China's challenges in 2008

WITH NEW LAWS ON LABOUR AND CORPORATE INCOME TAX COMING INTO EFFECT, 2008 SEEMS TO BE THE YEAR OF MAJOR CHANGES FOR FOREIGN BUSINESSES OPERATING IN THE COUNTRY. A QUALITATIVE SURVEY AMONGST FIDUCIA's CLIENTS AND BUSINESS PARTNERS REVEALS THEIR MAIN CHALLENGES AND PLANS FOR 2008.

Main challenges

"Definitely the quality issue" was an answer given by a number of leaders of Western companies in China when asked about the "number one challenge" for their business in 2008. "It is not so much the image problem, but the operational consequences that hurt our business", one interviewee said. Besides higher fees for testing by the General Administration of Quality, Supervision, Inspection and Quarantine, the checking of every shipment out of China causes delays and costs money.

Other main challenges include the lid that China's Central Bank has put on liquidity and re-financing opportunities and the increasing competition from international and local companies: "We feel pressure on our profit margins by Chinese OEMs who are cheaper and also improve technologically." The creation of higher-value products within the Chinese market is also seen as a challenge that foreign companies will have to face in 2008.

As for macro developments, company leaders see the RMB appreciation and increase of raw material cost as likely factors to push up prices for products "made in China". Furthermore, there have been indications that this year might bring more direct control by the central government in Beijing. In the past, the old Chinese saying "the mountains are high and the emperor is far away" was often the answer to that question.

New labour law

Even though the new unified tax and labour laws were passed in March and April 2007 respectively, the first half of 2008 will be spent assessing the true impact that these laws will have on businesses and what long-term strategies foreign companies can apply to stay competitive. "The law simply increases the need for us to use sound management practices. It does not take away the right of management to "manage"", said one interviewee about the new labour law. It is welcomed by most Western companies - that are traditionally used to strong unions and labour protection in their home countries - because it fixes rights of both employers and staff and can help keep turnover down. However, while the new law brings salary increases and job security for workers, the supply of qualified staff may not necessarily rise, too. Some foreign companies are unable to expand their operations because of a lack of skilled technicians and senior management. This lead one interviewee to state that "foreign companies might leave China for more attractive options like Vietnam or India, or "go West" [within China], where they can expect lower salary cost and a less strict enforcement of the law".

New corporate income tax law

Enforcement is also the crucial point of the new corporate income tax law. "A tax of 25% is acceptable and we are happy to have a level playing field with our local competitors", said a German manufacturer, only to add shortly after: "But only if there are no double standards. In the past, the audit quality in Chinese firms hasn't always been the best." This view is shared by most interviewees who criticise the loopholes their Chinese competitors use to get around paying taxes. "We pay more taxes, because foreign firms are monitored more strictly and the quality of our reporting is better" was a common answer. The consequence of this assumption: Chinese companies can offer lower prices and therefore have a competitive advantage over foreign firms, most of whom want to sell their products in China (according to the 2007 Business Confidence Survey conducted by the European Union Chamber of Commerce). Apart from heavier monitoring by tax authorities, internal ethics codes prevent many foreign corporations from operating on the same level as their Chinese counterparts (see page 4 for more information on the law).

Challenges in the finance industry

Even though the deputy governor of the People's Bank of China, Wu Xiaoling, gave a speech supporting Private Equity (PE) in June 2007, the rest of the year wasn't a smooth road. Many foreign funds suffered from long approval pro-cesses for their attempted acquisitions. While it appears that PE will still be encouraged in China this year, the focus is going to be on Renminbi denominated funds, not US dollar funds. Experts see this as a move towards protectionism by the Chinese central government. Another protectionist policy is the new anti-monopoly law that was released by the central government during the summer of 2007. The law requires security checks on foreign merger and acquisitions, which are becoming an increasingly popular method for foreign companies to enter the China market. This isn't likely to affect many of the mid-market deals, but it may have a large effect on major purchases and mergers that are going on at the moment and in the future.

Plans for 2008

The most frequent answer foreign managers gave when asked about their plans for 2008 was the expansion of their companies' presence in China and Asia. Besides this and the obvious aim of revenue growth, the introduction of new products to the Chinese market is included in the plans for this year. Most foreign companies in China see the quality and high value of their products as the main advantage in comparison with local competitors. Or as one interviewee put it: "Quality is our lifeblood and we need to constantly remind ourselves not to be duped into the lure of going after the "quick buck"."

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