Foreign direct investment (FDI) to China is expected to keep on par with 2005 levels, but the structure will change, with service, research & development (R&D) and mergers & acquisitions (M&A) to be put under spotlight.

In the coming years, the service sector will become a significant destination for FDI in China, acting as an engine for foreign investment, which showed signs of a slow-down this year, said Zhao Jinping, director of Foreign Economic Studies at the State Council's Development Research Centre.

"Service sector investment growth will be faster than growth in the manufacturing sector," Zhao said.

So far, just 20 per cent of FDI is channelled into the services sector, while more than 70 per cent is absorbed by industry, especially the manufacturing sector.

According to Zhao, things will change as China fully opens its services market in 2006.

"Service sectors, like finance, insurance, transportation and utilities will all quickly attract investments."

Beijing has agreed to fully open its banking system to foreign investors by the end of 2006. A flood of foreign investment into China's largest State-owned commercial banks has signalled the start of a process that will have major economic ramifications.

FDI remains robust

Zhao believed FDI in China would sustain its steady momentum and grow at a rate of 5 per cent to 10 per cent during 2006.

A survey by PriceWaterHouseCoopers released earlier this year showed a large number of chief executive officers plan to invest in China in the next three years to win customers in the world's fastest-growing economy.

Fifty-five per cent of business leaders said they plan to do business in China between now and 2009.

Three-quarters of executives said they plan to win new customers in China, compared with the 48 per cent who said they are investing in the country to primarily cut labour costs.

Jin Bosheng, an expert from the Chinese Academy of International Trade and Economic Co-operation, said M&As would take a larger share of FDI ahead of green field investment as China's M&A policies mature.

Internationally, 80 per cent of FDI is obtained through M&A, while the figure is currently 10 per cent in China, where FDI is mainly obtained through investments like the establishment of new properties, according to the Ministry of Commerce.

Opportunities will arise from Chinese share reform, as Beijing looks to offload some US$200 billion non-tradable State holdings without causing major market disruptions.

Investment in R&D is another bright point. According to a survey by the global consultant company AT Kearney, China will become the most attractive R&D location in the world in three years.

Low R&D costs, availability and quality of the local R&D workforce, and protection of intellectual property are the three most important aspects in the evaluation of R&D investment locations.

China ranks highly in all three categories, and is especially favoured by companies from the United States, the United Kingdom, Japan and Germany, said the survey.

About half of the surveyed investors plan to increase spending on R&D in the coming three years, and more than 40 per cent of managers expressed a willingness to develop research and investments in China and India.

Threat to FDI

However, one possible negative influence on FDI is the long-awaited plan to unify the tax rate paid by domestic and foreign-invested companies, said Jin.

He said the change, which is expected to raise the tax rate by foreign firms, would probably have the greatest impact on investment in sectors already facing the threat of overcapacity.

Foreign firms enjoy preferential income tax rates as low as 15 per cent while domestic firms are typically taxed at 33 per cent.

The National People's Congress, China's legislative body, is set to discuss a revision of tax law for a unified business tax rate this year.

However, most companies will generally not stop their investment just because of the tax change, he said, and also noted there would be future tax breaks.

Cheap labour and huge market demand are two advantages still offered by China.

China is making efforts to improve the structure of foreign investment as well as the quality and scale of foreign-invested projects.

To investment in manufacturing areas, Central China is expecting to attract FDI at a faster rate, compared with steady growth in West China and East China, and in the high-tech, chemical, and auto parts industries, which will also see an increase in FDI.

Source: China Daily