Executive Summary

China continues to limit foreign investment in key economic sectors by requiring joint ventures with domestic Chinese firms, restricting ownership and shareholder rights of foreign investors, and outright prohibiting investment in some sectors. While China in 2017 made modest market access liberalizations in some sectors, China’s investment environment continues to be more restrictive than its major trading partners, including the United States.

China remains one of the top destinations for global foreign direct investment; however, many sectors of China’s economy remain closed to foreign investment. China historically has used the Catalogue for the Guidance of Foreign Investment in Industries, also known as the “Foreign Investment Catalogue” (FIC), to segment foreign investment into “encouraged”, “restricted”, or “prohibited” categories. In June 2017, China released an updated version of the catalogue that was rebranded as the nationwide “negative list.” China announced openings in a few new industries, including: edible seed oil processing; rice, flour, sugar, and corn processing; biofuels; credit ratings and valuation services; and motorcycle manufacturing. However, important and key industries remained restricted to foreign investment, including financial services, culture, media, telecommunications, vehicles, and transportation equipment.

China has a restrictive foreign investment approval system that shields inefficient and monopolistic Chinese enterprises in many industries – especially state-owned enterprises (SOEs) and other enterprises deemed “national champions” – from competition from private and foreign companies. In addition, foreign investors experience a lack of transparency and a lack of rule of law in China’s regulatory and legal systems, including discriminatory practices, selective enforcement of regulations, and a judiciary subject to interference by the Chinese government and the Chinese Communist Party (CCP). Moreover, China’s industrial policies, like Made in China 2025 (MIC 2025), rely on poor enforcement of intellectual property rights (IPR), forced technology transfers, and a systemic lack of rule of law to inherently discriminate against foreign companies and brands by favoring local products in key high-tech and advanced manufacturing industries.

During the Chinese Communist Party’s (CCP) 19th Party Congress held in October 2017, the CCP leadership underscored Xi Jinping’s primacy by adding “Xi Jinping Thought on Socialism with Chinese Characteristics for the New Era” to the Party Charter. In addition to significant personnel changes, the Party announced large-scale government and Party restructuring plans in early 2018 that further strengthened Xi’s leadership and expanded the role of the Party in all facets of Chinese life: cultural, social, military, and economic. An increasingly assertive CCP has raised concerns among the foreign business community about the ability of future foreign investors to make decisions based on commercial and profit considerations, rather than political dictates from the Party.

While market access reform has been slow, the Chinese government has pledged greater market access and national treatment for foreign investors through the following announcements:

  • State Council-issued circulars 5 (January 2017), 39 (August 2017), and 19 (June 2018) announced future foreign investment liberalization in several economic sectors like alternate energy vehicles, banking, securities and insurance, shipping vessels, call centers, and internet/media content businesses. In addition, the circulars said financial incentives would be provided to foreign investors in high-tech and high-value added services industries (or MIC 2025 fields, which will be detailed in a later section of the report), and foreign investors were promised national treatment in China’s legal system, currency flows, IP protections, and overall investment approval system. The most recent circular, number 19, includes provisions to adhere to World Trade Organization (WTO) commitments on joint ventures, explicitly prohibiting local officials from using administrative means to force technology concessions for foreign investment.
  • On June 28, the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM) jointly announced the release of Special Administrative Measures for Foreign Investment Access (the “nationwide negative list”), which replaced the FIC. The new negative list was reformatted to remove “encouraged” economic sectors and divides restrictions/prohibitions by industry. Some of the liberalizations were previously announced, like financial services and insurance (November 2017) and automobile manufacturing and shipbuilding (April 2018).
  • On June 30, NDRC and MOFCOM jointly released the Special Administrative Measures for Foreign Investment Access in the Pilot Free Trade Zones (the Free Trade Zone (FTZ) negative list). The FTZ negative list matches the nationwide negative list with a few exceptions, including: foreign equity caps of 66 percent in the development of new variety crops of corn and wheat (the nationwide cap is 49 percent), removal of joint venture requires on oil and gas exploration, and removal of the prohibition on radioactive mineral smelting and processing (including nuclear fuel production).

While further market access liberalization and fair treatment of foreign investment is welcomed, these announcements lack implementation details and timelines. Even with greater market access, foreign companies will still be subject to inconsistent regulations, growing labor costs, licensing and registration problems, shortages of qualified employees, insufficient intellectual property (IP) protections, and other forms of Chinese protectionism that have contributed to China’s unpredictable and discriminatory business climate.

Table 1 – Key Transparency Indicators of China’s Economy

Measure Year Index/Rank Website Address
TI Corruption Perceptions Index 2017 77 of 180
World Bank’s Doing Business Report “Ease of Doing Business” 2017 78 of 190
Global Innovation Index 2017 22 of 127
U.S. FDI in partner country (M USD, stock positions) 2016 USD 92,481
World Bank GNI per capita 2016 USD 8,250

6. Financial Sector

Capital Markets and Portfolio Investment

China’s leadership has stated that it seeks to build a modern, highly developed, and multi-tiered capital market. Bank loans continue to provide the majority of credit options (reportedly around 70 percent) for Chinese companies, although other sources of capital, such as corporate bonds, trust loans, equity financing, and private equity are quickly expanding their scope, reach, and sophistication. Chinese regulators regularly use administrative methods to control credit growth, although market-based tools such as interest rate policy play an increasingly important role.

The People’s Bank of China (PBOC), China’s central bank, has gradually increased flexibility for banks in setting interest rates, formally removing the floor on the lending rate in 2013 and the deposit rate cap in 2015 – but is understood to still influence bank’s interest rates through “window guidance.” Favored borrowers, particularly SOEs, benefit from greater access to capital and lower financing costs, as they can use political influence to secure bank loans, and lenders perceive these entities to have an implicit government guarantee. Small- and medium-sized enterprises, by contrast, have the most difficulty obtaining financing, often forced to rely on retained earnings or informal investment channels.

In the past year, Chinese regulators have taken measures to rein in the rapid growth of China’s “shadow banking” sector, which includes vehicles such as wealth management and trust products. These vehicles often provide private firms additional channels to obtain capital, although at higher than benchmark rates. Chinese authorities have taken steps to increase the transparency requirements and strengthen supervision of these banking activities. In 2017, worried about increasingly interconnected leverage across China’s corporate sector, President Xi Jinping declared China’s financial security to be a matter of national security, and regulators redoubled their efforts to rein in financial sector risks.

Direct financing has expanded over the last few years, including through public listings on stock exchanges, both inside and outside of China, and issuing more corporate and local government bonds. The majority of foreign portfolio investment in Chinese companies occurs on foreign exchanges, primarily in the United States and Hong Kong. In addition, China has significantly expanded quotas for certain foreign institutional investors to invest in domestic stock markets; opened up direct access for foreign investors into China’s interbank bond market; and approved a two-way, cross-border equity direct investment scheme between Shanghai and Hong Kong that allows Chinese investors to trade designated Hong Kong-listed stocks through the Shanghai Exchange, and vice versa. Direct investment by private equity and venture capital firms is also rising, although from a small base, and has faced setbacks due to China’s capital controls that complicate the repatriation of returns.

Money and Banking System

After several years of rapid credit growth, China’s banking sector faces asset quality concerns. For 2017, the China Banking Regulatory Commission reported a non-performing loans (NPL) ratio of 1.74 percent, the same NPL ratio reported the last quarter of 2016. The outstanding balance of commercial bank NPLs in 2017 reached 1.71 trillion RMB (approximately USD 270.6 billion). China’s total banking assets surpassed 252 trillion RMB (approximately USD 39.9 trillion) in December 2017, an 8.7 percent year-on-year increase. Experts estimate Chinese banking assets account for over 20 percent of global banking assets. In 2017, China’s credit and broad money supply slowed to 8.2 percent growth, slower than the nominal gross domestic product (GDP) growth rate of 11.23 percent and the lowest published rate since the PBOC first started publishing M2 money supply data in 1986.

Foreign Exchange and Remittances

Foreign Exchange Policies

While the central bank’s official position is that companies with proper documentation should be able to freely conduct business, in practice, companies have reported challenges and delays in getting foreign currency transactions approved by sub-national regulatory branches. In 2017, several foreign companies complained about administrative delays in remitting large sums of money from China, even after completing all of the documentation requirements. Such incidents come amid announcements that the State Administration of Foreign Exchange (SAFE) had issued guidance to tighten scrutiny of foreign currency outflows due to China’s rapidly decreasing foreign currency exchange. China has since announced that it will gradually reduce those controls, but market analysts expect they would be re-imposed if capital outflows accelerate again.

Under Chinese law, FIEs do not need pre-approval to open foreign exchange accounts and are allowed to retain income as foreign exchange or to convert it into RMB without quota requirements. Foreign exchange transactions related to China’s capital account activities do not require review by SAFE, but designated foreign exchange banks review and directly conduct foreign exchange settlements. Chinese officials register all commercial foreign debt and will limit foreign firms’ accumulated medium- and long-term debt from abroad to the difference between total investment and registered capital. China issued guidelines in February 2015 that allow, on a pilot basis, a more flexible approach to foreign debt within several specific geographic areas, including the Shanghai Pilot FTZ. The main change under this new approach is to allow FIEs to expand their foreign debt above the difference between total investment and registered capital, so long as they have sufficient net assets.

Chinese foreign exchange rules cap the maximum amount of RMB individuals are allowed to convert into other currencies at approximately USD 50,000 each year and restrict them from directly transferring RMB abroad without prior approval from SAFE. In 2017, authorities further restricted overseas currency withdrawals by banning sales of life insurance products and capping credit card withdrawals at USD 5,000 per transaction. SAFE has not reduced this quota, but during periods of higher than normal capital outflows, banks are reportedly instructed by SAFE to increase scrutiny over individuals’ requests for foreign currency and to require additional paperwork clarifying the intended use of the funds, with the express intent of slowing capital outflows.

China’s exchange rate regime is managed within a band that allows the currency to rise or fall by 2 percent per day from the “reference rate” set each morning. In August 2015, China announced that the reference rate would more closely reflect the previous day’s closing spot rate. Since that change, daily volatility of the RMB has at times been higher than in recent years, but for the most part, remains below what is typical for other currencies. In 2017, the PBOC took additional measures to reduce volatility, introducing a “countercyclical factor” into its daily RMB exchange rate calculation. Although the PBOC reportedly suspended the countercyclical factor in January 2018, the tool remains available to policymakers if volatility re-emerges.

Remittance Policies

The following operations do not require SAFE approval: purchase and remittance of foreign exchange as a result of capital reduction, liquidation, or early repatriation of an investment in a foreign-owned enterprise, or as a result of the transfer of equity in an FIE to a Chinese domestic entity or individual where lawful income derived in China is reinvested.

The remittance of profits and dividends by FIEs is not subject to time limitations, but FIEs need to submit a series of documents to designated banks for review and approval. The review period is not fixed, and is frequently completed within one or two working days of the submission of complete documents. In the past year, this period has lengthened during periods of higher than normal capital outflows, when the government strengthens capital controls.

Remittance policies have not changed substantially since SAFE simplified some regulations in January 2014, devolving many review and approval procedures to banks. Firms that remit profits at or below USD 50,000 dollars can do so without submitting documents to the banks for review. For remittances above USD 50,000, the firm must submit tax documents, as well as the formal decision by its management to distribute profits.

For remittance of interest and principle on private foreign debt, firms must submit an application form, a foreign debt agreement, and the notice on repayment of the principle and interest. Banks will then check if the repayment volume is within the repayable principle.

The remittance of financial lease payments falls under foreign debt management rules. There are no specific rules on the remittance of royalties and management fees. In September 2017, SAFE lowered the reserve requirement for foreign currency transactions to zero, significantly reducing the cost of foreign currency transactions. The reserve ratio was raised to 20 percent in 2016.

The Financial Action Task Force has identified China as a country of primary concern. Global Financial Integrity (GFI) estimates that over USD 1 trillion of illicit money left China between 2003 and 2012, making China the world leader in illicit capital flows. In 2013, GFI estimated that another USD 260 billion left the country.

Sovereign Wealth Funds

China officially has only one sovereign wealth fund (SWF), the China Investment Corporation (CIC). Established in 2007, CIC manages over USD 900 billion in assets (as of August 2017) and invests on a 10-year time horizon. China’s sovereign wealth is also invested by a subsidiary of SAFE, the government agency that manages China’s foreign currency reserves, and reports directly to the PBOC. The SAFE Administrator also serves concurrently as a PBOC Deputy Governor.

CIC publishes an annual report containing information on its structure, investments, and returns. CIC invests in diverse sectors like financial, consumer products, information technology, high-end manufacturing, healthcare, energy, telecommunication services, and utilities.

China also operates other funds that function in part like sovereign wealth funds, including: China’s National Social Security Fund, with an estimate USD 295 billion in assets; the China-Africa Development Fund (solely funded by the China Development Bank), with an estimated USD 5 billion; the SAFE Investment Company, with an estimated USD 441 billion; and China’s state-owned Silk Road Fund, established in December 2014 with USD 40 billion to foster investment in countries along the Belt and Road. Chinese SWFs do not report the percentage of their assets that are invested domestically.

Chinese SWFs follow the voluntary code of good practices known as the Santiago Principles and participate in the IMF-hosted International Working Group on SWFs. The Chinese government does not have any formal policies specifying that CIC invest funds consistent with industrial policies or in government-designated projects, although CIC is expected to pursue government objectives. The SWF generally adopts a “passive” role as a portfolio investor.

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