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Successfully investing in China

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last updated on 19 May 2021 | reading time approx. 8 minutes

 


 

How do you assess the current economic situation in China?

After a dramatic economic slump in the 1st quarter of 2020, China's economy was able to recover comparatively quickly in view of the global pandemic. China was the only major economy to achieve a slight increase of around 2.3 per cent compared with 2019. The strict measures to control the epidemic – including the complete isolation of entire cities with millions of inhabitants, quarantine, mass tests and entry bans – paid off and Chinese companies are not the only ones benefiting from the recovery. Billions of yuan were made available to relieve companies affected by the pandemic and a broad economic stimulus package was launched. However, not only Chinese companies are returning to the track of success, German and European companies are also optimistic about the well-filled order books and sales figures in the Middle Kingdom.

In the 1st quarter of the current year, imports and exports with Germany increased strongly compared with the same period in 2020. However, it should be noted that the high growth rates of over 30 per cent for German exports to its most important trading partner also resulted from the comparatively low figures of 2020. Overall, China's foreign trade has stabilised on the whole and is picking up considerable momentum, partly because global demand has increased strongly again in recent months.

For 2021, the People's Republic is aiming for economic growth of around 8 per cent; analysts at Deutsche Bank Research in February even assumed 10 per cent [1]. The IMF is somewhat more neutral, forecasting growth of around 8,4 per cent [2] for China in the current year. Given the comparatively weak pre-crisis level, it is not unlikely that China will achieve its target.  However, growth for 2021 does not only look comparatively good for China. The entire Asian region recorded a decline in economic output of -1 per cent for 2020 – in comparison with the euro zone, which had to struggle with a minus of 6.6 per cent. The Asian global economic engine has stuttered mightily in 2020, but with a forecast economic upturn of 8.6 per cent, the turbo will be re-ignited and the local German economy will be boosted along with it.

A major cause for concern at present is private consumption, which has also picked up strongly but is still falling short of expectations. The government is trying to further boost consumption with various measures. For German car manufacturers and their suppliers in particular, the strong Chinese market proved to be a bright spot throughout the crisis, with sales recovering comparatively quickly and partly offsetting the losses in other countries. Likewise, the well-positioned German mechanical engineering sector is looking forward to growing sales and profits, and exports of German goods to China are also on a growth trajectory.

However, one drop of bitterness remains: The global supply chains are still massively disrupted in some areas and are affecting production capacities, not only in China but globally. Particularly in the semiconductor segment, but also in the construction industry, there are significant disruptions in the supply chains and thus supply bottlenecks.

Despite a number of positive aspects, the still very strict entry requirements are seen as a major obstacle by many German companies to participate in the success. Not only on the part of the expatriates but also for general business trips or assembly and maintenance orders. In principle, a quarantine period of at least 2 weeks applies, which can be extended by a further 7-14 days, depending on the final destination of the trip. In view of the different intentions on the part of the German business community, this is not only a deterrent but also highly impractical. The different interpretations in the various provinces and changes in the regulations at short notice also lead to great uncertainty and make it almost impossible to plan any assignments or business meetings on site.

 

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

The Chinese government is striving to further optimize the investment climate by adjusting the regulatory framework and attract foreign investors to the country – whether with direct or indirect investments. Since the beginning of 2020, the China Foreign Investment Law (FIL) has been in force with the aim of further improving investment conditions for foreign investors. Among other things, the FIL aims to put foreign investment on an equal footing with domestic investment. In the course of this, the list of industries and sectors that were previously restricted or prohibited for foreign investment has been curtailed. As a result, investments can be made in most sectors relevant to German SMEs and only a few restrictions have been maintained. The requirement to enter into a joint venture with a Chinese partner in certain sectors is also increasingly becoming a thing of the past. In addition to the adjustments already mentioned, the protection of intellectual property has also improved. And not only at the regulatory level, but also in practice when it comes to enforcing one's rights with the support of Chinese authorities and courts.

At the end of 2020, the EU-China Comprehensive Agreement on Investment (CAI) marked another milestone in trade relations between China and the EU member states. However, the expectations placed in the agreement on the part of the German economy have not yet been met, as the agreement still owes an answer on many points and the ratification process of the agreement is still pending – due to the current tensions between the EU and China, this could be delayed even further.

In economic terms, China was able to emerge from the ongoing Corona crisis as one of the winners in 2020. Not only in terms of strong imports and exports, but also in terms of foreign direct investment (FDI). The middle class, which continues to grow and has purchasing power, especially in the metropolitan areas, good educational standards, a good infrastructure, and the country's special position as a drawing card in the Asia-Pacific region offer good conditions for investment.

We see particular potential in the following sectors, driven in part by the ongoing global healthcare crisis:

  • Medical technology, manufacturer of medical protective equipment and materials;
  • Medical devices and diagnostics;
  • Pharmaceutical industry;
  • Pharmaceuticals and medical supplies;
  • E-commerce;
  • High-tech and robotics;
  • Electric vehicles and mobility;
  • Environmental technology;
  • Logistics industry;
  • Services in the field of digitalization and transformation.


China has been able to prove its supremacy in the field of medical protective material in 2020. According to official figures from the Chinese customs authorities, more than 200 billion medical masks were shipped, and China thus remains the largest producer of medical protective material. Production capacity will be stably utilised in the coming months to meet the continued high global demand. In addition, as in recent years, the e-commerce sector remains on the fast track, additionally boosted by the Corona pandemic.

 

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

Despite the positive signals, questions remain as to how effectively new regulations will be implemented in practice and in the various provinces. Even after a year of “equalization” of foreign and domestic investments, domestic investments are preferred. Particularly in public tenders, the necessary transparency is lacking.

Another complaint is the accessibility and speed of the available Internet, which in many places does not meet Western standards and constitutes an obstacle in times of video telephony and virtual conferences as well as business meetings. As in previous years, the Chinese “Cyber Security Law” and its supplementary and interpretative provisions pose a major challenge. It is still unclear to what extent the law could restrict cross-border data traffic. For globally active companies in a globalised world and with the current travel restrictions everywhere, this is a major risk and uncertainty factor.

A further challenge is the Corporate Social Credit System, which poses new regulatory hurdles. The system was supposed to be rolled out nationwide in 2020, but to date only the province of Zheijang is “online” as a model project with a fully comprehensive system. It remains to be seen when and to what extent all components of the system will be implemented nationwide.

The most pressing issue, however, are the existing travel restrictions for foreigners. Business trips are almost impossible due to the administrative effort for visa and travel as well as the subsequent quarantine of at least 14 days. Many expatriate positions currently remain unfilled due to the travel restrictions – a circumstance that many German investors even consider to be desired by the Chinese side.

It is not only the travel restrictions that have a negative impact on China's attractiveness as an expatriate country.

In addition, the income tax reform and the tax year 2022 will bring further changes, which will no longer provide for a large part of tax benefits for foreigners, for example the tax exemption of subsidies for school fees and the tax creditability of rental costs (Housing Allowance). There may also be new regulations for bonus payments to the disadvantage of the resident taxpayer, which will further increase the tax burden. For companies that rely on foreign employees, this can be a high cost factor to compensate monetarily for the dwindling attractiveness of employment in China.

As a result, the absence of foreign specialists and managers intensifies the cultural hurdles that exist either way. Be it virtual negotiations or the virtual management of teams on site in China.

 

What prospects do the agreements on the Regional Comprehensive Economic Partnership (RCEP) and the EU-China Comprehensive Agreement on Investment (CAI) open up for investors?

The CAI is particularly relevant for German investors in China, and many companies hope that the new agreement will improve market access conditions. In the near future, it will play only a secondary role, especially in view of recent political developments, since the EU is currently not actively pursuing the ratification process. The CAI is not only viewed positively within the EU – among other things, the timing of the announcement at the end of 2020 and too lax regulations to enforce the interests of the EU member states have been criticized. Yet the provisions that were put up for discussion in the CAI's annexes did not appear translated until March 2021.

The same applies to the RCEP, which has also been adopted but will still take some time to go through the ratification process. Due to the large number of signatory states, both on the part of the RCEP and the CAI, the ratification processes are highly complex.

Nevertheless, we assume that once both agreements have been finally ratified, German and European companies will also benefit from the agreements. With regard to the RCEP, this will particularly affect German companies that are already represented locally in the region with their own branches and production facilities, and cross-border trade within the Asia-Pacific region will be further simplified and trade barriers minimised.

That being said, it should be noted that the RCEP and CAI are fundamentally different, as the CAI is an investment agreement and not, as in the case of the RCEP, a free trade agreement. Thus, companies based in Germany or Europe will not be able to count on tariffs or other trade barriers being removed in the medium term by means of a free trade agreement. Moreover, there are currently no discernible efforts on the part of the EU or China to initiate negotiations on a comprehensive free trade agreement, as was the case, for example, with the FTAs concluded by the EU with Singapore or, most recently, Vietnam in the Asian region.

 

In your opinion, how will China develop?

China's current economic situation is a positive signal for the global economy - in the current pandemic, the Middle Kingdom is acting as a strong powerhouse to get the global economy back on track. Global demand is picking up again to the benefit not least of German companies in China. But China would not be China if it did not know how to take advantage of the opportunity and the head start it has in combating the pandemic. And yet the Communist Party is planning for comparatively low growth in 2021 – around 6 per cent. China will do everything in its power to achieve the goals it has set and to consolidate its position as an economic power. To the frustration of many foreign businessmen, the country is expected to stick to its zero-covid strategy beyond 2021, and entry will remain possible only under more difficult conditions.

However, the challenges of these days also harbor opportunities to review existing business models in the light of ongoing digitisation and, ideally, to reshape them. This applies not least to management tasks that have to be performed at a distance. One of the keys to success these days: courage, sensitivity, intercultural know-how, and the knowledge and application of appropriate management tools.

Despite all the challenges and the current diplomatic tensions between the EU and China, as well as the ongoing trade conflict with the U.S. – China will continue to expand its position as one of the most important investment and sales markets, especially in the coming post-covid years, and will continue to gain in importance for the German economy.   




[1] Deutsche Bank Research, Ausblick Deutschland, Ausgabe vom 19. Februar 2021


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