China's absorption of foreign direct investment has been described as "just as scary as terror". Are China's neighbours afraid?

According to the World Bank, since the 1997 crisis, the share of foreign direct investment (FDI) inflows to most developing East Asian countries has decreased while the share going to China has risen. Korea, Indonesia, Malaysia, the Philippines, Thailand and Vietnam together received US$8bn of FDI in 2003, compared with China's US$53bn.

Malaysia has probably seen the worst of the downward trend, with its FDI decreasing from an annual average between 1990 and 1997 of US$5.2bn, to US$3.5bn between 1998 and 2000, and it has since dipped lower still to US$1.9bn.

Singapore has fared very well. In 2003, an improved global economy and the Singaporean government's efforts to attract FDI caused incoming investments to shoot to US$11.4bn, double the amount from 2002. This is good news for Singaporean lawyers. Law firms owe much of their existence in Singapore to FDI, according to Gerald Singham, a partner at the island state's oldest firm, Rodyk & Davidson.

"I'm quite passionate about FDI because it's my financial lifeline - and the firm's," says Singham. "We have grown with Singapore. We are here because of Singapore's growth as an FDI centre."

Singapore's growth will continue to rely on its ability to attract foreign investment. A country lacking natural resources (importing drinking water from Malaysia), it is the most reliant on FDI out of the Southeast Asian countries. In 2002, Singapore's stock of FDI to GDP ratio was 143%. For Malaysia it was 60%, Indonesia 32% and Thailand 24%.

Singham assesses the mood in Singapore as optimistic. "Generally, there is an air of optimism, we feel we are a continent on the move. My generation sees that the world is looking to Asia. This century will be the Asian century."

As Singham's comments suggest, regionalism is a hot topic in this part of the world. Against the backdrop of a rising China, regional cooperation is key to remaining relevant. In Indonesia, the outgoing leader Megawati Sukarnoputri is a keen believer that cooperation would draw foreign investment into the region. To that end, she is urging economic ministers from the region to overcome their differences and achieve economic integration akin to the European Union.

Optimists in the region subscribe to the notion that the new economic power will pull its neighbours along to greater prosperity. In his keynote address at the ASEAN-China Forum held in Singapore in June, the  ASEAN Secretary- General HE Ong Keng Yong said, "ASEAN has been watching the developments in China and has taken the prudent step of engaging China instead of treating it as a competitor."

ASEAN and China recently set a hopeful 2010 deadline for the  completion of a free trade agreement. Critics say realistically it will take much longer than that. But as Jonathan Anderson, head of Asia-Pacific economics at UBS Securities, assesses, the members of the key association in the region still have issues to resolve among themselves prior to dealing as one with China.

In the meantime, each country is looking out for itself, with governments making conditions more attractive for foreign investors, signing bilateral agreements and cheering on domestic businesses to penetrate the China market.

For lawyers in Asia, FDI work depends on how well their firms have positioned themselves in relation to China. Obviously, those in Hong Kong reap the benefits from the flurry of China-related dealmaking. The Asian Development Bank revealed that average annual investment in Hong Kong between 1991 and 1993 was US$2bn, which soared to US$33.8bn between 1998 and 2000. For firms doing FDI work in Hong Kong and in their satellite offices in mainland China, there is plenty of work to go around.

But what about lawyers based elsewhere in the region? It seems that tensions surrounding the engagement with, and competition against, China are shaping the way the rest of Asia is doing business.

Engaging China
ASEAN countries are keen to establish a dialogue with their giant neighbour. However, for now, the flow is mostly one way. According to Ong, by the end of 2003, accumulated contractual FDI from Southeast Asia into China was US$64.3bn and the actual paid-up capital was US$32.3bn. On the other hand, total FDI from China into Southeast Asia stood at US$150m in 2001.

China's neighbours are counting on its growth and development becoming a source of capital. The key word, however, is development. For all of the recent fanfare over Chinese businesses engaged in outbound activity, the reality is that the trend is in its early stages.

Jeremy Sargent, who is based in Stephenson Harwood & Lo's Guangzhou office, received enquiries from local businesses regarding outbound investment. "A lot of time was spent getting nowhere. The Chinese companies are still very tentative," he says. Stender expects that China-originated investment still needs to mature before it can become a substantial source of work for international firms.

Singaporeans stand out as particularly active investors into China. Total Singaporean  investment in China has reached US$24bn, the majority of which has been made by small to medium-sized enterprises.

CapitaLand, whose parent company is Temasek Holdings, has invested more than US$600m into China's booming real estate market. That number is expected to double over the next two or three years. CapitaLand's biggest project in China is the US$350m Raffles City Shanghai, located near People's Square.

At the launch of the Raffles City Shanghai project this year, Lee Hsien Loong, then Deputy Prime Minister of Singapore, now Prime Minister, encouraged Singaporeans to invest in China. He said he wants to make China a "growth engine" for Singapore's economy.

Singaporean firms follow business wherever it may go. "China is both a threat and an  opportunity," says Susan de Silva, partner of Singapore firm ATMD. "We have had to make sure we remain relevant to our clients by building up capacity to take care of their China deals."

That's the good news. Now for the less pleasant aspect for nations watching China's rise.

Competing with China
According to the Asian Development Bank, between 1991 and 1993 and between 1998 and 2000, FDI into China swelled from US$14bn to nearly US$42bn. Last year, China attracted US$53bn, overtaking the US as the top destination for FDI.

Opinions vary on how these numbers should be interpreted. One writer for the Washington Post manipulates the perception that China is a threat, describing its rise as "just as scary as terror". Another, Alan Reynolds, argues against such a dramatic interpretation. "Much of 'foreign' investment in China is actually Chinese investment channelled through Hong Kong to make it appear foreign and therefore qualified for a tax break," he writes.

Perhaps 'terror' is too strong a word. Regardless, China's ability to suck in FDI is nothing short of awesome.

There are several compelling factors that make China an attractive destination for foreign investors. Over the past two decades, the Chinese economy has averaged annual growth of 9%. Although it has increased with the economy's boom, the cost of labour and production remains low. The domestic market comprises 1.2 billion consumers. The government's open-door policy is yet to reach a climax as the country continues to work towards fulfilling WTO requirements.

All things considered, that rapid rise in FDI is set to go higher. Understandably, one might imagine that there is a twinge of envy and, yes, fear among China's neighbours, particularly those whose economies share too many similarities to that of China. They are most vulnerable to being left high and dry in the wake of China's rise as an economic power.

In Singapore, as the statistics show, FDI remains robust. The pessimism from when the heavy labour industry moved to China has been replaced with competitive fervour. "I believe that the initial fear has passed. If countries are not hollowed out, like Singapore, then FDI is not finite," says Singham positively.

FDI lawyers play something of a support role to governments. Selling their jurisdiction to investors goes hand in hand with attracting work. Rodyk & Davidson gives a very convincing sales pitch for Singapore. "How do you make an island, a country that is so young, how do you make it attractive to multinational corporations?" asks Singham rhetorically.

Singham lists the items that are in Singapore's favour: it has a strategic location and worldclass infrastructure and connectivity. It is a transport hub and an international financial centre. Further, Singapore has a quality workforce, which he describes as intelligent, diligent and relatively inexpensive. "The cost of a worker in Singapore might be equivalent to two or three workers in India or China, but there is better productivity in Singapore, when one looks at education levels and quality of work."

The proof in the pudding is Bilcare, India's leading pharma packaging research company. It has chosen Singapore as its manufacturing base from where it will penetrate other markets in the region, including Indonesia, Malaysia, Vietnam and China.

Needless to say, much of Singapore's competitiveness is due to its very pro-business  government. In pursuing bilateral agreements, Singapore has been the most active Southeast Asian country.

Any discussion of countries competing with China cannot exclude India, the current darling of economists after China. India could be China's biggest competitor in Asia in the future. "India is at least a decade later than China in opening up," says Singham. "India will start mopping up FDI. It will be interesting to see how China will compete."

It remains to be seen how well India competes for FDI. The performance of India's economy justifiably captures worldwide  attention, however, FDI is not a major factor in fuelling the country's growth. In 2002, US$4.7bn worth of FDI flowed into India - there is daylight between that and the amount of FDI received by China.

Speaking at a seminar in Malaysia this year, Professor Tarun Khanna from Harvard Business School said India demonstrates that FDI is not the only way to achieve prosperity. The professor determined that India's weakness is with providing cheap blue-collar labour; its strength is its skilled knowledge base.

Khanna said that FDI to China drives economic progress. The development of local Chinese companies has been stunted as a consequence. He cited last year's Forbes 200 list of the world's best small companies, which included four Chinese companies compared with India's 13.

India might eventually mop up a good portion of FDI headed for Asia, but it might also be a source of FDI for its neighbours, as the case of Bilcare illustrates.

Investing in China
FDI work in China is becoming increasingly lucrative for the firms who have by now  established the resources and reputation as major players in the market.

As part of its entry to the WTO, China will fully open its banking system to foreign  competition by 2007. Foreign banks are currently in preparation mode, busying themselves with acquiring domestic banks to the extent that regulations allow. The acquisitions happening now are in preparation for the domestic banks' IPOs over the next two years.

Other moves by the PRC government to liberalise sectors previously off limits to wholly foreign-owned companies will spur further investment. "New freedom for FIEs to engage in reselling, distribution and other services not only puts out the welcome mat to foreign companies that specialise in these areas, but also gives foreign manufacturers the ability to move these functions and related margins out of PRC manufacturing subsidiaries," says Neal Stender, partner at Coudert Bros' Hong Kong office. This deregulation will take effect on 11 December.

According to Clifford Chance, the use of the term 'FDI' in China is outdated, particularly as the debt side of the deals involves more and more RMB financing, deals are becoming bigger and FDI is going into shares as well as assets.

Stender picks up on the last point. He observes that acquisitions of existing companies are becoming more common. In an increasing number of cases, the investor's risk of exposure to various liabilities of the Chinese party are outweighed by benefits. "The Chinese company may have a successful business that would be difficult to transfer into a new JV entity,  and/or may hold a non-transferable licence to engage in restricted activities," explains Stender.

"Some Chinese companies have become sufficiently attractive as strategic partners to justify investments less for their potential financial return than as a means of strengthening relationships," he continues.

Conclusion
East Asian countries that are concerned about FDI being diverted to China can take comfort from the World Bank's assessment that, on a global level, FDI has been weak in recent years. "It is more the continued high growth and FDI in China even during a period of global downturn that is exceptional, rather than the downturn in flows in the rest of East Asia," the World Bank's April 2004 East Asia Update determines.

Clifford Chance puts a positive spin on China in this way. "It is worth noting that there might be much less investment in Asia generally, were China not such a drawcard." So, is China a threat or saviour? For Singham, China is not a threat. "We can't compete with China; the issue is how will we be relevant. This is where I believe our efficient workforce and nimbleness with changing government policy will put us in good stead," he concludes.