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FDI patterns set to change
( 2003-05-28 09:50) (1)

Although SARS has curbed foreign direct investment (FDI) for the time being, overseas capital will still flow into China over the long term.

Actual foreign investment in China reached US$17.8 billion in the first four months of this year, up more than 50 per cent year-on-year.

Overall FDI this year is likely to exceed US$60 billion, compared to US$52.7 billion last year.

Analysts believe China's annual FDI growth will maintain a 5 to 10 per cent growth rate in the next decade.

The constant growth and re-engineering of China's economy will sustain a tremendous demand for foreign capital.

World Trade Organization (WTO) accession will fundamentally improve China's market environment and will pave the way for foreigners to implement long-term investment strategies.

The liberalization of the service sector will expand the portfolio of investments open to foreign players. Abundant cheap labour will also lure foreign companies to move their manufacturing bases to China.

However, the service sector will receive more foreign capital than the manufacturing sector.

According to China's WTO commitment, foreign investors will be allowed to participate in the service sector, including financing, insurance, commerce, telecommunications, transport and technological services.

Domestic companies in these fields mostly have low international competitiveness. They will naturally join with multinational giants to survive the global contest.

The government is also likely to encourage foreign investors to enter the service sector, because it can help absorb the country's redundant labour forces.

It is estimated that new FDI in the service sector will increase to about 40 per cent of China's overall FDI in the coming few years, with an annual growth of 10 to 15 per cent.

The direction of foreign investment will change according to the government's market access policies.

Generally speaking, labour intensive industries such as apparel and furniture-making will remain the main receiver of foreign capital.

Electronics and telecommunication equipment manufacturing will also lure foreign capital. Although these industries are already capital-intensive, their large scale and relatively low tax rates still appeal to foreign investors.

Foreign investment will have less involvement in State-monopolized sectors including power, gas and water.

Sectors with low profitability or high taxation burdens, such as ferrous metal smelters and coal mining, will also be less favoured by foreign investors.

Government support for innovative companies has already increased the number and scale of foreign-funded high-tech projects. Some multinationals have established regional headquarters and research centres in China.

This trend is very important to the upgrading of China's industry. How it develops depends on the government's industrial strategy.

China's improved legal system will also offer foreigners more options in how they invest.

Since the 1990s, mergers and acquisitions have become a main channel for international capital flow. They accounted for 90 per cent of investment between developed economies.

However, less than 5 per cent of FDI to China is through mergers and acquisitions. Most capital comes in the form of "greenfield investment,'' in which investors directly set up enterprises in the country.

Incomplete legal and administrative rules are the main obstacle to international mergers and acquisitions in China. The lack of competent intermediary agencies is another reason.

The situation will gradually change as the government takes steps to develop the rules required. Late last year, several ministries jointly issued a provisional regulation which allows foreign investors to acquire assets of State companies.

As the legal environment improves, mergers, acquisitions and investment via the securities market will become common forms of FDI in China.

Meanwhile, greenfield investment will by no means shrink. More and more foreign investors are creating exclusively foreign-owned enterprises in China.

In 2002, exclusively foreign-owned companies accounted for more than 60 per cent of all foreign-funded firms in the country, compared to about 20 per cent in early 1990s.

As China's economic climate matures, foreign investors favours this type of corporate control, which avoids conflicts of interest with local partners.

Many overseas investors in Sino-foreign joint venture companies also buy out shares of Chinese partners to secure exclusive control of their investment projects.

China's FDI strategy used to encourage foreign-funded companies to be export-oriented and help accumulate trade surpluses. The government also imposed strict limits on foreign-funded companies' sales in the domestic market.

But with the expansion of domestic demand, more and more foreign investors will target the Chinese market.

Domestic-oriented foreign-funded companies will gradually make up most foreign investment. A growing number of big cities, including those in western and central provinces, will become new destinations for foreign investment.

The author is a researcher with the Foreign Economic Research Division of the State Council's Development Research Centre.

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