Insight from China’s Two Sessions Summit

Two of the world’s most powerful assemblies, the National People’s Congress and the Chinese People’s Political Consultative Conference held a meeting on March 5^th to sketch out the near future for China.

The Two Sessions as this annual summit is known, presented a road map for the economic and political development during 2019. Premier Li Keqiang acknowledged at the summit that China would “face a graver and more complicated environment” this year due to the effects of the trade war in 2018, but what does this mean in reality? We take a look at the results from the summit and what they imply for foreign business in China.

Tax Cuts

Nothing new under the sun, but yet again the slowing growth has been highlighted. The GDP growth last year at 6.6% was the lowest in 28 years, and yet many analysts believe even that number to be inflated. The trade war also affected foreign investments with FDI growth falling to just 3% from 7.9% in the previous year. For 2019, the government has set the GDP growth target in a range between 6.0% and 6.5%, and many analysts see that as overly optimistic.

To help shore up economic growth, China will raise its deficit target to 2.8% of GDP, up from 2.6% in 2018, providing more fiscal leeway for government spending. At the same time, a record tax cut of up to 2 trillion yuan ($300 billion) was planned at the summit, dwarfing the already record high tax-cut of i 1.3 trillion yuan during 2018. The tax cuts during 2019 will primarily target VAT in order to stimulate consumption. VAT is currently the largest source of the government’s tax revenue, and will remain so even after the following VAT reductions are implemented during the year:

• Manufacturing from 16% to 13%;
• Transport and construction from 10% to 9%;
• Other tax rebates to the service sector, whose current 6% VAT rate will remain unchanged.

According to an estimate by Tianfeng Securities, the VAT-reduction by 3 percentage points for the manufacturing sector alone will save Chinese companies up to 668.4 billion CNY (US$99.69 million) annually.

Apart from VAT, there will also be lower requirements for employers to pay into pension funds, a reduction of toll stations on motorways and a cut of utility prices.

Debt Financing

At the same time as massive tax cuts are rolled out, more investments are planned. This includes stimulus for in new technology sectors such as artificial intelligence, electric cars, biotechnology, and new materials. These technological areas were highlighted as China’s path to prosperity and global influence at the summit. More funds for education, social programs and public infrastructure were also planned.

With spend increases implemented at the same time as extensive tax cuts, China will have to turn to other funding. The country´s debt growth is expected to accelerate significantly during 2019. A 30% increase in bank loans to SME:s (small & medium enterprises) will also be required from the 4 largest state owned banks.

Foreign Investment and Trade

During the Two Sessions, China’s leadership highlighted foreign investment as one of the six areas to “stabilize” during 2019, along with employment, growth, trade, domestic investment and market expectations. The plan is to attract further foreign capital and technology, especially in the manufacturing sector and hi-tech sectors.

The Two Sessions fast-tracked a new law on foreign investments that reignites hopes of foreign actors being treated more fairly with their Chinese counterparts. Regulation that currently discriminates foreign business in terms of ownership, technology licensing, or in other areas, in order to shield Chinese enterprises from competition is to be phased out. This has long been a discussed topic in Chinese politics with little actual change.

According to the fast-tracked new Foreign Investment Law, foreign-invested enterprises will be guaranteed with fair competition and equal treatment in multiple sectors including technological cooperation and government procurement. The long criticized administrative measures by local governments to force technology transfer are also to be removed.

Foreign investors should still wait with popping their champagne bottles and remain cautiously optimistic. Analysts have pointed out that the new legislation is filled with loopholes and will have little real impact. The Foreign Investment Law has been trimmed down from 170 to just 39 articles, but instead of offering a huge relief in terms of legal burden, this has created a risk of legal opacity. One-third of the articles are single sentences that lack required specificity. Articles 6, for example, states that foreign investors and foreign-invested enterprises shall not harm national security or the public interest, without offering any further clarification. This opens the door for differing regional applications of the law. Until the actual effects of the law has been demonstrated, investors should remain cautious of any investments or business activities that could in any way be considered as politically sensitive.

In terms of trade barriers, import tariffs on 706 product types will be lowered or removed; including raw materials for pharmaceutical products and lithium-ion batteries for vehicles. Moreover, China canceled export duties on 94 items beginning in 2019.

Pollution Prevention

China´s environmental policies have already improved substantially since the era of peak pollution during the early noughties. The planned measures for 2019 alone are estimated to lower the emissions of sulfur dioxide and nitrogen oxide by drop 3% in just one year. At the same time PM2.5 air pollution will continue to decrease. To reach these targets, companies active in heavy manufacturing, coal combustion and the automobile industry – China´s main pollutants – should expect increased scrutiny. The development promises great market demand for foreign environmental technology.

Main Implications for foreign companies from the Two Sessions

• Both VAT and input costs will drop across most sectors as tax reductions increase margins.
• The cost of electricity for industrial use will be reduced by 10 percent during 2019, with broadband internet fees cut by 15 per cent and mobile communications fees by 20 percent.
• Tax cuts and increased lending will significantly boost the spending of consumers and companies, thus fueling the sagging demand for automotive, household appliances and other goods.
• The ripple effect of accelerated bank lending to small companies is expected to improve the overall financial condition of mid-sized manufacturers, making them less reliable of payment term credit.
• Market barriers for foreign firms will be lowered in the sectors for pharmaceutical products, information technology, and environmental technology. Business activities in these sectors have partly been removed from the list of discouraged activities for foreign businesses and partly been placed on the list of foreign investments that should be promoted.
• Environmental technology and solutions will significantly increase in demand for sectors including manufacturing, construction, transportation and mining.

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