European Business Confidence in China: Revising Expectations as 2023 Falls Short
This article was originally published in Italian in Panorama on 24th June 2024.
Please note that this is a courtesy translation of the Italian language article originally published in the Panorama Magazine Issue at: https://www.panorama.it/economia/fiducia-imprese-europee-cina-mercati
European companies in China have been facing significant headwinds, with 2023 turning out to be a sobering year for many companies operating in the region. The latest European Business in China - Business Confidence Survey 2024 by the European Union Chamber of Commerce in China[1] reveals a complex interplay of factors that are dampening optimism and reshaping investment strategies. The survey highlights a myriad of challenges, ranging from economic headwinds and regulatory uncertainties to geopolitical tensions and internal decoupling.
Economic slowdown and Regulatory Challenges
The economic slowdown in China is a primary concern for business, with 55% of survey respondents citing it as a top-three business challenge, a sharp increase from previous years. This slowdown is compounded by China’s weak domestic demand, high levels of local government debt, and ongoing issues in the real estate sector, all of which are affecting overall profitability and growth prospects.
Regulatory challenges remain a persistent issue. European businesses have long struggled with ambiguous rules and unpredictable legislative environments in China. In 2023, 46% of respondents identified ambiguous regulations as their primary challenge, marking the eighth consecutive year this issue has topped the list. Furthermore, only 16% of respondents expect regulatory obstacles to decrease, the lowest level on record.
The business environment in China has become more politicised, with over half of the respondents feeling the increase over the past year. A key reason is that European businesses have to navigate conflicting legal regimes between the European Union, the United States, and China, which places additional pressure on businesses. In addition, geopolitical risks have prompted companies to diversify and silo supply chains. However, finding alternative sources for certain components or equipment remains a significant challenge.
All of this is having an impact on China's position as a prime investment destination, which has been waning for European businesses. Only 15% of respondents see China as a top destination for current investments, and an even lower 12% for future investments. This marks a significant decline in confidence, driven by a variety of economic and regulatory challenges.
Decoupling Communications
While it is clear that European businesses, on the whole, remain committed to the China market, there is a different kind of decoupling taking place. The decoupling between European companies' headquarters and their China operations has intensified, affecting nearly two-fifths of respondents. This decoupling has led to decreased communication and a diminished understanding of the realities of the local environment by headquarters.
The rising inaccessibility to reliable information about China's economy exacerbates these issues, making it difficult for CEOs to justify maintaining or increasing investments without necessary transparency and legal certainty.
Shifting Investment Strategies
In response to these challenges, European companies are making strategic adjustments. Many are cutting costs, reducing headcounts, and toning down expansion plans. A notable 52% of respondents plan to cut costs in 2024, the highest level on record, with headcount reduction being the most common cost-cutting measure.
In light of these challenges, European companies are increasingly redirecting their investments away from China towards more predictable markets. The survey noted that 35% of companies plan to reinvest less than their historical average in China in 2024. Additionally, 45% reported that their Chinese suppliers or customers are moving operations to other markets, reflecting a broader trend of diversification.
Even with a notable increase in market opening in some industries, this has not translated into a corresponding increase in investment. The proportion of respondents likely to increase investments if granted greater market access dropped to 53%, down 10 percentage points year-on-year. This suggests that the overall business environment remains too uncertain even with improved market access to attract substantial new investments.
Shanghai: A poster boy for China’s re-opening?
The Business Confidence Survey revealed a fascinating yet challenging landscape for European businesses in Shanghai. Known as China's most international city, Shanghai continues to be a beacon for innovation, housing the highest number of multinational regional headquarters in the country. In fact, it is often seen as the ‘poster boy’ for the rest of China, leading the way for market opening.
However, despite its international reputation, the ease of doing business has declined across the board. Over two-thirds of businesses report increased difficulties, particularly in cross-border money transfers, relocation, and trade. The survey found that market access restrictions and regulatory barriers have caused significant missed opportunities for 63% of respondents, impacting revenues and dampening optimism. For 62% of those, the missed opportunities equated to over 10% of their annual revenue. As a result, less than half of Shanghai respondents are considering expanding their current China operations in 2024, and only 10% are considering moving their Asia regional headquarters to the city. The anticipated economic rebound has not materialised as expected, and escalating geopolitical tensions add to the complexity.
Despite these setbacks, Shanghai’s allure as an innovation hub persists. With 63% of respondents acknowledging Shanghai’s edge in research and development makes it stand out as a top destination for setting up R&D facilities. Yet, to retain its competitive edge, concrete actions are urgently needed. European businesses call for better coordination among government departments, improved communication, and greater transparency. They highlight the importance of Shanghai's intellectual property protections, as fear of IP infringement remains a barrier to bringing the latest technology to China. As competitive pressures mount, the city's promise of innovation and growth risks turning into a tale of disillusionment unless authorities 'walk the talk' and implement the necessary reforms. Without these critical changes, Shanghai's bright future as a magnet for foreign investment may dim, leaving European businesses to reconsider their plans in the iconic city.
Opportunities Amidst Challenges
Despite the challenges, there are still opportunities for European businesses in China. Notably, there has been a significant increase in the proportion of respondents reporting market opening in their industry to 45%, up 9 percentage points year-on-year. This is particularly encouraging in sectors where the European Chamber has actively advocated for change. The Chinese government has made several pledges to improve the business environment, such as the Opinions of the State Council on Further Optimising the Business Environment for Foreign Investment. However, many companies are adopting a wait-and-see approach before committing to new investments.
While some sectors report market openings and improved profitability, the overall sentiment remains cautious. European businesses are strategically adjusting, focusing on cost-cutting and re-evaluating investment plans. Significant improvements in the business environment and regulatory transparency are necessary to restore confidence and encourage investment.
For European companies, navigating this complex landscape requires staying informed, maintaining open communication with headquarters, and being prepared to adapt to evolving regulatory and economic conditions. As they reassess their strategies, it is clear that while China remains an important market, the path to renewed confidence will require concerted efforts from both businesses and policymakers to address the underlying challenges and leverage emerging opportunities.
This comprehensive understanding of the current European business sentiment in China underscores the need for strategic adaptations and a robust engagement framework to navigate the prevailing uncertainties and harness potential growth areas amidst the evolving economic landscape.
Edited by: Lawyer Carlo Diego D'Andrea, Vice President of the European Union Chamber of Commerce in China
[1] European Union Chamber of Commerce in China, European Business in China – Business Confidence Survey 2024, 10th May 2024, viewed 12th June 2024, https://www.europeanchamber.com.cn/en/publications-business-confidence-survey
