Foreign direct investment (FDI) is the purchase or acquisition of a substantial stake in a company from an entity that is located outside its borders. China has been successful in enticing foreign entities to invest in their market by capitalizing on their large consumer base, while also providing attractive incentives, especially through the legislation of the new Foreign Investment Law (FIL).
Under the FIL, restrictions became relaxed enough to allow greater market access and fairer treatment to foreign investors. Additionally, certain limitations in the financial industry were lifted, allowing foreigners to have full direct ownership over companies in the futures, securities, fund management, and life insurance sectors. The new foreign investment policies, growing economy, and preferential tax policies continue to invite more foreign entities to venture into the Chinese local market.
This article aims to provide insight on FDI in China, the most popular sectors for foreign investors, and what future investors can expect from the Chinese market.
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Foreign Direct Investment (FDI) in China
At the end of 2020, China had overtaken the US in attracting FDI, becoming the world’s leading destination for foreign investment. FDI inflow attracted more than $149 billion USD in 2020, with a year-on-year growth of 5.7%.
China has been ranking next to the US for years but became the center of the global economy as its FDI rose by 4% from 2019 to 2020. The attractive inflow compared to the sharp fall of 49% experienced the by the US, during the same period, had led to China reaching the top spot.
FDI in the US saw its height in 2016 at US$ 472 billion. However, China continued its steady rise as the country established its strong position as the world’s factory floor while expanding global trade efforts. In the first quarter of 2021, China had already reached US$ 98 billion in FDI inflows which moderately increased throughout the year.
Most Popular Sectors for FDI in China
According to the China Statistical Yearbook of 2020, the sectors that benefit the most from foreign investment include:
- Manufacturing
- Real estate
- Leasing and business services
- Information transmission, software, and computer services
- Scientific research, technical service, and geologic prospecting
- Distribution, wholesale, and retail trade
- Financial intermediation
- Transport, storage, and post
- Production and supply of electricity, water, and gas
- Construction
Some of the largest foreign multinationals that operate in China include American corporations like GM, Apple, and Nike, as well as Asian corporations like Toyota and Samsung. Enterprises like these generally fall under the categories listed in the Encouraged Catalogue.
The Encouraged Catalogue contains a list of sectors that are highly encouraged to participate in the market through Foreign Direct Investment. Qualified businesses may also enjoy favorable policies to entice them to enter the market like tariff reductions, exemptions on imported goods, increased accessibility, reduced regulations on land use, and a reduced Corporate Income Tax (CIT) rate.
Under the Encouraged Catalogue, these are the three high priority categories encouraged for FDI:
- High-end manufacturing
- Production-oriented service
- Investment in provinces in the central, western, and northeastern parts of the country
If the nature of the investment does not fall in any of the sectors that are listed under the Negative List, then investors can enjoy the same rights and treatment given to domestic enterprises. Usually, the abovementioned sectors belong to the Encouraged Catalogue, which is the opposite of the Negative List.
Investment Restrictions – China’s Negative List
According to China’s Foreign Investment Law, foreign enterprises and individuals can directly invest in the country, unless their investment is prohibited or restricted as defined in the Negative List for Market Access. The Negative List is the guideline used by the Chinese government to prohibit or restrict foreign investments as applicable. In July 2020, the list was updated to further reduce the limitations on foreign investments.
According to the Negative List, businesses falling into the following categories are prohibited from entering the Chinese market, any business that:
- Threatens national security or the country’s military facilities
- Harms public interest
- Damages the environment
- Hinders the development and protection of land resources
- Uses a unique technology considered the property of China for manufacturing purposes
Businesses in the sector of creative, energy, telecommunications, automotive, IT, and compulsory education industries face heavy restrictions. Restricted industries may still be accessible but will require investors to form a partnership with a Chinese entity in an equity or cooperative Joint Venture.
Most Popular Investment Vehicles for Foreign Companies in China
Wholly Foreign-Owned Entity (WFOE)
This is the most common and preferred investment vehicle for foreign investors to enter the market. It is equivalent to a Limited Liability Company (LLC), established exclusively using the capital of the foreign investor for the business. This gives the foreign investors the greatest level of independence and control over business operations, strategies, and recruitment.
A WFOE can engage in any commercial activities that have not been specifically outlined in the Negative List. With complete control over the hiring process, a WFOE can employ both foreigners and Chinese citizens.
Joint Venture (JV)
A JV is also considered an LLC. Its main difference from a WFOE is that a partnership with a Chinese investor or company is required to establish the business. A JV is more complex to handle because of diverging interests between shareholders.
This type of investment vehicle is often pursued by those who want to establish a business in the sector listed in the Negative List and those who wish to reduce risk upon market entry.
Representative Office (RO)
A Representative Office is considered a branch or extension of its headquarters and is allowed to perform limited activities in the Chinese market. It can only do marketing and research activities as well as act as a liaison by coordinating business contacts for its parent company. It cannot engage in commercial activities, sign contracts, collect revenue, or issue invoices to customers.
To find out more about establishing a company and the different investment vehicles in China click here.
6 Important Things to Consider when Investing in China
Large Consumer Market
China has the largest consumer market in the world, with more than 1.4 billion potential customers to capture. To successfully tap into the Chinese market, businesses should be aware of the cultural differences and preferences amongst Chinese consumers and potential partners. Adapting is essential to not only ensure sales of products and services, but also to maintain business relationships.
Extensive Trade Network
China continues to see growth in FDI despite experiencing moderate slowdowns due to the Covid-19 pandemic. As stressed in the 14th Five-Year Plan for the National Economic and Social Development and the Long-Range Objectives Through the Year 2035, China plans to improve its export policies and optimize the structure of export commodities.
The country’s expansion of its global trade network through its Belt and Road Initiative (BRI) will offer new opportunities and benefits for foreign investors, as China extends its trading scope to neighboring countries.
Rapid Urbanization
Rapid growth in population and development has strongly affected the environmental situation in urban areas. Due to the number of people in urban areas labor costs are relatively low, although there are some exceptions in highly urbanized areas with higher rates.
Legal Environment
In comparison to Western countries, the Chinese economy is closely tied to government regulations. More than 76% of assets in China are owned by the government. To do business in China, investors may have to negotiate with the state, which can end up making the market entry a complex and slow process. Legal matters can also be inconsistent because they heavily rely on the will of the government. Therefore, having legal support or a partner that understands the Chinese business environment is advised.
Cultural Differences
Chinese culture has a strong influence on how people do business in the country, and this must be respected and observed by foreign investors. Establishing relationships and developing mutual trust are key elements for any business that wants to succeed in the Chinese market.
Sector Development
China has a well-developed and highly competitive production sector in the manufacturing and heavy machinery industries. Industrial overcapacity can be observed, and this contributes to the increasing operating costs of businesses.
How China Promotes FDI
As part of the government’s effort to promote FDI, it offers tax levies on Corporate Income Tax (CIT) and Individual Income Tax (IIT) among other incentives. Free Trade Zones
were established where foreign enterprises can enjoy preferential tax policies, improved hiring policies, better market regulations, and a more open financial system, all to invite rapid economic growth in assigned areas.
Currently, there are three Free Trade Zones in the country that are designed to attract foreign investors:
- Shanghai Pilot Free Trade Zone
- Guangdong – Hong Kong – Macau Greater Bay Area
- Hainan Free Trade Port
Businesses in these areas enjoy reduced corporate and individual income tax rates. Favorable policies are continuously drafted to further spur capital flow and increase the competitiveness of both domestic and foreign investment companies.
Overall while other parts of the world may still be in the recovery phase from the effects of COVID-19, China has maintained steady growth. As such, we will continue to see foreign investors rely on China’s manufacturing sector as well as their large consumer market, for increased profits and for to see growth in their consumer base.
How MSA Can Help Your Business
For nearly a decade we have been helping companies to setup and operate independently in China. We have also worked with a long list of clients, ranging from small enterprises to large corporations, and helped them correct all their accounting and tax related issues. Our dedication to quality is what has allowed us to maintain long term relationships with our clients and continue to achieve growth for us and the companies we help. Get in touch with us today and find out how we can help you.
