SUMMARY OBSERVATIONS

WORLD TRADE ORGANIZATION Trade Policy Review Body RESTRICTED WT/TPR/S/199 16 April 2008 (08-1663) TRADE POLICY REVIEW Report by the Secretariat CHINA This report, prepared for the second Trade Policy Review of China, has been drawn up by the WTO Secretariat on its own responsibility. The Secretariat has, as required by the Agreement establishing the Trade Policy Review Mechanism (Annex 3 of the Marrakesh Agreement Establishing the World Trade Organization), sought clarification from China on its trade policies and practices. Any technical questions arising from this report may be addressed to Mr. Masahiro Hayafuji (Tel.: 022 739 5873). Document WT/TPR/G/199 contains the policy statement submitted by China. __________________________________________________________________________________ Note: This report is subject to restricted circulation and press embargo until the end of the first session of the meeting of the Trade Policy Review Body on China. China WT/TPR/S/199 Page iii CONTENTS Page SUMMARY OBSERVATIONS (1) (2) (3) (4) (5) I. ECONOMIC ENVIRONMENT TRADE AND INVESTMENT POLICY FRAMEWORK TRADE POLICIES AND PRACTICES BY MEASURE TRADE POLICIES BY SECTOR OUTLOOK ix ix x x xii xiv 1 1 4 9 9 11 13 13 13 14 16 17 17 19 19 19 22 24 24 24 25 27 29 31 31 31 32 32 33 33 33 35 38 ECONOMIC ENVIRONMENT (1) (2) (3) INTRODUCTION RECENT ECONOMIC DEVELOPMENTS MACROECONOMIC POLICIES (i) Monetary policy (ii) Fiscal policy MAIN STRUCTURAL REFORM ISSUES (i) Environmental policies (ii) Tax reforms (iii) Financial sector reform (iv) Labour market DEVELOPMENTS IN TRADE (i) Composition of merchandise trade (ii) Direction of merchandise trade (iii) Composition of trade in services (iv) Foreign investment OUTLOOK (4) (5) (6) II. TRADE POLICY REGIME: FRAMEWORK AND OBJECTIVES (1) (2) INTRODUCTION INSTITUTIONAL AND LEGAL FRAMEWORK (i) Institutional structure (ii) Legal structure and the legislative process (iii) Transparency (iv) Centre–subnational relations and local barriers to internal trade FORMULATION, ADMINISTRATION, AND IMPLEMENTATION OF TRADE POLICY (i) Main trade laws (ii) Agencies involved in trade policy implementation TRADE POLICY OBJECTIVES TRADE AGREEMENTS AND ARRANGEMENTS (i) WTO (ii) Regional agreements (iii) Bilateral agreements (iv) Unilateral preferences (3) (4) (5) WT/TPR/S/199 Page iv Trade Policy Review Page (6) FOREIGN INVESTMENT REGIME (i) Recent developments in FDI policy (ii) Legislative framework and procedures (iii) Examination and approval procedure (iv) FDI incentives (v) Bilateral investment and tax agreements 38 38 39 40 41 42 43 43 44 44 46 47 56 57 59 60 63 70 73 73 73 74 74 75 76 79 79 79 81 81 88 89 92 100 103 109 109 111 111 112 114 118 118 119 III. TRADE POLICIES AND PRACTICES BY MEASURE (1) (2) INTRODUCTION MEASURES DIRECTLY AFFECTING IMPORTS (i) Procedures (ii) Customs valuation and rules of origin (iii) Tariffs (iv) Indirect taxes affecting imports (v) Import prohibitions, restrictions, and licensing (vi) State trading (vii) Contingency measures (viii) Standards and other technical requirements (ix) Government procurement (x) Import-related financing MEASURES DIRECTLY AFFECTING EXPORTS (i) Procedures (ii) Export taxes (iii) Tax rebates on exports (iv) Tax concessions under processing trade (v) Export prohibitions, restrictions and licensing (vi) Measures maintained by importing countries (vii) State trading (viii) Export promotion and marketing assistance MEASURES AFFECTING PRODUCTION AND TRADE (i) Taxation and tax incentives (ii) Direct transfers and non-tax subsidies (iii) Other industrial policies and measures (iv) State-owned enterprises, privatization, and corporate governance (v) Competition and consumer protection policy (vi) Intellectual property rights (3) (4) IV. TRADE POLICIES BY SECTOR (1) (2) INTRODUCTION AGRICULTURE (i) Features and market developments (ii) Policy objective and administration (iii) Policy instruments ENERGY (i) Introduction (ii) Key sub-sectors (3) China WT/TPR/S/199 Page v Page (4) MANUFACTURING (i) Iron and steel (ii) Textiles and clothing (iii) Automotive sector (iv) Electronics and information industry SERVICES (i) Overview (ii) Commitments under the General Agreement on Trade in Services (iii) Financial Services (iv) Telecommunications (v) Transport services (vi) Distribution services (vii) Postal services (viii) Legal services (ix) Accountancy services (x) Tourism 128 128 130 132 134 135 135 137 137 163 168 175 179 182 185 187 189 195 (5) REFERENCES APPENDIX TABLES WT/TPR/S/199 Page vi Trade Policy Review Page CHARTS I. I.1 I.2 I.3 III. III.1 III.2 III.3 III.4 IV. IV.1 ECONOMIC ENVIRONMENT Product composition of merchandise trade, 2004 and 2007 Direction of merchandise trade, 2004 and 2007 Trade in services, 2004 and 2006 TRADE POLICIES AND PRACTICES BY MEASURES Average applied MFN tariff rates 2005 and 2007 and final bound tariff, by HS section Distribution of MFN tariff rates, 2005 and 2007 Tariff escalation by 2-digit ISIC industry, 2007 Anti-dumping cases, 1 January 2005 to 30 June 2007 TRADE POLICIES BY SECTOR Composition of GDP, 2006 136 18 20 21 50 51 52 62 TABLES I. I.1 I.2 I.3 III. III.1 III.2 III.3 III.4 III.5 III.6 III.7 III.8 III.9 III.10 III.11 III.12 III.13 III.14 IV. IV.1 IV.2 IV.3 IV.4 IV.5 ECONOMIC ENVIRONMENT Basic economic and social indicators, 2004-07 Selected macroeconomic indicators, 2004-07 Balance of payments, 2004-07 (January-June) TRADE POLICIES AND PRACTICES BY MEASURES China's preferential rules of origin, 2007 Structure of the MFN tariff Summary analysis of China's preferential tariff, 2007 China's standards, 2002-06 Government procurement of goods, construction projects, and services, 2004-06 Government procurement by procurement entities, 2004-06 Government procurement by procurement method, 2004-06 Tax revenue, 2004-06 Excise (or consumption) tax, 2007 VAT, 2007 Selected government transfers, 2004-06 Tradeable and non-tradeable shares of companies listed in China, 2004-06 Number of enterprises, 2004-06 Enforcement of intellectual property rights, 2004-06 TRADE POLICIES BY SECTOR Textiles and clothing industry, 2005-06 Automotive industry, 2004-06 Total assets of the financial system, 2003-06 Financing by the domestic non-financial secor, 2005-06 Total assets of banking institutions, 2003-06 130 132 138 139 140 47 49 54 64 70 71 72 82 83 85 88 95 96 107 2 5 8 China WT/TPR/S/199 Page vii Page IV.6 IV.7 IV.8 IV.9 IV.10 IV.11 Insurance premiums, 2001-06 Overview of the stock market, 2000-06 Telecommunications statistics, 2001-06 Basic telecommunications service providers, 2005 Law firms and representative offices, 2002-07 China's international tourism receipts and expenditures 152 157 163 164 183 187 APPENDIX TABLES I. AI.1 AI.2 AI.3 AI.4 II. AII.1 AII.2 AII.3 III. AIII.1 AIII.2 AIII.3 AIII.4 AIII.5 AIII.6 AIII.7 AIII.8 AIII.9 IV. AIV.1 AIV.2 AIV.3 AIV.4 ECONOMIC ENVIRONMENT Merchandise exports by group of products, 2004-07 Merchandise imports by group of products, 2004-07 Merchandise exports by destination, 2004-07 Merchandise imports by origin, 2004-07 TRADE POLICY REGIME: FRAMEWORK AND OBJECTIVES China's major trade-related laws and regulations, April 2008 Principal notifications under WTO Agreements, as at 12 February 2008 Involvement in the WTO dispute settlement mechanism, March 2008 TRADE POLICIES AND PRACTICES BY MEASURES Inward duty, 2007 Imports allocated to state-trading enterprises, 2005-07 Export quotas allocated to state-trading enterprises, 2005-06 Tax revenues allocated to different levels of government: central, local, and shared taxes, 2007 Special economic and other zones, 2006 Selected competition-related legislation, 2007 China's membership of international intellectual property rights conventions, 2007 Patent and trade mark statistics, 2004-06 Intellectual property rights cases dealt with by courts, 2006 TRADE POLICIES BY SECTOR Tariff quota utilization in China, 2004-06 China's sector specific commitments in the GATS Banking institutions in China Registration requirements and application procedures in maritime transport service, 2008 221 223 229 230 211 212 213 215 216 217 218 219 220 201 206 209 197 198 199 200 China WT/TPR/S/199 Page ix SUMMARY OBSERVATIONS (1) ECONOMIC ENVIRONMENT of foreign direct investment (FDI) (together with associated transfers of technology and know-how), most of which is channelled into manufacturing. 4. Since China's previous Trade Policy Review, its monetary policy has largely been driven by the need to mop up excess liquidity, reduce credit growth and investment, and consequently cool economic growth. In addition to “sterilization” of capital inflows and moral suasion ("window guidance"), monetary policy instruments used by the Peoples Bank of China (PBC) during the period under review include increases in interest rates together with higher reserve ratios for banks. More specifically, the PBC has raised the benchmark one-year lending rate seven times (from 5.85% in April 2006 to 7.47% in December 2007) and the required reserve ratio 11 times (since January 2007). However, the PBC’s ability to use interest rates as an effective instrument of monetary policy is relatively limited owing to China's exchange rate regime (which is now classified by the IMF as a "crawling peg"). 5. With revenue increasing faster than expenditure since its previous Review, China's fiscal position has strengthened. The fiscal deficit fell from 1.3% of GDP in 2004 to 0.6% in 2007. The sustained decrease in the fiscal deficit has led to a decline in the level of public debt from 17.5% in 2005 to 16.3% of GDP in 2006. 6. Notwithstanding China's rapid growth, its economy is characterized by a number of imbalances. In particular, there is the imbalance in the sources of growth in the economy, which has been driven much more by exports and investment than by consumption, as reflected in China's growing current account surplus. Moreover, the efficient allocation of the vast amount of investment within the economy has been hampered by, inter alia, an underdeveloped capital market and by incentives and other forms of assistance accorded to manufacturing. At the same time, the pace of China's growth has exacerbated environmental 1. Continued trade liberalization has remained an integral part of the China's longstanding structural reform strategy, which is aimed at establishing an outward-oriented "socialist market economy" that can deliver sustained economic growth and facilitate poverty reduction. The ongoing structural reforms coupled with unabated export growth has resulted in real GDP growth rates in excess of 10% since China's previous Trade Policy Review in 2006. As a result, it ranks as world's third largest economy and the third largest trader. GDP per capita rose from US$1,490 in 2004 to US$2,017 in 2006. The number of people living on less than US$1 has decreased to about 10% of the population. The rapid rise in GDP per capita and decline in people living in poverty demonstrate clearly the value of integrating more liberal trade and foreign investment policies into broader macroeconomic and structural reforms in order to promote economic development. 2. In 2007, real GDP growth in China was 11.4%. The urban unemployment rate fell to 4.0% in 2007. Nonetheless, inflation measured by consumer price index has recently been rising, reaching an eleven-year high of 7.1% in January 2008, largely due to increasing food prices. The consumer price index does not capture the full extent of inflation, however, as some of the prices included in the index are controlled by the Government. Gross domestic investment and gross national saving amounted to 44.9% and 54.4% of GDP, respectively, in 2006. The widening gap between China's saving and investment is reflected in its growing current account surplus, which increased from 7.1% of GDP in 2005 to 11.0% in 2007. 3. Since its previous Review, China's trade and investment reforms have increased China's integration into the world economy. Its total trade in goods alone accounted for about 65% of GDP and 13% of global trade in 2006. China continues to be a major recipient WT/TPR/S/199 Page x Trade Policy Review problems, and income inequality has widened, especially between urban and rural residents. In order to redress some of these imbalances, the Government has taken a number of policy initiatives, which, in some instances, involve trade policy measures (such as taxes and reduced VAT rebates in respect of exports). These measures tend to discourage exports and increase the domestic supply of products concerned, and thus result in lower domestic prices of these products than otherwise; this possibly assists downstream processing of these products, without necessarily helping to improve the environment or reduce the current account balance. Consequently, the effectiveness of such trade policy measures in addressing the current account surplus and environmental problems is questionable. (2) TRADE AND INVESTMENT POLICY FRAMEWORK force on 1 July 2007. Four further agreements are being negotiated. 10. Although some aspects of China's trade policy regime remain opaque, it has continued to adopt measures to increase the level of transparency of its trade and traderelated policies, practices, and measures. Since its previous Review, additional measures, such as the Regulation on Open Government Information, have been introduced with a view to enhancing transparency. On 13 September 2007, the National Corruption Prevention Bureau was established. Since its previous Trade Policy Review, several new trade-related laws, including the Property Law, the Enterprise Income Tax Law, the Anti-Monopoly Law and the Law on Enterprise Bankruptcy, have been adopted. 11. China has recently been moving towards achieving a level playing field for foreign and domestic investors in China. Until the end of 2007, China had provided better than national treatment in its taxation policies for foreign-invested enterprises (FIEs); since 1 January 2008, a uniform enterprise income tax rate of 25% has been applied to all enterprises (including FIEs) in accordance with the Enterprise Income Tax Law, with some exceptions such as lower rates granted for investment in certain industries. It would appear that all tax incentives now apply equally to domestic firms and FIEs. Several regulations and rules have been introduced or amended with a view to further liberalizing foreign direct investment and establishing a more rules-based and predictable business environment for foreign investors. (3) TRADE POLICIES AND PRACTICES BY MEASURE 7. The overall aim of China's trade policy, which has remained unchanged since its previous Trade Policy Review, is to accelerate the opening of its economy to the outside world to introduce foreign technology and know-how, develop foreign trade, and promote "sound economic development". China aims to further strengthen the multilateral trading system; at the same time, it has been intensifying its pursuit of bilateral/regional free-trade agreements with some of its trading partners. 8. China has continued to attach high priority to the multilateral trading system and has been participating in the Doha Development Agenda negotiations. China grants at least MFN treatment to all WTO Members except El Salvador and some territories of EC member states. China has been a party to one dispute as a complainant and nine disputes as a respondent since 2006. 9. During the period under Review, two free-trade agreements entered into force (the China – Chile FTA on 1 October 2006 and the China – Pakistan FTA on 1 July 2007). The Agreement on Trade in Services of the ChinaASEAN Free Trade Area also entered into 12. Since its previous Trade Policy Review in 2006, China has, by and large, continued to liberalize gradually its trade and related policies. Nonetheless, trade and traderelated measures, both at the border and internally, are still used as instruments of industrial policy. China WT/TPR/S/199 Page xi 13. The tariff remains one of China’s main trade policy instruments. The overall average applied MFN tariff was 9.7% in 2007 (the same as in 2005). The average applied MFN tariffs for agricultural and nonagricultural products were 15.3% and 8.8%, respectively (also the same as in 2005). Preferential tariff rates are applied under bilateral free-trade agreements to which China is a party; the tariff averages range from 3.5% to 9.1%. In 2007, China unilaterally applied preferential tariffs to 37 LDCs; the tariff averages ranged from 9.0% to 9.5%, depending on the origin of goods. Tariff rate quotas on soybean oil, palm oil, and some rapeseed oil were eliminated in 2006. Tariff revenue accounts for a minor source of total tax revenue (3.3% in 2006). 14. Whereas the average applied MFN tariff has remained largely unchanged, nontariff barriers have been reduced; for example, the number of lines subject to automatic import licensing has declined. China’s institutional and procedural framework on contingency measures has remained largely unchanged. Between 1 January 2005 and 30 June 2007, China initiated 39 anti-dumping investigations. China has not taken any countervailing measures or safeguard measures since its previous Review. 15. China has adopted measures to increase the alignment of its national standards with international norms. It has notified the WTO of a number of sanitary and phytosanitary (SPS) measures and technical barriers to trade. With a large number of laws governing SPS measures, the SPS regime remains complex. Under the Law on Government Procurement, goods may be purchased from foreigners only under exceptional circumstances; although, in practice, procurement from foreign suppliers appears to occur routinely for some products. The law does not cover purchasing by stateowned enterprises. China is an observer to the WTO Agreement on Government Procurement (GPA), and submitted its application for accession to the GPA in December 2007. 16. China's already complex export regime has become considerably more restrictive. A variety of measures, including export taxes, reduced rebates of VAT on exports, and export prohibitions, licensing and quotas, are used to restrain, if not prohibit, exports of a considerable and growing number of products. Although some of these export restraints are implemented to meet China's international obligations, many are intended to, inter alia, reduce exports of products using large amounts of natural resources and energy, or to reduce China's large trade surplus in an attempt to reduce trade friction. For instance, the number of tariff lines subject to interim export duties was almost doubled in the last two years, VAT rebate rates on exports of some 2,800 lines (HS 8-digit) were eliminated or lowered in July 2007, and the number of lines subject to export quotas and licensing requirements has increased. 17. China has continued to use policy tools to channel resources into certain activities, with a view, inter alia, to promoting investment in high technology, encouraging innovation, and protecting the environment (by, for example, reducing energy consumption). These tools include tax incentives, non-tax subsidies, price controls, and various forms of "guidance" including sector-specific "industrial policies". In April 2006, China notified the Central Government's subsidies programmes to the WTO; these included income tax reductions and exemptions granted to enterprises located in selected areas, engaging in certain activities, or involving foreign ownership (foreigninvested enterprises (FIEs)). 18. Reform of the public sector, including state-owned enterprise (SOEs), remains a major challenge. Recent progress in the reform of SOEs by, inter alia, their reorganization, corporatization and privatization, has improved their performance; by reducing state involvement or freeing-up resources once owned by the State, the reform has also helped the development of the private (non-public) sector. Nonetheless, SOEs continue to play a dominant role in the WT/TPR/S/199 Page xii Trade Policy Review economy (accounting for some 35% of GDP) and enjoy monopoly positions in certain sectors. By contrast, the private sector continues to face constraints, including in access to finance. A main challenge to SOEs is to raise their productivity through further reforms; private firms operating in China (especially FIEs) are, by and large, more productive than SOEs. 19. Corporate governance has been improved not only because of the development of the private sector and the corporatization of SOEs, but also because of the entry into force of the Law on Enterprise Bankruptcy, which applies to all enterprises (including SOEs) in China. In addition, China's accounting standards have been revised to further align them with international practices. At the same time, to promote competition in the economy, the Anti-Monopoly Law was promulgated and is to enter into force on 1 August 2008. All sectors of the economy, apart from certain activities related to agriculture, are covered by this law. However, the implementing details of the Law have not yet been formulated. 20. One of the major targets of the Eleventh Five-Year Plan is to ensure adequate returns to investment in innovation by protecting intellectual property rights. Thus, China is revising several pieces of legislation, including the Patent Law and the Trademark Law, to achieve an appropriate balance between the protection of intellectual property rights (IPR) and the promotion of competition. The enforcement of IPR protection has been strengthened, although questions remain about the sufficiency of fines and criminal penalties to deter IPR violations. (4) TRADE POLICIES BY SECTOR labour-intensive than manufacturing. If sufficiently competitive, services have the potential in the long run to generate new jobs for surplus labour currently located in rural areas. Progress has been especially noteworthy in the financial services sector (including banking), whose development is essential for the establishment of a smoothfunctioning capital market, which can contribute to a more efficient allocation of investment across all sectors of the economy and thereby to improved productivity and growth. 22. One of the main changes concerning agriculture has been the shift from taxing the sector to supporting it. Most agricultural taxes were eliminated in 2006, and farmers have been provided with financial support (since 2004). Nonetheless, agriculture's contribution to GDP has continued to decline (from 13.4% in 2004 to 11.8% in 2006). With agriculture accounting for some 40% of total employment in 2006, labour productivity is barely one-fifth of the level in the rest of the economy, and there is still a considerable surplus of labour in the sector. As a result, average rural incomes have fallen further behind the urban average, thus widening the gap between rural and urban living standards. The authorities are well aware of the need to further develop rural areas, raise productivity in the sector, and improve farmers' welfare. Against this background, the rural reform process has continued as stipulated in the Eleventh FiveYear-Plan (2006-10) through the implementation of a series of measures to increase productivity including improved infrastructure, production technologies, and training (for farmers). The plan also encourages the movement of rural labour, and reiterates the Government's intention to continue increasing the support granted to agriculture through direct transfers and subsidies. 23. Agricultural policy has traditionally been aimed at ensuring an adequate supply of food at stable prices. To meet this goal, procurement, distribution and marketing restrictions are used in addition to measures 21. China's ongoing reform of its trade and investment regime remains an integral part of its structural reform strategy. Having concentrated much of its past efforts on manufacturing, which tends to be capitalintensive, the Government's attention is now turning to services (and, to a lesser extent, agriculture), which tend to be much more China WT/TPR/S/199 Page xiii such as price controls and import and export restrictions. China's average applied MFN tariff on agricultural products (WTO definition) remained unchanged at 15.3% during the period 2005 – 2007. Although tariff rate quotas (TRQs) on some edible oils were eliminated, those for some cereals, sugar, mineral and chemical fertilizers, and wool and cotton have been maintained. China continues to use state trading to manage trade of some products. Despite liberalization, direct management remains an important instrument of Chinese policy making. In particular, the domestic prices of some products are subject to controls, principally to maintain the stability of supply and prices. Furthermore, to achieve a high degree of grain self-sufficiency, and thus food security, procurement of grain is, to some extent, controlled by the Government. 24. Since the previous Review, there have been no major changes in policies concerning China's energy sector, which continues to be characterized by a high level of state ownership, regulation and limited competition. China is the second largest energy user in the world. Moreover, it emits the second largest amount of greenhouse gases, mostly due to the use of coal, which continues to account for some 70% of China’s energy production, and to the increasing number of cars on the roads. China’s rapid growth and the economy's high energy intensity is also putting considerable upward pressure on world demand for energy, particularly on oil, and thus energy prices. While China's high energy intensity may be partly explained by the share of industry (which tends to be relatively energy intensive) in GDP, it is also undoubtedly due to the existing insufficiently market-oriented price mechanism for oil, coal, electricity and natural gas, which sets artificially low prices and, as a consequence, leads to a waste of energy, to the detriment of the environment. Hence, one of the key compulsory targets in the Eleventh Five-Year Plan is a 20% reduction in energy intensity by 2010. China's energy policy is also aimed at self sufficiency by supplementing domestic supplies of primary energy through imports and by encouraging state-owned enterprises (SOEs) to invest in energy-rich countries, and more recently through the establishment of strategic oil reserves to stabilize domestic supply and prices. China's markets for energy products are at different stages of reform. While the Government has, in general, adopted a more liberal approach to economic policy, it regards energy as a strategic commodity and has therefore adopted a gradual approach to reforming the sector. As a result, consumers remain insulated from the global markets, while trade restrictions and regulatory barriers protect domestic producers from international competition. However, it remains to be seen whether such a gradual approach to reform will be sufficient to address the challenges the sector faces, especially the compatibility of China's large and rapidly growing energy needs with protection of the environment. 25. Reflecting greater liberalization compared to other sectors of the economy, manufacturing, particularly by FIEs, and resulting exports, has been the main driving force behind China’s industrialization and rapid economic growth in recent years. Manufacturing accounted for 92.4% of China's merchandise exports in 2006; it is also the source of much of China's processing trade, which is dominated by FIEs. By developingcountry standards, tariffs on manufactured goods are low, with a simple average applied MFN tariff of 9.7% in 2007 (9.8% in 2005). Nonetheless, the allocation of the vast amount of domestic investment has been distorted by, inter alia, incentives and other forms of assistance accorded largely to manufacturing (rather than services or agriculture), where foreign-invested enterprises (FIEs) have hitherto been favoured over domestic private firms. A range of other measures also remain in place with a view to controlling domestic supplies for key industries and to assisting or managing their growth, although sectors subject to government intervention (e.g. the automobile industry) have been found less efficient than those facing less government intervention (e.g. computer manufacturing). For example, VAT rebate rates were adjusted during the period under review to, inter alia, reduce exports of certain products; as a WT/TPR/S/199 Page xiv Trade Policy Review consequence, the domestic prices of these products tend to be lower than would otherwise be the case, thereby possibly assisting their downstream processing. At the same time, rebate rates on some other products were increased. Furthermore, the State "guides" investment into or out of certain sectors or activities. For example, the Government employs various measures/practices (including "guidance" to banks as regards financing) to discourage investment in the sectors that are contrary to state policy, including "unchecked investment" in industries "with high energy consumption and pollution", such as the coke, calcium carbide and iron alloy industries, or where production capacity is considered to be excessive. 26. While the Government's intention is to open the services sector further to private and foreign participation as a means of boosting growth and providing alternative employment to agriculture, the pace of liberalization has been slower than that for manufacturing. As a result, most services sectors are still subject to a high degree of state control and, therefore, lack of competition. 27. China's capital market remains heavily dependent on the banking system, which is still under-developed and relatively inefficient. Lack of access to external financing through the capital market has resulted in domestic private enterprises relying heavily on retained earnings (or funds raised from family and friends). Against this background, banking reform has continued, including the introduction in December 2006 of a new regulation allowing foreign-funded banks (FFBs) to offer RMB business to Chinese nationals, with no geographical restrictions. However, stringent qualification requirements still apply to FFBs; these include high minimum asset requirements on the sole or controlling shareholder, high minimum paid-in capital amounts, restrictions on the supply of credit-card services, and restrictions on the business scope of foreign banks branches. The stock market has developed quickly during the period under Review, prompted by several reforms. For example, institutional investors have been allowed to play an increasing role, by raising the quota allocations in the qualified foreign institutional investor (QFII) programme, encouraging the development of investment funds, and the participation of insurance companies and social security funds. Foreign investment is limited to 33% in jointventure (JV) securities companies and to 49% in JV fund management companies. Restrictions on foreign participation also remain in the insurance sector, where foreign companies are not allowed to own more than a 50% equity interest (directly or indirectly) in a Chinese-foreign JV company undertaking life insurance. Other regulatory requirements add to the difficulty in expanding foreign presence, such as geographical restrictions to carry on businesses. 28. Since 2006, China has issued various regulations and rules concerning telecommunications, including: those aimed at clarifying licensing requirement for foreign investment in value-added telecommunication business, and stipulation that e-mail service providers must obtain approval or register before actually providing the service. Prices have been liberalized considerably, except for a few items, such as monthly rental charges and local call charges, and foreign participation limitations exist. 29. Limitations to foreign participation still exist for maritime and air transport, legal and accounting, tourism, and postal services. As an important step in the reform of the latter, the China Post Group Corporation was formally established on 29 January 2007, marking the formal separation of business activities from the administrative functions of the State Postal Bureau. (5) OUTLOOK 30. With continuing strong growth in the latter half of 2007, China's annual growth rate was estimated at 11.4%, which was higher than the average rate achieved during 2003-06. Consequently, the Government's target of doubling GDP per capita in 2010 relative to China WT/TPR/S/199 Page xv 2000, as set out in its the Eleventh Five-Year Plan, would appear to be within reach. Furthermore, with its vast human resources, high rate of investment in physical and, to a lesser extent, human capital, strong growth in labour productivity, and increasingly marketoriented economy, open to international trade and foreign investment (and associated technology), China has the potential to sustain its rapid growth in the foreseeable future, albeit at a somewhat slower rate as its economy matures and its labour force starts to shrink (largely as a result of its one-child policy). In order to realize this potential, however, China needs to continue to address a number of important social and economic challenges, including various economic imbalances, which could jeopardize the economy's stability and thus the achievement of a "harmonious society". 31. First, there is the challenge posed by widening income disparities among regions and between urban and rural areas, one of the primary causes of which is wage differentials reflecting differences in labour productivity. A related challenge is the need to facilitate the movement of surplus labour from relatively low-productivity agriculture into other activities, notably services, which tend to be less labour-intensive than manufacturing. Moreover, as growth in the labour force slows, technological progress will assume much greater importance as a source of economic growth and productivity improvement, so that China needs to continue to pursue its goal of substantially raising expenditure on R&D as a percentage of GDP (and improve protection of intellectual property). China also needs to proceed with its plans to increase government spending on social services, such as health and education, and thus human capital, as well as basic pensions, thereby possibly reducing the need for precautionary saving and thus raising consumption. These and other measures to increase consumption would not only reduce China's reliance on exports for growth, and hence its vulnerability to economic slowdowns abroad, but would also narrow the gap between national saving and gross domestic investment and therefore help to reduce China's large current account surplus. Another way of reducing China's high propensity to save would be by channelling savings into the most profitable investments, thus improving the productivity of capital in the economy as a whole; this requires ongoing reform of the capital market to render it more efficient (and improve the transmission, and thus operation, of monetary policy). In addition, impediments to the efficient allocation of land, energy, water and other natural resources, such as price controls, need to be gradually dismantled; this would help protect the environment, especially if supplemented by market-based tax and non-tax instruments, based on the "polluter pays" principle, for example, to correct market failure. There is also the challenge of tax reforms that would render the tax system (especially the VAT and enterprise income tax) more neutral with respect to economic decisions, so that it raises sufficient revenues in an administratively simple and equitable way in order to meet China's developmental needs, including expenditures mentioned above, while minimizing consequent distortions in the domestic allocation of resources and trade. 32. Although no forecasts of economic growth for 2008 were available from the authorities, the World Bank envisages a slowdown to 9.6% owing to decelerating exports and a weakening global outlook. Such a slowdown will bring the growth rate more into line with the Government's target of 8%, something that macroeconomic policies, especially monetary policy, have hitherto proved ineffective in achieving. Such a cooling of the economy could reduce inflationary pressure and contribute to its rebalancing. Nonetheless, there remains the immediate issue concerning the ability of monetary policy to combat rising inflation. In this regard, a more flexible exchange rate regime could enable China to operate a more independent monetary policy, which would be better suited to ensuring a low and stable rate of inflation, and therefore contribute to a macroeconomic environment more conducive to sustained strong economic growth. A more flexible exchange rate and thus more WT/TPR/S/199 Page xvi Trade Policy Review independent monetary policy would complement structural reforms, especially those concerning the capital market, and obviate the need for price controls and other non-market measures to contain inflation. There are signs that China's exchange rate regime has become more flexible recently; in January 2008, the renminbi appreciated nearly 1.6% in relation to the U.S. dollar, the largest monthly increase since the July 2005 reform of the foreign exchange regime.