China

2008 Investment Climate Statement - China

Openness to Foreign Investment

The volume of foreign direct investment inflows in China grew more than 17 percent in 2007 to $74.8 billion, according to Ministry of Commerce statistics. American direct investment in China continued to drop, as it has since 2002. Mainland China was the world's fifth largest foreign direct investment destination, after the United States, the United Kingdom, France, and the Netherlands, according to the United Nations Conference on Trade and Development (UNCTAD). Outbound investment from China in 2007 increased notably from a small base and will continue to grow significantly in future years, as China encourages leading domestic firms to acquire key technologies, brands, and access to natural resources abroad.

Investors continued to face a lack of transparency, inconsistently enforced laws and regulations, weak IPR protection, corruption, industrial policies protecting local firms, and an unreliable legal system incapable of guaranteeing the sanctity of contracts. Despite these challenges,China remained an attractive market in which to invest. The American Chamber of Commerce has reported that American firms' operations in China are more profitable than they are in the United States.

In 2007, China adopted new laws and regulations codifying procedures to review inward investment, continuing a trend from 2006. These laws and regulations appear to give Chinese regulators discretion to shield inefficient or monopolistic enterprises from foreign competition. The United States Government has raised its concerns about these laws and regulations and will continue to monitor developments closely in 2008. Several of the most important measures are described below.

While insisting it remained open to inward investment, China's leadership stated that China would more actively seek to target 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 would also seek to spread the benefits of foreign investment beyond China's more wealthy coastal areas by encouraging multinationals to establish regional headquarters and operations in Central, Western, and Northeastern China.

Investment Requirements:

Although China has revised many laws and regulations to conform to WTO investment requirements, in practice, Chinese industrial planners encourage investments that meet economic development goals. U.S. companies are concerned that encouragement may amount, in many cases, to WTO- prohibited requirements, particularly in light of the high degree of discretion provided to the Chinese officials who review investment applications.

Investment Guidelines:

China outlines its foreign investment objectives primarily through its Foreign Investment Catalogue. The most recent version went into effect December 1, 2007. The catalogue is revised every few years and supplemented by directives from various government agencies. Contradictions between the catalogue and other measures, some of which are outlined below, have confused investors and added to the perception that investment guidelines do not provide a stable 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.

Foreign Investment Catalogue

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, permitted, restricted, and prohibited. In addition, the catalogue spells out specific restrictions in various sectors, like caps on foreign ownership and permissible types of investment. The catalogue is intended only as a general guideline, not a fully exhaustive list of restrictions. 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. In sectors where catalogue revisions reflect policies China has already adopted, few new implementing measures may be required.

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 do not meet "the needs of China's national economic development." Even in encouraged and permitted sectors, regulations apart from the Catalogue often specify restrictions on the specific forms of investment that are allowed. In all restricted sectors, foreign firms wishing to invest must form a joint venture with a Chinese company, restricting their equity to a minority share.

China "prohibits" foreign investment in a limited number of sectors, such as news agencies, radio and TV transmission networks, film production, publication and importation of press and audio-visual products, compulsory basic education, mining and processing of certain minerals, processing of green and "special" tea using Chinese traditional crafts, and preparation of Chinese traditional medicine. U.S. investors have expressed concern about China's prohibition of investment in the production and development of genetically modified plant seeds.

Since 2004, provincial governments have enjoyed expanded authority to directly approve many foreign investment projects. Currently, in "encouraged" and "permitted" sectors, only proposed investments valued above $500 million require National Development and Reform Commission (NDRC) review and State Council approval. Projects in "restricted" sectors valued above $50 million require Central Government review and approval. In targeted sectors, like high-technology industries, China uses a variety of incentives to encourage investment.

Administrative Measures Restricting Investment:

In 2007, China adopted measures that could be used to limit foreigners' ability to participate in the domestic market. In August 2007, the National People's Congress passed China's Anti-monopoly Law, which takes effect in August 2008. Legal experts generally agree that the text of the law meets international standards. However, several provisions in the law suggest it could be used to help the Chinese government manage competition with local and state- owned firms, rather than promote it. For example, Article 31 states that China will establish a process to review proposed inward investments for national security concerns. China is currently drafting implementing regulations for the law.

In December 2006, the State Council published an expansive list of sectors deemed critical to the national economy, including "pillar" industries such as equipment manufacturing, automobiles, electronic information, construction, iron and steel, non-ferrous metals, chemicals, survey and design, and science and technology. The State- owned Assets Supervision and Administration Commission (SASAC), charged with overseeing the government of China's stakes in state owned enterprises (SOE's), which developed the list, said it intended to restrict foreign investment in state-owned firms in these fields.

In November 2006, the NDRC released a Five-Year Plan on foreign investment, which promised greater scrutiny over foreign capital utilization. The plan calls for the realization of a "fundamental shift" from "quantity" to "quality" in foreign investment from 2006 to 2010. The focus would change from shoring up domestic capital and foreign exchange shortfalls to introducing advanced technology, management expertise, and talent. There should be more attention to ecology, environment and energy efficiency. The document also demands tighter tax supervision of foreign enterprises. The new policy is intended 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 "industry security," and prevent "abuse of intellectual property."

In August 2006, the Ministry of Commerce (MOFCOM) and five other government agencies issued revised rules for foreign mergers and acquisitions that established a legal basis for an "economic security review" that can block deals. Under the new rules, foreign acquisitions that would result in "actual control" of a domestic enterprise in a "key industry" with "potential impact on national economic security" or altering control of a "prominent Chinese old brand" must be reported to MOFCOM for approval and certification that the target has been accurately valued.

Chinese officials claim these regulations are broadly based on and equivalent to the U.S. interagency Committee on Foreign Investment in the United States (CFIUS) process (a more narrowly focused review of the national security implications of foreign acquisitions of U.S. firms). Although the implementing regulations for the M&A review process are not yet complete, foreign investors have reported that they face greater difficulties purchasing controlling stakes in prominent firms and several prominent proposed deals are stalled.

The State Council's June 2006 Opinions on the Revitalization of the Industrial Machinery Manufacturing Industries, calls 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.

Also in 2007, some measures the government used to cool economic activity specifically targeted foreign investors. For example, China applied residency requirements for foreigners seeking to buy real estate. Also, China's steel policy requires foreign investors to possess proprietary technology or intellectual property in steel processing. Given that foreign investors are not allowed to have a controlling share in steel and iron enterprises in China, this requirement constitutes a de facto technology transfer requirement, in apparent conflict with China's WTO accession agreement obligations. The policy also prescribes the number and size of steel producers in China, their location, the types of products that will and will not be produced, and the technology that will be used. This high degree of government direction and decision- making regarding the allocation of resources in China's steel industry raises concerns because China committed in its WTO accession agreement to refrain from influencing, directly or indirectly, commercial decisions on the part of state-owned or state-invested enterprises.

Distribution of Foreign Investment:

The vast majority of foreign investment is concentrated in China's more prosperous coastal areas, including Guangdong, Jiangsu, Fujian, and Shandong provinces, and Shanghai. Foreign investment in most service sectors lags manufacturing, mainly due to government-imposed restrictions. China is committed to gradually phasing out barriers in many service industries. FDI in banking is expected to rise as more foreign banks that have incorporated in  China obtain licenses to operate and conduct local currency business. Onerous requirements limit foreign investment in service sectors, like education, culture, arts, radio, film, and television broadcasting.

Laws Governing Investment and Business Operations:

In March 2007, the National People's Congress passed a new Corporate Income Tax Law, which eliminated many of the tax advantages that had been enjoyed by foreign investors. The law, which took effect January 1, 2008, fixed corporate tax rates for both foreign and domestic firms at 25 percent, following a transitional adjustment period. However, it maintained two exceptions to the flat rate: one for qualified small-scale and thin profit companies, which will pay 20%, and another to encourage investment by high-tech companies, which will pay 15%. Current preferential tax treatment will apply to investments in agriculture, forestry, animal husbandry, fisheries, and infrastructure.

Although the law could result in narrower margins for FIEs, it provides new incentives to enterprises with high-wage labor costs. Under the new law, financial services, securities, consulting, and other high-wage professional services firms will be able to deduct all wage outlays from their taxable income, which had previously been limited to RMB 1,600 per month, per employee.

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 (FIE), governing some technology imports, and relating to infrastructure projects require government approval.

The Government Procurement Law establishes rudimentary criteria to qualify domestic and foreign suppliers and various categories of procurement, as well as broad standards for publicity, notification, bid scheduling, sealed bidding and bid evaluation. Foreign reactions to the law have been mixed. The law clarifies that purchases by SOE's do not constitute government procurement, thereby removing the bulk of commercial value from this procurement system. The legislation mandates domestic procurement unless the goods or services are unavailable at reasonable commercial terms in China.

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 enterprises have yet issued shares on a Chinese exchange, though the Chinese regulator has voiced support for this in the future.

Additional relevant laws include: the Company Law, Insurance Law, Arbitration Law, Labor Contract Law, and other tax laws. Regulations and updates on China's investment laws, projects, and conditions can be found on the websites of the Chinese Ministry of Commerce, at http://www.mofcom.gov.cn and http://www.fdi.gov.cn. MOFCOM also publishes a comprehensive summary of foreign investment laws, including the complete Catalogue on Foreign Investment, in a regularly updated 100-page booklet, known as "China Investment Guide."

Policies on Conversion and Transfer of Foreign Exchange

China has been gradually loosening foreign exchange regulations facing foreign-invested firms. While China permits foreign investors liberal access to foreign exchange for current account transactions, like repatriating profits, capital account (financial investment) transactions are tightly restricted. Investors can also purchase foreign-currency denominated Chinese bonds.

However, recently, in response to its large trade surplus and capital inflows, Chinese authorities have tightened restrictions on capital inflows, while easing restrictions on capital outflows. Chinese authorities have also reduced foreign banks' quota to borrow foreign currency and several foreign firms have noted increased difficulties in getting approval to bring in foreign capital to expand their business.

Authorities have also begun to liberalize the exchange rate regime and operation of exchange rate markets. Recent regulations permitting greater capital outflow and China's encouragement of domestic firms to invest abroad appear to be motivated by Chinese desire to better balance against the massive capital inflows China has experienced.

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

Foreign exchange transactions on China's capital account require a case-by-case review and approvals are tightly regulated. These barriers to capital market access are not addressed in Chinass WTO accession agreement and Chinese firms face even more onerous restrictions than foreign- invested enterprises. Most major firms reinvest their profits in the Chinese market.

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

Expropriation and Compensation

Chinese law prohibits nationalization of foreign-invested enterprises, including investments from Hong Kong, Taiwan, and Macau, 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 calculation.  China limits foreigners' access to certain sectors of the economy. The United States has not formally determined that China has expropriated any investments since reforms began in 1979, however the Department of State has notified Congress of several cases of concern.

Dispute Settlement

Foreign firms have experienced inconsistent results with all of China's dispute settlement mechanisms, none of which are independent of the government. The government often intervenes in high profile disputes. Corruption may also influence local court decisions and local officials may flaunt the judgments of domestic courts. China's legal system rarely enforces foreign court judgments.

Commercial disputes are heard in economic courts within 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 offensives.China uses this system extensively to address intellectual property infringements, with limited results.

Chinese officials typically urge firms to resolve disputes through informal conciliation. If a formal mediation is necessary, Chinese parties and the authorities promote arbitration over litigation. Most foreign investors consider arbitration a last resort, as they generally find it time-consuming and unreliable.

Most contracts propose 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. In CIETAC arbitration involving at least one purely foreign entity, a panel with a foreign arbitrator is possible. (Foreign joint ventures are considered Chinese legal persons.) Provinces and municipalities also have their own arbitration institutions. For contracts involving at least one foreign party, offshore arbitration may be adopted. Contracts stipulating foreign arbitration should name the arbitration body.  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."

In August 2006, China adopted an Enterprise Bankruptcy Law, which extended bankruptcy to private companies, including financial firms, whereas earlier laws covered only state- owned 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 WTO standards on intellectual property and Trade-Related Investment Measures.

In practice, however, local officials and some regulators prefer investments that increase exports, develop industry, and support the local job market. Local authorities also operate with great autonomy from the central government. In addition, foreigners seeking to invest in sectors the government views as key to its economic development or national security face an array of often opaque regulations that limit operations and may impose 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 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. The Special Economic Zones (SEZ's) of Shenzhen, Shantou, Zhuhai, Xiamen and Hainan, 14 coastal cities, hundreds of development zones and designated inland cities all court foreign investors with unique packages of reduced national and local income taxes, 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 offers preferences for investments in sectors it seeks to develop, including transportation, communications, energy, metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment, environmental protection, energy conservation, and electronics. Finally,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.

In the past, foreign-invested enterprises benefited from preferential tax rates and could obtain a rebate of 40% of taxes paid on income if profits were reinvested in China for five years. Where profits are reinvested in high technology or export-oriented enterprises, a foreign investor could receive a full tax rebate. However, in March 2007, the National People's Congress passed a new Corporate Income Tax Law, which eliminated many of the tax advantages that had been enjoyed by foreign investors.

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. The 54 national-level SEZ's accounted for over 22% of total FDI in 2004. 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. By late 2005, China had reduced by more than half the number of SEZ's, at the national and sub-national levels, to around 2000.

Together, these incentives amount to an ad hoc system. In November 2007, China agreed to terminate subsidies benefiting Chinese exporters in a range of industrial sectors which the United States had alleged were illegal under WTO rules.

Chinese visas, legal residency, and work permits are tightly 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. Disposition of an enterprise is tightly regulated. China's amended Company Law, effective January 1, 2006, did not greatly affect foreign investment rules; rather, it focused on problems prevalent in domestic companies.

Chinese laws clearly define the structures of foreign investments. The most important distinction is the Foreign-Invested Enterprise, or FIE. If foreigners own at least 25% of a firm, China considers it an FIE, which qualifies the firm for foreign investment incentives. Enterprises with foreign ownership between 10 and 25% can register as "enterprises with foreign investment below 25%" and do not qualify for incentives aimed at FIE's.

Foreign-invested enterprises exist in many forms. The most popular is the Wholly Foreign Owned Enterprise, or WFOE. Under the amended WFOE Law,  China may reject an application to establish a WFOE for five reasons: danger to China's national security; violation of China's laws and regulations; detriment to China's sovereignty or public interest; nonconformity with the requirements of the development of China's national economy; and danger of environmental pollution.

In the past, China had encouraged the formation of Equity Joint Ventures, or EJV's, as a means of rescuing poorly performing state-owned industries. This structure has since fallen out of favor as some foreign investors experienced disagreements with local partners about board of director decisions, capital formation, dividend distributions, and other matters and  China loosened restrictions on WFOE's.

Contractual Joint Ventures (CJV's) resemble legal partnerships and often mandate proportional investment, return on capital, governance, and dividend distributions. CJV's have never been as popular as EJV's, in part because of investors' unfamiliarity with the structure. Another type of CJV involves infrastructure projects, in which the foreign investor is allowed an early return on capital in consideration for relinquishing any claim to residual assets upon expiration of the CJV's term.

Foreign-Invested Companies Limited by Shares (FICLS) are shareholdings in which foreign investors hold at least 25% of the equity. In the past, they have been difficult to organize because of demanding regulatory preconditions and required Ministry of Commerce approval. This structure may become more popular as Chinese share companies have established a market presence.

Foreign investors with multiple investments may also be eligible to establish a Foreign- Invested Holding Company. Minimum capital requirements normally make this suitable only for corporations with several sizeable investments. Holding companies may manage human resources across their affiliates and provide market research and other services. Foreign firms commonly complain that China's administrative rules governing holding companies prevent consolidation of accounts of subsidiaries for tax purposes, limit joint import businesses, and hamper the performance of true central treasury functions.

Wholly foreign-invested Venture Capital Companies may fund high-technology and new technology startups in industries open to foreign investment. Regulations introduced in 2003 lowered capital requirements, allowed firms to manage funds from overseas, and permitted investors to form venture capital firms organized like limited partnerships. China bars securities firms operating in China from the domestic private equity business and limits foreign private equity firms' investment exit options. As a result, most foreign venture capital and private equity investments in China are conducted via offshore entities. NDRC is currently developing rules and regulations regarding private equity, which it will likely announce in 2008.

China's Company Law also allows foreign firms to establish Branch Offices. In practice, only foreign commercial banks and non-life insurance financial firms are permitted to do so. Foreign firms may establish Representative Offices, but these are prohibited from engaging in profit-making activities. Foreign law firms, however, are only allowed to incorporate as representative offices and are exempted from the prohibition.

In 2007, a new Partnership Enterprise Law came into effect, aiming to encourage venture capital investment and the expansion of professional services firms. The Partnership Enterprise Law only governs domestic partnerships, however, and the State Council is expected to issue rules governing establishment of foreign partnerships under sometime this year.

Protection of Property Rights

The Chinese legal system mediates acquisition and disposition of propertyDispute Settlement. Besides the weaknesses of Chinese courts outlined above, there are two significant limits on property rights in China -- land and intellectual property ownership.

Land and Property Ownership:

First, all land in China is owned by the State, state- controlled entities, or rural collectives. Individuals and firms, including foreigners, however, can own and transfer long-term leases for land use, subject to many restrictions, as well as structures and personal property. 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 purpose, to 70 years for residential use. China's Property Law, passed by the National People's Congress in March 2007, stipulates that residential property rights will be automatically renewed while commercial and industrial grants should be renewed absent a conflicting public interest.

China's Security Law defines debtor and guarantor rights and allows mortgages of property and other tangible assets. Important areas of the law remain unclear -- such as how to affect transfer of property under foreclosure. Chinese commercial banks have successfully repossessed vehicles from delinquent borrowers and a December 2005 policy update enabled banks to foreclose on owner-occupied residences. Foreigners can buy non-performing debt through state-owned asset management firms, but bureaucratic hurdles limiting their ability to liquidate assets have dampened investor interest.

Limited Intellectual Property Rights:

China remains a top intellectual property enforcement priority for the United States. The United States has requested WTO dispute settlement consultations with China on IPR protection and enforcement issues. Any U.S. company or individual encountering or anticipating encountering problems arising from IPR protection in China should consider an appropriate strategy to minimize the risks and actual losses it faces. Some assistance can be found at the "IPR Toolkit" hosted at the website of the U.S. Embassy in Beijing at http://www.usembassy-china.org.cn/ipr/. Additional information can be found in the third chapter of the Country Commercial Guide for China, at http://www.buyusa.gov/china/en/ccg.html.

China remains a very challenging environment for IPR protection and enforcement. Industry associations representing software, entertainment, and consumer goods report high levels of piracy. The Business Software Alliance estimates that 82% of the business software that was used in China in 2006 was pirated, a decline of two percentage points from 2005. At the same time, because business software use grew faster than the rate of piracy declined, the value of the pirated software used in China grew from $3.9 billion to $5.4 billion over the same period, according to BSA statistics. Consumer goods companies report that as much as 20% of their products in Chinese markets are counterfeits. Online copyright violations are pervasive. Further, Chinese-origin infringing goods are also found throughout the world.

In general, criminal penalties for infringement are seldom applied, while administrative sanctions are typically non- transparent and so weak as to lack deterrent effect. Civil sanctions tend also to be of limited effect. Trademark and copyright violations are blatant and widespread. There are widespread technology transfer practices which 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, while unethical, may often be legal, 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.

Despite these great challenges, China has made efforts to improve intellectual property rights protection. China acceded to the World Intellectual Property Organization (WIPO) Copyright Treaty and the WIPO Performances and Phonograms Treaty in June 2007. Apart from its membership in WIPO, 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 also updated laws and regulations to comply with the Agreement on Trade-Related Aspects of Intellectual Property (TRIPS), as required by its WTO membership. Industry officials report improved cooperation with enforcement agencies on raids. China has stepped up coordination with foreign enforcement agencies in cases involving international organized crime. 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. In 2005, China also required that government-procured computers come re-loaded with legal software. China began establishing specialized IPR complaint centers in provincial capitals and other large cities in the spring of 2006.

Improving protection of intellectual property rights is the United States Government's highest priority in its economic relationship with China. To that end, the American Ambassador to China sponsors an annual roundtable on intellectual property attended by hundreds of U.S. investors, and numerous IPR activities. For further information on the roundtable and other USG IPR programs contact: usptochina@mail.doc.gov.

Transparency of the Regulatory System

China's legal and regulatory system is complex, contradictory, and lacks consistent enforcement. Foreign investors rank inconsistent and arbitrary regulatory enforcement and lack of transparency among the major problems in China's market. The situation tends to be worse outside of coastal regions. No prospective foreign investor should venture into China without professional advice.

China has made some progress in publicizing its regulations. The State Council's Legislative Affairs Office has reiterated 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.

Chinese agencies have increased the number of draft trade and investment related regulations made available for public comment, including from foreign parties. 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

China has continued to slowly and steadily modernize its financial sector. Bank reforms and recapitalizations in 2003 led to expanded minority participation by foreign strategic investors, the appointment of independent directors, and listings on overseas and domestic stock exchanges. Together this has led to more modern corporate governance and risk-based credit decisions. The ratio of non-performing loans (NPLs) has dropped steadily. NPLs system-wide dropped to about 6% by Q307 from 8% in 2006, according to PBOC statistics. Moreover, many of these NPLs are "legacy loans" made many years ago when state banks financed the quasi-public services provided by state-owned enterprises (housing, healthcare, medical care). NPLs on new loans have been under 2% since 2003, according to the China Banking Regulatory Commission (CBRC).

Bank loans continue to provide the vast majority of credit, accounting for roughly 85% of formal financial sector financing. The People's Bank of China (PBOC), China's central bank, continues to maintain a floor on lending rates that is between 2-3 percentage points above the ceiling on deposit rates, thereby maintaining a healthy profit margin on bank loans. This raises borrowings cost for the most credit worthy borrowers, which are usually large firms, both state and foreign-owned. Commercial banks are increasingly being urged by regulators to limit financing to projects not in compliance with environmental regulations. The lack of adequate credit information on borrowers also contributes to inefficient credit allocation, and small and medium sized firms experience the most difficulty obtaining bank financing.

Alternate financing methods have expanded over the last few years. Regulators are increasingly proactive in supporting both state-owned and private Chinese firms to list on domestic exchanges. In 2007 alone, over $87.1 billion was raised on the A Share market, with over $57.7 billion of this coming from initial public offerings. Bond markets remain a small source of funding at $13.6 billion in the first three quarters of 2007, though recent moves to shift regulatory authority for bonds issues of listed companies to theChina Securities Regulatory Commission appears to be a positive step, though China's nascent bond markets are not yet able to provide a robust alternative method of financing. Nevertheless, Chinese authorities have announced that they will allow foreign firms doing business in China to raise capital on China's stock and bond markets, which will help U.S. firms obtain financing in light of increased restrictions on borrowing in foreign currency, which can be an obstacle to financing expansion. Small- and medium-sized firms often face difficulties accessing credit through formal channels, and instead finance investment through retained earnings or informal channels.

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) scheme, China had granted QFII status to 52 foreign firms by December 2007 and distributed over $9.9 billion of the $10 billion quota. At the May 2007 meeting of the U.S.-China Strategic Economic Dialogue, China agreed to raise the annual quota to $30 billion by the end of 2007, and additional quota allocations are expected in the first half of 2008.

Of note, China has also increased channels for domestic investors to invest in international capital markets through the Qualified Domestic Institutional Investor (QDII) program. While the QDII program exceeded $35 billion in its first six months after inception in July 2006, interest in the QDII program was tepid in 2007 given China's roaring A-share market and expectations of continued appreciation of the renminbi. Nevertheless, at the December 2007 meeting of the Strategic Economic Dialogue, CBRC announced an agreement in principle with the Securities Regulatory Commission to launch QDII investment in U.S. stock markets.

Political Violence

Violent but unconnected protests in areas throughout China continued in 2007. Protesters tend to target local officials and powerful business interests rather than the central government. Such "mass incidents" commonly involve, for example, rural residents with environmental concerns or protesting inadequate compensation for confiscated property. Other riots and protests, however, were sparked by specific events such as traffic accidents perceived to reflect abuse of power by local officials, especially corruption. Business disputes in China are not always handled through the courts. Sometimes the foreign partner has been held hostage, threatened with violence, or beaten up. For additional information on safety and security in China, please consult the State Department's Consular Information Sheet on China at http://travel.state.gov.

Corruption

In 2006, China raised the profile of its anti-corruption drive by sacking high ranking officials, including the Shanghai Municipal Communist Party chief, who concurrently had been a member of the Party's Politburo. In another high-profile case, in July 2007, China executed its former top food and drug regulator for taking bribes to approve untested medicine. The National Audit Office continued to inspect accounts of state-owned enterprises and government entities. China ratified the UN Anti-Corruption Convention in 2005 and participates in APEC and OECD anti-corruption initiatives, but has not signed the OECD Convention on Combating Bribery.

Corruption remains endemic. Surveys show that it limits U.S. firms' investment. Banking, finance, government procurement, and construction are most affected. Anti- corruption efforts are hampered by the lack of independent investigative bodies and courts. Senior officials and family members are suspected of using connections to avoid investigation or prosecution for alleged misdeeds.

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. Anti-corruption drives have not targeted foreign firms.

In China, giving or accepting a bribes is a serious crime. 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. 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 5 years to life; RMB 5,000 to 50,000 gets 1 to 7 years; less than RMB 5,000 is punishable by up to 2 years.

It is not 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.

The United States provides anti-corruption training to officials from the Ministries of Public Security and Supervision and the Supreme People's Procuratorate. Domestic scholars cooperate with foreign non-government organizations, like Transparency International, which is itself exploring opportunities to work with the government to reduce corruption.

Bilateral Investment Agreements

China has bilateral investment agreements with 121 countries, more than any other developing economy, according to UNCTAD. China's bilateral investment partners include Japan, the United Kingdom, Germany, France, Italy, Spain, the Belgium-Luxembourg Economic Union, Austria, and Thailand. These agreements cover expropriation, arbitration, most-favored-nation treatment, and repatriation of investment proceeds.

The United States and China signed an agreement on investment guaranties, which entered into force in 1980. In December 2006, the United States and China committed to explore the possibility of a bilateral investment agreement. China has also signed treaties to avoid double taxation with the United States and dozens of other economies.

Overseas Private Investment Corporation and Other Insurance Programs

The United States suspended OPIC programs in China after the Tiananmen Incident in June 1989. OPIC honors outstanding political risk insurance contracts. The Multilateral Investment Guarantee Agency (MIGA), 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 (PICC). Political risk insurers have experienced a decline in business in China.

Labor

Human resource constraints top American Chamber of Commerce companies' list of operating challenges in China. Skilled managers and technical personnel are in high demand with employers often citing difficulty in locating appropriate skilled talent. Experienced managers at foreign firms typically command salaries far greater than their counterparts in Chinese enterprises. While talented and motivated university graduates are abundant, many firms find they must invest heavily in additional training. At the same time, many Chinese workers with high-demand qualifications move rapidly from job to job within the growing foreign-invested and private sectors. Foreign firms are generally free to find and hire employees, although representative offices must hire local employees through a labor services agency.

Foreign companies may offer local workers market-rate salary, hourly pay, or piecework wages, so long as the rate exceeds designated minimums. In addition, wages are typically supplemented by subsidized services, like medical care and housing, which China's tax laws encourage. Mandatory health, workplace injury and maternity insurance are additional labor costs. Enterprises that merge with state-owned firms may also be required to provide dormitory housing. Other firms pay into a housing fund that amounts to as much as 10% of payroll. Local governments require contributions to pension and unemployment insurance funds that can also amount to 20% of an enterprise's wage bill. (Employees also contribute 3-8% of salary.) Regulations on non-wage compensation differ by locality. Chinese law limits, and requires premium compensation for, overtime work.

China's Labor Contract Law may make it more difficult for employers to release staff.. Labor regulations in general vary widely according to location, type, and size of enterprise. Terminating a worker for cause may require prior consultation with the local labor bureau and labor union. In general, it is easier to release workers in southern China than in the northeast, and in smaller enterprises than in larger ones. Foreign firms generally do not encounter problems releasing workers at the end of a short-term contract. However the Labor Contract Law favors the use of indefinite term employment contracts.

Enterprises that hire workers from state-owned enterprises usually find it difficult to terminate employment. Large- scale layoffs from long-established state-owned firms have created tensions and prompted demonstrations. In some cases, limited violence has occurred. The Chinese government did not issue regulations to implement the Labor Contract Law before it went into effect in January 2008, creating significant uncertainty.

China's labor laws allows collective contracts that specify wage levels, hours, working conditions, insurance and welfare. Collective contracts can cover individual enterprises, geographical regions, or specific industries within geographical regions. Most contract consultations do not rise to the level of negotiations, in part because local Communist Party committees or regional trade union bodies, rather than workers, control the selection of workers' representatives.

It is illegal in China to oppose efforts to establish officially sanctioned unions. The Communist Party controls the country's sole recognized workers' organization, the All-China Federation of Trade Unions (ACFTU). Independent trade unions are illegal. The Trade Union law requires enterprises with ACFTU unions to contribute 2% of their wage bill to the union. Since mid-2006, the ACFTU has engaged in a centralized campaign to organize chapters in foreign firms. Foreign firms also often host worker organizations that perform union functions, like organizing social and charitable activities.

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 banning independent unions, Chinese labor laws meet international labor standards, and the Chinese Government is in the process of implementing new legislation to improve workers' rights protection. However, enforcement of existing labor regulations is poor. Some FIE's have faced negative publicity arising from labor disputes related to domestic partners or suppliers.

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. In 2007, China also actively promoted economic development outside its relatively wealthy coastal area by encouraging multinationals to establish regional headquarters and operations in Central, Western, and Northeast China. Some analysts speculate that China will eventually grant full trading and distribution rights nationwide.

China's General Administration of Customs claims to successfully control duty-free imports into the zones, but the lack of physical barriers between the duty free zones and surrounding areas makes it difficult to control the outbound flow of untaxed items.

Investment Trends and Statistics

The top sources of FDI in China in 2007 were: Hong Kong, the British Virgin Islands, South Korea, Japan, Singapore, the United States, the Cayman Islands, Western Samoa, and Taiwan. Of note, many mainland companies utilize "roundtrip" investment via subsidiaries in the Special Administrative Regions (SAR's) 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% 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 is actually two to three times the amount formally recorded.

The past few years also witnessed an upsurge in investment from tax-havens, like the British Virgin Islands and Cayman Islands. Anecdotal information suggests these funds originate from companies based in Organization for Economic Cooperation and Development (OECD) economies, Taiwan, and even China itself. Some researchers estimate that as much as one-third of nominally "foreign" investment in China is really of Chinese origin. That is, Chinese investors find ways to send money out of the country so that they can then re-enter as a "foreign investor," taking advantage of policies that single out foreign investment for preferential treatment. The elimination of certain tax benefits for foreign investors is expected to lead to a drop in "round trip" investment.

U.S. direct investment abroad is increasingly concentrated in developed countries, reflecting a focus on high-tech and financial services and a move away from basic manufacturing and extractive industries. U.S. direct investment in China has fallen in line with this trend. While China's processing trade exports to the United States are booming, U.S. retailers often buy goods from enterprises whose source of investment is not American, thus de-linking this trend from U.S. direct investment abroad statistics. Also, it is important to note that Chinese data on foreign direct investment does not include much of the high-dollar value minority equity stakes that American financial services firms have taken in major Chinese lenders. Finally, American-invested enterprises continue to grow by reinvesting locally generated profits in China, but China does not classify this as new investment.

Notes on Statistics:

Most of the data below is provided by the Ministry of Commerce. Statistics on utilized investment are based on FIEs' required reports of committed capital. Cumulative values are totals of the data collected each year, are not adjusted for inflation, and do not account for divestment. More sophisticated data on investment in China is not now available. Yearly figures do not sum exactly to total due to rounding.

Table 1 -- Utilized Foreign Direct Investment in China
(1979-2007) (In $ Millions)

Year	Utilized FDI
1979-84	3,060
1985	1,956
1986	2,244
1987	2,314
1988	3,194
1989	3,392
1990	3,487
1991	4,366
1992	11,008
1993	27,515
1994	33,767
1995	37,521
1996	41,726
1997	45,257
1998	45,463
1999	40,319
2000	40,714
2001	46,878
2002	52,743
2003	53,505
2004	60,630
2005	72,410 (60,325)
2006	69,470 (63,020)
2007	82,658 (74,768)
Total	786,632

Source: Ministry of Commerce Note: Numbers in parentheses include financial sector investment. Other data does not.

Table 2 -- Utilized Foreign Direct Investment from the United States in China (1985-2007)
 (In $ millions)

Year	Utilized FDI
1985	357
1986	326
1987	263
1988	236
1989	284
1990	456
1991	323
1992	511
1993	2,063
1994	2,491
1995	3,083
1996	3,443
1997	3,239
1998	3,898
1999	4,216
2000	4,384
2001	4,433
2002	5,424
2003	4,199
2004	3,941
2005	3,061
2006	2,865
2007	2,616
Total	56,571

| Source: Ministry of Commerce

Table 3 -- China's Utilized and Cumulative Foreign Direct Investment (in non-financial sectors) by Selected Source Economy as of