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Cablegate: 2010 Investment Climate Statement - China

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ZNR UUUUU ZZH
R 050739Z FEB 10
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC 7946
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUCPCIM/CIMS NTDB WASHDC
INFO RUEHOO/CHINA POSTS COLLECTIVE

UNCLAS SECTION 01 OF 13 BEIJING 000303

SIPDIS

DEPT FOR EEB/IFD/OIA
STATE PASS USTR

E.O. 12958: N/A
TAGS: EINV EFIN ETRD ELAB KTDB PGOV USTR OPIC CH
SUBJECT: 2010 INVESTMENT CLIMATE STATEMENT - CHINA

REF: 09 STATE 124006

1. The following is Post's submission for the 2010 Investment
Climate Statement for China, keyed to the categories listed in
reftel.

2. 2010 Investment Climate Statement - China

--------------------------------------
Overview of China's Investment Climate
--------------------------------------

Amid a 39 percent decrease in global foreign direct investment (FDI)
flows, FDI into China fell only 2.6 percent in 2009, according to
the United Nations Conference on Trade and Development (UNCTAD).
UNCTAD's preliminary estimates show 2009 FDI flows into China (not
including finance) totaled $90 billion, making China the second
largest recipient of FDI after the United States. UNCTAD estimates
that FDI stopped declining in China in the latter half of 2009.

China's sustained high economic growth rate explains its relative
attractiveness as an FDI destination. However, foreign investors
face a range of potential problems that affect China's investment
climate. These problems include a lack of transparency, weak
intellectual property rights (IPR) protection, corruption,
industrial policies that protect and promote local firms, and an
unreliable legal system.

China has a legal and regulatory framework granting it the authority
to restrict foreign investment that it deems not to be in China's
national interest. Key terms and standards in many regulations are
undefined. China has told the United States that it wants to
preserve flexibility for its regulators to approve or block foreign
investment projects in response to changing circumstances. The
potential restrictions that China may impose are much broader than
those of most developed countries, including the national security
review conducted by the Committee on Foreign Investment in the
United States (CFIUS).

At the moment, China appears to discourage foreign investments:

- intended to profit from currency, real estate, or asset
speculation;

- in sectors where China is seeking to cultivate national
champions;

- in sectors that have benefited historically from state-authorized
monopolies or from a legacy of state investment;

- in sectors deemed key to social stability; and

- that are nominally foreign but are actually Chinese capital that
has been exported offshore and then re-imported to take advantage of
preferential treatment accorded to foreigners, i.e., "roundtrip"
investment.

China's laws and regulations give regulators significant discretion
to shield inefficient or monopolistic enterprises from foreign
competition. They are also often applied in a manner that is not
transparent. In addition, overall predictability for foreign
investors has suffered because investors are less certain that China
will approve proposed investment projects.

Investment Guidelines
---------------------

While insisting it remains open to inward investment, China's
leadership has also stated that China is actively seeking to promote
investment in higher value-added sectors, including high technology
research and development, advanced manufacturing, energy efficiency,
and modern agriculture and services, rather than basic
manufacturing. China also seeks to spread the benefits of foreign
investment beyond China's more wealthy coastal areas by encouraging
foreign companies to establish regional headquarters and operations
in Central, Western, and Northeastern China.

Five Year Plan
--------------

China defines its broad economic goals through five-year
macro-economic plans. The most significant of these for foreign
investors is China's Five-Year Plan on Foreign Capital Utilization.
The most recent version was released in November 2006 and promised
greater scrutiny of foreign capital utilization. The plan calls for
the realization of a "fundamental shift" from quantity to quality in
foreign investment from 2006 to 2010.

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According to the document, the focus of China's investment policy
should change from shoring up domestic capital and foreign exchange
shortfalls to introducing advanced technology, management expertise,
and talent. Government regulators should pay more attention to the
environment and energy efficiency when evaluating investments for
government approval. The document also demands tighter tax
supervision of foreign enterprises and seeks to restrict foreigners'
acquisition of "dragon head" enterprises (i.e., premier Chinese
firms), prevent the "emergence or expansion of foreign capital
monopolies," protect "national economic security," particularly
"industrial security," and prevent the "excessive use of
intellectual property rights protection that is unfavorable to
Chinese indigenous innovation."

Foreign Investment Catalogue
----------------------------

China outlines its specific foreign investment objectives primarily
through its Catalogue for the Guidance of Foreign Investment
Industries. The most recent version of this Foreign Investment
Catalogue entered into effect in 2007. The catalogue is revised
every few years and is supplemented by directives from various
government agencies. According to Chinese officials, it is a static
document, intended as a snapshot of policies in place at a given
time, subject to revision at the government's discretion, and thus
may not fully reflect China's foreign investment policy after it is
published. In December 2008, China also released an updated version
of its Catalogue of Priority Industries for Foreign Investment in
the Central-Western Regions, which outlines additional incentives to
attract investment in targeted sectors to those parts of China.

The Foreign Investment Catalogue serves two functions. First, China
intends for it to help foreign investors understand China's complex
industrial policy by delineating sectors of the economy where
foreign investment is "encouraged," "restricted," and "prohibited."
In addition, the catalogue spells out some more specific
restrictions in various sectors, like caps on foreign ownership and
permissible types of investment. In many restricted sectors,
foreign firms wishing to invest must form a joint venture with a
Chinese company, restricting their equity to a minority share. In
addition, the release of an updated catalogue, with State Council
blessing, sends a signal to other relevant agencies that they should
adopt measures to implement the new guidelines.

Investment in sectors not listed in the catalogue is considered
permitted. China "encourages" investment in sectors where it
believes it benefits from foreign assistance or technology.
Investment is "restricted" in sectors that China deems do not meet
the needs of its national economic development. China "prohibits"
foreign investment in a number of sectors, including certain
farming, mining, manufacturing, power, transportation, scientific
research, education, and publishing and broadcast industries.

Problems with the Foreign Investment Catalogue
--------------------------------------------- -

Foreign investors have expressed frustration that China does not
publicly seek input before updating the Catalogue and offers no
rationale for changes. In addition, Chinese regulators are not
bound to follow the catalogue and instead maintain the flexibility
to ignore its guidance and restrict or approve foreign investment
for other reasons. Part of the problem is that the catalogue is
intended only as a general guideline, not an exhaustive list of
formal restrictions. Even in "encouraged" and permitted sectors,
regulations apart from the Catalogue often specify additional
restrictions on the specific forms of investment that are allowed.
China may also adopt new regulations or make unannounced policy
decisions that supersede the most recently published edition of the
catalogue. Chinese officials have told the United States Government
that China is not able to exhaustively catalogue all existing
investment restrictions and requirements.

Contradictions between the Catalogue and other measures have also
confused investors and added to the perception that investment
guidelines do not provide a secure basis for business planning.
Uncertainty as to which industries are being promoted and how long
such designations will be valid undermines confidence in the
stability and predictability of the investment climate. As a
consequence, the practical implications of listing a sector in a
given category are uncertain.

China's Foreign Investment Review and Approval Process
--------------------------------------------- ---------

According to the Interim Measures for the Administration of
Examining and Approving Foreign Investment Projects, issued in

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October 2004 and still in effect, all proposed foreign investments
in China must be submitted for "project verification" to NDRC or to
provincial or local Development and Reform Commissions, depending on
the sector and value of the investment. Project verification
includes assessing the project's compliance with China's laws and
regulations, its national security implications, and its economic
development ramifications. In some cases, NDRC also solicits the
opinions of relevant Chinese industrial regulators and "consulting
agencies," which may include industry associations that represent
domestic firms. The State Council also weighs in during the
verification stage for high-value projects in "restricted" sectors.

Once project verification is complete, the Ministry of Commerce
(MOFCOM) conducts an "enterprise establishment verification," which
certifies that the contract establishing the foreign investment
conforms to China's laws and regulations. Foreign investors next
apply for a business license from the State Administration of
Industry and Commerce (SAIC), which allows the firm to operate.
Once a license is obtained, the investor registers with China's tax
and foreign exchange agencies. Greenfield investment projects must
also seek approval from China's Environmental Protection Ministry
and its Ministry of Land Resources. These ministries review
projects for compliance with environmental and land use regulations,
respectively.

Mergers and Acquisitions and the Anti-Monopoly Law
--------------------------------------------- -----

MOFCOM (or, depending on the sector and value of the investment,
provincial or local Departments of Commerce) also reviews all
proposed mergers and acquisitions (M&A) by a foreign investor. The
Regulations Concerning Foreign Investors Acquiring Domestic
Enterprises instruct regulators to consider an M&A's potential
impact on "national economic security" when evaluating a
transaction. The regulations also authorize MOFCOM to ensure that
proposed sale price of a "prominent Chinese old brand" to a foreign
investor has been accurately valued. Projects that result in
"actual control" of a domestic enterprise in a "key industry" are
also examined more closely.

China's Anti-Monopoly Law (AML) took effect in August 2008, and
China is in the midst of drafting implementing regulations. The
text of the law notes China will protect the "lawful activities" of
state-regulated monopolies and does not clearly resolve whether
state-owned enterprises (SOE) are otherwise subject to the law's
competitive provisions. The law allows regulators to make decisions
based on macroeconomic factors (e.g., social and employment goals)
other than consumer welfare. The AML states that China will set up
a national security review process for proposed inward investments,
but this process has not yet been established.

China's courts have been reluctant to take AML cases involving
China's largest SOEs. More than 70 percent of the mergers reviewed
by MOFCOM since the AML went into effect have involved multinational
firms. MOFCOM has reviewed 49 M&A transactions, approving 43
unconditionally and five with conditions. Only one case,
Coca-Cola's bid to buy Chinese juice-maker Huiyuan, has been
rejected by MOFCOM. All five M&A cases approved with conditions
involved offshore transactions between foreign parties rather than
transactions between Chinese companies.

AML implementation also suffers from a lack of decision-making
transparency. MOFCOM decisions to block or conditionally clear
proposed M&As are the only administrative decisions required to be
publicized, so the majority of MOFCOM reviews have left no public
record. MOFCOM's published decisions are brief and offer little
substantive analysis.

Problems with China's Foreign Investment Review and Approval Process
and the Anti-Monopoly Law
--------------------------------------------- ------

All proposed foreign investments in China are evaluated on a
case-by-case basis. This allows significant discretion on the part
of Chinese regulators to impose unexplained restrictions on new
investment projects, regardless of a given sector's designation in
the Foreign Investment Catalogue and taking into account the
interests of domestic competitors. This ad hoc system diminishes
the transparency of China's investment regulations and contributes
to anxiety among foreign investors by limiting their ability to
predict whether proposed investments will be approved.

Investment Restrictions in "Vital Industries and Key Fields"
--------------------------------------------- -------

China limits private investment in "vital industries and key
fields," defined by China's State Council as "industries concerning

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national security, major infrastructure and important mineral
resources, industries that provide essential public goods and
services, and key enterprises in pillar industries and high-tech
industries." The December 2006 Guiding Opinion Concerning the
Advancement of Adjustments of State Capital and the Restructuring of
State-Owned Enterprises calls on China to consolidate and develop
its state-owned economy, including enhancing its control and
influence in "vital industries and key fields relating to national
security and national economic lifelines."

The Chairman of the State-Owned Assets Supervision and
Administration Commission (SASAC) has since clarified that "vital
industries and key fields" include, but are not limited to:
aviation, coal, defense, electric power and the state grid, oil and
petrochemicals, shipping, and telecommunications. "Pillar
industries" include automotive, chemical, construction, electronic
information, equipment manufacturing, iron and steel, nonferrous
metal, science and technology, and exploration and design.

China's State Assets Law is intended to safeguard China's economic
system, promote the "socialist market economy," fortify and develop
the state-owned economy, and enable SOEs to play a leading role in
China's economy, especially in "vital industries and key fields."
The law requires China to adopt policies to encourage SOE
concentration and dominance in industries vital to national security
and "national economic security."

Additional Regulations that Could Restrict Foreign Investment
--------------------------------------------- -----

In addition to the measures outlined above, China has also adopted
policies in specific sectors that appear designed to restrict
foreign participation. For example, the State Council's 2006
Opinions on the Revitalization of the Industrial Machinery
Manufacturing Industries call for China to expand the market share
of domestic companies in 16 equipment manufacturing fields. Policy
supports include preferential import duties on parts needed for
research and development, encouraging domestic procurement of major
technical equipment, a dedicated capital market financing fund for
domestic firms, and a strict review of imports. The measure
suggests China will implement controls on foreign investments in the
sector, including requiring approval when foreign entities seek
majority ownership or control of leading domestic firms.

In November 2009, China formalized policies in place since 2006
promoting indigenous innovation by establishing a national
accreditation system for national indigenous innovation products.
This accreditations system will be used to award preferences for
qualified companies in government procurement. Many international
firms fear this system will further restrict their access to Chinese
government procurement contracts. Similar discriminatory practices
occur at the provincial level. For example, Hubei Province
officials have said they will exclude all foreign brand products
from government procurement, regardless of their manufactured
location.

Laws Governing Business Operations
----------------------------------

China's Corporate Income Tax Law fixes corporate tax rates for both
foreign and domestic firms at 25 percent. The law establishes two
exceptions to the flat rate: one for qualified small-scale and thin
profit companies, which pay 20 percent, and another to encourage
investment by high-tech companies, which pay 15 percent.
Preferential tax treatment applies to investments in agriculture,
forestry, animal husbandry, fisheries, and infrastructure.

China's Contract Law encourages contractual compliance by providing
legal recourse, although enforcement of judgments continues to be a
problem. Most contracts must be registered with the government.
Contracts establishing a foreign-invested enterprise require
government approval.

The Securities Law, which was amended in 2005, codifies and
strengthens administrative regulations governing the underwriting
and trading of corporate shares, as well as the activities of
China's stock exchanges in Shanghai and Shenzhen. No wholly
foreign-owned enterprise has yet issued shares on a Chinese
exchange, though China's regulator has voiced support for this in
the future.

Additional investment-related laws include: the Insurance Law, the
Foreign Trade Law, the Law on Import and Export of Goods, the
Arbitration Law, the Government Procurement Law, and the Labor
Contract Law.

Rankings

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--------

The following table lists China's most recent rankings by
organizations that monitor economies' economic freedom, business
regulations, and perceived level of corruption.

Index Year Score Rank

Transparency
International
Corruption Perceptions 2009 3.6/10 79/180

Heritage Foundation and
Wall Street Journal
Economic Freedom 2009 53.2/100 132/179

World Bank
Ease of Doing Business 2010 N/A 89/183

--------------------------------
Conversion and Transfer Policies
--------------------------------

To open and maintain foreign exchange accounts, foreign-invested
enterprises must apply to China's State Administration of Foreign
Exchange (SAFE). SAFE determines the amount of foreign exchange the
firm needs. Enterprises authorized to conduct current account
transactions can retain foreign exchange equal to 50 percent of
export earnings. Deposits above the limit SAFE sets must be
converted to local currency.

Foreign exchange transactions on China's capital account require a
case-by-case review, and approvals are tightly regulated. During
the first part of 2009, SAFE reportedly refused to allow some
American companies to repatriate their earnings. These restrictions
eased in the second half of the year. Several foreign firms have
noted difficulties in receiving government approval to bring in
foreign capital to expand their businesses.

The Chinese government registers all commercial foreign debt and
limits foreign firms' accumulated medium and long term debt from
abroad to the difference between total investment and registered
capital. Foreign firms must report their foreign exchange balance
twice per year.

------------------------------
Expropriation and Compensation
------------------------------

Chinese law prohibits nationalization of foreign-invested
enterprises except under "special" circumstances. Officials claim
these circumstances include national security and obstacles to large
civil engineering projects, but the law does not define the term.
Chinese law requires compensation of expropriated foreign
investments but does not describe the formula to be used in
calculating the amount. Foreign investors have reported
disappointment with compensation offers. China has not expropriated
any U.S. investments since 1979, though the Department of State has
notified Congress of several cases of concern.

Many sectors listed as "restricted" in the Foreign Investment
Catalogue require local ownership. Furthermore, investors face the
risk that the sector in which they have invested may be
recategorized to prohibit foreign investment, leaving investors
little legal recourse.

------------------
Dispute Settlement
------------------

Investor-state disputes leading to arbitration are rare in China,
and China has never lost an arbitration case resulting from an
investment dispute. China is a member of the International Center
for the Settlement of Investment Disputes (ICSID) and has ratified
the United Nations Convention on the Recognition and Enforcement of
Foreign Arbitral Awards, the New York Convention.

Formal commercial disputes between investors are heard in economic
courts that fall under China's Supreme People's Court and at three
levels in the provincial court system. These economic courts have
jurisdiction over: contract and commercial disputes involving
foreign parties; trade, maritime, intellectual property and
insurance; and economic crimes, like theft and tax evasion. Foreign
lawyers cannot act as attorneys in Chinese courts, but may observe
proceedings. China also has an extensive administrative legal
system, which adjudicates minor criminal offenses. China uses this
system extensively to address intellectual property infringements,

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with limited results.

China's court system is not independent of the government, and the
government often intervenes in disputes. Corruption may also
influence local court decisions and local officials may disregard
the judgments of domestic courts. Well-connected local business
people are often in a better position to win court cases than
foreign investors and reportedly use their connections to avoid
prosecution for taking illegal actions against their former foreign
partners. China's legal system rarely enforces foreign court
judgments.

Chinese officials typically urge firms to resolve disputes through
informal conciliation. If formal mediation is necessary, Chinese
parties and the authorities typically promote arbitration over
litigation. Many contracts prescribe arbitration by the China
International Economic and Trade Arbitration Commission (CIETAC).
Some foreign parties have obtained favorable rulings from CIETAC,
but difficulties in other cases have led other participants and
panelists to question CIETAC's procedures and effectiveness. For
contracts involving at least one foreign party, offshore arbitration
may be adopted. Provinces and municipalities also have their own
arbitration institutions.

Business disputes in China, whether between partners or competitors,
are not always handled through the courts or arbitration. The
Embassy has received reports of foreign partners being held hostage,
threatened with violence, or arrested.

China's Enterprise Bankruptcy Law extends bankruptcy protection to
both SOEs and private companies, including financial firms. The law
stipulates that all insolvent enterprises will pay creditors first
and use only assets not earmarked as credit guarantees to pay
laid-off workers.

---------------------------------------
Performance Requirements and Incentives
---------------------------------------

China has committed to eliminate export performance, trade and
foreign exchange balancing, and local content requirements in most
sectors. China has also committed to enforce only technology
transfer rules that do not violate World Trade Organization (WTO)
standards on intellectual property and trade-related investment
measures.

In practice, however, local officials and some regulators prefer
investments that develop favored industries and support the local
job market. Local authorities also operate with great autonomy from
the central government. In addition, foreigners seeking to invest
in "key sectors" that the government views as important to its
economic development or national security face an array of often
opaque regulations that limit their operations and may have the
effect of imposing performance requirements. For example, Chinese
regulators have pressured foreign firms in these sectors to disclose
intellectual property content or license it to competitors,
sometimes at below market rates. In many sectors where foreign
investment is restricted, Chinese nationals must own a majority of
the enterprise.

China offers investors a complex system of incentives at the
national, regional, and local levels. In particular, it offers
preferences for certain investments in sectors and regions it seeks
to develop.

The Special Economic Zones (SEZ) of Shenzhen, Shantou, Zhuhai,
Xiamen and Hainan, 14 coastal cities, hundreds of development zones
and designated inland cities all court foreign investors with
packages of reduced income taxes, resource and land use fees, and
import/export duties, as well as priority treatment in obtaining
basic infrastructure services. Many locales offer high-level
support and services to businesses, including streamlined government
approvals. Chinese authorities have also established a number of
free ports and bonded zones.

China boasts numerous national science parks, many focused on
commercializing research developed in Chinese universities. The
parks provide infrastructure, management and funding support for
start-ups across a variety of industries and welcome foreign firms.
Foreign investors often must negotiate directly with authorities as
benefits may not be conferred automatically. These packages also
often stipulate export, local content, technology transfer, and
other requirements. To achieve a unified national trade regime, as
required by its WTO accession, China has indicated that it will
decrease SEZ investment incentives over time.

Chinese visas, legal residency, and work permits are tightly

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regulated, and may inhibit investors' mobility. Foreign investors
working through established law firms typically are able to meet the
requirements.

--------------------------------------------
Right to Private Ownership and Establishment
--------------------------------------------

In China, all commercial enterprises require a license from the
government. There is no broad right to establish a business.
Disposition of an enterprise is also tightly regulated.

The principle law governing establishment of an enterprise is
China's Administrative Permissions Law, which requires China to
review proposed investments for conformity with Chinese laws and
regulations, and is the legal basis for China's complex approval
system for foreign investment. Apart from its legal regime, China
makes liberal use of administrative regulations that restrict
foreigners' ability to establish investments in some sectors.

-----------------------------
Protection of Property Rights
-----------------------------

The Chinese legal system mediates acquisition and disposition of
property. Chinese courts have an inconsistent record in protecting
the legal rights of foreigners.

All land in China is owned by the state, state-controlled entities,
or rural collectives. Individuals and firms, including foreigners,
can own and transfer long-term leases for land, structures, and
personal property, subject to many restrictions. To obtain land-use
rights, the land user must sign a land-grant contract with the local
land authority and pay a land-grant fee up front. The grantee will
enjoy a fixed land-grant term and must use the land for the purpose
specified in the land-grant contract. The maximum term of a land
grant ranges from 40 years for commercial usage, 50 years for
industrial purposes, and 70 years for residential use. China's
Property Law stipulates that residential property rights will be
automatically renewed while commercial and industrial grants shall
be renewed absent a conflicting public interest. A number of
foreign investors have seen their land-use rights revoked as
neighborhoods are slated by the government for development.
Investors report compensation in these cases has been nominal.

China's Securities Law defines debtor and guarantor rights and
allows mortgages of certain types of property and other tangible
assets, including long-term leases as described above. Important
areas of the law remain unclear, such as how to effect transfer of
property under foreclosure. Chinese commercial banks have
successfully repossessed vehicles from delinquent borrowers, and
banks are allowed to foreclose on owner-occupied residences.
Foreigners can buy non-performing debt through state-owned asset
management firms, but bureaucratic hurdles limit their ability to
liquidate assets.

China acceded to the World Intellectual Property Organization (WIPO)
Copyright Treaty and the WIPO Performances and Phonograms Treaty in
2007. China is also a member of the Paris Convention for the
Protection of Industrial Property, Berne Convention for the
Protection of Literary and Artistic Works, Madrid Trademark
Convention, Universal Copyright Convention, and Geneva Phonograms
Convention, among other conventions.

China has updated laws and regulations to comply with the Agreement
on Trade-Related Aspects of Intellectual Property (TRIPS), as
required by its WTO membership. The United States in 2007 requested
WTO dispute settlement consultations with China on IPR protection
and enforcement issues. The WTO panel found in favor of the United
States in January 2009 on two of three U.S. claims that China's IPR
regime is inconsistent with China's obligations under the
Trade-Related Aspects of Intellectual Property Rights (TRIPS
Agreement).

A recent amendment to China's Patent Law came into effect on October
1, 2009. The law now provides for the compulsory licensing of
patents if, after three years from the grant of a patent or four
years from the filing of a patent application, the patent holder,
"without proper justification," is found not to have exploited the
patent "sufficiently," or if the patent use is found to restrict
competition.

Industry associations representing software, entertainment, and
consumer goods continue to report high levels of piracy in China.
The Business Software Alliance (BSA) estimated that 82 percent of
the business software that was used in China in 2007 was pirated,
the same levels found in a 2006 study. At the same time, because

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business software use grew, the value of the pirated software used
in China grew from $5.4 billion to $6.6 billion over the same
period, according to BSA statistics. Consumer goods companies
report that as much as 20 percent of their products in Chinese
markets are counterfeits. Online copyright violations are
pervasive.

In general, criminal penalties for infringement are seldom applied,
while administrative sanctions are typically non-transparent and so
weak as to lack a deterrent effect. Civil sanctions also tend to be
of limited effect. Trademark and copyright violations are blatant
and widespread. There are widespread technology transfer practices
that are often predatory in nature. Chinese companies are
increasingly found squatting on the trademarks, company names, and
design patents of well-established companies, even companies with
household names. Such squatting practices are often legal in China,
particularly when they occur where a company has declined to obtain
registration of its rights in China in a timely fashion.

Significant regional differences exist in infringement and
enforcement, with some areas showing higher levels of protection of
IPR and others apparently offering safe harbors to local
counterfeiters and pirates. While many Chinese officials are
increasing enforcement efforts, violations also generally continue
to outpace enforcement. Lack of coordination among various
government agencies also continues to hamper many enforcement
efforts.

There has been some limited progress in terms of cooperation between
industry and enforcement agencies. In August 2009, a Chinese court
jailed four individuals for their role in spreading a bootleg
version of Microsoft's Windows XP software. China has stepped up
coordination with foreign enforcement agencies in cases involving
international organized crime, and in 2008 Chinese courts
successfully prosecuted several major counterfeiters caught as a
result of joint international enforcement efforts. China
established IPR law centers at Beijing University, Tsinghua
University, and People's University, among other institutions, and
dispatched Chinese IPR policymakers, enforcement officials, and
legal professionals to study other countries' intellectual property
enforcement techniques. China has also announced it will begin a
pilot program that will unify the trials of civil, administrative
and criminal intellectual property (IP) cases under a dedicated IP
court and will study the feasibility and necessity of setting up an
IP appeals court. China began establishing specialized IPR
complaint centers in provincial capitals and other large cities in
the spring of 2006, and now operates a national network of 50 such
centers.

-------------------------------------
Transparency of the Regulatory System
-------------------------------------

China's legal and regulatory system is complex and contradictory,
and generally lacks consistent enforcement. Foreign investors rank
inconsistent and arbitrary regulatory enforcement and lack of
transparency among the major problems in China's market,
particularly outside of coastal regions.

The State Council's Legislative Affairs Office (SCLAO) has issued
instructions to Chinese agencies to publish all foreign trade and
investment related laws, regulations, rules, and policy measures in
the MOFCOM Gazette, in accordance with China's WTO accession
commitment. China said it would also help WTO members and
enterprises understand its rules. However, foreign investors report
that Chinese regulators at times rely on unpublished internal
guidelines that impact their businesses.

SCLAO also posts an increasing number of draft administrative
regulations (which are issued by the State Council and have nearly
the legal force of laws passed by the National People's Congress) on
its website, as well as some draft departmental rules from various
ministries and agencies with economic responsibilities, but the
posting of such draft rules is not comprehensive. Central
government ministries agencies have increased the number of draft
trade and economic-related departmental rules made available on
their own ministry websites for public comment, including from
foreign parties, but comment periods can be extremely brief and the
impact of public comments on final regulations is not clear, as some
rules are published for comment in final form. Some agencies
release draft regulations only to certain favored enterprises,
usually domestic enterprises, or have allowed enterprises to read
but not retain drafts. Comments do not become part of a public
record.

--------------------------------------------- -----
Efficient Capital Markets and Portfolio Investment

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--------------------------------------------- -----

Bank loans continue to provide the vast majority of credit in China,
accounting for roughly 75 percent of formal financial sector
financing. Nevertheless, with the development of capital markets,
venture capital and private equity, and stock exchanges, that
percentage has fallen from 85 percent in 2007. The People's Bank of
China (PBOC), China's central bank, continues to maintain a floor on
lending rates that is 2-3 percentage points above the ceiling on
deposit rates, thereby maintaining a healthy profit margin on bank
loans. This raises borrowing costs for the most creditworthy
borrowers, which are usually large firms, both state and
foreign-owned. Commercial banks are increasingly being urged by
regulators to limit financing to projects that are not in compliance
with environmental regulations. The lack of adequate credit
information on borrowers also contributes to inefficient credit
allocation. Small- and medium-sized firms experience the most
difficulty obtaining bank financing, instead financing investments
through retained earnings or informal channels.

The ratio of non-performing loans (NPL) in China has dropped
steadily in recent years. NPLs system-wide dropped to about 1.7
percent by the third quarter of 2009 from 8 percent in 2006,
according to PBOC statistics, although many analysts warn of
possible future increases in the NPL rate stemming from 2009's large
flow of new bank lending.

Non-bank financing has expanded over the last few years. Regulators
increasingly support the listing on domestic exchanges of shares in
both state-owned and private Chinese firms. However, stock market
declines led regulators to limit the number of new issuances on
China's stock markets in 2008-09. Although new issuances resumed in
July 2009, in total only 250 billion renminbi (RMB) of capital was
raised in the first eleven months of 2009, with just RMB 95 billion
of this coming from initial public offerings, compared to almost RMB
438 billion in 2007. In comparison, corporate bond issuance stood
at over RMB 793 billion in 2009. Beginning January 2009, listed
Chinese banks were again allowed to trade exchange-listed bonds in
an open-ended pilot program, whereas since 1997, they had been
limited to trading in the interbank market.

Most foreign portfolio investment in Chinese companies occurs on
foreign exchanges, where investors buy and sell shares in Chinese
firms, primarily in New York (N-shares) and Hong Kong (H-shares).
In addition, China permits limited access to renminbi-denominated
A-share markets for portfolio investment by foreign institutional
investors. Through its Qualified Foreign Institutional Investor
(QFII) program, China had granted QFII status to 87 foreign firms
through August 2009.

----------------------------------------
Competition from State-Owned Enterprises
----------------------------------------

China's leading SOEs benefit from preferential government policies
and practices aimed at developing bigger and stronger national
champions. SOEs enjoy administrative monopolies over the most
essential economic inputs (hydrocarbons, finance, telecoms,
electricity) and considerable power in the markets for others
(steel, minerals). SOEs have long enjoyed preferential access to
credit. Provincial governments have reportedly used their power to
deny operating licenses to persuade reluctant owners to sell out to
bigger state-owned suitors.

China has two sovereign wealth funds: China Investment Corporation
(CIC) and SAFE. CIC generally is more open and transparent than
SAFE, and is overseen by a board of directors and a board of
supervisors. SAFE is a government agency that reports directly to
the PBOC. The SAFE Administrator serves concurrently as a PBOC Vice
Governor.

The portion of SAFE funds invested domestically is very small.
CIC's only domestic investments are as a financial holding company
for the state-owned portions of commercialized national-level bank
and securities companies. They also have some investments in
Chinese companies' non-mainland listings (for example through the
Hong Kong H-share market). CIC and SAFE otherwise play little role
in the local economy.

Sovereign wealth funds are not required to submit their books to
independent audit, nor are they required by law to publish annual
reports. CIC published its first annual report, for the year 2008,
in July 2009.

-------------------------------
Corporate Social Responsibility
-------------------------------

BEIJING 00000303 010 OF 013

Corporate social responsibility (CSR) is a new and still relatively
unknown concept for most Chinese, though CSR awareness appears to be
rising among younger and more-affluent consumers. However, it is
difficult to pinpoint any change in consumption behavior due to CSR
considerations. The 2008 Sichuan earthquake led many Chinese to
recognize the contributions of enterprises to earthquake relief
efforts, and there are an increasingly large number of press reports
about the importance of labor and environmental CSR commitments by
enterprises. Large Chinese SOEs and large foreign-invested
enterprises tend to follow generally accepted CSR principles, and
most report annually on their CSR policies and achievements.

------------------
Political Violence
------------------

The risk of political violence directed at foreign companies
operating in China remains small. Some violent but unconnected
protests have occurred in areas throughout China, but such mass
incidents generally involved local residents protesting corrupt
officials, environmental and food safety concerns, and confiscated
property. Large-scale ethnic riots in the province of Xinjiang
erupted in July 2009, leaving nearly 200 dead and 1600 injured, and
leading the Chinese government to cut off Internet connections in
the province. Tibet has also witnessed ethnic violence in recent
years, but political violence in China's other regions remains low.

----------
Corruption
----------

Corruption remains endemic in China. Surveys show that concerns
about corruption limit U.S. firms' investment in China. Sectors
requiring extensive government approval are most affected, including
banking, finance, government procurement, and construction. The
lack of an independent press as well as the fact that all bodies
responsible for conducting corruption investigations are all
controlled by the Communist Party hamper anti-corruption efforts.
Senior officials and family members are suspected of using
connections to avoid investigation or prosecution for alleged
misdeeds.

According to Chinese law, giving or accepting a bribe is a serious
crime. Accepting a bribe of greater than RMB100,000 is punishable
by 10 years to life in prison, or death in "especially serious"
circumstances; accepting a RMB 50,000 to 100,000 bribe is punishable
by five years to life; RMB 5,000 to 50,000 gets one to seven years;
less than RMB 5,000 is punishable by up to two years.

Offering a bribe merits five years' punishment. For serious
circumstances or "heavy losses" to state interests, the punishment
can range up to 10 years. "Especially serious" circumstances lead to
imprisonment from 10 years to life.

It is not, however, a crime under Chinese law to bribe a foreign
official. While a bribe denoted as such could not be deducted from
taxes as a business expenses, practically speaking, a Chinese firm
could mis-categorize a bribe and deduct it from revenues.

Three government bodies and one Communist Party organ are
responsible for combating corruption. The Supreme People's
Procuratorate and the Ministry of Public Security investigate
criminal violations of anti-corruption laws, while the Ministry of
Supervision and the Communist Party Discipline Inspection Committee
enforce ethics guidelines and party discipline. Corrupt officials
are first investigated by the Discipline Inspection Committee, which
gathers evidence outside of the judicial process and strips the
official of Party membership before deciding whether to hand the
case over to the judicial system. China's National Audit Office
also inspects accounts of state-owned enterprises and government
entities.

China ratified the United Nations Convention against Corruption in
2005 and participates in Asia-Pacific Economic Cooperation (APEC)
and Organization for Economic Cooperation and Development (OECD)
anti-corruption initiatives, but has not signed the OECD Convention
on Combating Bribery.

-------------------------------
Bilateral Investment Agreements
-------------------------------

China has bilateral investment agreements with 124 countries. As of
June 1, 2009, 92 of these agreements had entered into force.
China's treaty partners include Japan, the United Kingdom, Germany,
France, Italy, Spain, the Belgium-Luxembourg Economic Union, South

BEIJING 00000303 011 OF 013


Korea, Austria, and Thailand, among others. China's bilateral
investment agreements cover expropriation, arbitration,
most-favored-nation treatment, and repatriation of investment
proceeds, and are generally regarded as weaker than the investment
treaties the United States seeks to negotiate. In 2008, the United
States and China began negotiation of a bilateral investment treaty.
China has a bilateral taxation treaty with the United States.

--------------------------------------------- ----
Overseas Private Investment Corporation and Other
Insurance Programs
--------------------------------------------- ----

The United States suspended Overseas Private Investment Corporation
(OPIC) programs in the aftermath of China's violent crackdown on
Tiananmen Square demonstrators in June 1989. OPIC honors
outstanding political risk insurance contracts. The Multilateral
Investment Guarantee Agency, an organization affiliated with the
World Bank, provides political risk insurance for investors in
China. Some foreign commercial insurance companies also offer
political risk insurance, as does the People's Insurance Company of
China.

-----
Labor
-----

Human resource issues remain a major concern for American companies
operating in China. Difficulties in hiring appropriately skilled
labor, navigating new and comprehensive labor and social safety net
laws, the restriction on the mobility of workers, and the lack of
independent trade unions combine to create a challenging environment
for foreign-invested enterprises.

The cost and availability of labor has varied since the onset of the
2008 global financial crisis. The large surplus of rural workers
laid off or furloughed during the crisis appears essentially to have
been reabsorbed. Some of south China's manufacturing centers
currently experience a localized labor shortage. This is likely due
to many workers having left to seek employment in other cities or
other parts of China. The remaining workers have shown greater
selectivity than in the past, with their demands for higher wages
and willingness to turn down undesirable job offers also
contributing to a perceived labor shortage. Skilled workers remain
in short supply.

Independent trade unions are illegal in China. Officially
sanctioned trade unions must affiliate with the All-China Federation
of Trade Unions (ACFTU), which is an arm of the Communist Party. It
is illegal for employers to oppose efforts to establish ACFTU
unions. While worker protests and work stoppages occur regularly,
the right to strike is not protected in law.

China has not ratified core International Labor Organization
conventions on freedom of association and collective bargaining, but
has ratified conventions prohibiting child labor and employment
discrimination. Apart from a lack of freedom of association and the
right to strike, Chinese labor laws generally meet international
labor standards. However, enforcement of existing labor regulations
is poor.

------------------------------
Foreign-Trade Zones/Free Ports
------------------------------

China's principal duty-free import/export zones are in Dalian,
Guangzhou, Shanghai, Tianjin, and Hainan. Besides these official
duty-free zones, numerous free trade and economic development zones
and open cities offer similar privileges and benefits to foreign
investors.

------------------------------------
Foreign Direct Investment Statistics
------------------------------------

Data Limitations
----------------

Some mainland companies utilize "roundtrip" investment via
subsidiaries in the Special Administrative Regions of Hong Kong and
Macau in order to obtain incentives available only to foreign
investors. Analysts have estimated that mainland Chinese funds
flowing through Hong Kong may account for 10-30 percent of Hong
Kong's total realized direct investment in China. Hong Kong and
Macau statistics are further skewed because many Taiwan firms invest
through them to avoid scrutiny from Taiwan authorities. Indeed,
some observers estimate accumulated stock of FDI inflows from Taiwan

BEIJING 00000303 012 OF 013


is actually two to three times the amount formally recorded. The
data listing investments originating in the Virgin Islands is
similarly problematic.
Chinese FDI data do not include much of the high dollar value
minority equity stakes that American financial services firms have
taken in major Chinese lenders. In addition, China does not
classify reinvested locally-generated profits as new investment.

Foreign Direct Investment Flows for 2008
(Top 10 Sources of Origin)
----------------------------------------

Country/Economy Millions of
of Origin U.S. Dollars

Hong Kong 41,036
British
Virgin Islands 15,954
Singapore 4,435
Japan 3,652
Cayman Islands 3,145
South Korea 3,135
United States 2,944
Samoa 2,549
Taiwan 1,898
Mauritius 1,494

Source: China Commerce Yearbook 2009

Cumulative* Foreign Direct Investment for 2008
by Selected Source of Origin
--------------------------------------------- -

Country/Economy Millions of
of Origin U.S. Dollars

Hong Kong 349,569
British
Virgin Islands 90,100
Japan 65,376
United States 59,651
Taiwan 47,660
South Korea 41,911
Singapore 37,826
Cayman Islands 16,507
United Kingdom 15,695

Source: China Commerce Yearbook 2009

*Cumulative values are totals of the data collected each year, are
not adjusted for inflation, and do not account for divestment.

Flow of Outbound Direct Investment for 2008
(Top 10 Destinations)
-------------------------------------------

Destination Millions of U.S. Dollars

Hong Kong 38,640
South Africa 4,808
British
Virgin Islands 2,104
Australia 1,892
Singapore 1,551
Cayman Islands 1,524
Macau 643
Kazakhstan 496
United States 462
Russia 395

Source: China Commerce Yearbook 2009

Stock of Outbound Direct Investment for 2008
(Top 10 Destinations)
--------------------------------------------

Destination Millions of U.S. Dollars

Hong Kong 115,845
Cayman Islands 20,327
British
Virgin Islands 10,477
Australia 3,355
South Africa 3,049
United States 2,390
Macau 1,561
Kazakhstan 1,402

BEIJING 00000303 013 OF 013


Pakistan 1,328
Canada 1,268

FDI as a Percentage of Gross Domestic Product
---------------------------------------------

According to UNCTAD, China's FDI stocks equaled 8.7 percent of its
gross domestic product (GDP) in 2008; China's FDI inflows equaled
2.5 percent of GDP.

Selected Major Foreign Direct Investments
by U.S. and Other Nations' Companies
-----------------------------------------

Company Estimated Current Value
in Billions of U.S. Dollars

Intel 4.0
Motorola 3.6
Coca-Cola 3.3
General Motors 2.0
Wal-Mart 2.0
Anheuser-Busch 1.8
General Electric 1.5
Kodak 1.5
DaimlerChrysler 1.5
Alcoa 1.0
ExxonMobil 1.0
Ford 1.0
United
Technologies (UTC) 1.0 (including Hong Kong)
DuPont 0.7
IBM 0.4
Cummins 0.2
Microsoft 0.1-0.5

HUNTSMAN

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