Threats of Foreign Companies Investing in China

Subject: Economics
Pages: 6
Words: 1524
Reading time:
5 min

The Chinese economy is the second-largest in the world, commanding a GDP of $6.9 trillion in the year 2007 based on purchasing power parity. This represented a yearly growth rate of 9.9% p.a. Since the 1970s, China has experienced considerable reforms in its economic sector. It has carved a niche in world trade and become a major player in the international economy. China’s growth cannot be attributed to exports but to the growth in the private sector. In the modern age, China’s acquisition of sophisticated production equipment, including plants for the manufacture of nuclear weapons and satellites, has thrust it into the international limelight.

China has matured in the way it has dealt with foreign firms. In the 1980s, restricted foreign direct investments to export-oriented businesses and needed these investors to partner with Chinese firms in order to penetrate the Chinese market. In the aftermath of the Tiananmen Square massacre, many foreign businesses closed shop leading to a slump in the level of foreign investments. To counter this, the government created legislation aimed at encouraging foreign firms to increase their investments in China. Since then, Beijing has relaxed restrictions on investments in the domestic market. It has allowed free movement of goods, revised legal restrictions on joint ventures, clarified the notion of Chinese nationalization, paving the way for free capital mobility into China. Foreign investments have played a big role in economic development, especially employment creation. In 1998 foreign enterprises operating in China accounted for 40% of China’s exports, with foreign exchange reserves totaling $145 billion. The bulk of China’s incomes from FDI come from Hong Kong, Macau, and Taiwan.

As more and more foreign direct investments pour into China, numerous challenges spring up that strive to shape the future of these investments. Form government restrictions on the flow of information and nationalism fear to exchange rate fears, to questions of Chinese quality and safety in manufactured products. This calls for the uninformed investor to undertake all due diligence in the investment and the processes involved. For instance, fraud and infringement of intellectual property rights are rampant. Poor enforcement of laws that address counterfeit businesses is persistent. Patent leakages, internal theft, and dishonesty pose a challenge for every investor willing to open a shop in China. With control of supplies lying in the hands of local managers, continuous monitoring needs to be done for a firm operating in this country, and this calls for considerable investment in employee monitoring and surveillance mechanism to avoid loss-making. There have been increased security concerns for foreign investors operating multinational companies, many of whom have been victims of kidnapping and extortion. Besides, cases of product theft and violence in the workplace have increased in China. However, these problems occur to firms that overlook the due diligence process and do not invest in pre-employment and merchant selection. To escape all these, a firm hoping to invest in China should prioritize business risk management, governance, and ethics in the business to deter unfair trade practices and draw well-detailed entry and exit plans.

Another bottleneck to investment in China is the lack of private equity funds. Private equity funds are an offshore investment vehicle that channels massive funds for foreign direct investment. Private equity takes the form of leveraged buyouts, venture capital, or growth capital. LBO uses financial leverage or debt to acquire a business from its existing shareholders in an equity investments transaction. On the other hand, Venture capital involves investments in young firms for the development or expansion of the company. Venture capital can also be used to finance major expansion plans of the company. Growth capital calls for small equity investments in mature firms that are in need of capital to finance a project without affecting or altering ownership or control of the business. So far, China has sealed all approvals for the creation of private equity funds in the market except foreign-invested venture funds whose term should not exceed 12 years and is still in its infancy. The government has put stringent restrictions on capital requirements for venture capital enterprises with minimum capital pegged at the US $10 million out of reach of many would-be investors. This host of restrictions on foreign direct investments does not augur well with many would-be investors in China. It has classified some of its industries as strategic and therefore closed to venture capital investments. Offshore equity funds are prohibited from investing in publicly traded shares and bonds except for primary issuance, whether directly or indirectly. They are further restricted from investing in real estate other for self-use besides borrowing to invest and extending loans and guarantees.

The government has continually frustrated efforts to establish private equity in the country. It has encouraged inflexible capital requirements for firms and banned the creation of capital from borrowed funds. Government approval is required in every transaction that involves exit by firms into direct investments. There are limited rights by foreigners to invest in the share market through qualified investor schemes like major investment banks. The lack of a sophisticated capital market ensures the reliance on the banking sector is continued despite the shortcomings associated with this dependence. With little liberalization of the financial markets, skepticism is rife whether the country’s leading banks would want to pursue an expansion with persistent poor corporate governance and management of risk. With non-performing loans on the rise, access to capital by foreign investors has increasingly become difficult. Since the government uses these banks to mobilize savings and allocate its national savings, private estimates of the banks’ non-performing loans are appalling, and the authorities are undecided whether to accept funds from the foreign institution to recapitalize the banking sector. This state of a dysfunctional banking system has led to the following macroeconomic consequences for would-be investors.

Lending by the state-owned commercial banks to state-owned enterprises limits the availability of credit cards loans and mortgages to consumers. This leads to contraction of credit for the non-state-owned corporations and a scenario where the consumers having saved a large chunk of their income are left to spend on lowly priced goods and essentials. This restricts the availability of loans to private domestic firms leading to inadequate investments in new capital, business expansion, and employment with the aim of raising the GDP. With shaky and poorly capitalized banks, there is fear of a possible banking crisis in the future. Economists estimate that the banks have already accrued the whopping US $400 billion in bad debts, with rural cooperatives and a quarter of the banking sector experiencing chronic problems. In the insurance industry, for instance, several legal procedures have discouraged the establishment of new ventures. There exists no clear procedure for setting up branches of foreign non-life insurers and regional insurers. The new legal notices recently have doubled the initial capital needed to set up shop from 100 million to 200 million RMB, also doubling as the least required capital for regional insurers. This kind of regulation makes the operation of branches more expensive than corporations hence less attractive for doing business compared to other countries.

Other contemporary challenges facing the Chinese market include the falling stock market. Before the global financial crisis that hit the US and other world markets, the shanghai composite was on a decline despite the economy recording massive leaps of 8-9% GDP growth rates. Yes, China is a growing world market with a GDP in exchange rate terms of about 3.42 trillion, making the third after the US and Japan, but statistics tell a different story. The GDP of China has gradually been on a decline due to what economists call the exceeding of the sped limit. It is estimated that the subsequent growth rates will be as a result of domestic demand rather than trade surplus. Hence the question most investors ask themselves is if the growth question is overrated and the demand due to a rise in population and not in income. Compared with Brazil and Russia, China has almost survived the global credit crunch. Sings that that the Chinese economy is drooping is evident given the fact that export volumes have continued to dip and car sales falling by 6% the same year.

China has failed to shed its imperialism through control and regulation of all sectors of the economy. Control of commodity prices is in the hands of state officials leading to a skewed representation between the fast-expanding cities of Canton and Shanghai on the coast and the remote and underdeveloped rural China.

There is a considerable difference in investment levels on property in major cities and mall towns. With capital injected into the development of skyscrapers in the cities like Shanghai, there is competition for land resources. The housing market is also not spared, with nationwide prices falling by an average of 40% cumulatively over the past years. Speculation is rife that the prices could fall by as much as 50%. This is bad news for a firm intending to invest in the Chinese property market.