PEOPLE'S REPUBLIC OF CHINA

Measures set out in Fall 1991 called for preferential loans, tax reform to equalize treatment between state run and non-state run institutions, gradual lessening of involvement in the plan and more separation of government and enterprise management.

Much depends on how thoroughly these reforms are implemented, and they still do not deal with the core issue of bankruptcy. There is a vigorous debate going on within the Chinese government as to how to handle this politically sensitive issue. Many would like to see firms actually go under if they cannot compete in a market or quasi-market situation. Reformers cannot overcome opposition from others who believe China should not implement its bankruptcy laws without first setting up a social safety net for the unemployed.

The policy of "opening to the outside" is becoming more and more a part of standard Chinese socialist policy rhetoric. In policy speeches the words of Deng, Mao, Marx and Lenin are used in support of continuing the policy and many of the reforms in South China are based on openness rhetoric. Especially now that the period of austerity has ended, China is expected to actively pursue foreign investment and expanded trade.

Foreign investment is welcome in areas approved under the industrial policy and development plan. The government has allowed certain areas along the coast to offer preferential terms to foreign investors to increase the financial attractiveness of locating in China. Nevertheless, the myriad of difficulties in doing business in the Third World apply to an even greater degree in China's plan/market economy. Investment from other Asian areas, such as Hong Kong and Taiwan, has grown more quickly than from Western sources, especially following political turmoil in 1989. In general, the difficulties experienced by all enterprises have been shared by foreign investors; however, those firms concentrating on exports have been in a better position.

4. Debt Management Policies

The International Monetary Fund, the World Bank, and the commercial banking community regard China's current debt burden as within acceptable limits, although it has increased since 1989. At the end of 1990, China's total outstanding debt was officially reported at USD 52.5 billion. Of this total, an estimated 12.9 percent is in short-term loans, the rest is in long- and medium-term loans. Outstanding debt at the end of 1990 was equivalent to 16 percent of 1990 GNP or 85 percent of merchandise exports. The debt service ratio was estimated at about 10 percent of export earnings. These indicators, though higher than in 1989, are all well below internationally-recognized danger levels.

The majority of China's loans come from Japan and the World Bank, with these two entities providing approximately 60 percent of all of China's governmental and commercial loans. France, Hong Kong/Macau, the UK, and Germany are also major lenders. After a hiatus brought on by western governments'

PEOPLE'S REPUBLIC OF CHINA

sanctions following the events of June, 1989, multilateral bank lending to China resumed in the second half of 1990, as did certain foreign government lending. China cites the threat of further financial or trade sanctions, as well as its debt repayment obligations, as its rationale for the need to accumulate larger foreign exchange reserves. From a base of large reserves accumulated during the period of tight import controls, China's continued favorable export performance, helped by recent devaluations, has allowed the country to amass foreign exchange reserves of $35.2 billion by June 30, 1991. Reserves are believed to have continued to increase throughout 1991.

Debt management responsibility is shared by several central government agencies, including the State Planning Commission, the People's Bank of China, the Ministry of Finance, and the Ministry of Foreign Economic Relations and Trade (MOFERT). Annual quotas for foreign borrowing are allocated to localities and enterprises through the central planning process. The State Administration for Exchange Control (SAEC), a unit of the People's Bank, is responsible for enforcing quota restrictions, approving any out-of-plan borrowing, and ensuring that borrowers are capable of repaying their loans. Since mid-1987, all foreign loans nationwide (including those of Sino-foreign joint ventures) must be registered with the SAEC. Recent regulations have attempted to further tighten guidelines for management of international commercial loans.

5. Significant Barriers to U.S. Exports

China's barriers to U.S. exports have proven

intractable. U.S. exporters have not enjoyed the same freedom of access to China's market that Chinese exporters have enjoyed in the U.S. market. Trade talks held in both capitals during the Spring, Summer and Fall of 1991 failed to significantly remove the barriers to U.S. exports to China. Consequently, the United States Trade Representative (USTR), on October 10, 1991, announced a self-initiated 301 investigation of China's market access barriers. The investigation, which could take as long as one year, will focus on selected product specific and sector specific import prohibitions and quantitative restrictions, restrictive import licensing requirements, technical barriers to trade such as testing and certification requirements, among others, and the failure to publish laws and regulations on import restrictions.

China's centrally-directed annual import plan continues to play a key role in determining the composition of China's imports. The import plan affects some 40 percent of China's economy and is designed to ensure the inflow of materials and technology needed for the country's development. An annual determination is made for each class of raw material, foodstuff or manufactured product of what the domestic demands for that product will be the following year. If domestic production can meet that demand, imports are banned or strictly limited. If domestic production cannot meet

anticipated demand, the shortfall is designated as the import quota for the following year.

PEOPLE'S REPUBLIC OF CHINA

China's import licensing system covers about half of China's imports by volume. Currently, 53 broad categories of products require import licenses, covering a wide range of consumer goods, raw materials and production equipment. Even after a license has been issued by a local trade bureau, it can be rescinded if the central government decides that the transaction is not consistent with current trade policy.

Obtaining permission for an import often requires approval from several layers of bureaucracy, and in many cases, a certificate of approval from the ministry that oversees the manufacture of such products in China. Approval is often withheld if the ministry believes that an acceptable domestically-made substitute is available. Regulations state that the import substitutes must be "comparable" in quality and price to the imports, but in practice, domestic products often have not met this standard.

China uses embargoes to restrict certain consumer goods imports. China has also banned imports of production lines for televisions, tape recorders, washing machines and air-conditioners. Approximately 80 types of consumer goods, raw materials and production equipment are now embargoed.

U.S. firms frequently cite China's foreign exchange controls and non-convertibility of the renminbi as the most significant non-tariff barriers to trade and investment.

China's standards and testing requirements hold imports to a higher quality standard than applies to domestic products. Import certification can be a time-consuming and expensive process and appears designed to protect domestic producers and to exclude products considered unnecessary for China's development.

During bilateral discussions in October 1991 and later in the local press, the Chinese government announced a number of proposed changes to its trade regime. China was scheduled to adopt the Harmonized System for customs classification and statistics, effective January 1, 1992, and, in conjunction with its adoption, reduce tariffs on 225 items. China has also proposed eliminating import regulatory taxes and, within three years, reducing by two-thirds the number of items requiring import licenses. Lists of goods under import bans or quantitative restriction would be published. The number of items under control would gradually be reduced and replaced by a quota system within three years. MOFERT would compile trade rules, laws and regulations which are still in effect and publish these items within one year. MOFERT would, moreover, be the sole source authorized to issue and publish trade related regulations in the future. Import substitution lists would be published, although the People's Republic of China contends these lists are for "advertising only." The measures described in this paragraph are proposals with implementation schedules which post-date this report.

Services Barriers: Chinese restrictions on certain foreign firm service activities (including insurance, construction, banking, accounting, and legal services) prevent U.S. firms from participating fully in China's service sector. U.S. and other foreign banks, for example, are not

PEOPLE'S REPUBLIC OF CHINA

allowed to engage in local currency business in China, while the New York Branch of the Bank of China has conducted all forms of branch banking activities since 1980. U.S. insurance firms are not allowed to participate in the direct insurance market in China. U.S. lawyers and accountants must largely limit their activities to servicing foreign firms that do business in China. Foreign law firms cannot be registered as official representative offices, nor can accountants be registered as CPA's. We are awaiting implementation of an October 1991 agreement to permit U.S. maritime companies to establish branch offices in China.

Investment Barriers: Under Chinese regulations, export-oriented and advanced technology manufacturing investments are given special incentives. Beijing has

expressed interest in foreign direct investment (FDI) in basic infrastructure (energy production, communications, transportation, etc.). Chinese laws permit equity participation in investment projects from a minimum of 25 percent up to complete foreign ownership. Government approval is required for all foreign investment in China.

Chinese regulations and policies place strong pressure on most foreign investors to export. Encouraging localization is another central goal of Chinese investment policies. Chinese rules do not set a fixed limit on the percentage of foreign personnel in a given enterprise's staff, although in practice foreign personnel normally constitute only a very small portion of staff. Chinese law prohibits forced disinvestment, except under extraordinary circumstances. The law permits repatriation of profits, so long as the venture has sufficient foreign exchange to cover the remitted amount.

Many joint ventures are highly dependent on China's state-owned sector for downstream services. Some investors have been permitted to set up their own marketing and service organizations, but many have no choice but to rely on People's Repulic of China channels for support. China does not provide national treatment to foreign investors. In some key areas, such as input costs, foreign investors are often treated less favorably than Chinese firms. Foreign investors may not own land in China. Chinese authorities are, however, approving long-term land use deals for investors, some lasting up to 70 years.

6. Export Subsidies Policies

China abolished direct subsidies for exports on January 1, 1991. Nonetheless, many of China's manufactured exports receive indirect subsidies through guaranteed provision of energy, raw materials or labor supplies. Other indirect subsidies are also available such as bank loans that need not be repaid or enjoy lengthy or preferential terms. Import/export companies also cross-subsidize unprofitable exports with earnings from more lucrative products, although the Chinese are making efforts to define and assign enterprise responsibility. Other export incentives that may be regarded as subsidies include tax rebates for exporters and duty exemptions on imported inputs for export production. China's swap markets constitute a de facto alternative exchange rate

PEOPLE'S REPUBLIC OF CHINA

system where exporters can exchange earned foreign exchange for domestic currency at a rate higher than the official rate.

7. Protection of U.S. Intellectual Property

In

China has made significant progress in recent years in the enactment of laws, such as the new Copyright Law, and regulations to protect intellectual property. Despite this progress there are serious deficiencies in the degree of protection intellectual property is afforded in China. April 1991, China was identified as a Priority Foreign Country under the "Special 301" provision of the 1988 Trade Act and investigated because of its failure to provide adequate protection of U.S. intellectual property rights (IPR). The scale of piracy of computer software, video and sound recordings, and printed materials has been enormous and it is suspected that much of the copying--especially of computer software--has been by state agencies. The competing interests of such agencies and the difficulty of coordinating China's cumbersome bureaucratic process have made progress on IPR issues difficult.

Although China's new Copyright Law, which came into effect on June 1, 1991, was an important step forward in the protection of intellectual property, the law still does not provide adequate protection for foreign works. The law stipulates that foreign works must first be published in China (works published elsewhere which are then published in China within 30 days will be considered first published in China), and previously-published works are still not protected. There is inadequate protection for computer software which is not considered a literary work under the new law. Its patent law does not now protect either pharmaceutical or chemical products, and a Chinese process patent is not infringed by the importation of a compound made by the same process outside China. U.S. firms have reported that some fertilizers patented in the U.S have been produced in China without license for both the domestic and export market. Moreover, the formulae have sometimes been copied incorrectly, causing serious damage to end-users and damaging the reputation of the genuine product. China's trademark regime is generally consistent with international practice. However, pirating of trademarks is still widespread and actions taken against infringers generally must be instigated by the injured company.

On January 17, 1992, the U.S. and China signed a Memorandum of Understanding (MOU) that addresses many of these problems. In it, China agrees to make best efforts to amend its Patent Law by January 1, 1993. The amendments are to include a patent term of 20 years from filing of applications and extension of patent protection to pharmaceutical and chemical products. China also agreed to provide, beginning January 1, 1993, administrative protection for pharmaceuticals and agricultural chemicals patented in the U.S. since January 1, 1986. This protection will allow the patent holder or licensee to import or manufacture the product in China for seven and a half years from the date of issue of the certificate of administrative protection and will prohibit others from manufacturing the product without permission of the patent holder.