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WTO: China Enters Year Three

China has many new commitments to fulfill—and some catching up to do—during its third year as a WTO member

by Julie Walton

China began its third year as a World Trade Organization (WTO) member on December 11, 2003. That day, the clock started ticking on China's year-three commitments under its Schedule of Specific Commitments on Services—and all year-two commitments were to have been in place. On January 1, 2004, WTO-mandated tariff reductions for goods took effect.

But two years into China's WTO membership, the PRC government has been slow to implement its most significant commitments, and no progress has been made in some important areas. China has fallen into a pattern of renegotiating its WTO entry terms line by line as questions arise about implementation problems. China's interpretations of certain WTO terms violate the spirit, if not the letter, of its commitments, and new barriers China has erected in some areas make matters worse. Will China be able to pick up the pace in year three—a year with a heavy schedule of commitments and high expectations for rules in many areas, including trading rights and direct selling?

More service commitments to phase in

China's commitments to expand foreign participation in services are of major importance to foreign service providers in all industries. Though some year-two commitments remain outstanding (see Box 1), China must implement a range of new commitments before December 11, 2004. China is expected to issue a series of new regulations in the coming months to address these requirements.

• Trading rights

Foreign companies' right to import and export goods—a key element of all WTO agreements—has been a weak spot in China's implementation efforts. Joint ventures with minority foreign stakes should have been granted full trading rights by December 11, 2002. But regulations that conferred this right did not appear until February 2003 and were so vague that companies found it difficult to structure their operations. The rules did not clarify how existing foreign-invested enterprises (FIEs) could obtain trading rights, nor did they state that the granting of trading rights would be automatic. Meanwhile, in June 2003, China granted full trading rights to all enterprises, including FIEs, in Futian-Shatoujiao, Tianjin, Waigaoqiao, and Xiamen Xiangyu free-trade zones.

Further progress appears close at hand. In November 2003, the State Council approved revisions to the Foreign Trade Law. As the CBR went to press, details of the revised Foreign Trade Law had not yet been released, but there are indications that the procedure for granting import and export rights will be revised to eliminate the examination and approval process, as China's WTO commitments require. The new process will simply involve filing an application with relevant authorities, after which import and export rights will be added to the scope of existing business licenses. But because the National People's Congress was scheduled to meet at the end of December—after the December 11, 2003 deadline for China to grant majority-owned joint ventures trading rights—this deadline passed without the issuance of corresponding and vital implementing rules.

China also committed to allow domestic companies increased access to trading rights by progressively lowering registered capital requirements. In year three, the required registered capital for domestic Chinese trading companies should fall from $360,000 in year two to $120,773.

• Distribution and related services

China has agreed to implement a number of important commitments in the areas of retailing, wholesaling, and commission agents' services, and franchising by December 11, 2004.

Although a year late, a recently circulated draft of the Ministry of Commerce's (MOFCOM) Management Regulations on Foreign-Invested Commercial Enterprises may finally bring China up to date with many of its distribution-related WTO commitments and put it on track to meet its December 11, 2004 obligations. The draft covers Sino-foreign equity/cooperative joint ventures or wholly foreign-owned enterprises engaged in domestic retail, wholesale, commission agents', or franchising businesses. Though the draft does not clearly state whether an existing FIE can obtain distribution rights, it allows FIEs to establish companies to distribute their imported or China-made products. The draft also does not address direct selling, which China's WTO commitments define as one type of distribution service; MOFCOM is drafting a separate rule to address this industry. The draft regulation must be submitted to the State Council for final approval. The State Council has not yet indicated when it will issue the regulation.

Retail China has agreed to allow foreign majority control of retail operations by December 11, 2003 and to allow wholly foreign-owned enterprises (WFOEs) by December 11, 2004. Majority foreign investment in chain stores with more than 30 outlets will remain prohibited until 2006. All remaining geographic restrictions covering China's retail sector should be removed by the end of 2004. China has also agreed to remove remaining product-specific restrictions. In other words, by the end of year three, foreign retailers will be allowed to sell pharmaceuticals, pesticides, mulching films, and processed oil in addition to other goods.

The PRC government made some progress in opening the retail sector in March 2003 when MOFCOM (then the Ministry of Foreign Trade and Economic Cooperation) and the General Administration of Press and Publication (GAPP) published a rule that permits WFOEs in China's retail book, magazine, and newspaper distribution sector. USCBC sources confirm that, in principle, the new rule opens investment in retail distribution of publications ahead of schedule. The new rule requires $600,000 in registered capital for retail operations, and legal representatives and professional staff must possess publication distributor qualification certificates issued under existing rules. The new rule also allows for the provision of Internet publication sales, chain stores, and reader's clubs. Foreign investment in existing publication distributors, including state-owned enterprises, is also allowed. In December 2003, Germany's Bertelsmann AG took a 40 percent stake in Beijing 21st Century Book Chain, a nationwide bookseller.

Wholesale and commission agents' services Foreign companies are to be allowed to establish wholly foreign-owned wholesale operations by December 11, 2004. The wholesale distribution of books, newspapers, magazines, pharmaceutical products, pesticides, and mulching films, which had previously been restricted, is also to be permitted. The March 2003 rule that opened the distribution of publications does not apply to wholesale operations until December 1, 2004; China must allow investment via all types of ownership for wholesale distribution of publications by December 11, 2004. The distribution of chemical fertilizers and processed and crude oil will remain closed until December 11, 2006.

GAPP appears to be progressing toward the 2004 wholesale operation liberalization deadline. The agency published the Regulation on Administration of Printed Publications, which addresses verification of domestic publishing licenses, registration of printed matter, publication storage and delivery, and disposal of low-quality publications, September 1, 2003. GAPP also authorized Guangzhou-based Wende Guangyun Media Distribution Group as the first private book distributor on September 19, 2003, in line with the September 1 regulation. Prior to that decision, book distribution had been reserved for the State Postal Bureau, Xinhua General Bookstore, and state-run publishing houses.

Franchising China committed to lifting all equity, geographic, or quantity restrictions on franchising operations by December 11, 2004. According to the state-run China Chain Store and Franchise Association, rules that would remove existing restrictions are being drafted.

Wholesale or retail away from a fixed location Because China has prohibited direct selling, its commitment to remove all equity, geographic, and quantitative restrictions on sales away from a fixed location by December 11, 2004 is significant for companies that use direct selling as their business model. Regulations are currently in the works, though copies have not been widely circulated for public comment.

• Telecom

The problems that foreign telecom service providers have faced in accessing China's market should improve in year three as foreign companies will be permitted to establish joint venture operations in domestic or international data services (such as voice, packet- or circuit-switched transmission, and fax) without quantitative restrictions in Beijing, Guangzhou, and Shanghai—though the foreign investment share may not exceed 25 percent. Foreign companies will be able to invest up to 49 percent in mobile voice or data service joint ventures.

After an extended period with no new approvals of foreign investment in China's telecom sector, four Sino-foreign joint ventures were approved in 2003, all of which provide Internet access services.

• Financial services

China's WTO commitments required significant openings to foreign investment in the banking, insurance, and securities sectors during the first few years of China's WTO membership. A number of these commitments will phase in during 2004.

Banking By December 11, 2004, foreign companies should be able to participate in local currency business in Beijing; Kunming, Yunnan; and Xiamen, Fujian, raising the total number of cities open to this service to 16—up from the 13 cities that were opened before December 11, 2003.

Insurance Foreign providers' business scope is to expand in year three to allow FIEs to provide health, group, and pension/annuities insurance to both foreign and Chinese clients. All geographic restrictions will be lifted, and foreign partners in insurance brokerage joint ventures may raise their stakes to 51 percent. All reinsurance companies in China were required to reinsure 10 percent of their primary risk with China Reinsurance Co. beginning December 11, 2003; the requirement will drop to 5 percent by December 11, 2004.

Securities Foreign securities houses are to be permitted to establish joint ventures—with a limit of 33.3 percent foreign investment—to underwrite A shares and to underwrite and trade B and H shares, as well as government and corporate debt, in year three. No Chinese intermediary will be required. Foreign companies should be able to establish domestic securities fund management joint ventures, with investment limited to 49 percent in year-three. China's October 2003 Securities Investment Funds Law puts the country on track to fulfill this commitment.

Although China's WTO commitments did not require this liberalization, China launched a qualified foreign institutional investor plan in 2003 that opened China's renminbi-denominated, domestic A-share market to foreign investors. To date, Citigroup Inc., Deutsche Bank AG, Goldman Sachs Group, Inc., HSBC Holdings plc, ING Groep NV, JP Morgan Chase & Co., Morgan Stanley, Nomura Holdings, Inc., and UBS AG are among the foreign companies that have received approval to participate.

• Autos

China has committed to raise the level of auto manufacturing investment that requires provincial government approval to $90 million. This act will reduce the number of bureaucratic hoops that companies must jump through to establish manufacturing operations.

Though almost two years late, the China Banking Regulatory Commission issued regulations governing foreign nonbank investment in the auto financing sector in September 2003. The price of entry, however, is quite high. Companies seeking to establish new auto finance companies must possess at least ¥4 billion ($483.1 million) in assets, and the auto finance company itself must have paid-in capital of at least ¥500 million ($60.4 million). Other concerns with the auto finance rules include a prohibition on establishing branch offices, ambiguities in the approval process, and limitations on the scope of activities permitted.

• Tourism

China accelerated compliance with its WTO commitments in the tourism industry by two years when it issued regulations in June 2003 that permit wholly foreign-owned travel agencies to operate in China. The regulation covers only foreign-majority joint venture and wholly foreign-owned travel agencies established before December 11, 2007, when all geographic, registered capital, and branch restrictions are due to be lifted. Like the Management Regulations on the Administration of Travel Agencies, which opened the sector to minority foreign ownership in early 2002, the new regulation requires foreign-invested travel agencies to have at least ¥4 million ($483,092) in registered capital and does not permit foreign-invested travel agencies to open branches. The new regulation also requires the foreign party in a joint venture to have an annual income from tourism of more than $40 million, a restriction included in China's WTO entry agreement. Unlike the management regulation, the new regulation restricts foreign investors to an investment in one foreign-majority joint venture or wholly foreign-owned travel agency. According to China's WTO commitments, foreign-majority joint venture or wholly foreign-owned agencies cannot be established outside of State Council-approved resort areas and Beijing, Guangzhou, and Shanghai, and Xi'an, Shaanxi—although investment by such FIEs in Shenzhen is now permitted.

Though no foreign company has yet been approved to set up a wholly foreign-owned travel agency, German-based Touristik Union International recently became the first foreign company to have a controlling stake in a Sino-foreign travel joint venture.

• Repair, maintenance, rental, and leasing

In 2004, WFOEs are to be permitted in the repair/maintenance and rental/leasing sectors. MOFCOM stated in late October that it would release new regulations before the end of 2003 that permit wholly foreign-owned leasing operations. But MOFCOM also stated that, at first, only a few wholly foreign-owned leasing companies would be permitted to operate in China. Given the high capital requirements the PRC government has mandated in other sectors, China may use this tactic to limit foreign participation again. Meanwhile, Shell Lubricants' Jiffy Lube International and the Shanghai Automotive Industry Corp. signed a letter of intent in October 2003 to form a $30 million, 50-50 maintenance business venture; China's State Administration of Industry and Commerce must still approve the deal.

• Other services

In year three, China's construction, packaging, and entertainment WTO commitments kick in.

Construction Although regulations technically opened China's construction sector to WFOEs in November 2002, well ahead of the 2004 deadline, significant implementation problems have emerged in 2003 that render the liberalization virtually meaningless. High capitalization requirements, the potential repeal of laws that qualify foreign engineering and construction companies, and the lack of implementing regulations have stalled sector liberalization. But, according to China's entry documents, the country has until December 11, 2004 to iron out details permitting wholly foreign-owned construction and engineering firms.

Packaging China agreed to allow WFOEs to engage in packaging services by December 2004.

Entertainment In early October 2003, China approved Warner Brothers International Theaters, Inc. to take a 51 percent controlling stake in its upcoming joint venture with the Shanghai Cinema Group, which will build and operate 10 cinemas. In accordance with the WTO's Most Favored Nation principle, this deal effectively opens the door to foreign majority ownership in theater management, though China only committed to allow foreign minority shares in its services agreement.

In a related move, China's State Administration of Radio, Film, and Television issued a regulation in October 2003 that permits foreign investment in film production and film-technology companies beginning December 1, 2003. Foreign investors are permitted to hold controlling shares in film technology ventures in certain provinces and cities and foreign partners may take stakes of up to 49 percent in film production companies.

Tariffs and quotas

With the exception of certain agricultural goods, natural resources, and products under quota or license management, all imported goods reached their final bound duty rate on January 1, 2004. Most of China's agricultural products reached their final bound rate on January 1, though import licensing and quota restrictions remain (see Tables). The average agriculture tariff in 2004 is 17 percent.

Tariffs on the import of complete vehicles dropped on January 1, 2004 to 34.2-37.6 percent, down from last year's tariff range of 38.2-43.0 percent. The import quota for autos and auto parts totals $10.49 billion, meeting China's commitment to raise the 2004 quota 15 percent from 2003.

Tariffs on chemicals also fell substantially. As part of its WTO commitments, China signed the Chemical Tariff Harmonization Agreement, which requires it to lower the average tariff on basic and intermediate chemical products to 5.5 percent and 6.5 percent, respectively, by 2004. In an attempt to meet this requirement, China dropped its tariff on basic chemical imports to zero, thus reducing the average tariff on all imported chemicals to 6.9 percent, down from China's pre-WTO tariff level of 14.7 percent.

The National Development and Reform Commission (NDRC) has confirmed that the import quota distinction between state and nonstate traders of processed oil was eliminated on January 1. Now any domestic company may apply directly to MOFCOM for an import permit.

As part of China's WTO commitments, six categories of goods were initially set aside as "Products Subject to Designated Trading"—a mechanism by which the listed goods would be temporarily under China's state trading regime. This designation will be eliminated in year three, liberalizing trade in steel, acrylic, natural rubber, timber, plywood, and wool. Since January 1, China has allowed nonstate traders to deal in numerous products subject to import licensing, import quotas, and import tendering. Import quota and license requirements were lifted on gasoline, tires, and road tractors. Products no longer subject to import tendering include bulldozers, printing machinery, machine tools, satellite earth stations, and circuit breakers.

Nontariff barriers

Throughout the first two years of China's WTO membership, China's tariff-rate quota (TRQ) system on agricultural products has acted as a nontariff barrier on imports of foreign agricultural goods. Specific barriers included complex licensing procedures, allocation of quota in commercially unviable quantities, lack of transparency in rule setting, and adoption of vague or scientifically suspect phytosanitary requirements.

In response to calls from WTO members to bring its agricultural TRQ administration process into compliance with WTO rules, MOFCOM and NDRC published rules in September 2003 governing the management of TRQs for imported agricultural products. The regulation is an important step in addressing concerns about transparency in China's TRQ allocation process. Yet the rule does not completely resolve problems with transparency, conformity to international standards, and assessment of value-added tax, particularly regarding wheat, corn, and soybean imports.

Standards certification and testing are also, in effect, barriers to imports. China does not recognize any testing or certification that occurs outside of China. Importers must have their products retested in China—a process that can be prohibitively expensive. China also has yet to implement the regulatory framework necessary to allow foreign-invested testing and certification organizations to conduct conformity assessment services for the domestic market. Majority-owned ventures were to be allowed in this area by no later than December 11, 2003.

Finding that WTO spirit

Observers note that China's recent WTO implementation actions have rested with agencies belonging to the central government in Beijing, not at the local level as some have speculated. The main obstacles to implementation are government protectionism and industry protectionism rather than a lack of understanding or resources (see Box 2). It is thus up to China's central government to apply pressure internally, if necessary, to make sure its year-three commitments are fully implemented.

Severe acute respiratory syndrome and the change of PRC government leadership may have curtailed China's WTO implementation in year two. To be meaningful, China's implementation in year three must reflect the full terms and spirit of China's WTO entry agreements and ensure that market access is allowed as negotiated. Though China has moved forward on liberalization in some of its services commitments—such as book retail operation and tourist agencies—its tendency to delay regulations or redefine its commitments particularly in areas that open the economy broadly to foreign participation, such as in trading rights and distribution, do not reassure companies that China will implement its year-three commitments fully.

Julie Walton is associate, Business Advisory Services, in the US-China Business Council's Washington, DC, office.

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