look%20out.jpgChina is changing and whole areas of its economy that were once closed are opening up. But there are some areas that continue to be very challenging.

I guess we've all read a lot of these “China is changing” articles, but thanks to Ian Lewis, of Hong Kong-based law firm Johnson Stokes and Masters, for this nice clear overview (R) of what is hot in China — and what is not.

A decade ago, many investors saw China as a source of cheap labour and as a manufacturing base for low-quality goods designed mainly for export.

That attraction continues and China's admission to the WTO has accelerated the trend for manufacturing industries to relocate to China from traditional bases elsewhere.

But more and more investors are today focusing on China as a market, one with particularly attractive characteristics thanks to its burgeoning and youthful middle class — see our earlier post. Their appetite for western goods creates big opportunities, particularly in the retail and distribution sectors.

Here, things have changed dramatically with the advent of new legislation at the end of 2004, which allowed wholly foreign-invested companies to participate in retail and distribution activities. However, sectors like books, petrol and tobacco remain subject to separate regulations.

The new law essentially applies the same standard to foreign-invested enterprises as it does to domestic companies, so you can now go and set up a a foreign-invested distribution company with a registered capital of only RMB500,000 or around US$60,000.

The power sector, by contrast, is much more problematic area for investment. Even though China needs to increase its power capacity dramatically, this is a particularly challenging sector for foreigners.

According to Lewis, Chinese power sector remains quite corrupt — something acknowledged by China's auditor general. This made it difficult for foreign investors to take advantage of the obvious opportunities that there should be.

In addition, the guaranteed returns that characterised power purchasing agreements in the 1990s are now largely gone, domestic players are a lot stronger and China is now experimenting with western-style pooling system. All these factors increase the risk and reduce the attractiveness of China's power market for foreign investors, according to Lewis.

Not surprisingly, the share of foreign investors in new power projects has halved in recent years from around 14.5% in 1997 to about 7% in 2005.

Lewis also highlights the emergence of a new generation of Chinese global players, with deals such as SAIC taking control of Korea's Ssangyong and Lenovo's purchase of IBM's PC operations.

He signs off with this:

The emergence of China as a major player in the world economy has been so fast that many observers have been taken by surprise… Investors who are well prepared and have a good grasp of the risks and nature of the market that they are entering can look forward to many opportunities as China continues to adapt and change in the global business environment in which it is now able to play such an important role.”

We couldn't have put it better ourselves.

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