January 1, 1998. Official Chinese press reports in June 1998 suggested that similar VAT rebate increases may come soon for even more products, including ships, coal, machinery, electronics and certain categories of high technology products and large plant equipment. 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 addition, in the fall of 1996 China began approving foreign bank branches in the Pudong area of Shanghai to engage in local currency business, though this is mainly limited to providing services for foreign-invested enterprises (FIEs). Nine foreign banks have thus far been approved to engage in this limited local currency business. In 1996, China also announced plans to expand some of its "experiments," permitting foreign participation in services industries such as retailing and trade. For the past several years, however, concerns about inflation and social instability have constrained the central government's ability to undertake more thorough reforms of state-owned enterprises (SOEs) and have made the Government more reluctant to open further certain sectors of the economy to foreign investment. This could change if the government does engage in the comprehensive state-owned enterprise reform announced at NPC in March. Premier Zhu Rongji has set a target of restructuring and/or eliminating most of China's 270,000 SOEs within the next 3-5 years. Zhu has indicated that he would welcome foreign participation in the process, though largely in non-sensitive sectors. Basic Laws and Regulations Covering Direct Investment. The fundamental legislation dealing with foreign investment in China, the "Law on Chinese-Foreign Joint Ventures," appeared in 1979. 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 "cooperative joint ventures" were promulgated in 1986 and 1990. 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, "Provisional Regulations Guiding Foreign Investment" and a "Catalogue of Industries Open to Foreign Investment," both of which had been under debate for some time. These guidelines did not break new policy ground but instead clarified existing practices by the Government. Nevertheless, the guidelines, for the first time, detailed in which sectors the Chinese Government encouraged foreign investment and which sectors were restricted or completely off limits to foreign investment. The Government's stated intention in promulgating the guidelines was better to channel foreign investment into infrastructure-building and basic industries, especially, in the case of the latter, those involving advanced technologies and high value-added export-oriented products. The Catalogue of Industries Open to Foreign Investment was reissued in revised form in *December 1997 and included a number of additions and deletions in all three categories of "encouraged" "restricted" and "prohibited" areas for foreign investment. In addition to those laws and regulations already mentioned, the Chinese government has issued a steady stream of "opinions" and "provisional measures" which address specific, and often technical, issues related to approval of foreign investments. For example, in November 1996, MOFTEC issued a document entitled "Directing of the Examination and Approval of Foreign Investment Enterprises Opinion." 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. 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, cooperative (or contractual) joint ventures or foreign-invested companies limited by shares. Under China's company law, foreign firms can also now open branches in China. A new partnership enterprises law promulgated by China in February 1997 is unclear as to whether foreign persons or entities can establish partnerships under the law. Investment Screening Procedures. Potential investment projects usually go through a multi-tiered screening process. The first step is approval of the project proposal. The central government has delegated varying levels of approval authority to local governments. Until a few years ago, only the Special Economic Zones (SEZs) and open cities could approve projects valued at up to $30 million. Such approval authority has now been extended to all provincial capitals and a number of other cities throughout China. Most other cities and regions are limited to approving projects valued below $10 million. Projects exceeding these limits are approved by MOFTEC and the SDPC. If an investment involves US$100 million or more, it must also obtain State Council approval. MOFTEC, however, is authorized to review all projects, regardless of size. The approval process for projects over $30 million has become less of an obstacle than in the past, but government officials still evaluate each project against official guidelines to determine whether it promotes exports which increase foreign currency income, introduces advanced technology, or provides technical or managerial training. Even if it meets one or more of these requirements, a project may still be rejected if the contract is considered unfair, the technology is available elsewhere in China, China already has sufficient production capacity, or if the political relationship between China and the home country of the foreign investor is strained. Investment Incentives. China's complex system of investment incentives has developed and broadened since the late seventies. The Special Economic Zones of Shenzhen, Shantou, Zhuhai, Xiamen and Hainan, 14 coastal cities, and designated inland cities all promote investment with unique packages of tax incentives. (The Pudong area in Shanghai is particularly worth watching as a location for Chinese experiments in liberalization, which are then extended nationwide.) In recent years, Chinese authorities also established a number of free ports and bonded zones. Up to early 1994, there was a proliferation of locally-organized "development zones," some of which had no approval from central authorities and which were later closed down. Foreign investors sometimes may have to negotiate incentives and benefits directly with the relevant government authorities; these incentives and benefits may not be automatically conferred. The incentives available include significant reductions in national and local income taxes, land fees, import and export duties, and priority treatment in obtaining basic infrastructure services. The Chinese authorities have also established special preferences for projects involving high-tech and export-oriented investments. Priority sectors include transportation, communications, energy, metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment and electronics. China encourages reinvestment of profits. A foreign investor may obtain a refund of 40 percent of the tax paid on the 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. In addition, many foreign companies have adopted a strategic plan for China which requires reinvestment of profits for growth and expansion. 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 limits the right to import and export goods to certain Chinese companies, it has greatly expanded the number of such companies authorized. In 1996, China began allowing a very limited number of foreign companies to form joint venture trading companies, with Chinese partners, in the Pudong area of Shanghai. In October 1992, the U.S. and China signed a Memorandum of Understanding (MOU) which committed China: -- to phase out non-tariff import barriers including licensing requirements, quotas, controls, and other restrictions; --to publicize all laws related to trade and refrain from enforcing unpublished laws; --to reduce tariffs on a range of goods and eliminate scientifically unsound standards and testing barriers. In addition, China adopted the Harmonized System for customs classification and statistics, eliminated import regulatory taxes, and stated that it would not use import-substitution measures. The U.S. and China have met a number of times to discuss and cooperate in the implementation of the Market Access Agreement, which was supposed to have been fully phased in by January 1, 1998. Nonetheless, a significant number of non-tariff barriers not covered in the 1992 MOU still remain and restrictions on trading rights continue to impair access to China's market. 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 virtually all service and industrial sectors. The U.S. is working with other WTO contracting parties, as well as bilaterally with China, to encourage China to grant unconditional national treatment as part of its accession to the WTO. Acquisitions and Takeovers. This concept, as understood in the West, is not applicable to the foreign investment environment in China. A simple share buy-out could occur under existing regulations, but would be subject not only to the approval of all partners in a given venture but also by the supervising Chinese government agency. Such deals have been approved and consummated, but only rarely. Foreigners can also purchase shares in a small minority of Chinese companies listed on Chinese stock exchanges, but foreign portfolio investment is restricted to less than majority ownership. 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 means to introduce high technology. During the 1994 meeting of the U.S.-China Joint Commission on Science and Technology, both the U.S. private sector and Chinese enterprises were invited to participate in, and collaborate on, U.S. and Chinese government-sponsored research and development efforts in new pharmaceuticals, advanced materials, environmental technologies, and energy production. At present, there appear to be no formal barriers to access by U.S.-invested companies to Chinese government-sponsored, non-military research and development projects. China is currently considering the role foreign companies play in joint research and development activities with Chinese partners. B. CONVERSION AND TRANSFER POLICIES In periods such as late 1993, when foreign currency was relatively scarce in China, it was difficult to repatriate profits which were not generated in foreign exchange. Beginning in 1994, however, China's foreign reserves grew rapidly (exceeding $140 billion by mid-1998) and FIEs currently enjoy liberal access to foreign exchange. In December 1996, China announced full convertibility in the current account and implemented new, liberal measures which allow foreign investors to freely convert currencies for trade and profit-repatriation transactions. Capital account transactions, however, remain controlled. In October 1997, China issued "Provisions on the Administration of Foreign Exchange Accounts in China." The provisions establish new procedures for the setting up and maintenance of foreign exchange accounts 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 and 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. The Provisions also provide procedures for the establishment of foreign exchange accounts for capital account transactions. The latter 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 often ignored in practice. It is unclear, however, whether such contract provisions would be enforced if China's foreign exchange reserves began to decline. While the new, liberal regulations on foreign exchange conversion eliminated requirements that each foreign exchange transaction be approved, FIEs are required to submit to annual reviews by Chinese authorities to determine if the FIE is complying with all Chinese laws and regulations as well as its contract provisions. One requirement for free access to foreign exchange under the new regulations is that the FIE pass this annual review. Such reviews could conceivably be used to enforce forex balancing provisions in FIE contracts. In actual practice, under either the old regulations or the new forex conversion rules, there have not been any cases of Chinese authorities' flatly refusing to sell foreign exchange for purposes of repatriation. Many FIEs report that they have encountered few or no problems when their foreign exchange receipts and expenditures have been out of balance. C. EXPROPRIATION AND COMPENSATION There have been no cases of expropriation of foreign investment since China opened to the outside in 1979. In fact, the Joint Venture Law was amended to forbid nationalization, except under "special" circumstances. Such protection had already existed for Taiwan investments and wholly-owned foreign enterprises. The "special" circumstances have not yet been defined; officials claim that they would include national security considerations and obstacles to large civil engineering projects. Chinese law calls for compensation of expropriated foreign investments, but does not define the terms of compensation. Nevertheless, there have been investment dispute cases in which local authorities have sometimes intervened on the part of a Chinese company in a manner considered unfair and capricious by the foreign investor. For example, local courts have occasionally intervened to prevent the sale or transfer of foreign-owned property, pending resolution of a commercial dispute between a foreign company and Chinese company. In general, such cases are the exception, rather than the rule, and are eventually resolved through negotiation between the commercial parties and/or intervention of central authorities. An investment dispute in early 1994 involving a major U.S. glass maker also illustrates the potential for local and provincial authorities to seize or interfere in foreign investments in contravention of central government regulations. Local authorities in Nanchang city in Jiangxi Province, apparently acting at the request of the minority Chinese owner, attempted to take over a local joint venture chemical plant, in which the U.S. investor had a 60 percent equity. MOFTEC later worked with the U.S. firm, the U.S. Embassy, and Jiangxi officials to resolve the dispute. One case which received international publicity in Fall 1994 involved the alleged decision of Beijing municipal authorities to cancel McDonald's Corporation's land lease on its flagship restaurant near Tiananmen Square. The city's position was that the location was needed as part of a larger redevelopment project funded by a Hong Kong investor. A settlement of the dispute, providing compensation to McDonald's, was reportedly reached between the parties in mid-1996. Several other 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 allegedly stripped, without consent. It seems likely that as the number of investors increases in China such examples will also increase. Finally, U.S. direct sellers, who have invested millions in production facilities in China to support their operations, found themselves declared "illegal" overnight and are now trying to find some way to redefine themselves and their scope of business in order to get back into the market. D. DISPUTE SETTLEMENT Although China is a member of the International Center for the Settlement of Investment Disputes (ICSID) and has ratified the New York Convention on the Enforcement of Foreign Arbitral Awards, it places strong emphasis on resolving disputes through informal conciliation and consultation between the parties of disputes. If it is necessary to employ a formal mechanism, the authorities greatly prefer arbitration through Chinese agencies. Litigation is considered only reluctantly as a final option. Many foreign investors have found the Chinese approach time-consuming and unreliable. Investment contracts often stipulate arbitration in Stockholm because the forum there is considered neutral. Most Chinese contracts stipulate arbitration by the China International Economic and Trade Arbitration Commission (CIETAC). Another forum for resolving investment and trade disputes is the Beijing Conciliation Center (BCC), an organization affiliated with the China Council for the Promotion of International Trade (CCPIT). The BCC signed an agreement with the American Arbitration Association (AAA) in 1992 whereby the BCC and AAA would work together in joint conciliation to resolve trade and investment disputes between U.S. and Chinese parties. One case, however, raises questions about the willingness and ability of the Chinese government to follow through on its international arbitration commitments. For nearly a year beginning in December 1993, a U.S. company tried unsuccessfully to file for enforcement of a Swedish arbitration award with the Intermediate Court in Shanghai. Under Chinese law and the New York Convention, the Court should have acknowledged the request within seven days. Although the Court eventually accepted the suit filing and ruled in March 1996 that the arbitration award is enforceable in China, it remains unclear whether the U.S. company will ever be able to recover the award from the Chinese company, which has had years to liquidate and hide its assets. 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. At times, China's governmental departments have interfered in court decisions. 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, insurance, and intellectual property rights; other business disputes involving foreign parties; and various economic crimes including theft, bribery, and tax evasion. 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. Mortgages/secured interests in property. Under Chinese law, the land is owned by the "whole people" and cannot be privately owned. However, enterprises, including FIEs, can obtain long-term leasehold rights to the use of 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 "security law" - the first national legislation covering mortgages, liens, rules on guarantors for debt and registration of financial instruments as pledges for debt. The law defines debtor and guarantor rights and provides for mortgaging of property, including land and buildings, as well as other tangible assets such as machinery, aircraft or other types of vehicles. While some areas of the law remain unclear, such as how the transfer of property under foreclosure is effected, the law represents an important step forward. Prior to October 1995, there was no comprehensive legislation protecting the rights of mortgage holders, though there were security laws in effect in some provinces and localities. Bankruptcy. China's bankruptcy law, passed in December 1986, provides for creditors' meetings to discuss and adopt plans for the distribution of bankrupt property. The resolutions of creditors' meetings, which are binding on all creditors, are adopted by a majority of the attending creditors, who must account for more than half of the total amount of unsecured credit. Nevertheless, even Chinese officials contemplating broad enterprise reforms recognize the inadequacy of China's current bankruptcy law. The 1986 civil law failed to address bankruptcy of individuals, private companies, and township and village enterprises (TVEs), including for private companies and TVEs how to handle the distribution of liquidated assets and settlements for current workers and pensioners. A 1991 civil procedure law and implementing regulations of the State Council made some progress in dealing with bankruptcies of private companies, TVEs and FIEs. A major problem for Chinese commercial banks is the formal and informal constraints on liquidating the assets of non-performing state enterprise loans. China continues to work on additional legislation to address the inadequacies of current bankruptcy laws. Throughout 1995 and 1996, media reports indicated that China's NPC would soon pass new legislation. However, the expected dates for passage of new legislation have come and gone; internal debates continue over the relationship among the bankruptcy law, reform of state-owned enterprises, and labor rights. As of mid-1998, the Chinese government had still not implemented a comprehensive and effective bankruptcy law, though an "experiment" with allowing some companies to declare bankruptcy continues. E. PERFORMANCE REQUIREMENTS/INCENTIVES Export requirements. Export requirements, while not formally required by Chinese law, are stipulated in many contracts between Chinese and foreign partners. MOFTEC and SDPC, moreover, strongly encourage contractual clauses with such targets. Such requirements are usually negotiated between the investment contract partners and the various government bodies as part of the process of obtaining government approval for the investment. While failure to meet export targets has not resulted in withholding of rights to purchase foreign exchange, Chinese officials still examine the performance of in annual certifications. The passage of these certifications is necessary for FIEs to obtain certification to continue to obtain foreign exchange at China's banks. Local content. Chinese regulations grant foreign-funded enterprises freedom to source inputs both in China and abroad, though priority is given to Chinese products when conditions are equal. Chinese regulations forbid the imposition of "unreasonable" geographical, price, or quantity restrictions on the marketing of a licensed product. The foreign venture, thus, retains the right to purchase equipment, parts, and raw materials from any source. Nonetheless, Chinese officials strongly encourage localization of production. Investment contracts often call for foreign investors to commit themselves gradually to increase the percentage of local content. Such provisions and plans for sourcing production inputs are factors which are considered by Chinese officials in the approval process for foreign investment projects. Other incentives to source inputs locally include a partial rebate of value-added taxes on the local content of exports. Under China's current automotive industrial policy, no joint venture will be approved unless it provides for a "high percentage" of local content. The percentage for local content that is negotiated between companies and officials in the auto joint venture contracts is generally 40 or more percent, and is raised over time. (Note: Chinese Customs has granted preferential import treatment to domestic-automobile manufacturers when their local content exceeded a certain percentage. End note.) One problem, however, is that the poor quality of many domestically-produced inputs makes localization difficult for joint ventures, especially in high-tech sectors. Technology Transfer. Most joint ventures involve the transfer of technology through a licensing agreement, the transfer of technology from a third party, or the transfer from the foreign partner as part of its capital contribution. While China's investment laws and regulations do not require technology transfer, they strongly encourage it, and foreign investors are likely to encounter pressure to agree to it. A range of incentives is available to attract technology transfer. Employment of Host-Country Nationals. Rules for hiring Chinese nationals depend on the type of establishment: wholly foreign-owned, joint venture, or representative office. (See paragraph D on labor regulations.) Although wholly foreign-owned companies are not required to nominate Chinese nationals to their upper management, in practice expatriate personnel normally occupy only a small number of managerial and technical slots. In some ventures, there are no foreign personnel at all. The amended Chinese-foreign equity joint venture law provides that the joint venture partners shall determine, by consultation, the chairman and vice chairman, leaving open the possibility for a foreign or a Chinese representative to hold either of these positions. However, the consultation or election process is restricted by the provision that, if the foreign side assumes the chairmanship, the Chinese party must have the vice chairmanship, and vice versa. While FIEs are free to recruit employees directly or through agencies, representative offices of foreign companies must hire all local employees under contract with approved "labor services companies." These labor services companies pay contracted local employees only a portion of the amount paid by foreign companies for their services and the employees remain technically employed by the labor services company. Enforcement procedures for performance requirements. Article 13 of the same joint ventures law provides that the failure of a party to fulfill the obligations prescribed by the contract is a basis for termination of the joint venture. To the extent that performance requirements such as local content and export performance are typically part of contracts establishing joint ventures, Article 13 implicitly provides the legal basis for enforcing performance requirements. F. RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT In China's partially-reformed economy, there are numerous restrictions placed on the establishment of business enterprises. 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 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, insurance, and tourism, have been opened on an experimental basis. These experiments in the service sector, however, are limited by the maximum number of investments and locations. Although China has recently announced plans to expand both the number and locations, China currently allows a maximum of 22 foreign investments in joint venture retail department stores in 11 cities and SEZs. However, only 15 have been approved to date and of these only 10 are in operation. Three years after China announced it would allow a few joint-venture chain stores, two such ventures, one involving a Dutch company and the other a Japanese consortium, were approved in late 1996. The two companies reportedly initially plan to open three retail locations each in Beijing. Foreign investment in such joint ventures is limited to a minority stake. Investment in specialty retailing is allowed if all the products sold in the stores are produced in Chinese factories owned by the foreign investor. Foreign investment in wholesaling and distribution is still prohibited. Eight foreign insurance companies have been approved to do limited business in China, but all but one are restricted to operations in Shanghai. One U.S. company is also allowed to operate in Guangzhou. In addition, all of the firms are limited in the products they can offer and the customers they can solicit. China's first joint venture tourism company, with minority-stake Japanese and Hong Kong investment, was approved in December 1996. China is now also encouraging, on a limited basis, foreign investment in other hitherto-closed sectors. In August 1993, China announced plans to allow foreign investment in roads and harbors. Since then, there have been a number of foreign investments (minority stake) in toll roads and port facilities such as container handling terminals. In May 1994, China announced it would allow foreign investors to take up to a 35-percent stake in Chinese airlines (with the percentage of voting shares limited to 25 percent). The first such investment occurred in late 1995, when an investment consortium led by an American investor purchased a 25 percent stake in Hainan Airlines. In mid-1994, foreign investment was also allowed in selected gold mines. G. PROTECTION OF PROPERTY RIGHTS Since the January 1992 conclusion of a U.S.-China Memorandum of Understanding (MOU) on the protection of intellectual property rights (IPR), China has followed through on its commitments to join relevant international conventions and enact or amend IPR legislation. However, enforcement of IPR either through judicial or administrative means remains a serious problem. In March 1995, USTR Kantor and MOFTEC Minister Wu Yi concluded an extension to the 1992 MOU in which China promised to open its market to foreign companies with IPR products and enforce rigorously its IPR regulations. In June 1996, after intensive consultations, the U.S. and China announced a report on China's enforcement efforts which described the measures China had taken on IPR enforcement. In the March 1995 extension of the IPR MOU, China confirmed that it would not impose non-tariff restrictions on the importation of audiovisual or published products. China also committed to allow joint ventures with Chinese entities in audio-visual products and computer software. China further agreed to allow U.S. individuals and entities to enter film products into revenue-sharing arrangements in China. However, unwritten quotas for both foreign films and foreign music persist. Trademark violations for many name-brand consumer products persist. Legal Environment. In response to the increasing importance of the resolution of IPR disputes, China has established special IPR courts in several cities and provinces, including Beijing, Shanghai, Guangzhou, Fujian and Hainan. Judges in Chinese courts are charged with fact-finding and have greater discretion in the adjudication of cases than those in the U.S. The lack of legal training of many of the trial court judges detracts from the effectiveness of these courts. Authorities are attempting to remedy this training gap by establishing IPR law centers at Beijing University and People's University. They are also actively studying the training of IPR professionals in foreign countries. Membership in International IPR Organizations. China is a member of the World Intellectual Property Organization (WIPO), the Paris Convention for the Protection of Industrial Property, the Berne Convention, the Madrid Trademark Convention, the Universal Copyright Convention, and the Geneva Phonogram Convention. H. TRANSPARENCY OF THE REGULATORY SYSTEM Although more than 150 major laws and regulations apply to foreign investment, China's legal and regulatory system reveals a general lack of transparency and inconsistent enforcement. Investors may also face excessive bureaucratic influence in joint venture operations. Since the original legislation and regulations on foreign investment were formulated, some measures have been introduced to simplify procedures for foreign investors. However, these laws and regulations are still fraught with ambiguities, and no prospective foreign investor should venture into the China market without experienced counsel. I. EFFICIENT CAPITAL MARKETS AND PORTFOLIO INVESTMENT China's spectacular growth since 1979 has fueled a concomitant demand for financial institutions to provide sources for investment capital. China's securities market has developed in response to these continuing needs. Among the early highlights, the first post-1949 issuances of treasury bonds and other debt instruments were made in 1981, and, in 1984, the first post-1949 public issue of corporate shares was offered. A secondary stock market gradually began to evolve in 1986, initially via the Industrial and Commercial Bank of China. The Shanghai Securities Exchange opened in November 1990. The city of Shenzhen in southern China's booming Guangdong Province opened a second exchange in July 1991. Besides the two officially-recognized exchanges, there are now also several "securities exchange centers" in cities such as Wuhan, Shenyang, and Tianjin. These markets are approved by the People's Bank of China (PBOC), China's central bank, and are used mostly by local companies to attract small amounts of capital. When rioting erupted at the Shenzhen Stock Exchange in August 1992, Beijing authorities recognized that China's lack of adequate securities law and regulation was a serious problem. The State Council later established a two-tiered regulatory structure to oversee policy-making and day-to-day regulation. The first tier was the State Council Security Policy Commission (SCSPC), consisting of top officials from relevant government departments such as the People's Bank of China (PBOC). It was responsible for overall policy. The second tier was the China Securities Regulatory Commission (CSRC) which was responsible for such tasks as designating firms for listing and licensing brokerage companies. In 1997, the two organizations were unified under a revamped CSRC that was totally independent from the PBOC and under direct State Council supervision. Legal framework for Equity Investment. Despite the organizational reform, a lingering problem that affects China's securities market is the lack of a sophisticated national legal framework -and the resulting overlap of responsibilities between a handful of competing agencies including the PBOC, the Ministry of Finance, and the SDPC, in addition to the CSRC. This overlap of responsibilities causes many disputes with no clear system for resolution. Another problem is a lack of national accounting standards and trained accountants to evaluate a firm's financial standing. Although CSRC promulgated provisional regulations in May 1993 and, in 1994, issued supplemental regulations on auditing Chinese enterprises wishing to list abroad, China still lacks a complete set of securities laws. A negotiable instruments law was passed in May 1995. State Banking Sector. China's capital markets are dominated by a state banking sector which still channels funds to state-owned enterprises on the basis of public policy rather than market considerations. Other domestic firms must often 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 in lending by these institutions is often given to those investments that bring in advanced technology or produce goods for export. Foreign-invested firms generally borrow funds from abroad, registering all foreign loans with the State Administration for Foreign Exchange (SAFE). With the creation of three policy banks in 1994 - the Import Export Bank of China, the State Development Bank, and the Agricultural Development Bank - China is attempting to make a clearer division between policy and commercial banks. Despite the establishment of three policy banks, China's commercial banks still carry a heavy percentage of non-performing loans, and are under pressure from the government to accept uneconomic policy loans. The People's Bank of China (PBOC) announced in early 1998 its plans to make its accounting standards, and those of China's commercial banks, follow international practice by the end of the year. 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 US$ 3 million, debt cannot exceed 30 percent of the total investment. The debt/capital ratio for investments in the US$ 3-10 million, $10 - 30 million, and over $30 million ranges cannot exceed, 50, 60, and 70 percent respectively. Debt for investments over US$ 60 million is limited to two thirds of the total value of the investment. It is legally possible for FIEs to raise funds in China through the sale of bonds, but only a few have tried to do so. J. POLITICAL VIOLENCE Corruption, layoffs from state-run enterprises, the growing gap between coastal regions and the interior, inflation, and economic disparities between rural and urban areas have at one time or another contributed to dissatisfaction among the Chinese populace. Northwestern China has been troubled by occasional unrest among minority ethnic and religious groups. Dissatisfaction has not translated into widespread political activity since 1989, however, because the government is working to minimize tensions and because most people believe Beijing is able and willing to repress any sizeable anti-government protests. As China continued to push forward in 1997 and 1998 on 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 reports of local labor actions. To date, however, local authorities appear to be dealing with these in a peaceful manner and have not resorted to violence. K. CORRUPTION China has a variety of regulations which are intended to combat corruption. For example, there are regulations which forbid relatives from supervising one another, forbid office petty cash "slush funds," or ban unauthorized highway tolls. However, China has found many of these regulations difficult to enforce. China still does not have an over-arching anti-corruption law. In May 1997, China promulgated a new Supervision Law which spells out responsibilities and procedures for government oversight organs and investigations government corruption. China's newly-elected NPC reportedly has assigned a high priority to passing this law within the next year or two. From surveys reported in the western media and on the 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. In 1995, the Chinese Government launched a massive anti-corruption campaign. Tens of thousands of people, including several major political figures such as former Beijing Communist Party Secretary Chen Xitong, were detained as a result of this campaign. Accepting bribes or giving bribes are criminal acts. It is unclear if giving a bribe to a foreign official in another country is illegal under PRC law. Bribes cannot be deducted from taxes, because they are illegal. Criminal penalties for corruption include imprisonment, and, for large sums, death. Officials who participate in corrupt behavior can receive six different administrative punishments: (in ascending order) a warning, minor demerit, major demerit, demotion, removal from position, and dismissal from the civil service. Three different central government ministries and one Communist Party organ are responsible for combating corruption: the Ministry of Supervision, the Procuratorate, Ministry of Public Security, and the Communist Party Commission for Discipline Inspection. 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 earlier this year. 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 two sides are considering steps for bilateral cooperation in this area. L. BILATERAL INVESTMENT AGREEMENTS While periodic discussions had been held in past years, the U.S. does not have a bilateral investment treaty with China. The two sides disagree on a number of issues, such as national treatment, third party arbitration, and compensation for expropriation. At present, such subjects are covered in the body of each investment contract. China has entered into bilateral investment agreements with more than 50 countries. Some of the larger countries that have bilateral investment treaties with China are Japan, Germany, the United Kingdom, France, Italy, Thailand, Romania, Sweden, the Belgium0-Luxembourg Economic Union, Finland, Norway, Spain, Canada, and Austria. The provisions of these agreements cover in general terms such issues as expropriation, arbitration, most-favored-nation treatment, and transfer or repatriation of proceeds. In general, these investment agreements only address the treatment of investments after establishment and do not grant national treatment for establishment. M. OPIC AND INVESTMENT INSURANCE PROGRAMS In the past, OPIC had a very active program in China. OPIC's program in China has been suspended since the Tiananmen incident in June 1989, first by Executive Action, and then by the legislative sanctions that took effect in February, 1990. OPIC continues to honor outstanding political risk insurance contracts. At the end of 1990, 31 U.S. investments with approximately 300 million dollars had OPIC political risk insurance. OPIC programs will remain suspended in China subject to U.S. foreign policy concerns, the terms of the sanctions legislation enacted, and improvements in worker rights conditions. Although OPIC may remain unavailable for the foreseeable future, the Multilateral Investment Guarantee Agency (MIGA), an organization affiliated with the World Bank, can be a source of political risk insurance for investors interested in investing in China. Some commercial insurance companies also offer political risk insurance, as does the People's Insurance Company of China (PICC) N. LABOR 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 must hire their local employees through a labor services agency. Skilled workers are often in short supply, although many companies have found an abundance of recent university graduates who are talented and highly motivated. 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. Compensation. Workers are paid a salary, hourly wages, or piece-work wages. The provision of subsidized services, such as housing and medical care, is very widespread, and compensation beyond the basic wage constitutes a very 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. Local governments also tax enterprises and workers to support social security and unemployment insurance funds. 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. 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. 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 FIEs 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. O. FOREIGN TRADE ZONES/FREE PORTS China has established a number of duty-free import/export zones. The main ones are located in Dalian, Tianjin, Shanghai, Guangzhou, and Hainan. Other free trade zones are envisioned in other SEZs and open cities in China. Privileges similar to those offered in the officially-designated free zones can also be found in the other SEZs and open cities, but restrictions and charges can affect venture operations and business there. To make progress toward a consistent national trade regime as part of its WTO accession, China has indicated that it will not introduce any new investment incentives for its SEZs and will decrease existing incentives over time. China's Customs Administration claims success in controlling the duty-free importation of production inputs into the Zones, but the lack of physical barriers makes it difficult to control the flow of non-duty items out of the Zones. Considerable attention was placed on the status of the SEZs in the run up to and aftermath of the March 1995 session of the NPC with Zone officials from Shenzhen attempting to enhance their Zone's autonomy, and delegates from primarily inland parts of China requesting that SEZ privileges be reduced further. During and after the NPC meeting, the central government leadership made a series of statements emphasizing that there would be no changes in China's basic policies towards SEZ's. Similar statements appeared periodically in Chinese official publications throughout 1996 and 1997. Foreign Direct Investment in China's Economy FIEs in China probably represent the most efficient part of the Chinese economy. FIE's play a particularly significant role in China's trade economy -- FIE's accounted for 55 percent of China's imports and 41 percent of exports in 1997. The 145,000 foreign-funded enterprises currently operating in China employ some 17.5 million people, accounting for about 11 percent of China's non-agricultural population. FIE's contributed 12 percent of China's total industrial and commercial revenues and 14 percent of its total industrial output. Foreign investment stock in China is difficult to estimate given a lack of available sophisticated data. China publishes yearly investment in-flow numbers that, added together from the earliest significant investments in 1979, total $222 billion. However, this figure takes neither depreciation nor disinvestment (or current value) into account. Probably more reliable, an FDI stock figure was published by China's State Statistical Bureau (SSB) for 1996 which, with the addition of the new FDI in-flow of 1997, would indicate a total FDI stock in China of just under $109 billion. This is equivalent to 12 percent of China's 1997 GDP of $903 billion. Total new FDI in-flow in 1997 totaled $45.278 billion, or 5 percent of China's 1997 GDP. Major U.S. Investors in China. Countries and regions with the highest cumulative contracted FDI in China are, in declining order, Hong Kong, Taiwan, the United States, Japan, and Singapore. A large number of U.S. companies have established and are expanding direct foreign investments in China. The following is a list of the top 10 major U.S. companies with investments in China and the total value of their investments according to official Chinese government publications. Unless otherwise noted, the information is based on the status of investments at the beginning of 1997. Motorola ($1.2 billion) -- recent investments in china include several joint ventures and a $506 million semiconductor plant in Tianjin. ARCO ($625 million) -- opened China's largest offshore natural gas project; half of the $1.13 billion investment in a pipeline project will be assumed by the Chinese partner. Coca Cola ($500 million) -- Coca Cola, Fanta, Sprite and other products are already produced in 16 areas in china. Seven more plants are being built. Amoco ($350 million) -- opened an oil project on the South China Sea in March 1996. General Motors ($350 million) -- As of mid-1998, Delphi, GM's subsidiary, had 11 joint ventures and four wholly-owned plants producing auto parts in China. (Note: the total investment figure does not include the approved $1 billion auto production joint venture in Shanghai which GM entered into last year). Ford ($250 million) -- at least three facilities in China producing auto parts, light vehicles and trucks. Two other facilities are being established. United Technologies ($250 million) -- UT's subsidiary, Otis Elevator, produces elevators in China. Another of its companies, Carrier, produces air conditioners. Other subsidiaries such as UT Automotive, tubo Power Systems and Pratt and Whitney also have joint ventures. Pepsi ($200 million) -- twelve beverage plants in China, two cheese production joint ventures, 62 Kentucky Fried Chicken restaurants, and 19 Pizza Hut restaurants. Hewlett-Packard ($200 million) -- as of mid-1998, had $200 million in registered capital in manufacturing facilities for personal computers and printers in Shanghai and elsewhere in China. Sales in China, including both domestically produced and imported equipment, totalled $800 million in 1997. Lucent Technologies ($150 million) -- seven joint ventures in China. General Electric ($165 million) -- 14 joint ventures in china, including a factory producing x-ray equipment for medical use. GE holds 80 percent of the stock in China's largest lighting equipment production enterprise.

Country Commercial Guide FY 1999: People's Republic of China

Country Commercial Guide
FY 1999: People's Republic of China