Given its voracious appetite for invest-ment and annual GDP growth rates that consistently lurch towards double .gure territory, China's ranking on this year's World Economic Forum Global Competitive-ness Report was a disappointment. The annual report, which polled nearly 11,000 business leaders on the quality of public institutions and the level of technological readiness and inno-vation in 117 economies worldwide, put China at 49th. That's down three points from its 2004 score, only one place ahead of India, which moved up .ve places thanks to a higher rank-ing in technology. China was marked down on "Institutional weaknesses" which, warned the World Economic Forum, if unaddressed, would slow its ascension to the top tier of the most competitive economies in the world.

One of China's woes, as aptly highlighted in this year's European Chamber's Position Paper, is the close partnership between state-owned en-terprises and state agencies in crucial sectors like energy and telecom. To be fair, China's govern-ment agencies are under frantic pressure to keep up with lightening fast economic growth but overlapping agencies and laws doesn.t help. Red tape and regulatory obstacles are deterring Euro-pean investors with an eye to compliance risks and cost control. "Regulations are often unclear or confusing," says Ian O.Brien, managing part-ner at KPMG Huazhen, suggesting China needs a centralized register where all legislation en-acted by central and provincial authorities can be made available to the public.

But there were good news stories too for foreign investors in 2005. One was the com-ing into effect of China.s new Foreign-In-vested Commercial Enterprise (FICE) rules, which permit foreign .rms to distribute goods throughout China. New rules on direct sell-ing were also .nally established. Still, .rms have to go through a bureaucratic provincial and national application process, say consul-tants with experience in structuring FICEs. It.s more dif.cult for FICEs to handle auto-motive, pharmaceuticals and media goods, and even harder to get licenses to distribute audio-visual equipment and healthcare drugs.

More good news also came with the govern-ment.s sensible Automotive Brand Sales Policy, which quelled fears of dual distribution systems just as competition for China.s family car buyers becomes more intense. A long-sought simpli.-cation of the system for registering cosmetics imports came through. More relief came when the Supreme Court.s Judicial Interpretation of IPR legislation lowered the criminal threshold on copyright and trademark infringements. En-forcement of the laws remains a problem, how-ever.

Hong Kong fever

With pro.ts at the country's major coal .rms doubling in the .rst seven months of 2005 and PetroChina offering US$2.44 billion in stock, China's power was never far from the year's headlines. Power stations don't look as if they'll be getting over their reliance on coal anytime soon, but the government has been making the right moves to encourage bluer skies. The Renewable Energy Law and Law of Energy Conservation were issued in 2005 with thick catalogues to specify the clean and renew-able energy technologies that China will favor. Wind, hydro and nuclear power are encouraged but energy saving technology makers setting up in China are also offered tax breaks.

The polluter may be about to pay, but for-eign banks seeking customers in China are still limited by high capital requirements and are restricted to one branch per year. Even as they rush to take stakes in locals, the foreign-ers. share of the market has shrunk to less than 1.5 percent. With a poor choice of investment selections, China could do both domestic and foreign .nancial institutions and stock bro-kers a big favor by allowing insurance com-panies to invest more easily on China.s ailing exchanges, says Barry Livett, director of the EU-China Financial Services Co-operation Project. "There.s the paradox of nine percent GDP growth mirrored by slumping stock mar-kets. The barometer is disconnected," suggests Livett. Little wonder, considering a glut of state-held non-tradeable shares has kept the local markets sluggish for several years. Un-stable securities .rms and a domestic broking community are other reasons for the malaise of China.s exchanges, says Livett.

Avoiding the gloom at home, the strongest Chinese companies in 2005 moved to foreign stock exchanges. Keen for greater liquidity and a higher pro.le, China.s blue chips will be making a beeline for dual listings, according to Michael Fosh, a senior partner at the Beijing of.ce of law .rm Herbert Smith, who advised Huaneng Power on its listing on the Hong Kong Stock Exchange. "It makes sense if you list in Hong Kong to sell shares in London or New York too," says Fosh, adding that both exchang-es are eyed by Chinese energy and mining com-panies in particular for their large numbers of institutional investors.

Overseas-listed Chinese companies like Hai-er and Lenovo have also been looking to Eu-rope and the US as markets and places to invest. In 2004, China spent US$5.5 billion acquiring assets and factory space overseas. Back in Chi-na, still awaiting a decision on 3G, China-based telecom operators turned on to information services instead. China restricts its companies from paying licensing fees to international IT standards patents, instead focusing on coming up with its own, as in the TDSCMA wireless communications standard.

Olympic buzz

China.s economic success story may be just beginning. On December 11, the country will enter the .fth and .nal year of implementation of its WTO commitments. Europe has a lot rid-ing on the outcome. China is the second-largest trade partner of the European Union, second only to the United States, according to a report issued in September by EU numbers agency Eurostat. China bought .ve percent of EU ex-ports, while China.s sales to the EU comprised 12 percent of the bloc.s imports up to Septem-ber 2004 . EUR48 billion and EUR127 bil-lion respectively. The European Chamber has warned against the replacement of trade barri-ers with non-tariff barriers such as cumbersome licensing procedures.

"It.s time to look from strict interpretation of the WTO rules to .xing what.s not work-ing," says Barry Livett. Getting enforcement across China.s 23 provinces, four municipali-ties and .ve autonomous regions isn.t going to be easy. But the Olympic buzz building in Beijing is but an enticing hint of the enormous business opportunity for European companies. Foreign .nancial institutions. cash will also pour into property and infrastructure sectors as the city prepares for the 2008 Games, predicts Ian O.Brien. If China takes European Chamber suggestions on hand, 2006 could be a very good year for business.

SMEs

Small and medium .rms are the meat and pota-toes of big economies and so it is in China, where the private economy is powering most of the economic growth the country is enjoying. More European SMEs are coming, too, says Hanna Boehme, chair of the European Chamber's SME working group. China needs them - SMEs create jobs in sourcing and manufacturing - but many European SMEs are nervous of having their IPR infringed upon and their competitiveness snatched if they shift manufacturing to China. "Getting into China is a daunting enough task for a company with a small staff and little time for research," says Boehme. "Finding a reliable joint venture partner is dif.cult, but most small companies complain of having to sift through complex but vague laws if they opt to establish a wholly foreign-owned enterprise (WFOE)..


Sourcing RMB-denominated bank loans lo-cally and getting pro.ts out of the country are particular dif.culties which Boehme's group hopes to see eased with banking and foreign exchange reform in 2006. With ambitious young businesses from new EU member states like Hungary, Poland and Estonia increasingly seeking a piece of the China market, the SME Working Group seems set to become a more vocal part of the EU Chamber.

Banking

The more things changed in other sectors the more they stayed the same in banking in 2005. Even while headlines were being made by China's big banks listing or preparing for listings in Hong Kong, foreign banks remained restricted to opening one branch per year. Still, 2005 was a good year overall for foreign banks in China, says Olivier Rousselet, general manager at BNP Paribas’ Beijing branch. "pro.tability of foreign banks in China is improv-ing in most of their businesses." An important advancement in 2005 was the opening up of the onshore RMB forward market. Above all, says Rousselet, 2005 will be remembered as the year in which foreign banks moved decisively to take stakes in Chinese counterparts.

Regulations such as registration with SAFE of offshore guarantees and implementation of funding quotas implemented in 2004 and 2005 have stunted the development of the domestic business for the foreign bankers like Rousselet. Is he hopeful for 2006? "Yes, if banks can offer a wider range of products. But the cost of capital in operating through branches should be reduced." A full five years after China's entry into the WTO, conducting RMB business with Chinese customers will .nally be permitted next year, but, Rous-selet add-ed, at an extra cost of RMB200 million per for-eign bank branch.

Automotive

The enormous pro.t margins enjoyed by foreign automakers here in 2002 and 2003 taste like a sweet memory now as a lag in China sales in 2005 pulls prices downwards. But even as demand slows, production capac-ity is increasing at a ferocious pace. Deutsche Bank projects oversupply in China to reach 23 percent in 2005. But worries about over capacity in China may be overstated, says Dominik Declercq, China representative of the European Automobile Manufactures Association (ACEA) and Vice Presi-dent of the Chamber's Automotive Working Group. "things can change very rapidly in the Chinese market. Producers in the past have found themselves quickly under capacity." And development plans are often merely promotional tools, he warns.

Surprisingly perhaps, production costs are also still higher in China, says Declercq. "Output must be raised before it's more economical to produce in China for export markets." But sourcing of parts here is set to get cheaper. Under China's WTO membership, manufacturers import-ing 60 percent of parts will, in 2006, be taxed at the same rate as imported cars. “Major consolidation" in the new year will also weed out competition, predicts Declercq, who also projects that market growth will continue at a still-impressive ten percent per an-num. "that's considerable compared to Europe, where it's one or two percent a year..

IT & Telecom

Wireless is the word. The new year will be tumultuous for IT companies if, as expected, China announces how it intends to hand out licenses for third generation (3G) telecommunications. China's kept everyone guessing and waiting but telecoms businesses are eager for clarity, says Jari Vaario, chief representative at Nokia China and Chairman of the Chamber's IT&T Working Group. "Making an announcement on 3G will give clarity and allow people to line up products and alliances," says Vaario, who's also keen that market demand rather than regulators alone decide the technolo-gies to be licensed. As software outsourcing con-tracts start to pour into Zhonguan-cun, Beijing's "Silicon Valley" and into Yangtze River Delta cities, China is spending record sums on wireless and telecommunications infrastruc-ture. European companies want an easier run at these government pro-curement contracts in 2006 - deals often unfairly go to state owned com-panies with close ties to government agencies, rather to those offering the best products. Standards also remain a thorn in the side for IT executives like Vaario, who’d like foreign .rms to be able to sit on China's standards bodies with full voting rights. Chinese IT .rms should be encouraged to negotiate with international coun-terparts on royalties for using global standards.

Pharmaceuticals

With the specter of bird flu looming and China embarking on the daunting task of building a better healthcare system, it would seem to be a crucial time to be a European pharmaceuti-cal company in China. But the country's drug pricing system and slow approval of new drugs makes it a harder place to do business, says Eric Bouteiller, who heads up the Tianjin oper-ations of Beaufour-Ipsen Phar-maceutical Co and also chairs the Chamber's Pharmaceutical Working Group. "European .rms rely on tried and trusted brands to make money, but China would be better served by making life easier for R&D based firms keen to introduce new products to the market," says Bouteiller.

Innovation is not being re-warded by the state's cumber-some pricing system which doesn't always re.ect the value of new drugs. But if China ramps up public spending on healthcare (from a compara-tively low 5.3 percent of GDP in 2004) and gets its skeletal social insurance system in or-der, Chinese patients will have more access to and money for drugs. Bouteiller goes into 2006 with hopes for a faster approval process for new drugs and a promised regulation from the Ministry of Commerce which will decide whether foreign manufacturers like his can widen their business scope to sell imported drugs to Chinese wholesalers.