1. law, govt and politics
2. government

FT SPECIAL REPORT
Doing Business in China
www.ft.com/reports | @ftreports
Tuesday November 4 2014
Slowdown is
part of new
economic
narrative
Inside
Bribes just one malady
in healthcare system
Achieving affordability
and quality of care is
proving to be a struggle
Page 2
Driving the car craze
Antitrust fines have a
wider agenda: to lower
prices of vehicles
Page 3
Jamil Anderlini says shifts in investment patterns
and internal problems signal end to strong growth
T
he Chinese flag was flying
over the New York Stock
Exchange in late September
as a grinning, elflike former
English teacher watched his
ecommerce company smash the record
for the world’s largest ever initial public
offering.
Alibaba’s $25bn share sale made Jack
Ma the richest man in China, but it
also provided the kind of moment that
symbolises historic shifts in the global
landscape.
From outside, China’s rising economic
and political power appears unstoppable and relentless.
Chinese are now the biggest purchasers of expensive properties in London,
New York and Sydney, and Chinese
investors are buying up everything from
Italian utility companies to the Waldorf
Astoria Hotel in New York City.
China’s increasingly assertive Communist leaders seem to want their own
version of the United States’ 19th century’s Monroe Doctrine for their own
back yard of Asia.
This policy stated that any intervention by external powers in the politics of
the Americas was seen as a potential
hostile act.
At the same time, Beijing’s rising
influence can be seen around the globe,
from Sierra Leone to São Paulo.
As he revelled in his company’s successful debut in New York, Mr Ma
declared that Alibaba was a company
that had already “shaped the world”
and said he wanted it to be “bigger than
Walmart” as it expands outside its home
market.
US capitalist investors lapped it up
and appeared to have bought into the
newest Chinese dream. Alibaba shares
Hong Kong protests
Beijing’s plans for
electoral reform spark
fears of long-term
impact on business hub
Page 4
ended their first trading day up nearly
40 per cent and the company was
valued at more than Facebook, Amazon, JPMorgan or Procter & Gamble.
Alibaba is not the only Chinese company with dreams of world domination.
As growth continues to slow at home,
many Chinese companies are looking
abroad to make investments, enter foreign markets and acquire valuable technology and brands.
But this interest in overseas corporate
expansion is increasing just as foreign
Rising energy, transport and
labour costs squeeze profits
Cheap China
Local consumers are not
prepared to pay the prices
that foreign customers will,
reports Lucy Hornby
Order a child’s Halloween costume in
China ($3.44 for pirate hat, eye patch
and black cape) and it will arrive at your
door the next day, with a mere $1.60 in
shipping costs added. If the supplier is in
your city, you get it the same day free.
This consumer bonanza is increasingly a problem for local and foreign
companies selling in China, where rising
energy, transport and labour costs are
squeezing profits, not just for manufacturers but for the growing number of
brands targeting Chinese consumers.
For years, the price of labour has been
rising, especially for managers, but
overall costs were still so low compared
with the prices foreign customers would
pay that its export industry thrived.
By contrast, brands that market to
cost-conscious Chinese buyers not only
have to manage their manufacturing
costs but also contend with shipping and
retail costs inside the country. And that
in turn means high energy costs are taking a double toll.
“Energy costs are so high in China, it’s
becoming a concern,” says Shaun Rein,
author of The End of Cheap China and
managing director of China Market
Research Group.
Those high costs can show up in unexpected ways as China’s business landscape changes. “Sales have moved so
decidedly from bricks and mortar to
online that transport is really a problem,” Mr Rein says.
For retailers still selling the old fashioned way, the shift from tiny storefronts to malls or box stores has meant
higher power costs for air conditioning
and lighting, as well as rising rent.
Much of the problem lies in China’s
industrial structure. “There is not much
transparency in how authorities set
domestic oil prices and a good system of
supervision is not in place,” says Dong
Zhengwei, a lawyer and veteran campaigner against state-owned monopolies. “The government wants to protect the interests of large oil companies.”
International oil prices dropped by
nearly a quarter between late June and
mid-October; but Chinese retail petrol
Going up: move from tiny storefronts to malls has increased overheads – Bloomberg
and diesel prices fell by only half that
amount, or 11-12 per cent. The government, which adjusts prices on an irregular basis, is allowing oil companies to
recoup some revenues denied them
when oil prices were higher. That puts
Chinese retail petrol prices about 20 per
cent above US prices and diesel prices
about 9 per cent higher.
Relatively few manufacturers rely on
natural gas in China, but those that do
have also been facing rising prices.
Increases in the state-set natural gas
price were designed to offset import
losses for state oil companies and
encourage them to produce more gas,
but the price rises have deterred industrial customers. “It’s one of the few markets in the world where industrial gas
prices are higher than residential
‘It’s one of the few markets
in the world where industrial
gas prices are higher than
residential prices’
prices,” says Kim Woodard, an investment adviser in Beijing.
Most of China’s industrial sector still
relies directly on coal, the cheapest fuel
around, but by 2010, 28 per cent of Chinese industry’s energy needs were met
by electricity, surpassing the level of
industrial electrification in the US. The
switch has helped mitigate noxious coal
pollution in wealthier cities but made
managing energy costs more complicated for Chinese companies.
This is important, because power can
account for up to 90 per cent of a factory’s cost, depending on the industry.
First Financial Daily, a Shanghaibased newspaper, tried to analyse
China’s electricity rates last year and
concluded there were at least 1,000 tariffs across the country, with 314 in Beijing alone.
The result is so confusing it creates a
business opportunity. Taryn Sullivan,
an American, founded EEx, a consultancy that is helping Chinese factories
cut electricity costs by 10 -20 per cent.
EEx’s entry-level service is helping clients make sense of their electricity bills.
Chinese labour costs are rising steadily as the workforce shrinks, but wages
are still well below those in the US,
Europe or Japan. The labour-intensive
textile industry has already moved to
lower-cost markets such as Vietnam or
Bangladesh, but for many other industries, especially electronics, China’s
ports, roads and clusters of supplier factories make it unattractive to move.
Minimum wages are $2.50 an hour in
the manufacturing hub of Guangdong
(versus $7.25 in the US), although many
workers earn more for overtime work
during peak order season.
The introduction of social security,
medical insurance and other programmes has raised costs, although
many factories skimp on these legally
required payments or deduct other, random fees, from salaries. They also hire
“interns” through vocational schools
who can legally be paid much less.
There is one labour cost that factories
are not able to dodge.
“Management salaries in China have
seen a large increase in the past decade,”
says David Alexander, whose Floridabased company BaySource Global
advises companies on offshoring.
“Where a mid-level manager may have
been paid $20,000 about 10 years ago,
that position is double that now.”
Additional reporting by Owen Guo
High stakes: Alibaba’s New York
IPO made Jack Ma China’s
richestman — Andrew Burton/Getty Images
Even the most optimistic
forecasters believe China
will keep slowing
direct investment (FDI) into China is
slowing sharply. In recent months, it has
fallen at the steepest rate since the
height of the global financial crisis, with
a drop of 14 per cent in August and a 17
per cent fall in July from the same
months a year earlier.
Apart from a drop during the financial
crisis, FDI inflows to China have grown
steadily since the country joined the
World Trade Organisation in 2001 and
reached a record $118bn in 2013, comContinued on page 2
Financial system in for
short-term shocks
Liberalisation plans aim
to foster longer-term
growth
Page 5
Internet giants train
sights on killer apps
Mobile gateway
developers become top
targets for acquisitions
Page 6
2
FINANCIAL TIMES
Tuesday 4 November 2014
Doing Business in China
Corruption a symptom of healthcare ills
Medical system Beijing
plans to improve care
for its 1.4bn citizens, but
distrust of private
hospitals is a hurdle,
writes Patti Waldmeir
Healthcare shortfall
Number of licensed doctors for
every 1,000 people
D
oing business in China
became that bit more
unpredictable when a court
hit UK pharmaceutical
company GlaxoSmithKline
with the largest bribery fine ever
imposed on a foreign company in China,
while GSK’s British head in China, Mark
Reilly, received a suspended three-year
prison sentence.
Four Chinese managers got sentences
of two to three years in a verdict handed
down in September. Their sentences
were also suspended, but the message
was clear, drug industry analysts and
insiders say. Foreign drug companies in
China can no longer turn a blind eye (or
worse) to sales staff who offer bribes to
doctors and hospitals that buy their
products.
Soon after Chinese police began investigating GSK in 2013, the company
stopped using individual sales targets as
a basis for calculating staff bonuses, globally as well as in China. Other multinational pharmaceutical companies in
China have not been so categorical, but
industry and legal sources say they have
all re-examined their compliance procedures to make sure they are not setting unrealistic sales targets that can
only be achieved through what are
euphemistically known locally as “commissions”.
But punishing one foreign drug company will hardly solve corruption in the
Chinese healthcare system, which has
eroded public trust in doctors and the
objectivity of their treatment choices.
Drug industry analysts, doctors and
hospital officials all say that local
generic companies are more profligate
with kickbacks than foreign companies,
and that the underfunded hospital system cannot function without them.
Local suppliers are still very dependent on such payments, despite the anti-
GSK
Case timeline
Number of outpatient visits
(bn)
2.5
8
2.0
6
2013: June 28 Police in Changsha
announce that GSK company
officials are under investigation for
alleged “economic crimes”.
July 2 The National Development
and Reform Commission, China’s
main economic planning agency,
announces a probe into the costs of
medicines at 60 domestic and
international drugmakers.
July 11 The Public Security Ministry
issues a statement accusing GSK of
bribing doctors to prescribe their
drugs and concocting a “huge
scheme” to raise drug prices.
4
1.5
2004
05
06
07
08
09
10
11
12
13
Source: China National Health and Family Planning Commission
New start: pharmaceutical multinationals have re-examined their compliance
procedures after GlaxoSmithKline was found guilty of bribery — Alexander F Yuan/AP
corruption campaign’s efforts to prevent bribery of staff at hospitals.
Many doctors say they cannot make
ends meet – or live a lifestyle commensurate with being a medical professional
– without accepting “gifts” from drug
companies, so their incentive to take
“commissions” will remain strong,
whatever the risk.
But bribes to doctors are far from the
only problem facing a medical system
that must serve 1.4bn increasingly
sophisticated, urbanised, demanding –
and elderly – patients. China’s leaders
have ambitious plans to improve both
the quality and affordability of medical
care, through complicated reforms of
the healthcare system including drug
price controls and a radical transformation of health insurance. However, none
of this will happen swiftly.
Beijing is certainly willing to spend
money on the problem, but in 2013
healthcare still accounted for only 6 per
cent of gross domestic product, according to national statistics, compared with
10-12 per cent in western Europe and
15-17 per cent in the US – and far less per
capita, according to McKinsey.
The government promised in 2009 to
provide universal, low-cost healthcare
within three years. Since then, 95 per
cent of the population has been given
basic health insurance. However, the
coverage is so limited that many families face crippling costs.
While public dissatisfaction is high,
Beijing sees improving healthcare as
critical to maintaining social harmony.
However, many interactions between
healthcare staff and patients are far
from agreeable, with hundreds of
attacks on healthcare workers every
month. Many doctors say the last thing
they want their children to do is study
medicine.
Beijing hopes to ease the pressures on
the public system by doubling the share
of private hospitals to 20 per cent by
2015 and private investors are eager to
jump on that bandwagon. Private
investment in the mainland healthcare
sector rose to an all-time high, with
deals worth $10bn last year, nearly five
times the 2006 figure, according to statistics from Dealogic. So far this year,
there have been another $7bn in deals.
But public distrust of private hospitals is a hurdle, and they struggle to
attract top-quality doctors, who prefer
the prestigious state system. Investors
may battle to identify potentially profitable deals in a sector where corruption
is rife and hospital finances are opaque.
Additionally, privatisation will not
solve the problems of corruption, overwork, low salaries and conflict in the
state hospital system – where most of
China will continue to receive its medical treatment.
Additional reporting by Zhang Yan
July 15 Police say GSK made “illegal”
transfers. Gao Feng, head of the
economic crimes investigation unit,
says four senior Chinese executives
from GSK have been held.
Aug 15 China’s State Administration
for Industry and Commerce says it
is investigating possible bribery,
fraud and anti-competitive
practices in a range of sectors,
including the drugs industry.
Dec 16 GSK says it is to scrap
individual sales targets for
commercial staff and will instead
link pay to improved patient care
and company-wide performance.
2014: Feb 4 GSK says sales of
medicines and vaccines in China fell
18 per cent in the fourth quarter of
2013, year on year, after falling 61
per cent in the third quarter.
May 14 Chinese police say their
investigation shows that GSK as a
company and individuals engaged
in bribery on a “massive scale”.
June 29 GSK says senior executives
had been sent a secretly filmed sex
tape of the company’s top manager
in China shortly before Beijing
opened its bribery investigation.
Sep 19 GSK says its Chinese unit
will pay a fine of about £300m after
it is found guilty of bribery.
Slowdown is
part of new
economic
narrative
Continued from page 1
merce ministry figures show.
But inbound FDI is not expected to
reach that level again this year and
accelerating outbound investment,
which hit $108bn in 2013, according to
the commerce ministry, is likely to overtake inbound investment within the
next year or two.
This trend of rising outbound and falling inbound investment suggests a different narrative from the dominant
international impression of a relentlessly rising China.
Charles Wolf, a China expert and distinguished chair in international economics at the Rand Corporation thinktank, argues that shifts in investment
patterns are important for judging economic prospects in a given market.
“If we look at inbound and outbound
FDI in China and we examine the rates
of change, we can see that outbound
Chinese investment to Europe and the
US is extremely positive, while inbound
FDI from those markets and elsewhere
to China is now quite negative,” he says.
“This shift is indicative of expectations regarding market opportunities
and GDP growth,” he adds.
In fact, from Beijing’s viewpoint, global perceptions of indomitable Chinese
strength seem somewhat far-fetched.
The country’s borrowing-to-GDP
ratio continues to rise rapidly, even as
growth continues to slow.
The world’s second-largest economy
is almost certain this year to report its
weakest annual expansion rate since
1990, when the country still faced international sanctions in the wake of the
Tiananmen Square massacre.
Owing to the stimulus measures Beijing introduced in the wake of the financial crisis, debt relative to GDP has
expanded from about 130 per cent in
2008 to more than 250 per cent by the
middle of this year.
No economy in history has experienced credit growth of that speed and
scale without suffering a financial crisis
and a protracted period of low growth.
China’s expansion is also being
dragged down by a prolonged correction in the property market, which has
been the single most important driver of
the economy for much of the past decade.
Even the most optimistic forecasters
Top of the world: Jack Ma’s Alibaba was the largest ever IPO — Andrew Burton/Getty Images
believe China will keep slowing in the
next few years, even if it is able fully to
implement a range of reforms intended
to rebalance growth away from an overreliance on investment towards consumption, particularly of services.
China faces double-digit wage
increases and indeed rising costs across
the board that are making the country
less and less attractive as the world’s
workshop.
But it is also becoming less attractive
as a market for global businesses and
not just because of the falling growth
rate.
Over the past year, many multinational companies have been hit by a
wave of state media attacks and opaque
regulatory investigations that have
$108
bn
China’s outbound
investment
last year
250
%
China’s debt
relative to GDP, up
from 130% in 2008
sometimes resulted in hefty fines.
Many of the world’s largest carmakers, household names from the world of
technology, such as Microsoft and Qualcomm, and a host of others from sectors
as varied as pharmaceuticals and baby
milk formula makers, have been investigated for alleged price fixing and
monopolistic activities.
The US and EU Chambers of
Commerce in China have strongly
criticised the heavy-handed “intimidation tactics” of the “discriminatory”
government campaign against their
members. They have warned that these
actions could violate commitments that
China made when it joined the World
Trade Organisation.
Jacob Lew, the US treasury secretary,
sent a letter to China’s leaders saying
such tactics could have serious implications for broader Sino-US relations.
Shaken by the criticism, Chinese premier Li Keqiang responded by saying
foreign companies have only been
involved in 10 per cent of the anti-monopoly cases brought under the current
campaign.
No other statistics are publicly available and the claim has been met by deep
scepticism among multinational executives, who point out that none of the
country’s large state-owned monopolies, which dominate most big industries, have been targeted.
Experts on China’s investment policies believe the investigations are part of
a broader trend that has developed as
the country has shifted from being a
cash-starved importer of capital to an
exporter of capital.
Lei Li, a Beijing-based partner with
the law firm Sidley Austin and a former
official in the legal department of
China’s ministry of commerce, declares:
“I can remember the good old days a
decade ago, when the Chinese authorities, particularly local governments,
welcomed almost any kind of foreign
investment.”
However, Mr Li says that since 2009
the government has become much
more selective about the kinds of investment it wants:
“It has imposed more and more conditions on foreign investment and has
actively discouraged certain kinds, such
as polluting, low-end manufacturing.”
Decades from now, the Alibaba IPO
will definitely be remembered as a historic symbol of changing fortunes and
shifting economic realities.
However, those shifts may not go
entirely in the direction most people
assume they are heading today.
3
FINANCIAL TIMES
Tuesday 4 November 2014
Doing Business in China
Antitrust fines
for foreign car
companies fail
to stall growth
Chinese antitrust fines
Largest fines, Rmb million
Sumitomo Electric and nine other parts suppliers (Japan)
1,240
Audi JV and dealerships (Germany)
278
Maotai (China)
247
Mead Johnson (US)
304
Fines paid
Rmb
Wuliangye (China)
202
Sales drive Price probe
has not dented profits,
reports Tom Mitchell
648.6m
Danone Dumex (France)
172
F
or multinational car companies operating in China, the
euphoria from the biggest ever
automotive boom in industrial
history is finally being tempered by some unexpected risks, most
notably a controversial investigation by
the National Development and Reform
Commission (NDRC) into allegedly
anti-competitive behaviour by Audi,
Mercedes-Benz and other brands.
The investigations have so far
resulted in fines that are peanuts in
comparison to the vast profits that foreign automakers have enjoyed over
recent years – and continue to enjoy.
In July, a joint venture between
Volkswagen unit Audi and state-owned
First Auto Works was ordered to pay
$41m for alleged violations of China’s
2008 Anti-Monopoly Law. This compares with reported operating profits of
$12.2bn for VW’s joint ventures in China
(its otheriswithSAICMotor) last year.
Fiat unit Chrysler was also hit with a
small fine this summer, while Daimler’s
joint venture with BAIC Motor, which
makes Mercedes-Benz saloons, is still
awaiting the outcome of an NDRC investigation after one of its Shanghai sales
offices was raided in July.
These fines are the byproduct of a
wide-ranging investigation that appears
to have a much larger aim – forcing car
companies, regardless of whether they
are in fact guilty of anti-competitive
practices, to lower the prices of their
vehicles, spare parts and services.
According to one industry executive,
the head of a multinational company’s
China operations has told visiting board
members that, in view of the NDRC’s
offensive, his biggest fear is of a sudden
shift in government policy. “It’s bad for
business,” the executive says of the
Investigations have so
far resulted in fines that
are peanuts in comparison
to the vast profits that
foreign automakers
continue to enjoy
investigation. “It has made the investment environmentveryuncertain.
“If people can afford the cars, they can
afford the spare parts and after-sales
service,” he adds. “It’s not like the NDCR
is lowering the price of medical care or
making food cheaper.”
Foreign automobile executives argue
that the relatively high prices asked for
cars – especially premium vehicles that
can be almost twice as expensive in
China as they are in the US – is a function
of unprecedented demand, even for
overseas models subject to expensive
import taxes.
China’s car craze began in earnest in
2008-09, during the depths of the global
financial crisis, when it overtook the US
as the world’s largest car market.
Demand from entire generations of
first-time drivers soared in the world’s
second-largest economy, just as purchasing power collapsed in the US and
Europe – a nadir symbolically marked
by Washington’s bailout of General
Motors in December 2008.
Over the ensuing half decade, foreign
carmakers in China, especially long
established ones such as Volkswagen
and GM, had a licence to print money.
Biostime (China)
163
LG (Korea)
118
Lucy Hornby
China correspondent
Patti Waldmeir
Shanghai correspondent
Gabriel Wildau
Shanghai correspondent
Charles Clover
Beijing correspondent
Tom Mitchell
China correspondent
Demetri Sevastopulo
South China correspondent
2,394.9m
Paid by foreign
companies
Samsung (Korea)
101
Total: Rmb 3,043.6m
Trading up: premium vehicles cost
almost twice as much as in the US
Even last year, when double-digit
annual growth was finally expected to
taper, annual sales grew by about 15 per
cent to 18m passenger cars – 10 times as
many as were sold in India.
This year began in similar fashion,
especially for foreign brands and their
Chinese joint venture companies. Sales
of Chinese brands, however, began to
fall sharply and their share of the passenger car market tumbled from 27 per
cent to 23 per cent.
The precipitous fall-off in sales of
local brands and slower economic
growth has forced the China Association
of Automobile Manufacturers to lower
its projection of an 8.3 per cent increase
in year-on-year sales this year to 4.6 per
cent – two-thirds down on last year.
In the first quarter, Geely, the private
sector carmaker most famous for its
purchase of Volvo Cars from Ford, saw
sales of its own-brand vehicles fall by as
much as 40 per cent over the same
period a year earlier.
This was despite a gradual improvement in the quality of local-brand cars
in China, according to Geoff Broderick
at JD Power, which publishes an annual
customer survey of 212 models across
62 brands. “The domestic brands are
doing exactly what they should be doing
– focusing on quality,” Mr Broderick
says. “But as we see the quality gap closing, we’re not seeing a pick-up in [local
brands’] market share.”
One reason for the fall has been a
counterintuitive NDRC requirement
that foreign-invested joint ventures
develop a local brand for the China market, such as the Baojun saloon manufactured by GM, SAIC and Wuling. Many of
these new entrants are priced to compete against domestic rivals, especially
in smaller cities where car ownership
rates are relatively low.
“I don’t understand what the Chinese
government’s objective was in encouraging foreign companies to create local
brands,” says Bill Russo, a Shanghaibased industry consultant.
“It only cannibalises already distressed sales of local brands. I think the
intent was for more technology to be
shared by the foreign companies. But
the unintended consequence is to take
volume from local carmakers producing
similar products,” he adds.
At the other end of the spectrum, foreign carmakers continue to thrive in saturated markets such as Beijing and
Shanghai, where premium brands such
as Audi, BMW and Mercedes-Benz
account for a quarter of the market.
Even now, limits on expensive new
licence plates to combat congestion and
pollution are spurring their sales, as
existing plate holders trade up.
“As cities implement plate restrictions, people gravitate towards premium foreign brands,” says Mr Russo.
“They want to put their expensive
plates on the best piece of automotive
technology that they can.”
Contributors
Jamil Anderlini
Beijing bureau chief
Paid by Chinese
companies
Jörg Wuttke
President of the EU Chamber of
Commerce in China
Adam Jezard
Commissioning editor
Steven Bird
Designer
Andy Mears
Picture Editor
For advertising details, contact:
Maralyn Ho +852 2905 5580; email:
maralyn.ho@ft.com,
or your usual FT representative.
All FT Reports are available on FT.com at
ft.com/reports.
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Source: China Central Television, NDRC
4
FINANCIAL TIMES
Tuesday 4 November 2014
Doing Business in China
Hong Kong Fears grow over impact on business of
electoral reform plans, reports Demetri Sevastopulo
Power of Beijing
looms large in
territory’s future
H
ong Kong has witnessed
the most heated debate
about its political future
since Britain handed the
territory back to China in
1997.
From the end of September, tens of
thousands of students and other pro-democracy demonstrators took to the
streets to oppose a controversial Chinese plan for electoral reform in the
former British colony.
The protesters were so successful in
blocking traffic in a crucial commercial
district that they sparked concerns
about the impact on the economy and
the city’s reputation as a leading financial centre.
The Occupy movement even
prompted a rare intervention from Li
Ka-shing, Asia’s richest man, who urged
the students to return home.
“We understand student passion, but
your pursuit needs to be guided by wisdom,” the Hong Kong tycoon said
recently. “It would be Hong Kong’s greatestsorrowiftheruleoflawbreaksdown.”
So far, few protesters appear to have
listened, partly because one of their
main concerns is that the Chinese plan
allows the elites who wield power in
Hong Kong to retain far too much influence at the expense of the public.
In August, China followed through on
a promise to introduce universal suffrage – one person, one vote – for the
election of Hong Kong chief executive,
the top political job, in 2017. It has urged
people in Hong Kong to support the plan
– which requires approval from Hong
Kong’s legislature – on the grounds that
it provides them with a greater political
voice than was available during the British colonial period.
But critics say tough conditions that
Beijing included in the plan mean it
amounts to nothing more than “sham
democracy”. Those concerns morphed
into the physical protests that forced the
closure of traffic arteries in the Admiralty district and other shopping and
entertainment areas in what has been
dubbed the “umbrella revolution” after
demonstrators huddled under umbrellas during downpours.
While many business people say privately the protests could do lasting damage to the city’s reputation, few have
Tide of opinion:
while many
Hong Kong
people are
sympathetic
towards the
protesters, few
have been
willing to speak
out publicly – AFP
been willing to speak out. Some are concerned about generating anger among
the protesters that might be directed at
their businesses.
Following a visit to Hong Kong,
Stephen Roach, a senior fellow at Yale
University’s Jackson Institute for Global
Affairs and a former Morgan Stanley
Asia economist, said that while the protests were still causing a little inconvenience, they were “not a big deal” in
terms of economic impact.
Mr Roach said the bigger question was
whether there would be any long-term
impact on Hong Kong’s reputation as a
business hub. At the height of the protests when masses of people were demonstrating on the streets, he said there
were signs multinationals might start to
look at places such as Singapore as an
alternative, but “now that the intensity
has diminished, I don’t think it is going
to be a significant factor”. He added that
as long as the confrontation did not lead
to “extreme” police action, “the reputational impact will be minimal”.
Some people who are sympathetic to
the protesters fear that speaking publicly would earn them the wrath of
China, on which they increasingly rely
for business deals. For example, Jimmy
Lai, the Hong Kong media tycoon who
owns the anti-Beijing Apple Daily newspaper, has accused the Hong Kong government of persecuting him in the wake
of a move by the anti-graft agency to
investigate payments he made to democratic lawmakers who are critical of Beijing. Apple Daily has also accused Standard Chartered and HSBC of pulling
advertising because of pressure from
Beijing, claims both banks have denied.
Even before China unveiled its controversial plan, a Chinese official speaking in Hong Kong gave an unusual warning – for a senior Communist party
member – that the territory’s famed
capitalist system could come under
threat if protesters followed through on
their threat to occupy the city.
Under the current electoral system,
an elite committee of 1,200 people who
are mostly loyal to Beijing, elect the
chief executive. Beijing is prepared to let
5m people in Hong Kong vote for their
leader, but is not prepared to give the
public a role in choosing the candidates.
The leaders of the democracy move-
Beijing
is not
prepared
to give the
public a role
in choosing
the
candidates
ment in Hong Kong argue that, as a
result, the plan on offer does not
amount to “genuine” universal suffrage.
China has also ruled that potential
candidates must secure support of a
majority of a nominating committee
that is expected to resemble closely the
current 1,200-member election committee. At present, candidates need support of only one-eighth of committee
members – a formula that has allowed
opponents of the Communist party
twice to get on the ballot. Critics say the
new proposal would be more restrictive,
giving Beijing even more scope to ensure
itscriticscouldnotrunforelection.
At a rally on the day that China
unveiled its electoral reform plan, Martin Lee, the founder of Hong Kong’s
Democratic party, summed up the concerns of critics when he said the people
of Hong Kong wanted “genuine universal suffrage and not democracy with
Chinese characteristics”. “Hong Kong
people will have one person, one vote,
but Beijing will select all the candidates
– puppets,” he said. “What is the difference between a rotten apple, a rotten
orange and a rotten banana?”
Hermès takes long view to feed
appetite for understated style
Luxury case study
Even as Beijing cracks down
on extravagance, brand holds
its appeal for sophisticates,
writes Patti Waldmeir
Luxury goods were the currency of
Chinese corruption for decades, until
Beijing stepped in two years ago to block
the flow of fine baubles into the hands of
government officials – and stem the
flood of profits into the coffers of luxury
goods companies.
Hermès, the luxury dynasty best
known for its sought-after Birkin and
Kelly handbags, is one of the few luxury
brands that has prospered despite Beijing’s abstemiousness campaign.
“So far we haven’t seen any impact on
ourfigures,”saysAxelDumas,chiefexecutive of Hermès and scion of the foundingfamily.
The French company does not break
out mainland sales, but sales in Asia
(excluding Japan) rose 17 per cent in the
first half of 2014, while first-half sales for
its rival LVMH in Asia (excluding Japan)
wereuponly3percent.
And despite the generally gloomy
atmosphere around luxury in China
these days, in September Hermès
opened its first mainland maison, in
Shanghai, to complement those in Paris,
New York, Tokyo and Seoul.
It might seem like the worst time to do
such a thing, but Mr Dumas is not in the
least bit worried. That could just be the
self-confidence that comes with representing the sixth generation of the company’s founding family. But it is more
likely that his optimism reflects a more
important underlying fact about why
the French luxury group continues to do
well in the middle kingdom, despite the
most challenging luxury market conditions in a decade.
Hermès represents what China
aspires to be: not just another nouveau
riche nation with more money than
taste, but a country of sophisticated
affluence and understated extravagance.
Mr Dumas thinks time is on the company’s side, as Chinese consumers outgrow their tendency to show off with
luxury brands and develop an appetite
for savouring them.
Most retail analysts agree: Chinese
consumers are growing keener on niche
Lap of luxury: Hermès’ Shanghai maison took seven years to build
top-level brands such as Hermès and
less fond of logo-laden, mass luxury
rivals such as LVMH and Gucci.
Torsten Stocker, retail partner at
consultancy AT Kearney in Hong Kong,
says: “Hermès’ more classic style fits
well with the high-end Chinese
consumer’s shift to less ostentatious
items.” Cao Weiming, Hermès head in
China, agrees: “Two to three years ago,
we started to see some changes, even
Hermès represents what
China aspires to be: not just
another nouveau riche
nation with more money
than taste, but a country of
understated affluence
before the anti-corruption campaign
began, as the market moved naturally
toward greater sophistication, where
consumers are more brand-knowledgeable than show-off.”
That transformation will take time;
but that is one thing the French house
prides itself on having.
It takes many years to train its craftsmen. It takes forever to get through the
waiting list to buy a Birkin bag. It even
took seven years to build the Shanghai
maison.
Mr Dumas points out that his family’s
connection with China stretches a long
way back: his grandmother, who was
born in the early 20th century, when
many French writers and artists
indulged a passion for the “far east”, was
a fan of mah-jong.
Gestures toward that Chinese heritage pepper the Beijing store, including
horse-themed dinnerware for the current lunar year of the horse.
Indeed, Hermès is so keen on winning
over this market that four years ago it
launched its own Chinese luxury brand,
Shang Xia– one of the few mainland
brands that celebrates its Chineseness,
rather than apologising for it.
Everything in the Shang Xia collection of clothing, jewellery, furniture and
objets d’art has a story: a cashmere felt
coat is inspired by the wool felt saddle
blankets used by Mongolian horsemen;
a jade “ladder to heaven” necklace echoes the bamboo undergarments worn in
imperial China to keep heavy ceremonial fabrics away from sweaty skin.
It is the first Chinese lifestyle brand
built from the ground by a leading European luxury house. Making it a success
will take time, even decades.
Additional reporting by Zhang Yan
5
FINANCIAL TIMES
Tuesday 4 November 2014
Doing Business in China
Liberalisation threatens stability in the short term
Finance Policy makers
set sights on long-term
growth and patient
investors will find
plenty of opportunities,
writes Gabriel Wildau
G
lobal financial institutions
are hoping that China’s
pledge to liberalise its
financial system will bring
opportunities in a market
that has long stymied their efforts to
gain a foothold.
Their hopes for swift progress may be
dashed, however, as risks from within
the system are likely to encourage policy makers to apply the brakes on
reform. Last November, Communist
party leaders approved a landmark
agenda that included pledges to deregulate interest rates and liberalise the flow
of investment funds in and out of the
country.
Their goal was to improve the allocation of financial resources and correct
distortions in the economy, putting the
country on a secure footing for several
more decades of rapid growth. For
instance, a cap on bank deposit rates has
encouraged excessive investment in
infrastructure and manufacturing by
keeping borrowing costs artificially low.
Meanwhile, overinvestment has led to
rampant overcapacity in sectors such as
steel, cement and non-ferrous metals,
creating a host of unprofitable firms and
imperilling the financial sector, as lossmaking companies fail to repay debt.
At the same time, restrictive capital
controls preventing Chinese citizens
from moving funds abroad have
trapped savings inside the nation’s borders, further contributing to wasteful
domestic investment. This liquidity has
also helped inflate a housing bubble, as
savers – prevented from buying foreign
assets and wary of the casino-like
domestic stock market – have embraced
bricks and mortar as an investment
rather than just a place to live.
Deregulation of rates, when it finally
occurs, should play to the advantage of
foreign banks and joint-venture broker-
Freer capital
flows will
open the
door to
capital flight
if investors
lose
confidence
in the
economy
ages operating in China, which are experienced at managing interest-rate and
foreign-exchange risk. They should also
be able to earn profits dealing in derivatives to help clients manage such risks.
Freer capital flows would also create
opportunities for foreigners, especially
overseas asset managers that will enjoy
increased access to mainland capital
markets. But such freedom may still be
years away.
Currently, foreign investors are
allowed to buy only into China’s domestic stock and bond markets under a strict
quotasystemthatseverelylimitsaccess.
By comparison, direct investment,
which involves buying an overseas company outright or starting an enterprise
from scratch, is relatively more open,
but still subject to government
approval.
John Greenwood, chief economist at
Invesco, a UK-based fund manager,
says: “The gradual relaxation of capital
controls should bring multiple opportunities to asset managers, but we must
China’s rising debt load
Total social financing stock by type, as a % of GDP
Critics are disappointed,
one year on, at the slow pace
of change in this important
test area for reforms,
writes Gabriel Wildau
A year after the launch of the Shanghai
“free trade zone”, hailed as a laboratory
for ambitious economic and financial
reforms, many investors are disappointed at the slow pace of change.
However, while critics rightly note
that precious few business and investment activities are currently permitted
in the zone (known as the FTZ) that are
not also allowed in the rest of China, it is
too early to dismiss it as a failure.
The government has used its first year
to establish a regulatory framework for
further liberalisation of rules on foreign
direct investment and cross-border capital flows.
Meaningful deregulation under this
framework has been slow, but with the
basic infrastructure now in place, the
government could proceed quickly to
loosen capital controls or open to foreign investment industries that were
previously off-limits.
“We still hold the view that the Shanghai FTZ and other [similar zones] will
be an important test ground for China’s
capital account convertibility,” says Ju
Wang, senior foreign exchange strategist at HSBC.
“Over time, we can expect companies
and individuals within the zone to be
able to conduct free borrowing and
lending activities as well as portfolio
investments.”
Full convertibility would enable
investors to exchange renminbi
freely for foreign currency for the
purpose of either portfolio or direct
investment, without being subject to
quotas and onerous administrative
approvals.
Last December, the central bank’s
Shanghai branch issued rules establishing a system of special FTZ bank
accounts. Moving funds between these
and offshore accounts is already possible with few restrictions, but
transfers between FTZ
Han Zheng:
no finance for
finance’s sake
Preferential policies
in the zone
• Simplified company registration:
a “one-stop shop” for all steps in
the process.
• Approach to foreign investment.
All industries not on the “negative
list” are open to foreigners.
• Investment in sectors not on the
list via a simple registration system;
no advance approvals necessary.
• Simplified procedures and less
red tape for customs, shipping and
logistics to make merchandise
trade more convenient.
• Unrestricted transfer of funds
between FTZ bank accounts and
offshore accounts.
• Suspension of 14-year ban on
games consoles, which can be
produced in the zone and sold
throughout China.
– Qilai Shen/Bloomberg
150
100
50
0
2002 03
04
05
06
07
08
09
10
11
12
13
Source: CEIC
accept that these changes will be slow in
coming. Nevertheless, since the Chinese
market has huge potential, it is worthwhile being patient.”
The problem is that such reforms,
while they will aid long-term growth,
are likely to be destabilising in the short
term. That is a problem for China’s
Authorities are taking a cautious
approach to Shanghai test ground
Trade zone
200
Entrusted loans, corporate bonds, nonfinancial equities, and others
Bank and trust loans to local governments
Bank and trust loans to corporates, households
accounts and the rest of China remain
tightly controlled.
Yet, with the FTZ account system now
in place, the ground is prepared for further opening up of the system. Officials
have said they are preparing stress tests
to gauge the impact of freer capital-account flows.
Nonetheless, investors should be
under no illusion that the authorities
will allow unfettered flows for financial
investment any time soon.
Han Zheng, Shanghai Communist
Party secretary, said recently: “Convertibility under the capital account does
not equate to full convertibility under
the capital account. These are different
concepts.”
He added: “We are opening up capital
account operations directly serving the
real economic growth, instead of
finance for the finance’s sake.”
Another example of the government’s
cautious approach to reforms in the
zone is the much-touted “negative list”.
For years, China has regulated foreign
direct investment by publishing a catalogue that categorises each sector of the
economy as either “encouraged”,
“restricted” or “prohibited”.
The FTZ has established a mirrorimage system for regulation of foreign
investment. All industries not included
in the negative list are permitted for foreign investment.
Like the FTZ bank account system,
the negative list has delivered few practical results so far.
‘It is not a matter of two or
three years: many things
need to be done’
The initial version of the list contained 190 items, making foreign investment in the zone barely less restrictive
than in the rest of China.
In late June, the government trimmed
51 items from the list, opening sectors
including real estate, oil exploration
technology, and chemicals. Officials say
that the negative list is likely to be shortened further in the coming years.
Yang Xiong, Shanghai’s mayor, has
said: “It is not a matter of two or
three years. Many things
need to be done. But
from a long-term perspective, it is the right
path.”
Patience pays:
investors
monitor stock
prices in
Shanghai
stability-obsessed leadership, which is
therefore likely to implement them
more slowly than the most zealous
advocates of reform would prefer.
Once banks are forced to compete for
depositors’ funds, interest rates will
rise. That will be painful, given the large
increase in corporate and local govern-
ment debt since the global financial crisis. Rising rates will also increase the
cost of servicing debt, potentially sparking a wave of defaults.
Freer capital flows will open the door
to capital flight if investors lose confidence in the economy. Such a scenario is
all the more likely if rising interest rates
spark a wave of defaults among highlyindebted corporate borrowers.
To be sure, China has already taken
cautious steps to open its financial system. A new programme will allow Hong
Kong and Chinese investors to buy into
each others’ stock markets.
However, this scheme is subject to a
strict quota, and authorities have made
it clear that “capital-account convertibility” – the technical term for freeing
cross-border investment flows – does
not mean it is open season for speculative capital to slosh in and out of the
territories. “A rapid opening up could be
highly destabilising for the economy, so
we understand the caution of the
authorities,” says Mr Greenwood.
6
★
FINANCIAL TIMES
Tuesday 4 November 2014
Doing Business in China
Internet titans
focus on staying
ahead of mobile
revolution
Technology Charles Clover says search for gateway
apps is driving acquisitions in a dynamic industry
T
he listing of Alibaba in New
York in September created
the world’s second-largest
internet company by market capitalisation, behind
Google. This did not happen by accident. Of the top10 internet companies
in the world, ranked by market cap,
three are Chinese, and the rest are from
the US.
Together, Baidu, Alibaba and Tencent
form what is know in China as “BAT”.
These economic juggernauts that have
come to dominate the internet in China
are operating almost along the lines of
Japan’s keiretsu, which are alliances of
businesses with similar interests or that
have shareholdings in one another.
They are also rapidly branching out into
offline sectors, such as transport, travel,
retail and banking.
Whether the rapid growth of the Chinese internet is just a bubble or a stable
trend is open to question. However, for
the time being at least, BAT has become
the nucleus of an internet industry that
is starting to rival the US, creating what
is essentially a US-China duopoly. The
three Chinese companies also benefit
from what has become known as the
“Great Firewall”, as most of the top US
companies, such as Google, Facebook
and Twitter, are excluded from operating in China.
However, no Chinese internet company has yet made the leap from China
to become a global brand. For now, it is
enough for them be dominant in China,
which had 632m internet users as of
June, 527m of whom go online using
mobile devices. The potential of the
forecast consumption boom, as China
moves from an investment-driven economy to a consumption-driven one, is
enough to attract investments such as
the $25bn sunk into Alibaba in its initial
public offering, the largest ever.
The internet is the most dynamic part
of China’s budding private sector,
though it remains solidly under the control of the state. Foreigners hold large
shareholdings in Alibaba, Tencent and
Baidu and dozens of other internet companies. But these stakes are largely theo-
Changing times:
of the 632m
internet users in
China, 527m go
online using
mobile devices
Ed Jones/AFP/Getty Images
retical at best and owned via “variable
interest entities”, or VIEs, which guarantee a payment stream from, but not
ownership of, the licence-holding vehicles in China. These VIE’s are technically illegal, though Chinese courts turn
a blind eye to the practice, and owners
know their large holding only exists
thanks to the tacit consent of the state.
Nimble private internet companies,
able to dance circles around the inefficient state-owned enterprises, have
begun impromptu liberalising of whole
sectors such as financial services. Alibaba’s fund company Yu’e Bao is China’s
biggest online money market fund, with
Rmb574bn ($93.8bn) worth of assets
The internet is a phenomenal wealth
generator. Five of the 10 richest men in
China are tech moguls, up from none
three years ago, according to the Hurun
China Rich List, which tracks wealthy
individuals. In September, Alibaba
founder Jack Ma joined the list in first
place and became one of the wealthiest
men in the world, with a 7.8 per cent
stake in a $230bn company.
China needs to be placed at the top of
the European Commission’s ‘to do’ list
OPINION
Jörg
Wuttke
Ukraine will undoubtedly be the main
foreign policy focus for the European
Commission’s newly appointed leaders.
The importance of this immediate
neighbour to the east is obvious. But
Jean-Claude Juncker and his
administration should place equal – if
not greater – emphasis on a country
this lies even further east.
With the EU exclusively responsible
for foreign trade and investment
matters since the entry into force of the
Lisbon Treaty in late 2009, the bloc’s
relations with China should be
prioritised to reflect the country’s size
and its restrictive investment
environment.
China has contributed substantially
more to the world’s economic growth
than any other country since the global
economic crisis and it has become its
largest economy in purchasing power
parity terms. Yet China has long
adopted an idiosyncratic approach to
foreign investment.
Unlike the EU, which does not even
have a term for classifying investment
within its borders as “foreign”, China
retains a distinction between external
and domestic investment. In doing so,
it places conditionality on the opening
of its marketplace by prescriptively
laying out conditions that accept
foreign investment only where it is
perceived to serve specific domestic
industrial policies.
The vast reform agenda outlined a
year ago in the so-called Decision of the
Communist Party Central Committee’s
third plenary session was therefore
welcomed by European industry in
China for its breadth and boldness. If
implemented resolutely, its emphasis
on further opening up of its markets
could rebalance China’s increasingly
precarious economy and level the
playing field for European and other
foreign companies. While this
demonstrates the political will of
China’s leaders to push reforms,
these will not come into
force overnight.
Jean-Claude Juncker:
setting tone for future
engagement
The recent spate of investigations
into antitrust violations indicates that
problems will continue to arise. One is
how China investigates tax collection,
particularly among foreign companies.
The EU’s leaders should be mindful of
these difficulties when working out
how to engage with China.
Foreign businesses have developed a
justified wariness of speaking out on
controversial topics.
So, when the European chamber
became the first association to express
concern openly about the opacity and
lack of due process in China’s
enforcement of its competition law
over the past year and a half, it was
praised for being courageous.
Foreign industry needed to voice its
concern, for reasons that go well
beyond today’s investigations. But this
China is now an economic
superpower that helps
shape global practices
and invests overseas
should not be done to disparage China’s
efforts to improve how it applies its
laws. China’s antimonopoly law is one
of the cornerstones for strengthening
exactly those conditions that are
required to rebalance and upgrade the
economy.
However, non-adherence to legal due
processes in antimonopoly
investigations risks a situation whereby
administrative power not only
perversely distorts competition but, in
a wider context, endangers the
credibility of China’s attempts to be
more open and its ability to let the
wider market place have a bigger role
in the economy.
China improved the positive
sentiment among foreign companies to
an all-time high following the third
plenary session last year. It would be a
shame if the praise it has earned for
this important policy direction is
undermined by poor execution.
The antimonopoly investigations
show that the EU’s political leadership
must be ready to engage head on with
China on politically prickly trade and
investment issues. Such a strategy
must be built on a deep and studied
understanding of the country’s
business environment. The European
parliament ought to look closely (and
regularly) at Beijing’s trade policies
and actions – as happens in the US – in
order to make the informed decisions
needed to engage with China.
At stake are millions of European
jobs, a substantial contribution to
economic growth, our ability to
innovate and the multiple benefits our
relationship with China has brought.
As China is now an economic
superpower that increasingly shapes
global practices and invests overseas, it
is high time that engagement with the
country commands the priority it
merits across all the EU’s institutions
and member states.
This means that the European
parliament, the 28 member states and
the European Commission speak with
one voice and avoid temptations to
bow down to China’s economic might
in return for short-term gains at the
expense of a unified and resultsorientated strategy.
Europe’s change in leadership
provides an opportunity for this
readjustment of its strategy with China.
The opportunity within that
opportunity is the EU’s continuing
negotiation of an ambitious bilateral
investment agreement (BIA) with
China. The negotiations represent the
most important engagement with
China on trade and investment policy
since China’s accession to the World
Trade Organisation in 2001.
They also present the EU with a
prime opportunity to set the tone for a
constructive engagement with China.
As explained in the EU-China 2020
Strategic Agenda for Cooperation,
the successful conclusion of a
comprehensive BIA would convey
China’s willingness to engage in a
deep and comprehensive trade
agreement with the EU.
The writer is president of the EU
Chamber of Commerce in China
Competition between internet companies is fierce, however. With the
entire industry switching from desktop
devices to mobile ones, many companies risk being left behind if they don’t
have a “killer app” that will act as a gateway for mobile users.
Alibaba has been searching for just
such a feature to challenge the currently
undisputed leadership of Tencent,
whose WeChat instant messenger has
350m monthly users. WeChat and Tencent’s other messenger, QQ, are the two
most popular mobile apps in China,
according to iResearch, a Beijing-based
internet research firm.
In June, Alibaba bought UCWeb, a
popular mobile browser company, and
the two have developed Shenme, a
mobile search engine. They are also
working with Quixey, a US-based company in which Alibaba has invested, to
design a mobile gateway using Quixey’s
app search engine. Francis Bea of PapayaMobile, a Chinese mobile technology
company, says Alibaba is attempting to
mirror Tencent’s success with WeChat.
‘There is
potential for
the mobile
internet to
disrupt the
established
internet
players’
He says: “In as highly competitive a
market as China, there is potential for
the mobile internet to disrupt established internet players if they don’t
manage the transition from desktop to
mobile.”
Alibaba has spent an estimated
$6bn-$8bn in the space of a year on full
acquisitions of, or investments in, companies including mobile providers,
chain stores, an internet TV company, a
maker of electrical appliances, a movie
producer, a digital broadcaster and a
professional Chinese football team.
While attention has focused on Alibaba’s acquisitions, Tencent and Baidu
have been on similar spending sprees.
Baidu is betting that its stake in Qunar,
China’s top travel website by users, and
mobile app store 91Wireless.com, will
complement its popular search engine
to carry it into the mobile age. Tencent
has taken a stake in JD.com, China’s second-largest ecommerce platform, and
mobile-friendly companies such as restaurant review site Dianping and South
Korea’s CJ Games.