That model threatening foreign companies' recovery on the Chinese market

When members of the European Chamber were surveyed in February 2020 on the business environment in China, nearly half declared they were optimistic about growth over the next two years. As it became increasingly evident that COVID-19 was not going to be over after an extended Chinese New Year holiday but rather a widespread pandemic with devastating economic consequences, this sentiment quickly changed. Members, once confident about the year ahead, found themselves in a complex and rapidly-changing situation.

The Business Confidence Survey 2020 (BCS2020) results indicated that even before the virus, there were many issues eroding the business environment for foreign companies.  Although the government touted reforms to the Special Administrative Measures on Access to Foreign Investment (Negative List) in 2019, only 10 per cent of members reported significant market opening over the previous year. In total, 45 per cent of members report market access barriers, two thirds of which are indirect barriers such as issues with licensing or certification, a data point unchanged from the previous year. These restrictions carry a hefty price tag; if granted more market access, a quarter of members would increase their investment in China.

Despite this desire to contribute to China’s economy, only half of members believe that foreign-invested companies are treated equally to domestic companies. The outlook for the future is grim, as nearly a third do not expect significant improvement towards a level playing field for foreign enterprises within the next ten years.  Behind this unequal treatment is a bifurcation of the economy—a “one economy, two systems” model where on one side, some industries have enjoyed improved regulatory regimes and varied levels of market opening. On the other side, some sectors are dominated or even exclusively populated by state-owned enterprises (SOEs). Indeed, 48 per cent of members believe that the state-owned sector will gain more opportunities at the expense of the private sector over the next two years, an increase of seven percentage points year-over-year. This sentiment looks to be accurate, as reflected by a recent government action plan in which SOEs are lauded as a “key pillar” of the Chinese economy.

Improving the business environment for European companies in China will be particularly important because of the pandemic’s repercussions. Even as the virus subsides, foreign companies continue to be vulnerable to disruptions. One example is the border restrictions put in place to mitigate the spread of the virus; since the closing of the borders to most foreign visa holders and permanent residents in late March, business leaders and technical experts have been stuck overseas. Despite some pathways for entry for personnel deemed essential, many member companies report that they are not able to obtain the necessary invitation letters from the district foreign affairs office for their employees.

According to a July survey of European Chamber members in Shanghai, more than half of respondents still have foreign staff stuck outside the country, and of those, more than a quarter anticipate a drop in revenue as a result. Many have had their applications rejected or delayed indefinitely, and report that the administrative requirements for obtaining a visa are too high. Such requirements are particularly burdensome for some groups of businesses. International schools, whose globally-aligned programs and accreditations make it feasible for foreign talent and their families to move to Shanghai, now face severe shortages of foreign staff, which some respondents say is the main reason they cannot return to China. Small and medium enterprises, who cannot reallocate resources the way their larger counterparts can, may face tremendous impact if the individual stuck abroad is the legal representative and thus unable to conduct necessary in-person business activities. Companies in the professional services sector struggle to meet a vague definition of ‘essential’; according to one respondent, authorities told them clearly that business consulting professionals are not a priority.

In this complicated scenario, China should seek to reassure foreign businesses, who despite the border predicament are still eager to contribute to China’s recovery. Recent official statistics state that the Chinese economy has expanded 3.2 per cent in the second quarter year-on-year. If accurate, this indicates that China has started on the path to recovery. However, growth potential will remain limited if foreign companies struggle to participate due to market barriers, or due to the absence of many foreign businesspeople stuck outside of China.

In late June, the State Council took a small step forward in market reform when it removed seven items from the updated Negative List and its Free Trade Zone counterpart. There was some relaxation of restrictions in sectors including nuclear fuel, oil and gas exploration, and pipe network facilities; while this marginal opening is welcome, it is of interest to only a few Chamber members. Meanwhile, the removal of equity cap restrictions in financial services, like asset management, futures and insurance, is also a positive development, but due to constraints across years of market growth, European financial institutions may struggle to take advantage. In short, this reform is too little, too late.

The update also includes a new mechanism that allows the State Council to selectively override the Negative List and permit specific foreign investors into the market upon their approval. Although this may be an effective way to test market opening for foreign investment into certain areas by allowing ad hoc approvals, it simultaneously raises major concerns that approvals may be based on regulators’ goodwill or considerations of global politics. According to the BCS2020, 43 per cent of members believe that doing business in China has become more political in the last year. As China rides the wave of economic recovery, while remaining vigilant against potential outbreaks of the virus, what it needs more than ever is a stable and predictable regulatory environment to reassure foreign investors.

Carlo Diego D’Andrea

Vice president of the European Chamber of Commerce in China

Italian version published on Milano Finanza, 21 July 2020