Foreign importers and WTO

An analysis of the impact of China''s WTO accession on foreign importers and retailers.

SMEs in the Hong Kong SAR should be the first to benefit from China's accession to the WTO because of their indisputable strength in China-HK cross-border trading and logistic services. However, we should not be relying too much on export business, as it is not going to be optimistic given the slow recovery in the World economy.

In fact, China's major trade partners are not expecting to buy more products from China. Rather, they are eagerly looking for selling more of their products to China when its trade barriers are removed after the WTO accession. Further, it is really difficult to find any developing country that has a comparable size of population and a GDP growth of 7% a year like China. The total population of the much wealthier coastal provinces exceeds that of the United States.

On the other hand, for a 12-month period up to May 2002, China has achieved a growth of more than 20% in FDI, part of which is attributable to those foreign suppliers which have moved their manufacturing operations to the Mainland. Our SMEs should have a prosperous future if they don't take the import business for granted.

Despite the well-developed infrastructure and free trade port features of the SAR, our SMEs are still very reluctant to sell their products in China. This is evidenced by a survey conducted by the HKTDC, which indicates that only 17% of SAR companies have plans to explore the China market. Some people say that because of the current regulatory hurdles and trade barriers, it is inevitable to engage ôconvertersö to bring goods into China through grey channels.

Others may give up the China market simply because of the adverse tax consequences they imagine. However, these should no longer be insurmountable. WTO will open up proper channels for importation and retail business in China. Proper tax planning can be put in place to manage the tax cost to the new investment structures and business activities in the Mainland. Hong Kong logistics companies should improve their legal structure and quality of services in order to be the preferred choice of foreign suppliers and their Chinese customers.

China will grant trading rights to all WTO members, including the SAR, within the next three years. In year 2002, foreign invested joint ventures for retail services will be allowed in some cities. In year 2003, majority foreign-owned joint ventures will be allowed and more cities will be opened up. In year 2004, wholly foreign-owned retail companies will be allowed anywhere in China.

Only a few restrictions will remain for large department stores and chain stores. Of course, the exact date of liberalizing the import and retail sectors, and the prerequisites for setting up these foreign-invested companies are yet to be announced.

However, this should not prevent our SMEs from creating an interim structure right away in order to occupy the market space earlier than others. The interim structure should be flexible enough to migrate to a more desirable structure after the full phase-in of the China market accession.

For example, the Chinese Government has already lowered the qualifications for domestic companies to be granted import and export rights. These new market players have the core competence in the local distribution network, but are much smaller than their SOEs counterparts. Most of them are short of working capital, know-how and an international viewpoint and may thus welcome partnering with international players.

It may not be a bad idea for our SMEs to start from a minority ownership structure with them, inserting a buyout clause in the joint venture contract. As long as the timeline for the buyout is in compliance with the WTO market access timetable, the Chinese approval authorities should not object to it. This should be done quickly or otherwise their competitors may pick all the best choices and leave them in the dust.

Alternatively, importers from Hong Kong may consider setting up wholly owned trading companies in some of the 15 free trade zones (FTZs) of China. These FTZs allow importation of goods duty-free until the goods leave the zone for other parts of China. Some FTZs provide bonded markets where foreign-invested trading companies could issue invoices in local currency and clear customs for goods sold to Chinese customers who cannot pay in foreign currencies. These FTZs could be an incubator before our SMEs can establish their full-fledged trading companies in the Mainland.

As far as retail business is concerned, nowadays it is quite common for a foreign premium brand owner to lease a consignment counter in a department store or a shop space in a shopping mall to sell their products in China. The department store or shopping mall possesses a patchwork of licences that allow the foreign brand owners to conduct retail business in its name under a ôborrowed licenseö concept. Foreign brand owners should select these licensed retailers carefully with a view to managing the credit and inventory risks involved.

Further, the contractual arrangement with these licensed retailers could be quite complex. The foreign party should take the available import channels, customs administration, invoicing and collection, tax exposure and possible exchange control of profit repatriation into consideration. Having said that, if planned properly, such a ôborrowed licenseö arrangement would still be a viable interim solution for foreign brand owners to establish their market presence and to build their brand image in China until they can set up a wholly owned marketing company in the year 2004.

SMEs should also keep a close look at the local governments' move to tap more foreign investment into their local market. For example, the Shenzhen Government recently indicated that it would allow foreign industry leaders to set up wholly owned procurement centres in Shenzhen with full trading rights. Other local governments may follow and hence would open more business opportunities to foreign players ahead of the WTO timeline.

One can think of many other creative structures to enter into the China market ahead of others during the market access phase-in period. However, we need to make one final remark that ôguanxiö will no longer work as before. The Chinese Government has been emphasizing the importance of the rule of law in China in compliance with the WTO principles.

Other WTO members would also have a say if China fails to treat all foreign investors in a fair and transparent manner. Any local government's blessing that violates the State policies will be clamped down. In fact, in August last year, the State Government asked some major cities to rectify 216 named foreign-invested commercial (i.e., wholesaling and retailing) enterprises that were approved to set up without the State authorities' consent.

These locally approved commercial enterprises do not meet the market entry prerequisites and therefore have to be rectified or closed down immediately. Therefore, any interim market entry structure during the coming three-year phase-in period should be in full compliance with the State regulations. Local governments' concessions are certainly not sufficient.

Danny Po, Partner, China Tax Division, PricewaterhouseCoopers
Email: [email protected]