Successfully investing in China

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last updated on 16 June 2023 | reading time approx. 8 minutes

 


 

How do you assess the current economic situation in China?

After nearly three years of complete lockdown and the strict zero-Covid policy of the Chinese government, al­most all Covid measures in China were lifted in December 2022. However, the effects are still noticeable in var­ious ways. For example, capacity in civil aviation is still not at pre-crisis levels, and much-needed (foreign) pro­fes­sionals and executives have not fully returned to China. This is primarily due to the relatively few flight con­nec­tions, and there may still be delays in visa issuance, as demand is high both in China and Germany. The pre­viously strict entry restrictions imposed by China were almost completely lifted at the end of April 2023, so trav­el is slowly normalizing.

In terms of economic recovery, China's economy is sending ambivalent signals. Surprisingly, foreign trade saw a strong increase in March 2023, with a growth rate of nearly 15 percent compared to the same period in 2022. Over­all, China's economy grew by 4.5 percent in the first quarter of 2023, the strongest quarterly growth in a year, driven in particular by increased consumer spending. However, growth significantly weakened again in April due to weaker demand from international markets and a slowdown in domestic demand. Geopolitical fac­tors and a generally slowly growing global economy also contributed to this.

The Chinese government has set a target of approximately 5 percent economic growth for 2023, while the International Monetary Fund (IMF) forecasts a growth rate of 5.2 percent. It remains to be seen whether this goal can be achieved without further stimulus packages and whether the growth will shift more towards con­sumer goods from investment goods.

Nevertheless, German companies in China are more optimistic about the future. The sustainability of this sen­ti­ment among European companies will also be reflected in the results of the Spring Business Confidence Survey conducted by the European Chamber of Commerce in China, which will be presented in June. Currently, we ex­pect that growth will stabilize and settle in the mid-single-digit range over the coming months.

 

How would you describe the investment climate in China? Which sectors offer the largest potential?

The investment climate is slowly improving after the end of the strict Zero-Covid policy. However, this is not sole­ly due to the Zero-Covid policy. The increasingly complex legal and economic conditions in the country, as well as geopolitical challenges, are taking their toll. Additionally, the yet-to-be-published China strategy of the German federal government is causing hesitation in investments.

The pandemic years and the political discussions regarding dependencies on the Chinese market have led to a stronger diversification of German companies and their supply chains. On the other hand, we also observe strong efforts to completely relocate production to China for the local market, adapt and design products lo­cal­ly, establish production facilities, and manufacture products tailored to the target audience.

Since the lifting of the pandemic measures, we have witnessed increased investments in the following sectors, which offer significant potential for German companies over the next few years:
  • Pharmaceutical industry
  • Medical technology, medical devices, and diagnostics
  • Pharmaceuticals and medical products
  • Care industry and healthcare services
  • Industrial services
  • High-tech and robotics, software
  • Environmental technology
  • Electromobility
  • Smart city technologies
  • Renewable energy and energy efficiency technologies
  • Water and wastewater management
  • Circular economy and waste management
  • Sustainable agricultural technology
  • Gaming & e-sports
  • E-commerce
  • Digitalization and transformation services

Although with comparatively weaker growth figures, "traditional" sectors such as mechanical and plant engi­neering, automotive and automotive suppliers, architectural and engineering services, the chemical industry, or the food and logistics sectors still hold potential for the German economy.

The Chinese government has launched investment and incentive programs for various industries to attract for­eign investments. The funding pools are well-filled, particularly for "green" projects and industries, as well as for companies that vigorously drive the transition and further development of their production and business mo­dels in terms of CO2 reduction, energy efficiency, and more. These programs include tax incentives, customs exemptions, discounted loans, and alternative financing models.

In the future, the Chinese government will place a special focus on investments in research and development (R&D). A circular issued by the State Council of China on 11 January 2023, calls on relevant departments and local authorities to take measures to encourage foreign investors to establish R&D centers in the country. The circular addresses various aspects, ranging from financial and tax support, facilitated access to land, infra­struc­ture, and necessary equipment, to the provision of top talents and access to data from national science and technology programs. A survey conducted between September 2021 and April 2022 among members of the European Union Chamber of Commerce in China in collaboration with the Mercator Institute for China Studies (MERICS) identified the following factors influencing the decisions of surveyed companies regarding R&D in­vest­ments in China:
  • Size of the Chinese market with strong demand for innovative products
  • Enormous pool of qualified professionals
  • Large number and diversity of cooperation partners
  • Speed of commercialization of R&D results

Due to a generally favorable investment environment, European companies appear to strategically shift their fo­cus to sectors and areas promoted by the Chinese government, such as "green" technologies, industrial ma­chin­ery, healthcare, chemistry, or automotive. The associated government support measures are particularly significant for small and medium-sized enterprises (SMEs).

In conclusion, with the right strategy, China remains one of the most exciting and dynamic markets worldwide.

 

What challenges do German companies face during their business ventures into China?

The Chinese regulatory framework remains complex and partly causes significant uncertainty. On the one hand, market access is facilitated through the gradually shortened Negative List, which specifies prohibited or restricted investments. Conversely, the catalog for foreign investments in industries supported by the Chinese government is expanding. On the other hand, compliance with the Chinese Cyber Security Law (CSL), Data Se­cu­rity Law (DSL), Personal Information Protection Law (PIPL), and their respective implementation regu­la­tions remain a major risk and uncertainty factor. The new Chinese Anti-Spying Law also adds to the uncertainty among European companies.

Although travel restrictions are virtually non-existent, many positions for foreign professionals and executives remain vacant, and many established and long-term expatriates have left the country during the pandemic or plan to return or relocate elsewhere. The attractiveness of China among expatriates has been significantly damp­ened during the pandemic and is not expected to recover quickly. Another attractive aspect is likely to be lost by the end of the year when the new (personal) income tax reform takes effect, which provides little tax benefits for expats, unless the Chinese Ministry of Finance initiates another extension of tax incentives or local governments introduce or continue corresponding regulations in their administrative regions.

This can be problematic for German and other foreign companies. The costs for foreign employees and thus for the urgently needed professionals and executives could increase significantly, as companies will likely bear the additional costs themselves to stay ahead in the competition for talents. Even for local talents and top per­for­mers, costs have steadily risen in recent years, particularly in major urban and industrial centers such as Shenzhen, Chengdu, Guangzhou, Shanghai, or Beijing, where not only salaries but also the cost of living are in­crea­sing. Foreign companies compete here with a multitude of national competitors for the best talent. There­fore, companies are well-advised to allocate a portion of their investments to brand building and maintenance, particularly employer branding, and to attract top talent with a convincing, attractive, and targeted employer brand.

The requirements for risk management for foreign companies based in China are also increasing. For example, the scrutiny of intercompany loans by authorities has been intensified, and companies overall face increased transfer pricing risks, facilitated by the pandemic and disrupted supply chains.

Speaking of supply chains, they have come under significant pressure in recent years. Many companies ex­pe­ri­enced the impact of a supplier's failure during the pandemic. The challenges these days are to diversify and build resilient supply chains. At the same time, the German Supply Chain Due Diligence Law, which has been in effect since January 2023, is another aspect that needs to be considered and should not be overlooked in in­ter­nal risk management. Companies need to take a closer look at their own supply chain and suppliers, par­tic­u­lar­ly in critical sectors and regions.

 

The supply chain due diligence act came into effect in January 2023 – What are the impacts and challenges for German companies in China?

Since the German Supply Chain Due Diligence Law came into force on 1 January 2023, the first group of com­pa­nies with at least 3,000 employees is required to conduct a risk analysis of their global supply chains to assess human rights and environmental risks. Transparency and the availability of relevant information are essential in this process.

As part of the risk analysis, subsidiaries and direct suppliers in China are particularly requested to provide com­­prehensive information on relevant aspects when such information cannot be obtained from other reliable sources. One advantage in China is the vast amount of corporate data available, either free of charge in official databases or for a fee through private providers of due diligence services.

Obtaining information from Chinese subsidiaries should generally not pose significant challenges when the sub­sidiary is wholly owned and under the complete factual control of the German parent company. It becomes more difficult when the subsidiary is a Sino-German joint venture and the Chinese partner holds key man­age­ment positions or otherwise controls access to important information. The most significant barriers to obtaining information, however, usually exist in relation to Chinese suppliers. In most cases, simply sending lengthy and complex questionnaires to the respective suppliers in the hope of receiving reliable and complete answers with­out further ado will not suffice. The likelihood of success in such an approach is particularly low when the German customer's significance and share of the Chinese supplier's total revenue are low. 

Moreover, there is often an assumption in China that German or European laws are being imposed on China through these requirements from German customers. It is important to find a balance between cooperation and control within reasonable economic limits. Ideally, both aspects should be addressed simultaneously: making sincere efforts to cooperate through respectful and understanding communication with the Chinese partner and conducting an early compliance audit to close information gaps. The feasibility of implementing this ap­proach in a specific case depends, among other factors, on the size and complexity of the supplier network. It may be advisable and even lawful, in line with the principle of proportionality, to set priorities early on when identified obstacles to information procurement arise.

 

In your opinion, how will China develop?

If China's growth stabilizes and global demand picks up again, it is quite possible that the country can once again assume the role of an economic powerhouse. This is especially true if the heavily strained supply chains return to normal. This will also benefit German and European companies on the ground, allowing them to par­ti­ci­pate more strongly in China's economic success.

In 2023, China will strive to achieve its stated goal of 5 percent growth and consolidate its position as a global economic power, keeping its competition at bay.

The challenges we have described above also present opportunities to review and, ideally, transform existing business models in light of ongoing digitalization, particularly with a focus on sustainability, which is de­manded everywhere. This applies not least to leadership roles, which may still need to be carried out remotely. The keys to success remain courage, tact, intercultural know-how, and the knowledge and application of ap­pro­pri­ate leadership tools.

Despite all the challenges, crises, and conflicts, China will continue to strengthen its position as one of the most important investment and sales markets in the post-Covid years and will continue to gain significance for the German economy in the future.

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