How Exchange Rate Reform Affects Foreign Direct Investment in China by pvt17390


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									           Is China Taking Over
               the World?
               Edward E. Lehman
                 Managing Director of
                LEHMAN, LEE & XU
      Past Vice Chairman of the ABA China Law
                   April 5 - 8, 2006                LEHMAN, LEE & XU
              What is happening
                 in China?
   Spectacular macroeconomic evolution
   Economic reforms process           market economy
        but strongly monitored and controlled by gov’t
   Integration into the world’s economy
   Deep social changes         change in consumption
   Risks: political instability, regional imbalances,
    financial systems, concealed deficit...                       LEHMAN, LEE & XU
             Macro Environment
   Social stability (priority) requires strong growth rate
    (minimum 7%), to create employment due to:
      Restructuring State Owned Enterprises
      Increase of urban population
   Growth based on foreign trade and investment (public
    and foreign)
   Overheating
   Weak consumption due to uncertainty
   Lack of welfare system
   Savings of 40%, but problems with financial system                         LEHMAN, LEE & XU
             FDI Forecast in China
   For 4th consecutive year China is the most preferred FDI
    location worldwide
   Global executives are more eager to commit FDI in China
    than anytime since 1998
   Also, China is seen as source of innovation and attractive
    R&D location
    • Lower R&D costs
    • Availability and quality of local R&D labour
    • IP protection
   China FDI destinations (next 3 years):
   • 48% product manufacturing
   • 18% R&D
   • 13% distribution and logistics                          LEHMAN, LEE & XU
             China Integration in
              World’s Economy
   Exports 2004 → 593 billion USD
           △ 2004 / 2003 → 35.4%
   Imports 2004 → 561 billion USD
           △ 2004 / 2003 → 36%
   Foreign Direct Investment 2004 → 60.6 billion USD
   Access to WTO: standardization of regulatory
    framework                       LEHMAN, LEE & XU
             Deep Social Changes

   Appearance of a young middle class
   Increasing urbanization
   Assimilation of Western life
   Quick development of a private industrial sector
   Appearance of a service and leisure culture
   One-child policy                        LEHMAN, LEE & XU
                       The Risks
   Economic Imbalances:
     Overheating
     Soft or hard landing?
   Geographic Imbalances
   Financial System                      Political
   Tax Balances? Contingent               stability?
     Welfare networks
     Banking recovery
     Local government investments
   Variations in the exchange rate?                      LEHMAN, LEE & XU
           How does it affect us?
   China will be one of the most dynamic areas in the world
    during the next 20 years
   China’s Economy will be the World’s Second-largest by
   How it affect us:
          China as a market
          China as productive base / provider
          China as competitor
          China as partner
   Not only affects each particular company, also to its
    competitors, providers and clients.                         LEHMAN, LEE & XU
             1. China as a Market:
   Market with great opportunities
    •   1.3 billion people, myth and reality
    •   Dynamic Evolution
    •   Opportunities and challenges
    •   Foreign presence in the market

   Successful
    • More than 400,000 FIEs
    • Presence of big multi-nationals
    • Presence of main companies in each sector                              LEHMAN, LEE & XU
             Market Advantages
    Reputable: good reputation of financing institutions
    Continued liberalization
     • Political decision
     • WTO commitments
    More integrated in global economy
    Good infrastructure
     • Telecommunications
     • Transport
     • A country “which works”
    A safe country                        LEHMAN, LEE & XU
    Very demanding market
     • Clients want the best
     • Idea of “middle technology” is rejected
     • Clients know what they want
    Very competitive
     •   Wide foreign presence
     •   Chinese client knows foreign markets
     •   Compete with Chinese prices
     •   Clients with negotiating experience
    Changing
     • Frequent changes in national and regional legislation
     • Political changes                          LEHMAN, LEE & XU
   Costly
    • Geographic distance
    • Establishment costs are high
    • Time factor. Lengthy:
                Project planning process
                Project approval process
                Project negotiation process
                Project implementation process

   Increasing capacity of Chinese companies
    • Powerful and competitive companies
    • Increasing industrial and technological capacity                                 LEHMAN, LEE & XU
                     Chinese Market
                    in numbers (2004)
POPULATION                           1.3 billion people
GDP                                  1.65 trillion USD
GDP / Person                         1,200 USD
△GDP                                 9.5%
Total Imports                        561 billion USD
Total Exports                        593 billion USD
Imports to GDP                       29.5%
 Huge country with high economic growth.
 5% of the population have income over 10,000 – 12,000 USD.
 Before the country was closed to foreign trade, now it is progressively opening.
 Liberalization process; WTO entry.                                     LEHMAN, LEE & XU
             Chinese Market:
          Geographic Delimitation
   Continental China (mainland China).
   Hong Kong: Redistribution Center and service provider.
   Hong Kong and Taiwan: FDI main origin.
   “Overseas Chinese”: 60 million, 3rd world economy. 65% of FDI
    comes from Asia.
   Development is concentrated in east coastal cities:
                             Gulf of Bohai area (Beijing-Tianjin
                             Yangze delta area (Shanghai, Nanjing,
                             Pearl River’s delta area (Guangdong and
                             Fujian provinces).
   Priority: Development of the Center-west and Northeast areas.                              LEHMAN, LEE & XU
                    The Market

   Strengths               Weaknesses
   Size                      Fragmentation
   Growth and Opening        Competition
   Modernization and         Immaturity in the distribution
    dynamism                   channels
   Multiple opportunity      Logistics Insufficiency
    areas                     Quick changes and volatility of
   Liquidity (cash)           commercial regulations
   Human Capital and         Financial system insufficiencies
    organization              State owned enterprise reform                          LEHMAN, LEE & XU
          Business opportunities
 Process of public investment, concessions and privatizations:
     Infrastructure Projects.
       o Roads and Highways
       o Railway
     Energy Projects
     Hydraulic Projects
     Center and west country development

 Growing environmental demands:
     Garbage collection and treatment systems
     Water treatment systems
     Alternative Energies                         LEHMAN, LEE & XU
           Business opportunities
   Fast Urbanization (population in rural areas 66%):
      Attention to collectives and public services
      Transport urban infrastructures: subway and railway
      Strong construction process

   Increase in living standards:
       Diversification and increase of consumption
       Sophistication of distribution channels
       Increase on vehicle demand
       Potential in the tourist market                              LEHMAN, LEE & XU
            Business opportunities
   Access to WTO:
      Increase opening to exports:
         Tariff reduction in more than 150 key products. Average tariff
          from 17% in 2000 to 10% in 2005
         Progressive quota increase (i.e. annual increase of import vehicles
          by 15%)

      Service sector opening: Distribution (2004), Banking
      (2006), Telecommunications, Logistics,...
      Clarification of the distribution system
      Standarization of legal system regarding foreign
        Same rights and liabilities for foreign and national companies                                LEHMAN, LEE & XU
            Olympic Games 2008

        Beijing Investment area: 27.5 billion USD

                                  Urban supply
                      Sport         projects
     Comunication                     6%

   Environmental                                  Projects
       20%                          LEHMAN, LEE & XU
           Opportunities for Olympic Games
       32 Sport facilities (19 new)
         Property and management
         Conceptual design

       Beijing Public services:
         Transport (subway)
         Environment
         Parking and traffic control                       LEHMAN, LEE & XU
              But some problems…
     Technical barriers: the other side of the opening
      process within WTO
        Certifications:
          •   Industrial Products (CCC)
          •   Cosmetics
          •   Food
          •   Packing
       Contingent management
       Capital requirements
          • Banking
          • Distribution
          • Construction
       Local Competition                         LEHMAN, LEE & XU
             But some problems…
   IPRs. Counterfeiting problems before WTO’s challenge:

     Not only bags, watches, DVDs or software.
     Affects everything: from elevators to pastries or wine,
     Notable improvements in legislation and applicable
     However, penalty enforcement is still weak.
     Lack   of “social censorship”.                            LEHMAN, LEE & XU
              China as a Market:
               Access Strategies
 Advantages:
          Small investment.
 Problems:
          Market fragmentation and real size
          Strong foreign and local competition
          Tariff and non-tariff barriers
          Lack of distribution networks and few specialized distributors.
          After-sales service.
          Continuous trips needed.
          Language.                              LEHMAN, LEE & XU
              China as a Market:
               Access Strategies
 Advantages:
             Permanent presence in the market.
             Huge market (unlimited).
             Lower competition.
             Better competitive position. Tariff and non-tariff
             Tax relief
             In most sectors it is possible to invest in the form
              of WFOE (80% of investors choose this way)                             LEHMAN, LEE & XU
              China as a Market:
               Access Strategies
 Problems:
             Search for the right partner, if necessary.
             Legal framework still under development.
             Not all sectors are open to FDI
             IPR problems.
             Personnel problems
             Language                               LEHMAN, LEE & XU
                    FDI Divisions
      New/high technology
      Industries which develop Western/Central regions
      Technologically-backward industries
      Resource-intensive/wasteful enterprises
      Industries which cause pollution and ruin natural resources
      Projects which utilize processes/technologies which are unique to
      All other industries not listed in the Catalogue.                                  LEHMAN, LEE & XU
            Operating Structures

       Representative Office
       Equity Joint Venture
       Cooperative Joint Venture
       Wholly Foreign Owned Enterprise
       Holding Company                  LEHMAN, LEE & XU
            Representative Office

       Quick and simple.
       No minimum registered capital.
       Allows for collection of market information and
        preparation for direct market entry.

       Cannot engage in revenue generation.
       Taxation regardless of prohibition on profit making
        activities.                           LEHMAN, LEE & XU
           Representative Office

   Set-up Requirements
        Application letter signed by Chairman of the Board.
        Certificate of incorporation.
        Credit report by bank.
        CV of foreign representatives and photocopy of passport.
        Business license in home jurisdiction
        Signed Power of Attorney, allowing agent to legally act on
         the company’s behalf.
        Lease agreement                          LEHMAN, LEE & XU
           Equity Joint Venture

    Most commonly used among the two types of Joint
    Main distinction between EJV and CJV is the
     requirement that profits must be shared in proportion
     to capital contributions.
    Key considerations:
     o Selection of Chinese JV Partner after a full due diligence
       of partner/assets.
     o Selection of location.                           LEHMAN, LEE & XU
             Equity Joint Venture
    Chinese partner will bring connections and an established
     sales and distribution network;
    Local partner will bring local and particularized knowledge
     of both market and bureaucracy.
    Chinese partner will usually have or can easily obtain an
     operational site, which aides in efficient start-up

    JV contract often difficult to negotiate
    Differing objectives and management styles often result in
    Lack of control by foreign party
    Difficulty in selling shares in venture.                            LEHMAN, LEE & XU
             Equity Joint Venture

  Setup Requirements
      o   Project Proposal
      o   Feasibility Study
      o   JV Contract
      o   Articles of Association
      o   Letter of intent
      o   Business License
     Capital investment requirements.
     Minimum equity investment by Foreign investor is
      25%.                      LEHMAN, LEE & XU
                    Joint Venture
    Similar to Equity Joint Venture in structure but with
     more flexibility because of the following:
         1.Sharing profits is governed entirely by contract
         2.Foreign partner can obtain return of investment in
           priority to Chinese partner.

    Setup requirements similar to that of Equity Joint
     Venture.                          LEHMAN, LEE & XU
          Wholly Foreign Owned
           Enterprise (WFOE)
     Essentially a wholly owned subsidiary of a foreign
     By far, the most commonly used investment vehicle
     If there is a significant amount of IP held by the
      corporation then the WFOE would be the primary
     Generally, WFOE approval is more difficult to obtain
      than JV approval.                       LEHMAN, LEE & XU
           Wholly Foreign Owned
            Enterprise (WFOE)
     Quicker setup as there is no Chinese partner
     Simpler management structure and objectives which are
      simply those of the parent organization.

     Independence is often, in itself, a shortcoming because of
      lack of connections, established markets, and local
     WFOEs cannot operate in some sensitive areas such as
      securities.                            LEHMAN, LEE & XU
         Wholly Foreign Owned
          Enterprise (WFOE)
     Setup Requirements

        o   Application Letter
        o   Feasibility study
        o   Articles of association
        o   Evidence of solvency from bank
        o   Business License
        o   Name of the legal representative
        o   CV and copies of passport                              LEHMAN, LEE & XU
                    Exit Strategy
    Mauritius holding company for conducting operations in
    Benefits:
     • Cost
         establishment is US $1,500
         (company secretary, nominee shareholders and bank account)
     • Exit Strategy
         1) easy transfer of interests in the China operation
         2) no approval needed for divestiture of interest in case of direct
                           investment relationship

     • Transfer Pricing                                LEHMAN, LEE & XU
                    Exit Strategy
 Limiting Liability
     liabilities incurred by the Chinese entity will be the
    liability of the holding company rather than the parent
  Tax Benefits
    • In Mauritius: any money held by the holding company will be
                  tax free
    • In China: impact of China taxation can be managed by
                 licensing the IP from parent company.
      Parent                  Mauritius              Chinese
      Company         IP      Company        IP      WFOE

    • In Spain: money can be repatriated at a tax advantageous
            time or reinvested in other international operations.                          LEHMAN, LEE & XU
                2. China as a
             Productive Platform

   Competitiveness of China production implies not only
    potential on producing to supply local market, but also
     China as a competitor
     China as a provider
     China as a platform to third markets                            LEHMAN, LEE & XU
                  China as a
              Productive Platform
   Competitiveness derived from:
     Labour costs: Unlimited labour reserves (lower wage
     Technology contributions and Western management
      through FDI.
     State policies to support foreign sector, critical for its
      growth (tax relief...).                              LEHMAN, LEE & XU
          China as a Competitor

   WTO entry also opens international markets to
    Chinese products
   Foreign Trade evolution
   FDI resounds in technological development: quality
   Development of its own industrial infrastructure
   Protection instruments (anti-dumping measures...).
    Market Economy?                       LEHMAN, LEE & XU
             China as a Provider

   Competitiveness of Chinese products is not only a
    threat but also an opportunity.
   Wide and increasing range of products
   Need to make purchasing process more competitive
   Another way of investing in China: central purchasing
   Cooperation agreements, licensed production. Risks                       LEHMAN, LEE & XU
           China and Third Markets

   Production investment in China, not only for Chinese
    market but also to export
   As Chinese industrial network improves, the foreign
    projection will be wider
   FDI companies in 2004 carried out 57% of the total
    exports (54.8% in 2003)
   Foreign companies are already taking profit from
    Chinese foreign competitiviness.                       LEHMAN, LEE & XU
             3. China as a Partner
   Official interest for the Internationalization of Chinese
    companies. Supporting measures:
     Goal: establish 6,000 multinationals by 2015
     Sectoral Priorities:
        o Electrical appliances in developing countries
        o High technology in developed countries
        o Mining, hydrocarbon, raw materials
   New aspects which can include:
     Chinese companies investing abroad
     Chinese companies interested in partnership with foreign
      companies to make use of their knowledge and
      experience of international markets.                               LEHMAN, LEE & XU
                    Some advice...
    1- Get rid of the myths
    2- Get trustworthy information
    3- Identify the oportunities
    4- Have a clear strategy
    5- Professional assesment
    6- Conduct market research and due diligence on
    8- Long term commitment is necessary
    9- Ensure that IP is fully protected
    10- Watch for personal relations and local customs
    11- Success in China implies dedication and big effort                        LEHMAN, LEE & XU
          Challenges for China to
           Take Over the World
   China must modify its development model to:
    • resolve the new problems created by the actual growth
    • avoid jeopardizing the country’s stability
    • Social point of view; Minimize social differences
         Improve welfare services
         Increase public expenditure in health and education
         Unemployment
    • Environmental point of view
         Avoid exhaustion of energy resources
         Use of new renewable energies
         Fight against environmental pollution                                 LEHMAN, LEE & XU
          Challenges for China to
           Take Over the World
   Change from extensive growth (exports and FDI) to
    intensive growing (internal demand and local companies)
    • Reduce export participation in its GDP
    • Increase local consumption
         Increase income in rural areas
         Increase expenditure on social welfare, health and education

   Maintain growing stability           Soft landing process
    • Reduce growing rates
    • Not affect social and economic stability                              LEHMAN, LEE & XU
                 THANK YOU

                       LEHMAN, LEE & XU
              10-2 Liangmaqiao Diplomatic Compound
             No.22 Dongfang East Road Chaoyang District
                        Beijing 100600 China
                       Tel: (86)(10) 8532-1919
                       Fax: (86)(10) 8532-1999
                Web site:                            LEHMAN, LEE & XU

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