M ORLEY F UND M ANAGEMENT I NSIGHT I NVESTMENT

For financial advisers and investment professionals only

China: Opportunities and Risks for Foreign Companies

Introduction
Liberalisation of Chinas economy and the countrys emergence as a major global economic power are among some of the most significant world developments of the past decade. Many experts believe that just as Britain ruled the 19th century and the US the 20th, so China will come to dominate the next 100 years. However, China currently remains a relatively poor country with per capita income only a fraction of that enjoyed by neighbours such as South Korea. It will also have to overcome huge problems if it is to become a global superpower. These include weak institutions, a rickety financial system, an inadequate legal framework, massive environmental degradation and a huge army of unemployed and underemployed migrant workers having little stake in society. Few major international firms can afford to ignore Chinas huge economic potential. The country already has a prosperous, 100 million-strong middle class, and is rapidly becoming the workshop of the world as companies in developed countries outsource production to factories in China. It has also become a much more attractive investment destination since its accession to the World Trade Organisation in 2001 and successful bid to host the 2008 Olympic Games. Over US$60 billion of Foreign Direct Investment flowed into the country in 2004 alone; meanwhile, Chinas foreign trade surged to a record US$1.15 trillion1 and the country became the worlds third biggest trading power after the US and Germany. Although Chinas potential as a market and investment opportunity continues to intrigue and attract many foreign companies, many are also aware of the attendant risks of this enormous and complex country.

http://www.chinaembassy.org.in/eng/zgbd/t181360.htm

For Financial Advisors and Investment Professsionals only

Promoting responsible business in China

To investigate the risks for foreign companies operating in China, Morley Fund Management and Insight Investment hosted a series of seminars, involving companies, investors and specialists, to facilitate debate on how foreign companies can operate successfully and responsibly in China. The aim of the seminars was to explore emerging best practice for managing some of the key risks facing foreign companies operating in or sourcing from China. This paper provides an overview of the issues covered in the seminars, and their key findings, including the experience of some European companies that realised a tangible benefit from putting in place effective risk management systems in their Chinese operations or supply chains. The report also highlights recommendations from the seminars with the aim of encouraging continued progress and further dialogue between investors and companies around issues relating to operating in China.

The Seminars
2 Three seminars were held during the course of the year which covered a number of themes: Seminar 1: Economic and Political Climate (January 2004): This seminar introduced the China Project to participants. General macroeconomic trends, political reforms, implications of the liberalisation of the Chinese economy and WTO accession were major themes. Seminar 2: Legal and Regulatory Issues (April 2004): This seminar established Chinese laws and regulations that currently affect businesses (e.g. corruption, intellectual property rights), and looked at effective procedures that can be implemented by companies in order to overcome the lack of existing legal safeguards. Seminar 3: Managing Labour Issues (September 2004): The final seminar was designed to increase awareness of the risks to business posed by poor management of labour standards in China, and to look at business benefits that have accrued to companies who have managed these issues effectively.

The seminars were small (between 15 - 20 participants) to ensure that discussions remained focused and participants were given ample opportunity to contribute their views. All of the seminars were conducted under Chatham House rules. The report does not represent the formal investment view of Morley Fund Management or Insight Investment, the seminar sponsors. This paper is for information purposes only and neither Morley Fund Management nor Insight Investment can be held liable for any decisions you take having read its contents.

Seminar Organisers
Morley Fund Management is the fund management arm of the Aviva Group UK, one of the UKs largest insurance groups. Morley manages assets in excess of 128bn2 across world markets, and manages a range of specialist Socially Responsible global and regional funds. Insight Investment is the asset management arm of the HBOS Group. Insight manages its 77.7bn2 of clients assets under management according to a responsible investment policy Morley and Insight take the view that as institutional shareholders and fund managers, we have a responsibility to play an active part in the governance of the companies in which we invest. An integral part of this strategy is engaging with companies to analyse risks and opportunities inherent
2

in their businesses to alert fund managers to any issues that are likely to have an impact on shareholder value. We believe this process is best undertaken through face-to-face dialogue with company management. For further information please contact: Melissa Gamble or Harriet Parker at Morley Fund Management 020 7809 6000 melissa.gamble@morleyfm.com harriet.parker@morleyfm.com Rachel Crossley at Insight Investment 020 7321 1262 rachel.crossley@insightinvestment.com

As at 31 December 2004.

Participants
We would like to thank guest speakers and panellists for their valuable contribution to the seminars, which helped to generate insightful and constructive discussions. We would also like to thank the companies and other specialist organisations that attended the meetings and contributed to the findings of this report.

Guest Speakers Daniella Gould, Director of China Office, Impactt Ltd Dr. Gerard Lyons, Chief Economist and Head of Global Research, Standard Chartered Bank Dr. Linda Yueh, Fellow and Tutor in Economics, London School of Economics and Pembroke College, Cambridge

Panellists Jo Carpenter, Control Risks Group Dr. Stephen Green, Royal Institute of International Affairs Rosey Hurst, Impactt Ltd. Callum Macleod, Great Britain China Centre Peter Nightingale, China Britain Business Council Pierre Robert, Future Considerations Graham Rodmell, Transparency International (UK) Hilary Thompson, Kingfisher (B&Q) Albert Wong, Royal Dutch Shell

Attendees AccountAbility Acona Associated British Foods Aviva Boots Diageo GK Goh GlaxoSmithKline GUS (Argos) GUS (Homebase) Imperial Tobacco Inditex

John Lewis Kingfisher (B&Q) Marks & Spencer MFI Rotork Safeway/Wm Morrison Sainsbury Shell Somerfield Standard Chartered Tesco

Seminar 1: Chinas Economic and Political Climate

Introduction Despite the ever-growing importance of China to global business, it remains a country with numerous social and political problems including rising unemployment, corruption, regional economic disparities and other factors associated with capital markets in their infancy. While the Government of China has adopted a wide range of policies to promote market-based economic development, full political and civil reform, through a shift towards a more democratic government, is still far from being realised. The restructuring of State Owned Enterprises (SOEs) has led to large-scale redundancies; and subsequent feelings of resentment among former workers toward the government could create a threat to the long-term social stability that is essential to Chinas development. Chinas emergence in the global economy over the last decade has also coincided with the emergence of wider scrutiny of multinational behaviour, both within and outside China, by non-governmental and civil society organisations and extensive media exposure. This is putting pressure on companies considering moving into China to consider the full range of potential business risks they face, including extra financial risks such as those related to human rights, corruption and environmental issues. Foreign Direct Investment in China
US$ billion 70 60 50 40 30 20 10 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Source: International Monetary Fund, International Financial Statistics; Reproduced with the kind permission of Dun & Bradstreet.

There are many other medium to long-term economic problems pose direct or indirect challenges to foreign investors: Regional disparities: Direct investment (both foreign and domestic) has tended to favour coastal areas and cities, which have thus enjoyed much faster economic growth than inland regions. Income disparities between inner and coastal regions have widened. Ongoing deregulation and the dismantling of SOEs: has precipitated massive job losses and the emergence of a vast army of displaced migrant workers. State-run giants were once at the heart of the planned economy. But these companies are increasingly forced to sink or swim in the face of market reforms, leaving employees without work and deprived of a system of lifetime benefits. Weak banking system: The current debt-to-GDP ratio is a problem, given the need for continued spending on social security and the domestic banking sector. Government-pressured lending has left domestic banks with weak lending portfolios and large numbers of nonperforming loans. In addition, the state has bailed out many recently privatised banks, increasing levels of recurrent domestic expenditure. Welfare Spending: Chinas rate of population growth has decreased since the 1990s. However, the population is forecast to peak at 1.45 billion in 2030, and an ageing demographic profile will put pressure on welfare spending and government finances. Some of this cost may fall on foreign companies operating in China in the form of increasing welfare benefits to the workforce.

Economic Background Chinas GDP per capita has risen on average by 8% per annum over the past 25 years. The country recently overtook the USA as the most popular destination for foreign direct investment. China admittedly remains a low-income economy with low productivity per head, but it also has huge potential for sustained economic development. The government has pledged to continue stimulating domestic demand and pursuing expansionary macroeconomic policies. It further plans to address problems inherent in the economic system, and to focus on rural development, corporate and financial restructuring, and the reform of government institutions. But serious structural problems continue to undermine the economys potential, despite Chinas impressive compound growth and marked rises in real output and standards of living. The countrys policy of gradual free market reform, as opposed to the big bang approach adopted by other former command economies, has allowed policymakers to delay addressing major problems such as urban unemployment or non-performing loans. But this strategy may be unsustainable.

Currency: The international community strongly supports an appreciation of Chinas currency in line with WTO accession commitments. Yet Chinas domestic policies are currently geared towards stabilising the economy, with a gradualist approach to currency appreciation. The currency has thus been allowed to fluctuate within boundaries set by this policy framework. China is currently the worlds fifth largest economy, accounting for one-twentieth of total world exports. Three-quarters of exporters in China are foreign (mainly US), hence a weaker currency, coupled with low-cost labour, work in their favour. Upward pressure on the Yuan-Renminbi would be unhelpful to foreign companies operating in China.

record sales of over $1billion in the China packaged food market, which is now estimated to be worth over 30 billion. Some foreign businesses are now on the right track, and are beginning to successfully target the Chinese mass consumer market. These companies were able to target the mass market after they acquired local companies that already had channels in place. Anecdotal evidence suggests there are some recurring hurdles that keep tripping up foreign companies in China: Underestimating local competition: Domestic corporations have less than 70% market share in only two sectors (instruments and electrical and electronic machinery). This suggests that mainland producers may stand to benefit extensively by WTO entry. Lack of intellectual property rights: Many companies (mostly in consumer goods, chemicals and auto parts) have seen their Chinese markets diluted with cheaper, fake goods. Underestimating the impact of company-government relationships: For example, AT&T decided to withdraw from China after 1989, but the State later excluded AT&T from participating in particular JVs so that they lost out to rival companies. Concentrating predominantly on lowering labour costs: Operating costs in China relative to the rest of the world can be much higher than the labour cost savings that can be made. Understanding infrastructure and distribution network needs: Some companies signed JVs before recognising that systems they thought were in place were not, or were badly designed for their business needs. The effects of this have sometimes been exacerbated when companies have not been allowed to set up their own systems or networks Inheriting demoralised workforces from SOEs: often these employees have not been receiving redundancy packages/pensions. There is a need to identify what company obligations must be met before entering into agreements with former SOE companies, e.g. liabilities of SOEs to pay lifetime subsidies.

Foreign companies in China Foreign companies profits in China may have increased rapidly in the past four years, but they remain modest in comparison with other countries with smaller markets and slower growth. China, with its billion-plus population and dynamic economic growth, is seen a reservoir of untapped potential by foreign companies looking for new markets. But recent research paints a picture of a market characterised not just by untapped potential, but by cut-throat competition and incredibly challenging conditions. Many foreign businesses in China are struggling to make money at all because of low margins and local competition. Some foreign companies have lost money in China by overinvesting too quickly, too early, and companies with smaller investments have been successful within three to four years because they knew where to position themselves, and make the best use of their money. Manufacturing has accounted for 60% of Chinas GDP growth over the past decade, with the low cost of production, coupled with favourable economic policies and preferential tax rates, among the drivers behind the growth. As a result, foreign companies that make the most money out of the China boom are those that use it as a base for exporting or sourcing cheaply. It can be argued that most foreign companies are neglecting 90% of the market - more than 700 million people - by targeting just the wealthiest minority. For example, the US companies that made the biggest profits selling into the China market, rather than exporting from it, were the fast-food giants Yum Brands and McDonalds. Major firms such as Coca-Cola and Nestl now

Political Stability China is an authoritarian state under the unchallenged dominance of the Chinese Communist Party (CCP). The fourth generation of CCP leaders was elected in March 2003, when Hu Jintao replaced Jiang Zemin as President/Party General Secretary of the CCP. This new leadership aims to focus on restructuring State-owned Enterprises (SOEs) and developing a free-market economy, in order to address the problems affecting rural China. Mr Hu has pledged to strengthen the rule of law and secure clearly defined property rights - moves that will go some way towards aiding economic development. Yet China may need a greater level of democracy nationwide to guarantee a stable, free-market economy over the longer term. Chinas political environment is certainly more relaxed than in the late 1980s, when the authorities clamped down on dissent in the aftermath of the 1989 Tianamen Square massacre. Many subjects, once taboo, are now openly discussed, and the Chinese enjoy relatively free access to the Internet, albeit subject to certain restrictions aimed at monitoring or preventing debate on issues seen by government as politically subversive. The central authorities also encourage discussion of environmental questions and consumer protection - again within fairly tight boundaries. A civil society is also emerging in the form of increasing numbers of community organisations and monitoring groups (similar to non-governmental organisations). These groups represent both a threat to corporate reputations and an opportunity for corporate-community co-operation in addressing issues such as labour standards. Foreign companies could indeed benefit from working with such groups. But the emergence of a civil society also poses risks to the CCPs dominance of the political environment. Civil unrest could certainly ensue if the CCP failed to deliver improved living standards and economic stability. Tibet remains a sensitive issue. Beijing claims a centuries-old sovereignty over the region, but the allegiances of many Tibetans lie with the exiled spiritual leader, the Dalai Lama, who is regarded by China as a separatist threat. Under international pressure, China eased its grip on Tibet in the 1980s, introducing Open Door reforms and boosting investment. Beijing says Tibet has developed considerably under its rule, but many groups say China continues to violate human rights in Tibet, accusing Beijing of political and religious repression.

Environmental pressures While economic growth has increased incomes and improved health indicators as well as reducing overall poverty levels, growth in China has not been entirely benign. Environmental pollution from coal use is damaging health, air and water quality, agriculture and ultimately the economy. The World Health Organisation reported that seven of the ten most polluted cities in the world are in China. Sulphur dioxide and soot caused by coal combustion are two major contributors, resulting in the formation of acid rain, which now falls on about 30% of Chinas total land area. The Government recognises that such issues require attention, and that rising water and air pollution, as well as deforestation and desertification, may also threaten Chinas economic development. The authorities have issued regulations to reduce the emission of greenhouse gases significantly, and have recently launched a five-year pollution control plan - estimated to cost around US$84 billion. The Government has also introduced initiatives to cut back on coal use (e.g. by introducing a tax on high sulphur coals). Consequently, environmental regulation is expanding and is relatively well monitored. New laws establishing environmental regulations have been introduced. At the national level policies are formulated by the State Council.

Managing energy and water scarcity Rising energy requirements, as well a widening gap between oil supply and demand, have encouraged the Chinese government to give priority to investment in energy infrastructure. China is now the second biggest energy consumer after the US, and the worlds third biggest oil consumer. In 2001 China accounted for 9.8% of world energy consumption. Of the 39.7 quadrillion Btu of total primary energy consumer in China in 2001, 63.4% was coal, 25.8% was oil, 6.9% hydroelectricity, and 3.1% natural gas. By 2025, the share of nuclear power used for Chinas electricity generation is expected to increase to 4% from the little over than 1% currently. The government has made significant strides over the past few years in opening its energy sectors to foreign capital. As yet, foreign direct investment in energy typically involves foreign firms paired with one of three major state-owned Chinese partners CNPC, Sinopec and CNOOC - with the controlling interest held by the Chinese firm.

After coal, renewables (including hydroelectricity) account for the second largest share (18.6% in 2001), of Chinas electricity generation. With assistance from the United Nations and the United States, China hopes to embark on a multi-million dollar renewable energy strategy to combat pollution. While solar and wind power provide significant renewable energy potential, Chinas growth in renewables will in the next decade will be dominated by hydropower, particularly with completion of the 18.2-gigawatt Three Gorges Dam project in 2009. Although the Three Gorges Dam is seen as both an important source of energy for Chinas growing electricity consumption needs and a means of taming the Yangtze River, notorious for its disastrous floods, the controversial dam also could prove to be an environmental disaster. Thus far, few attempts have been made to address concerns regarding the accumulation of toxic materials and other pollutants from industrial sites that will be inundated after construction of the dam. Possibly the most serious environmental challenge for China is access to clean water. About 60 million people find it difficult to obtain sufficient water for their daily needs. Water demand is expected to triple during 1995-2030, from 120bn tonnes to 400bn tonnes, and by 2030 per capita water supply will fall from 2,200cu m to below 1,700cu m.

Companies should not underestimate the cost of bringing manufacturing standards up to match their brand requirements. This can include expensive expatriate salaries for managerial roles and training, as well as high operating costs. Companies that invest in China should be wary of the risks posed to their employees who may be targeted due to their suspected involvement in groups or other activities that may be regarded as contrary to the CCPs interest of maintaining social stability. Companies should be particularly careful if they are involved in projects in parts of the country where civil unrest exists such as Tibet or Xinjiang as involvement in these areas may open up companies to criticism from campaign groups and could pose reputation risks. Greater environmental regulation will involve increased costs for companies operating in China. Companies operating in China should be aware that they are increasingly expected to adopt measures to mitigate the impact of their operations on the environment. Companies should consider implementing robust environmental policies and practices that meet international standards so as not to be caught out should regulation in this area be tightened. Demand for power and a poor infrastructure in the power industry are increasingly causing power cuts. Businesses must take this into account when organising the work schedules and expected profit streams. In Shanghai, more than 800 factories have changed work schedules to avoid consumption peak times and more than 300 factories are using power on a rotating basis. Growing concern about environmental issues also presents new market opportunities to those firms offering solutions to some of Chinas more pressing environmental challenges. Technologies that will treat wastewater, provide clean energy, reduce air pollution and improve environmental monitoring systems will be set to benefit from this trend. Civil society groups represent both an increased threat to corporate reputations, and an opportunity for companies to co-operate with local organisations in order to address stakeholder questions such as human rights (in areas such as Tibet) and labour standards.

Suggestions for companies Companies considering operating in China should exercise caution and carefully balance the significant potential the country offers against the substantial economic challenges that remain. While Chinese banking practice appears to have improved in recent years, fundamentally little has changed. Increased foreign presence in the financial sector could help to promote further but gradual reform. Using local partners can facilitate foreign company operations, as local people have considerable experience of Chinese laws, business practice, culture and superior access to information. However, choosing the right partner is difficult, and involves a significant degree of risk. Some companies are addressing this challenge by buying into an SOE venture; however it is important to consider the partners ethical standards as well as their business performance.

Seminar 2: Legal and regulatory challenges in China

Introduction China has been strengthening its regulatory framework, but lack of clarity characterises many areas of commercial and economic law, a position that poses a major challenge for foreign companies. Consistent application and transparency of laws, regulations and practices is fundamental to a freemarket economy. Yet in spite of the need for large-scale reforms, the government has hitherto adopted a cautious approach to reforming the legal environment. Conversely, rising foreign investment has brought issues to the fore such as corporate governance and accountancy standards, along with the increased need for regulatory structures. Lack of effective enforcement of existing laws also remains a major concern. China has many hurdles to overcome before it can comply with international legal standards. Central and local government regulations often conflict and in many cases local lawmakers and officials interpret and implement laws according to their own political interests. The current devolution of power to provincial governments is exacerbating the problem. In addition, the vast majority of Chinas judges have no legal training. Foreign companies operating or planning to invest in China need to be aware of several other issues that will undoubtedly affect their activities. These include the status of Chinas adherence to World Trade Organisation (WTO) rules and continuing reform of the state sector. hence, they lack adequate legal training. Businesses can request arbitration, which operates according to international standards and guidelines to resolve disputes. This mechanism is fairly sophisticated but time-consuming. The WTO also has a dispute settlement mechanism; however, only member countries can bring actions on behalf of a company, rather than the company itself. Businesses report experiencing difficulties at the local level because local lawmakers and officials often interpret and implement national laws and regulations to achieve their own political ends, and operate according to a host of unwritten cultural rules. They sometimes try to extract bribes, or seek to protect local businesses. Furthermore, central and local government laws frequently conflict and local officials may lack knowledge of national laws.

Reforming the state sector The growth of the private sector, as well as continuing reform of the state-owned sector, is helping to liberalise the economy. The private sector currently numbers some 2.5 million large firms - which employ 70-100 million people and millions of smaller enterprises. The private sector generates 30% of gross domestic product, despite limited access to bank capital, while foreign-owned enterprises generate 55% of Chinas exports (a figure that highlights the level of foreign investment flowing into China). The state has already sold off many small and medium-sized SOEs. But around 160,000 large-scale, provincial-level SOEs remain; these have been incorporated into the State Asset Management Commission. This strategy allows the state to maintain its key role in major firms, while selling off minority stakes in smaller enterprises. Ninety percent of listed companies are former SOEs sold to retail investors. Thus, the stock market has essentially served as a vehicle to enhance SOE performance, with no concomitant commitment to the private sector. This suggests that reform of the state-owned sector has not been as successful as might at first appear. Yet reforms are beginning to have an impact - at least in terms of companies regulated by the China Security Regulatory Commission (CSRC) in Shenzhen and Shanghai. Investors are now able to seek legal redress in the event of fraud. Consequently, the level of foreign capital is increasing and private investment at the provincial level is also growing. Meanwhile the gradual reduction in the states equity in the industrial sector is reducing the incidence of asset stripping and the use of soft loans to prop up unviable firms.

Enforcing the existing legal framework In recent years, the Chinese government has introduced a number of economic laws to provide a framework for foreign investment activity. These include the Company Law (1994), the Commercial Banking Law (1995) and the Mergers & Acquisition (M&A) Law (2002). WTO accession has heightened the need for more complex laws. For example, China introduced the 1995 M&A Law to permit the purchase of non-performing loans - estimated to account for around 30% of GDP. The law authorised the State Economic and Trade Commission (SETC) to sell and restructure various financial instruments, thus allowing foreign firms to buy into local firms through debt for equity swaps. This has undoubtedly helped to attract foreign creditors, but the law has proved inadequate in combating the endemic crony capitalism that still deters many potential investors. While the regulatory framework is improving, enforcement remains a problem. Many of Chinas judges start their careers as bailiffs and work their way up through the system;

WTO Accession Some foreign companies have expressed concern at Chinas slow adoption of WTO rules. They see ambiguous property rights, weak implementation of laws, the absence of a framework for corporate governance and financial sector distortions as factors constraining private sector development. Yet China only recently joined the WTO (in 2001) and, in some respects, has made remarkable progress. It has gradually reduced tariff rates and barriers, and has met its obligations on import regulations and the agricultural sector. The legal environment will undoubtedly become less risky as Chinas economy opens up and rule-based trading becomes the norm. But the impact of WTO accession and development of the private sector varies from sector to sector. The diagram below highlights those industries (such as banking) that remain highly protected.
High Impact of marketisation, WTO Accession, competition Internet Services Textiles Chemicals Insurance Distribution Retailing Banks

the counterfeiting problem and pose a threat to the reputation and sales of international brands. The US estimates the value of counterfeit goods in China at between $19 billion and $24 billion, with losses to US companies exceeding $1.8 billion a year. Although these problems are generally unavoidable in developing market economies, the situation in China is particularly concerning. For the past 40 years, until China began putting intellectual property laws in place, all patents were owned by the government, and could be shared with any company that was willing to use them. The Chinese government encouraged this, and that has left a deep impression on Chinese companies that intellectual property is there for anyone to use it. The practice of copycat production is also fuelled by the fierce competition among Chinese companies and provinces to join the global economy. Chinese Authorities have drafted new laws to protect intellectual property rights. For example, protecting clinical trial data used in the drug approval process and software registration rules to protect copyrights of domestic and foreign software. The State Intellectual Property Office deals with IPR issues. Beijing has been improving its record in combating piracy and counterfeiting amid mounting pressure on the government to improve its performance in implementing its WTO commitments. The government signed an agreement on trade-related aspects of IPRs under the auspices of Chinas WTO accession. The EU has also recently launched a formal dialogue with the Chinese government to try and improve enforcement of IPR rules. Western companies have won some legal cases, although enforcing the judgements has proven difficult. The countrys efforts at improving enforcement, though steady, require more time to reach the standards of intellectual property rights protection in many industrialised countries. Lawyers who represent Western companies embroiled in intellectual property disputes in China point to major loopholes in Chinese law and in the countrys trademark and patent system as parts of the problem. Many Chinese patents, for example, are granted without any examination of their originality, making it easy for local companies to claim others innovations as their own. There has been some progress towards greater protection in Chinas courts particularly in the richer provinces along the countrys east coast. But local and provincial governments eager to bolster their economies sometimes subsidise patent filings for local companies and provide pointers to them on how to beat foreign claims of infringement. One problematic area is joint venturing between foreign and Chinese

Auto

Agriculture/Agrobusiness

Pharmaceuticals

Energy

Securities

Processed goods, consumer goods Telecom Services Electrical Equipment Low Tariff and non-tariff barrier protection per sector (in China/Abroad) High

Source: McKinsey Quarterly and China Business Council

Under WTO rules, China is committed to opening up its financial sector to foreign competition and investment by 2006. Regulators are monitoring progress, yet much ground remains to be covered. The majority of larger banks have a deeply ingrained ethos of non-commercially driven lending, with around 85% of loans going to SOEs. And the governments monetary policy encourages banks to maintain old lending habits, while limiting the level of lending to the private sector. The introduction of best practice via a foreign presence within the financial sector could encourage such developments.

Protection of Intellectual property rights China suffers from serious intellectual property rights (IPR) infringements. Ineffective laws, local protectionism and weak enforcement by the Chinese government contribute to

companies. When the joint venture dissolves, or sometimes even while it remains active, the Chinese party illegally makes use of the technology or manufacturing processes.

Chart 2: Corruption Perceptions for Selected Asian Countries, 2003

Indonesia India

Pharmaceuticals companies and IPR The pharmaceuticals sector aptly illustrates the impact of WTO membership on Chinas investment environment. The countrys huge population and prospective ageing population profile represent enormous opportunities for pharmaceuticals companies, but the lack of clear intellectual property rights protection and the threat of parallel imports pose significant risks. China has adopted trade-related aspects of intellectual property rights (TRIPs) rules as required by the WTO. These resemble intellectual property rights laws in the US but are still inconsistent and incomplete. As a result, few pharmaceutical companies currently have manufacturing operations in China, and those that do exist are generally joint ventures. Some companies have protected their interests by including international arbitration agreements within their contracts. But technology transfer agreements are likely to materialise in the future.

Thailand China S. Korea Taiwan Japan Hong Kong Australia Singapore 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0

10

0.0=most corrupt

10.0=least corrupt

Source: Transparency International, http://www.transparency.org.uk

Corruption

Perceptions

Index,

Tackling corruption Corruption is one of Chinas biggest political and economic challenges. Estimates suggest that large-scale incidents of corruption between 1995 and 2000 caused economic losses of between Rmb 988 billion and Rmb 1.3 trillion, the equivalent of between 13.2% and 16.8% of Chinas GDP. The central authorities have taken numerous steps to fight corruption, including forbidding government, police and military officials from participating in business enterprises, designating different accounting channels for revenues and expenditures, and launching a system of accountant accreditation. Corruption is most common among lowerlevel government officials, a phenomenon that results from central governments policy of devolving political power to the regions. The probability of officials getting caught or punished remains low.

Companies are often asked to make a payment for a contract, or related to a business deal when it is not legally required. Companies with experience of operating in China report that local officials are very creative in finding ways to earn a little extra and often invent payments that need to be made. One large international company found that only 30% of licences it secured were legally necessary. Culture, language and an entrenched and sophisticated system of extortion means that companies often face this kind of situation and do not know how to navigate through it. A new Administration Permit Law, which recently came into effect, attempts to streamline the various permits required for business into a one-stop system that will insist on written applications and the avoidance of face to face contacts. Adopting an anti-bribery and corruption (B&C) policy is essential prior to beginning operations in China. Transparency International, the leading non-governmental organisation working to combat B&C has produced principles and guidelines for companies to follow - reference and link on page 12.

CASE STUDY Managing Corruption - Shells experience in China Shell takes the issue of bribery and corruption seriously. The Anglo-Dutch oil giant is active in over 145 countries, many of which experience such problems. Over 95% of Shells 118,000 people around the world are locally recruited and the company has extensive, indirect influence over its business partners (i.e. its suppliers, Joint Ventures, contractors, customers and host governments). Shell also encounters social corruption, which is difficult to tackle. This is where the company is asked to contribute schools, clinics, universities, etc. in local areas that do not receive sufficient funding for such development from central government. Shell adopts six measures to counter corruption: 1. Upholding Shell General Business Principles; 2. Facilitating internal communication and training; 3. Creating an anti-corruption culture; 4. Adopting assurance processes; 5. Ensuring regular, transparent reporting; and 6. Engaging with stakeholders and experts.

Suggestions for companies Prior to investing in China, companies could undertake extensive research into the relevant laws and regulations governing their sector and the problems likely to arise due to non-enforcement and corruption. Companies should adopt a comprehensive policy committing to combating bribery and corruption. They should ensure that the policy is communicated internally to facilitate an anti-corruption culture and ensure all reporting and processes are transparent and secure and whistle blowing mechanisms are in place to identify breaches. Companies asked to pay for a contract or any other kind of business deal should try and establish whether the law requires such payment. Where relevant, companies should take practical steps to prevent the theft of IPRs. They can do this by splitting the production of a component between several factories, so that no single manufacturer has a blueprint of the final product. In addition, international arbitration agreements signed into contracts can be key to protecting intellectual property. Companies could work to influence the central government: but should do so carefully. A collective effort, working with other companies or via industry associations, is preferable in China. This is harder for the government to resist and has been effective in the past.

11

TRANSPARENCY INTERNATIONAL (UK) and Business Principles for Countering Bribery Graham Rodmell, Director, Corporate and Regulatory Affairs, Transparency International TI is a not-for-profit, independent, non-governmental organisation formed in 1993, whose objective is to counter corruption, primarily in international business transactions TI promotes the message that corruption needs to be and can be overcome. It bases its case primarily on economic and developmental grounds. TI does not investigate and expose individual cases of corruption. 12 The Global Anti-corruption Revolution Anti-corruption measures have assumed increasing prominence around the world in recent years. Of most importance to UK companies among the numerous international conventions is the OECD 1997 Convention on combating the bribery of foreign public officials in international business transactions, signed by all 29 OECD states and 5 non-OECD states, but not China. The effect is to criminalise the bribery of foreign public officials to obtain business anywhere in the world. China has signed the UN Convention against Corruption. For England and Wales, the criminalisation of foreign bribes was included as Part 12 of the Anti-terrorism, Crime and Security Act, which came into force in February 2002. This extended the components of our corruption prevention offences, the common law and statutes, so that they would apply to UK nationals and companies incorporated under the laws of the UK, wherever the offence takes place and even if no part of the offence took place in the UK. Proceeds of corruption and the economic benefit that accrues to someone or a company from foreign bribery can be confiscated under the Proceeds of Crime Act 2002. For there to be real change, there has to be a commitment to integrity throughout a companys structure and this cannot be created and sustained by criminal penalties alone. Voluntary codes are important as part of a company's risk management programme.

Practical measures companies can take to combat corrupt practices Develop a robust integrity policy. A corporate code of conduct should be fully and regularly communicated throughout the company and promoted through training, supported by internal control systems and records designed to identify and prevent bribery. The more transparent these measures are, the more readily they will be communicated to suppliers, agents, consortium and joint venture partners etc. In this situation, the easier it will be to communicate the risk of prosecution in the UK. When an enterprise engages in a new joint venture, it should use its influence to persuade other partners to adopt its anti-corruption policies. An enterprise should not channel improper payments through an agent and should ensure that agents conform to the requirements of its policies, are hired only for bona fide business purposes and that compensation paid to agents is appropriate and justifiable remuneration for services rendered. It can sometimes be daunting to stand out against extortion. It might be possible to agree upon joint action to counter corruption and perhaps in more serious cases to enlist the help of the British Embassy. Set up full corporate responsibility structures, of which anti bribery and corruption measures should be a part and perhaps in more serious cases to enlist the help of the British Embassy.

TI has recently published their Business Principles for Countering Bribery. These should be valuable to businesses (including small and medium-sized enterprises) in setting up their own policies and codes to counter bribery and corruption. These can be accessed at: http://www.transparency.org/building_coalitions/ private_sector/business_principles.html Over time, business integrity will be seen as a competitive advantage.

Seminar 3: Managing Labour Issues

Introduction The gradual shift from a central command towards a more market-based economy has had a significant impact on the labour market. Millions of state workers in urban areas have lost their jobs or seen their wages cut as a result of industrial reforms. At the same time, rural unemployment and underemployment (now estimated to be over 30%) has produced a large and expanding migrant worker population. Tens of millions of peasants have left their homes in search of better jobs and living conditions. This floating population was recently estimated at between 80 and 130 million people. Traditionally, foreign direct investment in China has been concentrated in labour-intensive manufacturing industries, accounting for over 50% of Chinas main exports. These industries have been attracted by government policies that favour foreign investors and low wages that remain suppressed by massive unemployment. The huge increase of foreign direct investment into the manufacturing sector has increased the demand for low cost labour. Chinas legislation covering health, safety, labour standards and the environment is comprehensive and demanding, but there are widespread reports of Chinese production facilities violating health and safety standards, discriminating against workers, paying low wages and requiring excessive working hours. Many foreign companies operating in China have now started to adopt ethical trading codes, modelled on core International Labour Organisation (ILO) Conventions, requiring their suppliers to demonstrate that they uphold certain labour standards. These codes include provisions to limit excessive overtime, ensure payment of minimum wages and to freedom of association. Most companies report finding it particularly hard to uphold these provisions in China due to systemic labour market problems. However, companies recognise the commercial imperative of trying to tackle these issues, whether it is in their own factories or in their suppliers factories, to ensure high quality products and avoid brand and reputational damage in their home markets. ranging across of workplaces spread across China. In many of these cases, the company in question may only account for 1% or 2% of a manufacturers total output, making it difficult to encourage change. Suggestions have been made that companies that source from the same supplier should collaborate to audit the factories and develop improvement plans, but there are as yet few examples of this approach being taken.

Minimum Wage Chinese law sets a nationwide minimum wage. Wages are then determined at the local level to reflect regional differences in economic development. But massive unemployment means that the labour market is heavily skewed in the employers favour. Comparisons between UK and Chinese legislation on working hours, overtime and holidays show that Chinas laws are more stringent. In the UK, the legal number of working hours per week exceeds that of China by 8 hours, or a staggering 37 hours in the case of workers opting out of the 48-hour week. Chinas requisite time off work is double that of the UKs (two days as opposed to one day). Chinese legislation on overtime pay stipulates that workers should receive 150 percent on top of ordinary wages for ordinary overtime, 200 percent for weekends and as much as 300 percent for holidays. In stark contrast, the UK provides no legal requirement for employers to pay overtime rates. But while Chinese labour law stipulates the number of hours (including overtime) that employees may be requested to work, the system is open to abuse and unreasonable hours are not uncommon. A large bureaucracy and a lack of communication and co-ordination between separate bureaux make enforcement difficult. The government is also reluctant to enforce laws too stringently for fear of losing current investors and discouraging further investment. Some problems have arisen as a result of regions competing for investment on the basis of lowest wage on offer. Many Chinese workers are paid on a piece-rate basis, which reflects the number of items produced. Management stipulates the number of items that a worker or team of workers must produce in a set period (usually a day), and workers are paid according to the pieces completed. In some cases, quotas are so high that workers need to work double shifts to meet them. Minimum wage requirements are difficult to enforce, as most factories work on a low piecerate basis. 13

Managing specific labour issues A Companys ability to exert influence on workplace conditions is often correlated with ownership and the percentage of suppliers production that they account for. It is not unusual for companies to have contracts for goods

Migrant worker profile The majority of factory workers in China are young, single migrants from rural areas who are willing to accept overtime, given that often the sole purpose of moving to urban, industrial areas is to make money to send home. In many cases, workers eventually settle in industrial areas and either create families of their own or bring family members to join them. But since education and healthcare are increasingly expensive in China, workers are often left with little, if anything, to send home. 14 The average worker would ideally like to work around two hours overtime each night and to have four days off each month. In reality, many workers clock up excessive overtime, are permitted inadequate rest and receive poor food and wages. Dormitory conditions tend to be rudimentary and lack adequate arrangements for married couples (these are generally forced to sleep in separate dormitories). There are no paid holidays or days off, and no transparency of pay on piece rates - a key factor in the sustained depression of wages.

Payment in arrears and excessive overtime While China has generally stamped out the practice of forcing workers to pay a deposit for guaranteed work, new devices such as payment of wages in arrears, or charging workers for the use of machinery or uniforms have become more commonplace. The transfer of benefits and insurance packages between factories is often prohibited, compounding the problem. Impactt, a UK consultancy with an office in China, specialises in helping companies to improve labour standards in their supply chains. Their research reveals that around 80% of factories have issues with overtime; the latter can be as much as six times in excess of legally stipulated hours. Companies obtain authorisation for overtime and seasonal fluctuations in working hours by applying to local authorities. Yet according to the central government, many factories claim to have special permits that are neither legal nor issued by the proper authorities. Experience has shown that a reduction in workers hours is not automatically accompanied by an increase in productivity. Factories are often given ultimatums that add to existing problems. One factory was asked to quickly cut working hours by 90 hours per month, which resulted in a 10% decrease in already-low wages, and an increase in labour turnover.

CASE STUDY - Overtime Project Rosey Hurst, Managing Director, Impactt Ltd. Ms. Hurst presented the findings from the 'Overtime project' carried out by Impactt. The project findings showed that for improvements in labour standards to be made, companies must meet the economic and the social needs of both supplier factories and staff. Impactt's experience from the Overtime project suggests that the high labour turnover rate in China is the key problem affecting the management of labour issues, with some factories incurring an annual labour turnover of 120 percent. Other common problems include excessive overtime, ill and tired workers and low wages. The subsequent low quality of output often results in a high level of reworking (in some cases 60% of output needed to be reworked) leading to low productivity. Some factories included in the Overtime project were found to be operating at just 35% efficiency. A combination of poor management, poor planning and lack of communication tends to underpin low productivity. Fewer working hours result in higher quality output, reducing the need for costly and time-consuming reworking. Other factors that contribute to low productivity include lack of training on the part of management, order delays and late sample approval from buyers, resulting in complete lines having to be reworked. In many cases production lines were a fiasco, lacking any semblance of coordination. Furthermore, workers were not provided with any incentives for increasing their output.

Factories have problems attracting and retaining skilled workers. Traditionally, labour is hired on sight, rather than on the basis of skill. Factory management tend to use negative techniques, such as fines, deposits and retaining wages to keep workers at the factory. In the face of the current labour shortage in South China, these techniques are proving increasingly ineffective. Factory recruiters should concentrate on attracting the 'right' workers, by offering decent packages to retain a happy, skilled labour force, rather than hiring cheap labour and paying more in the long term due to low quality output and high staff turnover. However, it is important to identify exactly what workers want and what kind of benefits would meet their needs communication is essential. Hierarchy and cultural issues can create significant communication barriers. If these barriers are not dismantled it becomes difficult to find common solutions. Facilitating discussion groups is important. Research shows that when working hours are higher, productivity is lower. By reducing the amount of overtime worked, through implementing better basic management and production systems, four out of the six participating factories made substantial improvements in terms of productivity. Overall factories incurred a 25 percent reduction in garments/products requiring reworking (in some cases, there was a 75% reduction) and total takehome pay increased in all factories. Management gained a better understanding of the labour laws, and was happier with the increased profitability and reduced production costs. Most of the workers were much happier than before. As a result, the turnover rate also declined. For more information on the overtime project please see http://www.impacttlimited.com/site/casestudy.asp

15

Occupational Health and Safety Before November 2002, China had no generic Occupational Health and Safety (OHS) law to prescribe minimum health and safety standards. Regional differences also created confusion regarding best practice and minimum standards. Weak factory monitoring, poor law enforcement and inadequate public education further limited the effectiveness of OHS in China. Factory managers and workers generally remain unaware of health and safety issues and often do not know that a workplace could be made safer. Corruption also represents a serious obstacle to effective implementation, with well-connected owners and managers able to avoid inspections of any kind. At present, the safety net for injured workers is virtually non-existent, and compensation represents the exception rather than the rule. The most effective avenue for improving working conditions is by way of incremental steps, such as training and workforce participation in various OHS initiatives.

of the audit, enabling the establishment and monitoring of action plans which are the important part of the process leading to real and sustainable improvements in factory working conditions. B&Q has found that auditing home workers presents particular problems, given the enormous difficulties in even the fundamental requirements. Its solution has been to engage the help of outreach workers, who go to individual workers' homes to discuss health and safety issues and agree gradual improvements.

16

Auditing and compliance Foreign buyers tend to work with huge supply bases and, in many cases, lack the resources to engage with factories suppliers on an individual basis. Instead, they favour sample audits as a tool for monitoring compliance with their ethical trading codes. Chinese factories can find the burden of audits immense, as they often have to deal with tens of different customers, each with slightly different codes of practice and approaches to auditing, as well as with an independent assessor carrying out audits. Western companies frequently report that Chinese suppliers engage in elaborate cover-ups, such as double book keeping and staged worker responses to audit questions, to create the illusion of compliance rather than actually meeting the necessary standards.. Companies are increasingly realising that audits typically present a long list of problems that need to be addressed in each factory, but they do not offer solutions. They also do not take into account progress that has been made, as they provide a snapshot at one point in time. And Chinese factory managers fear negative repercussions if they openly discuss compliance-related problems with clients. Another disincentive to co-operate with audits is that even though a factory may make considerable efforts to comply with the rigorous demands of a key supplier, that supplier may move their business elsewhere the following season. Auditing, can therefore, lead to factories spending a great deal of time, money and effort in creating the illusion of compliance with standards, rather than spending that time more fruitfully improving productivity and working conditions. This erodes incentives for factory managers and their customers to develop long-term improvement strategies, while providing huge incentives for elaborate cover-ups such as double book keeping and staged worker responses to audit questions.

B&Qs policy of dialogue B&Q views the factory audit as the start of a process, not an end in itself, and identifies a need for greater dialogue with factory managers and workers. B&Q found, for example, that many factories in China were prepared to admit - at small B&Q workshops - that they knew little about handling chemicals and meeting the relevant regulatory requirements associated with them. B&Q responded by producing a FAQ sheet on chemicals and the hazards of working with them; it also provided health and safety advice. The company encourages its suppliers to ask questions about B&Q's code of supplier conduct, and holds workshops to facilitate problem solving. B&Q believes it is important not to 'scare off' factories from the outset by grilling management on employment procedures and working conditions but prefer to work in partnership with factories to agree a way forward that is right for all parties. For example, on worker/employer dialogue B&Q sees worker meetings on health and safety as a non-controversial issue, that it can use as a starting point for discussions on broader questions. B&Q believes that trust-building and the engagement of managers facilitate dialogue on all issues. But B&Q also employs factory record and factory assessment reports with highly specific entry requirements that must be backed up by hard evidence (e.g., pay roll sheets, employment contracts, chemical registers, etc.). The company sees these records as the start rather than the end

Union Representation In 1992 the Chinese Government passed the Trade Union Law preventing workers joining a union of their own choosing and the 1995 Labour Law states that workers do not have the right to strike. China has also made a reservation to article 8(a) of the UN International Covenant on Economic, Social and Cultural Rights (to which it is a state party), which guarantees the right to form trade unions. According to the Human Rights Watch, Chinas laws recognise only one government-sponsored workers organisation, the All China Federation of Trade Unions (ACFTU), which exerts leadership over some 590,000 official grassroots unions and their sub-branches. This makes it particularly difficult to manage labour conditions in Chinese factories The All-China Federation of Trade Unions (ACFTU) remains the only umbrella trade union in China authorised to represent workers. However, as a quasi-governmental organisation, it is limited in its ability to defend workers rights. In terms of collective bargaining, the ACFTU has generally favoured the partnership or collaborative approach to solving problems rather than the confrontational approach However, a dearth of Chinese representatives equipped with the requisite negotiating skills make partnership difficult to achieve. Cultural differences between China and the West should not be underestimated. In China, the ACFTU is accustomed to representing the interests of the state before those of individual workers; in the West, unions generally aim to reach a compromise either with the state or with private business following negotiations on behalf of workers. According to the Chinese system, convergence and the avoidance of confrontation between the state and the union occur from the outset. The Advisory, Conciliation and Arbitration Service (ACAS) principles currently form the basis for dispute resolution in China, with academic and training institutions increasingly interested in this approach. But the picture in the non-SOE sector is unclear. Whether the traditional partnership approach will continue to produce results as state intervention in the corporate arena diminishes is open to question. The rising incidence of non-standard working conditions and irrational pay distribution may help to galvanise real trade union action. But trade unions currently play a very limited role within companies.

Suggestions for companies Foreign companies entering China should familiarise themselves with national and local labour laws. They should try to put in place well-enforced codes in line with international labour laws, which guarantee workers their fundamental rights - including the right to organise and bargain collectively, to have limits on working hours, to be paid a minimum wage and to be free from discrimination. Companies could also refrain from acceding to requests by the Chinese authorities to discriminate against, fire or in any way discipline workers who attempt to form their own unions, peacefully protest about their working conditions, or go on strike. Similar commitments should apply to subcontractors and suppliers, and the implementation of workers rights should be regularly monitored. Foreign companies should attempt to understand the issues facing Chinese factories, rather than to take a black-and-white blanket approach of simply auditing. Foreign companies need to consider carefully how best to engage with suppliers and business partners in China, rather than whether to engage at all. They will likely have to balance their role as partner with that of regulator in their relationship with their Chinese contractor. Many foreign firms discover that a supportive/collaborative approach to improving conditions in their Chinese partners operations is more effective than an authoritarian, policing line. There is an emerging consensus among retailers sourcing from China (and elsewhere) that more could be done to share audit results and lessen the burden of audits on factory managers. Sedex, a database into which suppliers enter their audit results and by which buyers can track performance of suppliers against ethical standards across their supply chain has recently been set up and could prove an effective vehicle for driving change. www.sedex.org.uk Cultural and other differences have in the past held back foreign companies from raising labour standards issues with the Chinese government. A direct approach does not work well in China. But a more subtle tack is possible, for example, by working with Chinese thinktanks such as the Chinese Academy of Social Science and with experts from local universities, to find ways of raising labour issues in policy circles in such as way that does not offend the Chinese government. 17

Further Information
For further information on topics discussed in the seminars we provide a number of references and links to some of the organisations that participated in the discussions: China Britain Business Council CBBC is the UKs leading agency helping British companies do business in China, delivering a range of practical, costeffective services to British companies wishing to export goods and services to, invest in, or establish manufacturing under license arrangements with China. http://www.cbbc.org/ 18 Control Risks Group Control Risks Group is the leading, specialist, international business risk consultancy that aims to enable clients to take risks with greater certainty and precision and to solve problems that fall outside the scope of mainstream management resources. Control Risks offers a full range of value-added services to companies, governments and private clients world-wide, including: political and security risk analysis, confidential investigations, pre-employment screening, security consultancy, crisis management and response and information security and investigations http://www.crg.com/ Dun and Bradstreet Dun and Bradstreets Country Risk Services produce a comprehensive information source for evaluating crossborder risks and opportunities around the globe. For information relating to the content of D&Bs Country Risk Services, please contact the Country Risk Services Group in the UK. Email: CountryRisk@dnb.com Future Considerations Future Considerations is a management consultancy dedicated to creating sustainable business results through integral approaches, emerging ideas and new practices. http://www.futureconsiderations.com/ The Great Britain China Centre The Great Britain China Centre is a centre of excellence in the promotion of understanding between Britain and China particularly in the areas of legal and judicial reform, and labour reform. The Centre has experience of running exchange projects with Chinese partners and working with many different UK organisations. The Centre is able to respond rapidly and effectively to the need for dialogue in a particular area and is recognised on both the Chinese and UK sides as being a trusted facilitator. http://www.gbcc.org.uk/ Impactt Ltd Impactt is a consultancy working with companies, organisations and individuals to open their eyes to new possibilities and to develop business practice which extends the number of people who benefit from international trade and investment. Its role is to empower and support individuals, organisations and companies to gradually transform the way they work, bringing about positive social change http://www.impacttlimited.com/ London School of Economics (Dr Linda Yueh) Dr.Yuehs areas of expertise span economics and law, including the Chinese economy, WTO and international economics, as well as international law. Other areas of interest encompass unemployment, imperfect labour markets and social capital. Dr. Yueh is both an economist and a qualified attorney who has practised corporate law in the U.S., Europe and Asia, including China. http://www.lse.ac.uk/people/l.yueh@lse.ac.uk/ Royal Institute of International Affairs Chatham House is one of the worlds leading organizations for the analysis of international issues. It is membershipbased and aims to help individuals and organizations to be at the forefront of developments in an ever-changing and increasingly complex world. http://www.riia.org/ Standard Chartered Bank Standard Chartered employs 30,000 people in over 500 locations in more than 50 countries in the Asia Pacific Region, South Asia, the Middle East, Africa, the United Kingdom and the Americas. It is one of the worlds most international banks serving both Consumer and Wholesale Banking customers. The Bank is trusted across its network for its standard of governance and its commitment to making a difference in the communities in which it operates. http://www.standardchartered.com/ Transparency International (UK) Transparency International is an international nongovernmental organisation devoted to combating corruption, and brings civil society, business, and governments together in a powerful global coalition. TI works at both the national and international level to curb both the supply and demand of corruption, raise awareness about the damaging effects of corruption, advocate policy reform, and works towards the implementation of multilateral conventions. http://www.transparency.org/ http://www.transparency.org.uk/

China: Key Economic and Development Information

2001 GDP (nominal) Y billion US$ billion Breakdown of GDP Agriculture (%) Industry (%) Services (%) Economic indicators Real GDP growth (% change) Inflation, annual average (%) Government balance (% GDP) Urban unemployment (%) Current account balance (% GDP) 9,731 1,176 8.3 15.8 50.1 34.1 2002 10,479 1,266 8.3 15.3 50.4 34.3 2003e 11,669 1,410 8.3 14.6 52.3 33.1 2004f 13,242 1,600 8.3 14.2 51.8 34.0 2005f 14,719 1,732

14.1 53.0 32.9

7.3 0.7 -4.4 7.5 1.5

8.0 -0.8 -3.1 8.2 2.9

9.1 1.2 -2.5 8.4 3.3

8.9 4.2 -2.0 8.5 -0.4

7.5 3.4 -2.2 8.5 0.2

19

Long-term real GDP growth potential, annual average, 2000-10: 6.0-8.0%

Development indicators Population, 2000 (m) Population, 2010 (m) Population, 2050 (m) GNI per capita (US$) GNI per capita (US$ PPP) Life expectancy (years) Dependency ratio, 2000 Dependency ratio, 2010 Dependency ratio, 2050 Political Information Head of state Head of government Political system Present constitution adopted Ruling party Last elections Next election

China 1,265.10 1,352.20 1,505.00 840 3,920 70 0.48 0.41 0.62

Hong Kong 6.8 7.4 6.8 25,920 25,590 80 0.40 0.35 0.90

Indonesia 210.4 237.6 314.9 570 2,830 66 0.54 0.49 0.56

Japan 126.8 126.3 104.5 35,620 27,080 81 0.47 0.55 0.91

Thailand 60.7 66.3 78.0 2,000 6,320 69 0.45 0.41 0.64

President Hu Jintao Premier Wen Jiabao Communist 1982 Chinese Communist Party December 2002 to March 2003 (heavily controlled) before March 2008 (heavily controlled)

Sources: International Monetary Fund, International Financial Statistics; World Bank, World Development Indicators; United Nations Development Programme, Human Development Report; National Bureau of Statistics of China, China Statistical Yearbook; Reproduced with the kind permission of Dun & Bradstreet from the companys annual report on China published in July 2004

Insight Investment Management (Global) Limited is registered in England with No. 827982. Registered office: 33 Old Broad Street, London EC2N 1HZ. Authorised and regulated in the UK by the Financial Services Authority and a member of the Investment Management Association. Part of the HBOS Group.

Morley Fund Management is a business name of Morley Fund Management Limited, registered in England No. 1151805. Registered Office: No. 1 Poultry, London EC2R 8EJ. Authorised and regulated in the UK by the Financial Services Authority and a member of the Investment Management Association. Morley Fund Management is also a business name of Morley Fund Management International Limited. Both are Aviva companies. Contact us at Morley Fund Management, No. 1 Poultry, London EC2R 8EJ. MFM/05/463