Letter from Shanghai

The Perils of Central Planning

A slew of new laws and murky economic forecasts have made planning for 2008 particularly difficult

by Godfrey Firth

In late August or early September of each year, it is not unusual to find the China and Asia-Pacific management teams of US companies gathering to begin the arduous process of drafting the next year's operational plan for submission to headquarters. These meetings, usually held at a company's China headquarters, often here in Shanghai, are never easy. This year's were particularly challenging. Sweeping but frustratingly opaque regulatory changes in China, steadily rising costs, uncertainty surrounding the direction of both China's and the world's economies, and heightened expectations from headquarters were all weighing on the minds of Shanghai-based China presidents at US companies. Peering into the crystal ball and pulling together the PowerPoint and financial projections for the next year has never been quite so difficult.

Regulatory indigestion

The PRC National People's Congress (NPC) legislated with a vengeance in 2007, passing a wide array of laws that will affect every company in China. Particularly worrisome is the fact that key government ministries and regulators charged with issuing the vital implementing regulations, which provide explanatory details on how the often vague laws will be enforced, did not keep pace with the NPC, and, as the CBR went to press in early December, many key sets of regulations had not yet been passed. Perhaps distracted by China's landmark political event, October's 17th Chinese Communist Party Congress, these government bodies spent the last few months of the year besieged by clamoring interest groups and struggling to issue these vital regulations.

In taxation, the Enterprise Income Tax Law, which took effect January 1, has significantly altered the financial landscape for foreign firms. While the new, unified enterprise income tax rate of 25 percent was widely expected, as the CBR went to press, uncertainty surrounds changes to the qualifications for high- and new-tech status (and the preferential 15 percent tax rate that goes with it); withholding tax rates, which are expected to rise to 10 percent; and the extent of tax benefits special economic and development zones will be able to grant under the new law. In the last few months of 2007, companies scrambled to transfer ownership of China-based legal entities to Hong Kong- and Singapore-based holding companies before the end of 2007, to take advantage of lower withholding tax rates on dividends offered to these jurisdictions under China's tax treaties and to avoid a tax on such asset transfers, which also took effect on January 1.

On the human resources front, the new Labor Contract Law has kept labor lawyers and human resources departments poring over old and new employment contracts and revising employee handbooks. The related Employment Promotion Law has human resources managers reviewing their hiring and recruiting practices and taking a careful look at antidiscrimination provisions. Both of these laws took effect on January 1. The efforts of various localities to raise awareness of the new laws in their jurisdictions—by issuing sample contracts, for example—further complicated the picture for companies still grappling with the changes on the national level.

In mergers and acquisitions, companies have generally learned the ropes and assembled the piles of documentation required for the PRC Ministry of Commerce's merger reviews, which were launched in fall 2006. On August 1, 2008, however, the new Antimonopoly Law will take effect, bringing with it two new government entities under the State Council—the Antimonopoly Authority and the Antimonopoly Commission (see Anticipating Chinese Antitrust Policy). How these still non-existent bodies will operate—and who will staff them—remains a wide open question, and one relevant to any company with a significant market share or the intention to explore or undertake acquisitions. Recent comments by an NPC vice chair indicating that China plans to pass another 20 regulations on foreign merger and acquisition activity in China even before the law takes effect further clouds an already murky regulatory picture.

Higher expectations ahead

And then there's the good news. As the US-China Business Council's (USCBC) latest survey of its membership shows, companies are doing well in China (see the CBR, November-December 2007, US Companies' China Outlook). Largely focused on serving the domestic market, they are increasingly profitable and expanding their investments, operations, and staff. Many have higher margins in China than globally. Conversations with Shanghai-based executives in late 2007 indicated that most expected to hit their often quite ambitious revenue targets.

This, of course, means that the bar will be set higher for 2008. As the US economy shows signs of slowing, global management in headquarters will increasingly look to emerging markets for revenue growth and cost savings. China, as one of the fastest-growing emerging markets and the site of choice for low-cost procurement and sourcing, is often the centerpiece of these raised expectations.

For executives on the ground, however, peering at the tea leaves and investment bank reports on China's economy offers little guidance. On the macro level, asset bubbles in stock and property markets and rising inflation are signs of potential overheating, while on the micro level, higher commodity and input costs are raising supplier prices. Wages continue to rise rapidly, especially for key staff, and human resources shortages remain the top concern. Keep your team in the office too late, and it could disappear to any of several hundred other companies that are single-mindedly stalking talent, including direct competitors.

Hitting the pause button

The annual planning exercise provides a chance to pause from the headlong rush of managing US companies' expansion in the China market. It is a welcome, mandated chance to step back and assess, in a strategic fashion, where a company is going and what potential pitfalls await. From Shanghai, the perspective is still optimistic, but the optimism is more guarded than a year ago. Protectionist rumbles in the United States and China continue, and the height of the US political process—the 2008 presidential election—will likely crank up the heat. All eyes will turn to China for the Beijing Olympics, bringing with it a spike in the scrutiny of China by media, nongovernmental organizations, and other stakeholders (see Beijing Olympics: More at Stake than Gold Medals). A weakening world economy or an overheating China could put pressure on bottom lines.

Whatever 2008 brings, one thing is certain—Shanghai executives can expect more midnight conference calls with headquarters. Though no battle plan remains intact once the first shot is fired, in China a business can consider itself lucky if its plan lasts up to the start date. Fortunately most US businesses here, particularly USCBC member companies, are seasoned veterans of the volatile China business environment, with its ever-changing regulations and rapidly obsolete projections, and they continue to share information, pool resources, and find creative ways to keep on growing.

Godfrey Firth is chief representative, Shanghai, at the US-China Business Council.

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	E-Mail \| Print \| License Letter from Shanghai The Perils of Central Planning A slew of new laws and murky economic forecasts have made planning for 2008 particularly difficult by Godfrey Firth In late August or early September of each year, it is not unusual to find the China and Asia-Pacific management teams of US companies gathering to begin the arduous process of drafting the next year's operational plan for submission to headquarters. These meetings, usually held at a company's China headquarters, often here in Shanghai, are never easy. This year's were particularly challenging. Sweeping but frustratingly opaque regulatory changes in China, steadily rising costs, uncertainty surrounding the direction of both China's and the world's economies, and heightened expectations from headquarters were all weighing on the minds of Shanghai-based China presidents at US companies. Peering into the crystal ball and pulling together the PowerPoint and financial projections for the next year has never been quite so difficult. Regulatory indigestion The PRC National People's Congress (NPC) legislated with a vengeance in 2007, passing a wide array of laws that will affect every company in China. Particularly worrisome is the fact that key government ministries and regulators charged with issuing the vital implementing regulations, which provide explanatory details on how the often vague laws will be enforced, did not keep pace with the NPC, and, as the CBR went to press in early December, many key sets of regulations had not yet been passed. Perhaps distracted by China's landmark political event, October's 17th Chinese Communist Party Congress, these government bodies spent the last few months of the year besieged by clamoring interest groups and struggling to issue these vital regulations. In taxation, the Enterprise Income Tax Law, which took effect January 1, has significantly altered the financial landscape for foreign firms. While the new, unified enterprise income tax rate of 25 percent was widely expected, as the CBR went to press, uncertainty surrounds changes to the qualifications for high- and new-tech status (and the preferential 15 percent tax rate that goes with it); withholding tax rates, which are expected to rise to 10 percent; and the extent of tax benefits special economic and development zones will be able to grant under the new law. In the last few months of 2007, companies scrambled to transfer ownership of China-based legal entities to Hong Kong- and Singapore-based holding companies before the end of 2007, to take advantage of lower withholding tax rates on dividends offered to these jurisdictions under China's tax treaties and to avoid a tax on such asset transfers, which also took effect on January 1. On the human resources front, the new Labor Contract Law has kept labor lawyers and human resources departments poring over old and new employment contracts and revising employee handbooks. The related Employment Promotion Law has human resources managers reviewing their hiring and recruiting practices and taking a careful look at antidiscrimination provisions. Both of these laws took effect on January 1. The efforts of various localities to raise awareness of the new laws in their jurisdictions—by issuing sample contracts, for example—further complicated the picture for companies still grappling with the changes on the national level. In mergers and acquisitions, companies have generally learned the ropes and assembled the piles of documentation required for the PRC Ministry of Commerce's merger reviews, which were launched in fall 2006. On August 1, 2008, however, the new Antimonopoly Law will take effect, bringing with it two new government entities under the State Council—the Antimonopoly Authority and the Antimonopoly Commission (see Anticipating Chinese Antitrust Policy). How these still non-existent bodies will operate—and who will staff them—remains a wide open question, and one relevant to any company with a significant market share or the intention to explore or undertake acquisitions. Recent comments by an NPC vice chair indicating that China plans to pass another 20 regulations on foreign merger and acquisition activity in China even before the law takes effect further clouds an already murky regulatory picture. Higher expectations ahead And then there's the good news. As the US-China Business Council's (USCBC) latest survey of its membership shows, companies are doing well in China (see the CBR, November-December 2007, US Companies' China Outlook). Largely focused on serving the domestic market, they are increasingly profitable and expanding their investments, operations, and staff. Many have higher margins in China than globally. Conversations with Shanghai-based executives in late 2007 indicated that most expected to hit their often quite ambitious revenue targets. This, of course, means that the bar will be set higher for 2008. As the US economy shows signs of slowing, global management in headquarters will increasingly look to emerging markets for revenue growth and cost savings. China, as one of the fastest-growing emerging markets and the site of choice for low-cost procurement and sourcing, is often the centerpiece of these raised expectations. For executives on the ground, however, peering at the tea leaves and investment bank reports on China's economy offers little guidance. On the macro level, asset bubbles in stock and property markets and rising inflation are signs of potential overheating, while on the micro level, higher commodity and input costs are raising supplier prices. Wages continue to rise rapidly, especially for key staff, and human resources shortages remain the top concern. Keep your team in the office too late, and it could disappear to any of several hundred other companies that are single-mindedly stalking talent, including direct competitors. Hitting the pause button The annual planning exercise provides a chance to pause from the headlong rush of managing US companies' expansion in the China market. It is a welcome, mandated chance to step back and assess, in a strategic fashion, where a company is going and what potential pitfalls await. From Shanghai, the perspective is still optimistic, but the optimism is more guarded than a year ago. Protectionist rumbles in the United States and China continue, and the height of the US political process—the 2008 presidential election—will likely crank up the heat. All eyes will turn to China for the Beijing Olympics, bringing with it a spike in the scrutiny of China by media, nongovernmental organizations, and other stakeholders (see Beijing Olympics: More at Stake than Gold Medals). A weakening world economy or an overheating China could put pressure on bottom lines. Whatever 2008 brings, one thing is certain—Shanghai executives can expect more midnight conference calls with headquarters. Though no battle plan remains intact once the first shot is fired, in China a business can consider itself lucky if its plan lasts up to the start date. Fortunately most US businesses here, particularly USCBC member companies, are seasoned veterans of the volatile China business environment, with its ever-changing regulations and rapidly obsolete projections, and they continue to share information, pool resources, and find creative ways to keep on growing. Godfrey Firth is chief representative, Shanghai, at the US-China Business Council. Further Reading Letter from Shanghai: The Prodigal Prodigy Planning for Highly Improbable Events Letter from Beijing: Sustain This Click here for copyright permissions Copyright 2008 US-China Business Council Top of Page Table of Contents
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