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Foreign companies face increasing risks in China’s current economic environment

Faced with the current economic situation in China, foreign companies operating in the country must be prepared to mitigate risks by bolstering compliance, protecting IP, and conducting due diligence, among other strategies. The business environment in China has become more precarious in the past few months, forcing enterprises to reduce their exposure as much as possible.


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Many foreign companies are choosing to either exit China or scale down their operations in the country. In response, the Chinese government is making efforts to further control capital outflows.


Recently, China barred domestic and foreign brokerages from accepting new mainland clients for offshore trading, signaling intensified currency controls. These measures underscore the escalating challenges faced by businesses operating in or with China.


Economic Situation


According to the latest official figures, the youth unemployment rate (ages 17-24) neared 25%, while Evergrande, China’s premier real estate company, continues to face severe debt issues.

This situation is compounded by a demographic crisis, the Renminbi hitting an all-time low, and many foreign companies either exiting China or scaling down their operations.


The most pessimistic element of China’s economic outlook continues to be the property sector. Experts believe that the property market will remain under strain in the near term, with the situation for both home sales and property investment further deteriorating.


The Chinese government has launched a support package to bolster housing demand, including lower down payments and looser mortgage rules, but these measures may be limited to China’s large cities and may only cause a marginal improvement in the overall housing market outlook.

Nonetheless, these factors might help to fuel stronger retail sales of decoration materials and household appliances in the coming months. Any boost to retail sales via wealth effects will be limited, however, given long-term structural factors ranging from China’s policy direction, which will continue to discourage speculative practices, to unfavorable demographics, which will affect demand (particularly in smaller cities).


The lukewarm economic outlook, alongside recent credit data, suggests more generally that private investment will continue to struggle in the near term.


Private-sector fixed-asset investment (FAI) contracted by 0.7% year on year in January-August. Although strong contemporary infrastructure investment, which rose by 6.2% over that same eight-month period, has kept the overall FAI number steady, the difference in these dynamics illustrates the uneven trajectory of China’s economic recovery, and the limited benefits that the current economic situation has offered to (primarily non-state owned) firms.


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The sustained downturn in investment—including in both the property and private sectors—has pushed a revision of GDP forecast for 2024; now expected to be 4.8% (from 5.1% previously).

The risks for foreign companies that do business in or with China will remain elevated, while Chinese companies may continue to act desperately to survive, even if it means turning on partners.


Another major concern is local government debt, which has soared largely due to a sharp drop in land sale revenues because of the property slump, as well as the lingering impact of the cost of imposing pandemic lockdowns.


The severe fiscal stress seen at local levels not only poses great risks to Chinese banks, but also squeezes the government’s ability to spur growth and expand public services.


Beijing has so far unveiled a steady incremental drip of measures to boost the economy, including interest rate cuts and other steps to help the property market and consumer businesses.


But it has refrained from making any major moves. Economists and analysts believe that it is because China has become too indebted to pump up the economy like it did 15 years ago, during the global financial crisis.


Back then, Chinese leaders rolled out a four trillion yuan ($586 billion) fiscal package to minimize the impact of the global financial crisis. But the measures, which were focused on government-led infrastructure projects, also caused an unprecedented credit expansion and massive increase in local government debt, from which the economy is still struggling to recover.


Currency Restrictions


China's yuan has lost more than 5% against the dollar so far this year, becoming one of Asia's worst performing currencies for 2023.


The People's Bank of China (PBOC), China's central bank, asked some of the country's biggest lenders to refrain from immediately squaring their foreign exchange positions in the market, and to run open positions for a while to alleviate downside pressure on the yuan.


Banks have been asked not to square their positions in the inter-bank foreign exchange markets after any U.S. dollar sales to clients, until their spot foreign exchange position hits a certain level, according to Reuters.


Most banks are allowed to run a net short or long foreign currency position in spot dollar-yuan markets, within defined limits.


The move would effectively mean some of the heavy dollar purchases by companies would be absorbed by banks and sit on their books for a while, thus partially reducing downward pressure on the sliding yuan.


Banks were also told that companies requiring to purchase US$50 million or more will need to seek the central bank's approval, Reuters reported.


Some companies’ products are being delayed because their factory is unable to purchase needed components due to the Chinese government not allowing them to use hard currencies to buy those components overseas or simply delaying the approval of such payments.


This is not the first time China has severely tightened down on the use of hard currencies, but it is the first time it’s impacting its factories.


Chinese Companies turning on their foreign partners


A notable shift is the increasing willingness of Chinese firms to risk their relationships with foreign partners. This isn’t limited to the manufacturing sector.


Struggling Chinese firms seem ready to compete against, and potentially alienate, their existing customers.


Businesses sourcing from China should adopt proactive measures to counteract potential complications with their Chinese partners or suppliers.


Increasing Regulations

The Chinese government has intensified its efforts to maintain stability and manage public discontent amid China’s economic downturn. Evidence of this includes the uptick in exit bans and arrests of foreign executives, making China increasingly precarious for them.


Scaring foreign executives is bad for China’s economy and it underscores the government’s emphasis on control over economic growth.


Product Sourcing


China’s downturn is transforming how Chinese and international companies interact. Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering—in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys.


Short articles

Foreign businesses that work with Chinese companies in these sectors need to be vigilant. Sometimes, the Chinese supplier that received payment for a product from a foreign company, no longer exists or it exists, but it needs “more money” to buy raw materials for the product it already promised to produce.


Foreign managers must understand what is happening in their own industries within China. This might mean having someone you trust visit your Chinese factory, warehouse, or office to look for warning signs of a company in distress.


It might mean taking out insurance to cover your China business or transaction. Several Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent.


Geopolitical Implications


Chinese authorities fear that similar economic sanctions to those against Russia could be imposed against them.


However, in China, there is prevalent belief that the West aims to halt China’s ascent, leading to the notion that decoupling from Western economies is imminent. This has caused Chinese firms to shift their strategies, by competing with and/or stealing from their own customers.

Protecting Your Company

Using China-specific contracts is vital to prevent Chinese companies from leveraging your IP against you. The key is early protection, when you still have leverage and before your Chinese counterparty has run off with your product, software, design, and/or customers.

There have been increasingly more cases where Chinese companies take money from their foreign clients and disappear. The best defense against these sorts of thefts is to conduct due diligence on the company to which you will be sending funds.


China’s slowing economy and its causes are augmenting the risks for nearly every company that does business in or with China. Most companies that realize this should re-evaluate their China strategy and exposure.


 

Woodburn Accountants & Advisors is one of China’s most trusted business setup advisory firms.


Woodburn Accountants & Advisors is specialized in inbound investment to China and Hong Kong. We focus on eliminating the complexities of corporate services and compliance administration. We help clients with services ranging from trademark registration and company incorporation to the full outsourcing solution for accounting, tax, and human resource services. Our advisory services can be tailor-made based on the companies’ objectives, goals and needs which vary depending on the stage they are at on their journey.

 

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