“Growth in China has surpassed all expectations,” said Martin Winterkorn, CEO of Volkswagen, in late April as the German car company — Europe’s largest — announced plans to invest US$2 billion over the next two years in China, which includes building two additional plants and rolling-out or updating automobile models in the country.


Volkswagen certainly is not alone in its enthusiasm. Strong GDP growth and the allure of growing domestic consumption make China attractive for a range of foreign investors. Indeed, foreign direct investment (FDI) surged in April to US$7.3 billion, up from nearly US$6 billion in April the previous year, bringing the total for the first four months of 2010 to US$31 billion, an 11.3% increase on 2009. All the more striking is that relatively speaking, FDI in China was already relatively robust, falling less than 3% last year compared with an average worldwide decline of nearly 40%, according to the United Nations Conference on Trade and Development.


Yet amid this rosy news, there’s a cloud hanging over foreign investors in China. Events in recent months — see-sawing regulatory decisions, hints of economic nationalism and direct legal confrontations with foreign executives — might give jittery, inexperienced foreign companies operating in the country reason to believe the investment in climate is souring. Is that indeed the case?


Not everyone believes so. Nick Cham, a Beijing-based partner in tax and business advisory at Deloitte, says the last thing China wants to do is alienate foreign companies keen to invest in its economy. “Foreign investment is still a very important pillar to China’s economy,” he says, citing the importance of foreign-invested enterprises (FIEs) to the country’s economy. According to Cham, nearly 700,000 FIEs have received approval from the government to operate in China. Combined, they account for about 28% of national industrial output, 23% of tax revenue and 56% of exports, as well as providing around 45 million jobs.


While the welcome mat might not be the same one the government put out in earlier times, many foreign investors certainly aren’t complaining. As Helen Zhang, a partner at Zhong Lun law firm in Shanghai, notes, “even if the government doesn’t provide preferential treatment to foreign invested companies like it might have done 20 years ago, the promise of domestic demand will offset this.”


Regulatory Haze


That’s not to say the concerns aren’t well founded. In it latest annual research on the state of U.S. business in China, the American Chamber of Commerce (AmCham) led Christian Murck, AmCham China president, to conclude that overall, “as we look to the future, there is less certainty in the business community. And we see many actions that suggest the bargaining power [of business with the Chinese authorities] will begin to narrow.” Among the chief concerns cited by AmCham’s members is “inconsistent regulatory implementation” — from region to region as well as between foreign and domestic firms.


This has, in fact, been a perennial issue among foreign investors, but has been in sharper focus as firms expand into new areas, according to Matthew Estes, president and CEO of Babycare, a Beijing-based firm that sells nutritional supplements to expectant mothers and infants throughout China. “When [foreign firms] were only operating in Beijing and Shanghai, people didn’t notice,” he says. “But now that companies are operating across the entire country, we’re beginning to see more and more concerns raised about inconsistency and local favoritism and that is a problem that needs to be resolved.”


Other items are new on the list of concerns. For example, in a push to encourage “indigenous innovation,” the government issued new rules last November to qualify for its massive procurement program, which would require companies selling high-tech products to prove that the relevant patent was solely developed in China or its trademark first lodged in China. After the U.S. and European Union cried foul, however, the Ministry of Science and Technology, which issued the rule, retreated in April, clarifying that the relevant patents and trademarks must only be registered in China.


More Bark Than Bite?


Two months later, the State Administration for Industry and Commerce (SAIC) and the Ministry of Public Security introduced changes to how the Representative Offices (ROs) of foreign firms are overseen. ROs in the past have been a popular route for foreign businesses to get a foothold in the country, with many ROs going beyond their authorized representative duties and employing far more staff than legally allowed. The new rules aim to curb their expansion. Changes include reducing the duration of registration certificates from three years to one year, requiring on-site inspections of new ROs and increasing oversight of staff numbers.


While these rules increase the administrative and cost burden of ROs, Deloitte’s Cham asserts there is a silver lining to the changes: In the long run, formalizing the RO rules will “help foreign businesses improve how they structure their activities in China.” He also sees the changes as an opportunity for foreign investors to “review their existing presence in China and perhaps consider expanding activities under a more appropriate vehicle, such as a wholly owned foreign enterprise or joint venture.”


Regardless of the type of investment vehicle, however, some foreign investors feel unfairly put in the limelight, a sentiment highlighted following the recent sentencing of executives from Australian mining firm Rio Tinto after being found guilty of bribery. Yet observers such as Yan Jinny, an economist at Standard Chartered Bank in Shanghai, believe that foreign firms should expect more high-profile cases like Rio Tinto’s. “We’re going to have more strict rules and further investigations,” he predicts. But foreign firms shouldn’t feel unfairly singled out, say observers. China is applying the same strict treatment to domestic firms, as was clear with the sentencing in early May of Huang Guangyu, once China’s richest man and former chairman of home appliance giant Gome Group, for insider trading and bribery.


Olive Branches


But the government appears to be at pains to calm tensions. In April, the State Council, the chief administrative authority of the PRC, released a pronouncement — known generally as “Opinions” — reiterating the country’s intention to expand liberalization and encourage foreign investment in “priority areas,” such as high-end manufacturing, high-tech industries, and environmentally friendly enterprises, while restricting environmentally unfriendly ones.


A key part of the Opinions is an increase in the ceiling by which local governments are allowed to grant approvals to foreign investment projects from US$100 million to US$300 million, which should speed up the red tape that many FIEs have long bemoaned. Furthermore, it will be easier for FIEs to move from eastern China to less-developed areas in the country’s central and western regions by streamlining registration and approval procedures and tax administration.


Lester Ross, a partner at WilmerHale law firm in Beijing, notes that while “the details remain to be seen, the Opinions represent positive policy developments in multiple respects for foreign investors in China.”


“We applaud those developments in general as constituting further steps toward the development of China’s economy,” says Ross. However, he adds, “the next and increasingly urgent challenges are ensuring transparent, uniform and impartial implementation.”


Choosier by Choice


That could happen as part of a broader change of attitude toward foreign investors. Zhang of law firm Zhong Lun notes that previously, China needed foreign capital to help its economy grow. Now, “the Chinese government is more experienced,” she says, which is why it is targeting particular sectors, such as clean energy or services. “It welcomes foreign investment but it wants to know what you are bringing. It wants knowledge and high-tech engineering so [companies] can help upgrade industries. But you’re not welcome if you are just here for cheap labor and your products are not environmentally friendly.” Although she doubts that the Opinions will make much immediate practical difference, it “sends out the signal that the government welcomes investment and is improving procedures.”


Yan of Standard Chartered Bank notes that while these changes are positive, their impact won’t necessarily be felt immediately. “Everything needs to go through the National People’s Congress, so we’re talking about years, not months, for the right legislation to be enforced,” he says. “In the meantime, China needs to improve how it enforces its current policies so as not to dampen interest in the market.”

Until then, however, most foreign investors know where the buck stops, says Estes of Babycare. Rather getting caught up with government incentives, policies and procedures, he says China’s most successful investors — foreign and domestic — will stay focused on the “key factors” — that is, “how big is their market today and how big will it be in the next five to 10 years?” In other words: Growth, growth and more growth.