December, 2007

 

By BILL H. ZHANG

 

China National Development and Reform Commission and Ministry of Commerce jointly revised and promulgated the Catalogue of Industrial Guidance for Foreign Investment on November 7, 2007 (New Catalogue) which replaced its 2004 version and took into effect on December 1, 2007. Compared with its former version, the New Catalogue has undergone many dramatic changes and will definitely have significant impact on investment strategies of foreign investors, including existing foreign invested enterprises (FIEs). This article will briefly discuss and analyses the significant changes made to the New Catalogue and its impact on foreign investment, under which foreign investors shall appropriately adjust and reconsider their investment strategies in China after implementation of the New Catalogue.

 

BASIC INTRODUCTION TO THE CATALOGUE

 

In line with the practice and development of Chinese economy, Chinese policy makers issued five versions of the catalogue of industrial guidance for foreign investment (Catalogue) in 1995, 1997, 2002, 2004 and 2007 respectively. As a general industrial policy, the Catalogue is a long-standing tool of Chinese authority of the highest level to reflect their decisions and approach towards foreign investment in various industries at different stages of Chinese economic development. Foreign investors shall first consult with the most updated Catalogue to confirm the entry possibility and mode of investment vehicle in the industries they intend to invest.

 

Normally, the Catalogue divides industries into three basic categories, encouraged, restricted and prohibited. In the event that any industries are not listed in the Catalogue, unless otherwise forbidden by other applicable laws and regulations, foreign investment is generally permitted in such industries and the investment may take vehicles of wholly foreign owned enterprise (WFOE), equity joint venture (EJV) or contractual joint venture (CJV) with no restriction on Chinese or foreign partner being the majority shareholder. Foreign investment in encouraged industries is normally eligible for various incentives and investors are also permitted to establish WFOE, EJV or CJV. Foreign investment in restricted industries is subject to strict governmental examination and approval case by case and the investment vehicle is possibly limited to EJV or CJV under which Chinese partner shall hold majority interests in some cases. Investment in prohibited industries by any foreign investors is not allowed by any means. With no exception, the New Catalogue also remains the aforesaid structure, but makes adjustments to the entries of various industries in the above categories.

 

GENERAL COMPARISON ON QUANTITIES OF ENTRIES OF DIFFERENT INDUSTRIES UNDER THE THREE CATEGORIES BETWEEN THE NEW CATALOGUE AND ITS 2004 VERSION

 

Compared with its 2004 version, the New Catalogue has increased the total entries from 370 to 478, most importantly, the encouraged entries were expanded dramatically, which implies that China is still speeding its steps to welcome and encourage foreign investment as before. Among the encouraged entries, most changes have been made to the manufacturing industry, in which the encouraged lists in the New Catalogue were increased from 191 to 282. However, such increase of encouraged lists in the manufacturing industry resulted from breakdown of the industry into more detailed sectors rather than a significant broadening of scope of the industry. The industries and entries of manufacturing industry which have undergone dramatic changes can be briefly summarized as follows:

 

Entries or Sectors	New Catalogue (2007 Version)			Old Catalogue (2004 Version)
	Encouraged	Restricted	Prohibited	Encouraged	Restricted	Prohibited
Agriculture, forestry, animal husbandry and fishery industry	12	3	3	11	2	3
Mining industry	9	8	3	11	6	2
Medicine manufacturing	16	6	2	16	6	2
Chemical material and chemical products manufacturing	26	10	-	25	7	-
Non-metal mineral product manufacturing	20	-	-	9	-	-
General machinery manufacturing	19	-	-	7	3	-
Specialized equipment manufacturing	71	3	1	42	3	-
Transportation vehicle and equipment manufacturing	26	1	-	17	-	-
Communication equipment, computer and other electronic equipment manufacturing	35	2	-	30	1	-
Manufacturing of instruments and meters, and machinery for cultural and office use	18	-	-	8	-	-
Power generating machinery and equipment manufacturing	13	-	-	4	-	-
Chemical fiber manufacturing	6	2	-	3	3	-
Other	-	-	-	-	-	-
Total	351	87	40	257	78	35

 

 

HIGHLIGHTS OF THE REVISION TO THE NEW CATALOGUE

 

In addition to the above expansion of quantity of the entries, dramatic changes were also made to the contents of the New Catalogue. The New Catalogue has been revised mainly in the following aspects:

 

1.                  Promotion of Upgrade of Industrial Structure

According to the Eleventh Five Year Plan on Foreign Capital Utilization (Plan), which was promulgated by the National Development and Reform Commission in November, 2006, China will move from emphasizing the quantity of foreign investment to emphasizing the quality of that investment and upgrade its industrial structure, inducting foreign capital to those industries with high added-value. It was also clarified that items under restricted category in the Catalogue for Guidance for Industrial Structure Adjustment (Industrial Adjustment Catalogue), which was promulgated by the National Development and Reform Commission on December 2, 2005 and classified the items in different industries into encouraged, restricted and abolished categories, also applies to foreign investment.

In order to eliminate backward production capacity, under the New Catalogue, encouragement for investment in manufacturing sector has been shifted from traditional manufacturing industry in which domestic enterprises have already mastered necessary technologies and have strong production capacity to new high technology, high end equipment manufacturing, new materials production, infrastructures and modern agriculture. In order to encourage development of high technology industry, 522 types of products in the Catalogue of Encouraged High Tech Products for Foreign Investment (2006) (High Tech Products Catalogue), which was jointly promulgated by the Ministry of Commerce and the Ministry of Science and Technology on December 31, 2006 and covered 596 types of products under ten different industries, have been added into the New Catalogue as encouraged items, accounting 88% of the products in the High tech Products Catalogue. In line with China commitment to World Trade Organization, in addition to reducing restricted and prohibited items in the service industry, the New Catalogue has newly added service outsourcing and modern logistics and other service items as encouraged category. In order to avoid the continued overheating of real estate market and also in line with the Opinions on Regulating Access to and Administration of Foreign Investment in Real Estate Market (Opinions), which were jointly promulgated by the Ministry of Construction, the Ministry of Commerce, National Development and Reform Commission, the People Bank of China, the State Administration for Industry of Commerce and the State Administration of Foreign Exchange on July 11, 2006 and took an attitude to restrict foreign capital to access into real estate market, under the New Catalogue, foreign investment in common residences are not encouraged any longer and investment in real estate secondary market exchange, intermediaries and brokerages are restricted too.

The above revisions to the New Catalogue implies that the drive of Chinese economic growth will shift from the secondary industry to the codriver of the primary, secondary and tertiary industries and from relying on materials and resources consumption to high-tech progress, upgrading of labor quality and management innovation.

2.                  Protection to Environment and Conservation of Resources

Chinese economic growth has suffered a lot from its former extensive development mode by high input, high consumption of resources and heavy pollution but low efficiency, under which many resources and energies have been wasted and natural environment was seriously deteriorated. Having waken up to this adverse effect, China has recently called for harmonious development between society and nature and conservation of resources for next generation.

In response to the call for harmonious development, the New Catalogue encourages foreign investment in development of recycle economy, clean production, renewable energy, ecological environmental protection and comprehensive utilization of resources. Some relevant items satisfying these purposes have been newly added to the New Catalogue as encouraged category. Now no foreign investment is encouraged for exploration of important mineral resources which are rare in China or non-renewable. Further, foreign investment with high energy consumption, heavy resources consumption and high pollution is restricted or prohibited too. Also, foreign investment is not allowed for exploration for some important non-renewable mineral resources.

Obviously, after implementation of the New Catalogue, more and more environmentally friendly and energy-saving projects will be encouraged and welcomed.

3.                  Adjustment in Export-oriented Policy

In view of Chinese growing trade surplus and fast expanding of reserve of foreign currency and in order to balance import and export, especially to promote import for high technologies and high-tech equipments, a general provision that foreign investment devoted to export 100% of its products as encouraged category was moved from the New Catalogue. This is 360 degree reversal of the prior foreign trade policy which encouraged export and reserve of foreign currency. The message is that China will curb export processing growth and protect its important strategic resources. However, whether such policy can really be successfully implemented at local level remains an open question for consideration of financial revenue of the local government.

4.                  Promotion of Coordinated Regional Development

In parallel with the strategies of developing western regions, boosting rise of central regions and rejuvenating the old industrial bases in northeastern regions, the general provision apply only to the central and western regions?was moved from items under the encouraged category in the New Catalogue. So accordingly, the priority industries and characteristic industries in central, western regions and old industrial bases in northeastern regions which need to be encouraged for investment will be added to the Catalogue of Guidance for Foreign Investment in Priority Industries in the Central-Western Region (Central-Western Region Catalogue),which was promulgated by the Ministry of Commerce and the National Development and Reform Commission on July 23, 2004 and took into effect on September 1, 2004 and listed various industries and products which are encouraged for investment in each province in central and western regions of China, in the future revision to the Central-Western Region Catalogue.

5.                  Protection of National Economic and Spiritual Security

In order to protect national economic and spiritual security, China takes a prudent attitude towards the liberalization of a certain strategic and sensitive industries. Appropriate adjustments have been made to the relevant items under the New Catalogue for balance between domestic development and opening to the outside world. Under the New Catalogue, many encouraged items for investment are still limited to CJV or EJV, especially survey and exploration of important mineral resources is nearly limited to joint venture or Sino-foreign cooperation, restricted or even prohibited.?Investment in survey and exploration of tungsten, molybdenum, tin, antimony and fluorite was only formerly restricted, but is completely forbidden now. Many restricted items are limited to joint venture rather than WFOE and that the Chinese partner shall hold the controlling interests in the joint venture. Participation in publishing and media industry is still prohibited.? In recognition of internet as an alternative publishing, various internet based business, such as news websites, web streaming audio-visual services, e-commerce and culture-related websites, have been newly added as prohibited category in the New Catalogue.

CONCLUSION

The revision to the New Catalogue reflects the attitude and policies of the Chinese authority of the highest level towards foreign investment and is consistent with its other recent measures which limit foreign M&A activities, eliminate favorable tax treatment for FIE and cancel its support to export oriented enterprises. Under the New Catalogue, foreign investment in traditional manufacturing sectors and export oriented projects will no longer be encouraged, instead, investment in high technology, new materials production, high-end equipments, modern agriculture and high-end services, such as modern logistics, have been newly encouraged. Heavy pollution and high resources consumption projects, and exploration of important non-renewable mineral resources will be forbidden. However, some environmentally friendly and energy-saving projects will be more and more welcomed. In view of balance the regional development, investment in central-western regions and northeastern old industrial bases will also be encouraged. For national economic and spiritual security, some strategic and sensitive industries, such as internet content based service, is forbidden for foreign investment.

From the above, we can conclude that China is serious to upgrade and optimize its industrial structure through revising the Catalogue and really wants to use foreign capital rather than being used by foreign investors to achieve a sound and healthy economic development. The Catalogue has already undergone many dramatic changes.?Foreign investors need to be cautious to and make them familiarized with this New Catalogue before making decisions to invest in China.

 

 

About the Author

 

BILL H. ZHANG is the managing partner of China Sunbow & Associates with rich experience in cross-board transactions involving China with more focus on corporate and commercial matters, such as mergers and acquisitions, direct investment in China, joint venture, intellectual property, technology license and transfer, international trade, corporate governance and compliance, restructuring and reorganization, labor and employment, and dispute resolutions. He has represented many multi-national companies to merge and acquire Chinese enterprises, make investment, register and enforce various trademarks, patents and copyrights, resolve commercial disputes in China. He has also counseled many foreign invested enterprises on their daily operations in China.

 

For more information about this article and the author, please contact:

 

BILL H. ZHANG

 

F: +8621 5081 5239 (Shanghai) or

+852 2710 8266 (Hong Kong)

E: bill.zhang@chinasunbow.com

 

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