ICRG - China

D

CHINA ICRG MODEL Country Risk Management

Duy Dinh Tran (David) [email protected]

Abstract An analysis of the political, social, and economic risk factors of doing business in

China using ICRG Model.

Duy Dinh Tran (David) - 1468767

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Contents I. Introduction ........................................................................................................................................... 3

II. Financial Risks ...................................................................................................................................... 3

III. Economic Risks ................................................................................................................................ 4

IV. Political Risks ................................................................................................................................... 4

A. Government Stability ........................................................................................................................ 4

1. Government Unity ......................................................................................................................... 4

2. Legislative Strength ...................................................................................................................... 4

3. Popular Support ............................................................................................................................ 5

B. Socioeconomic Conditions ............................................................................................................... 5

1. Unemployment .............................................................................................................................. 5

2. Consumer confidence .................................................................................................................... 6

3. Poverty .......................................................................................................................................... 7

C. Investment Profile ............................................................................................................................. 8

1. Contracts viability/Expropriation risk ........................................................................................... 8

2. Profits repatriation ........................................................................................................................ 8

3. Payment delays ............................................................................................................................. 8

D. Internal Conflict ................................................................................................................................ 9

1. Civil War/Coup ............................................................................................................................. 9

2. Terrorism/Political violence ....................................................................................................... 10

3. Civil disorder .............................................................................................................................. 10

E. External Conflict ............................................................................................................................. 11

1. Cross-border conflict .................................................................................................................. 11

2. War .............................................................................................................................................. 11

3. Foreign pressures ....................................................................................................................... 11

F. Corruption ....................................................................................................................................... 12

G. Military in Politics .......................................................................................................................... 12

H. Religious Tensions .......................................................................................................................... 12

I. Law and Order ................................................................................................................................ 13

1. Law .............................................................................................................................................. 13

2. Order ........................................................................................................................................... 13

J. Ethnic Tensions ............................................................................................................................... 13

K. Democratic Accountability ............................................................................................................. 13


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L. Bureaucracy Quality ....................................................................................................................... 14

V. Aggregate Financial, Economic, and Political Risk Rating ................................................................ 14

VI. Summary ......................................................................................................................................... 14

VII. References ....................................................................................................................................... 15

VIII. Appendix 1 – China statistic from CIA World Factbook ............................................................... 18

IX. Appendix 2 – China Statistic from World Bank ............................................................................. 19

X. China Statistic from ICRG .................................................................................................................. 19


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I. Introduction

China is one of the most attractive emerging market in the world. China is well-known for

its huge population, high raw materials capacities, cheap labor, etc. For that reason, many global

companies have been seeking ways to do business in China. Following is an analysis of the

political, social, and economic risk factors of doing business in China.

II. Financial Risks

World Bank

2011

CIA Factbook

2012 (est)

Data Score Data Score Out

of

Foreign Debt as % of GDP 9.37% 9.5 6.11% 9.5 10

Foreign Debt Service as % of

Exports of Goods & Services (XGS) 1.69% 10 - - 10

Current Account as % of XGS 8.79% 13 10.43% 13.5 15

Net Liquidity as Months of Import

Cover 19.9 5 21.9 5 5

Exchange Rate Stability 3.08% 10 2.32% 10 10

Total 47.5 - 50

Note: See Appendix 1 & 2 for statistical data


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III. Economic Risks

World Bank

2011

CIA Factbook

2012 (est)

Data Score Data Score Out

of

GDP per capita 35.37% 1.5 56.85% 2.5 5

Real GDP annual growth 9.30% 10 7.80% 12 10

Annual Inflation Rate 5.40% 8.5 2.60% 9.5 10

Budget Balance as % of GDP - - -1.60% 7 10

Current Account Balance as % of

GDP 2.80% 13 1.70% 12.5 15

Total - 43.5 50

Note: See Appendix 1 & 2 for statistical data

IV. Political Risks

A. Government Stability: rating of 8 out of 12

1. Government Unity: rating of 4 out of 4

China is a single party state with the leading of the Chinese Communist Party (CCP). There

are eight nominally independent small parties, which have little national power, under the control

of the CCP. Any challenge to the CCP will be immediately and ruthlessly snuffed out. Thus the

Chinese government has a high degree of unity. 1, 2

2. Legislative Strength: rating of 1 out of 4

China does not have checks and balances system. The Chinese government influences the

law-making process to protect the leading party’s benefits. For example, in China, internet using

is strictly filtered and censored by the government3, or it is prohibited to talk badly about the


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leading party4. In addition, the government will find many ways to threaten independent

candidates and their supports to make them withdraw from the election to any government

positions5,6. Without checks and balances system, foreign investors doing business in China can

face disadvantage policies from the government.

3. Popular Support: rating of 3 out of 4

Due to strict control of the government towards its people and ruthless punishments to any

action against the leading party, the satisfaction of the Chinese to their central government is pretty

high. This satisfaction is lower for local governments due to corruption7. Thus, China’s political

system will remain stable. However, when more and more Chinese people can get access to

uncensored information and understand the truths, China’s society may become unstable.

B. Socioeconomic Conditions: rating of 8 out of 12

1. Unemployment: rating of 2 out of 4

According to World

Bank, the unemployment rate of

China in 2011 was 4.1%.

However, a survey from the Wall

Street Journal reveals that

China’s urban unemployment

rate in June 2012 was 8.05%8.

The survey also pointed out that

the unemployment mainly came from low-skilled or high age workers.


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On the other hand, there are not enough labors for factory jobs although China has millions

of graduates with few marketable skills. These graduates consider themselves as an elite force so

they refuse to work in factories9. As a result of unemployment and lacking factory labors, the

wages of blue collar workers have been increasing while the wages of white collar workers have

been reducing. Lacking blue-collar workers and increasing wages for factory jobs is potential

threats for firms operating in China.

2. Consumer confidence: rating of 3 out of 4

Based on Nielsen reports, China was

ranked as the 6th most optimistic country in

201110. The Consumer Confidence Index of

China has been even higher than US and

global average. This confidence of Chinese

consumer seems coming from the wealthy

rising of China society.

However, if we track the Consumer

Confidence Index of China further from

2002, we can see that the Confidence Index

has been decreasing over time. This

tendency implies that Chinese consumers

might probably switch to saving when the economy has a slowdown.

Although China’s wealthy makes younger generation, who were born under one-child

policy, prefer spending11, old people still has a tendency to save money more than to spend.. In


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China, due to food safety crisis, Chinese consumers prefer foreign products over domestic ones12.

Thus, foreign investors who seek to open factories in China should be aware the sales risk for

domestic market.

3. Poverty: rating of 3 out of 4

China has showed great

improvement to reduce the poverty rate

from 84% in 1981 to 12% in 2010. After the

Chinese government set the new poverty

line at RMB 2300 (approximately US

$3630) in 2011, the most recent number of

population below poverty line in China is

13.4%1.

However, the wealth gap between

rural and urban area is widening. China’s

Gini coefficient increased from 0.473

(2004) to 0.491 (2008)13. According to

Forbes magazine, this widening rich-poor

gap “caused social conflicts, and the

potential for even greater ones in the future, but undermine the Chinese belief in their government,

and work ethic.” 13


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C. Investment Profile: rating of 4 out of 12

1. Contracts viability/Expropriation risk: rating of 1 out of 4

Foreign investors face an expropriation risk in China. The Chinese government places high

priority in protecting and gaining more benefits. One example is the fight between Yahoo and

Alibaba for the owning right of an online payment company, Alipay. Although Yahoo owns 43%

of Alibaba, Alipay was finally sold secretly to Alibaba without any notice for Yahoo14. In high

tech industry, foreign firms also face the risk of losing their technology due to the intention of the

Chinese government when making laws15. In addition, Chinese government prevents foreign firms

from joining lucrative government procurement sector15.

Recently China’s new president, Xi Jinping, vows to protect foreign business in China16.

However, with many current barriers from inside the government, these changes will not likely to

occur soon.

2. Profits repatriation: rating of 1 out of 4

It is hard to get the profit out of China. The conversion of Yuan to foreign currencies is

closely regulated by the Chinese government to prevent capital flight17. In addition, if firms intent

to transfer the profits out of China, they will face many tax barriers17. Although China reduces the

tax from 10% to 5% for dividends sent to home countries which do not have tax treaties with

China, the law for this tax reduction is still vague for foreign firms18.

3. Payment delays: rating of 2 out of 4

Due to the vagueness of the law, foreign investors will face a risk of payment delays in

China. According to Coface's survey of 966 Chinese companies from October to December 2009,

the volume of overdue payment has been rising19. In the survey, two percent of the domestic sales


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were overdue for six to 12 months, and 24 percent for more than 12 months. Jingzhou Tao, Beijing-

based lawyer with Dechert LLP, says that Chinese firms use withholding payment as a frequent

tactic to force for price negotiation20.

Source: www.coface.com

D. Internal Conflict: rating of 7 out of 12

1. Civil War/Coup: rating of 2 out of 4

There are problems from Muslims in Xinjian, the biggest

province in the West side of China. In Xinjian, Islam is the

predominant religion among the Uighurs, a Turkic people uneasy

with Chinese rule21. There are confrontations between Uighurs,

which are resentful for employment discrimination of their ethnic

group, and the bingtuan, military corps of a state-run organization

whose main mission is to keep Uighurts quiet to maintain stability

of Xinjiang22. These confrontations create instability of Xinjian

province.

http://topics.nytimes.com/top/reference/timestopics/subjects/u/uighurs_chinese_ethnic_group/index.html?inline=nyt-classifier


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The Chinese government also detect the link between Uighurts and Al-Qaeda. In the fear

of Muslim extremist spreading, which cause instability to the society, the Chinese government is

trying to push more control to the Xinjian province22.

2. Terrorism/Political violence: rating of 3 out of 4

Most of terrorist case occurs in Xinjiang, where confrontations between Uighurs and the

bingtuan happened23. The risk is pretty low in Eastern cities of China.

3. Civil disorder: rating of 2 out of 4

Although the Chinese government claims that its crime rate has been fallen below Japan

and Switzerland24, the real crime rate of China in reality is more complicated. According to the

data of the UN Office on Drugs and Crime in 2009, China had a murder rate of 1.1 per 100,000

people, compared with 0.7 in Switzerland and 0.4 in Japan24.

In China, crime’s details are keep quiet to the public25. Chinese people can only know the

crime through crime-show on television, which has short amount of time per day25. This limited

information help the Chinese government create a safety atmosphere for its people. Although some

experts generally agree that China remains safe by Western standards25, lacking crime rate

acknowledgment can potentially create a safety risk for foreign investors in China.

In addition, there are several labor strikes in China that force factories to be shut down

temporarily26. These strikes mainly come from low wages and bad treatments for Chinese workers.


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E. External Conflict: rating of 5 out of 12

1. Cross-border conflict: rating of 0 out of 4

In Asia, China is having problems with

neighbor countries. China is facing strong

objections from the Philippines, Vietnam,

Malaysia, Brunei, Indonesia, and Taiwan for its

claim to own all islands in the “cow’s tongue”

area in South China Sea27. In addition, the

relationship between China and Japan are worsening in the confrontation for the authority of

Senkaku Island28. Furthermore, China is having border problems with Pakistan and India29.

Moreover, China’s support for North Korea hurts its relationship with South Korea30, America,

and United Nation. In general, most Asia countries are claiming that China is the big trouble spot

in the area. As China’s reputation is being damaged, consumers in other countries may avoid

buying goods from China, hurting sales of China’s local firms.

2. War: rating of 3 out of 4

Although China has border-conflict with neighbor countries, China has a low risk of war.

The main reason is many countries, including superpower nations such as US and Japan, have

invested in China, so fighting with China will eventually damage firms from their countries.

3. Foreign pressures: rating of 2 out of 4

Due to weak currencies and cheap labor cost, China faces many pressures from foreign

countries. US has continually put pressures on the Chinese government in order to stop

depreciating the Yuan31. However, it looks like that China’s currency will not be affected by US


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pressures. In addition, some Chinese export goods are claimed to be violated the dumping rule.

After EU imposed anti-dumping levies on Chinese solar panel imports, they are investigating

China’s wine for similar reason32.

F. Corruption: rating of 1 out of 6

Based on Transparency International, the corruption perception index of China in 2012 is

39, which perceives China as highly corrupt. The main reason for high corruption is that the leading

party has all the power so no other parties can check the government actions. Although China’s

new president Xi Jinping would like to create more transparency in China, without checks and

balances system, corruption will still remain high in China for a long time.

G. Military in Politics: rating of 5 out of 6

China is the single state party with the leading of the Communist Party. The Chinese

government does not allow any actions against the benefits of the leading party. With the power

of the current government, the risk of other parties using military to take over the government is

currently low.

H. Religious Tensions: rating of 2 out of 6

In the past, the Chinese government has confronted with Falun Gong, a big religion in China at that

time. Falun Gong attracted a large number of members, larger than the Communist Party, so the Chinese

government considered Falun Gong religion as a threat for the leading party. Thus, the Chinese government

has violently attacked Falun Gong members in order to dismiss this religion.33


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I. Law and Order: rating of 2 out of 6

1. Law: rating of 1 out of 3

China’s law is vague and complicated. Due to the vagueness of the law, the rulers can

interpret the law in the way that can benefit them34. Thus, one law can be interpreted differently in

a court of each province. Foreign investors frequently get confused with the complicated laws in

China, preventing them quickly expand their domestic market35.

2. Order: rating of 1 out of 3

Due to large distances between Central Government and Local Governments, the Central

Government hardly control the Local Governments34. Thus, it takes a lot of times for these local

governments to implement new laws from the Central Government. These local governments can

also overuse their power for corruption actions.

J. Ethnic Tensions: rating of 2 out of 6

China’s problem with other countries poses a very high political risk and unstable society

for foreign firms in China. The anti-Japan riots in China created losses for Japanese and their firms.

Consequently, many Japanese firms are moving their investment out of China to other places36.

These riots can also happen to citizens and firms of other countries, which have troubles with

China, in the future.

K. Democratic Accountability: rating of 2 out of 6

With single party state structure, democratic accountability in China is pretty low. The

Chinese government will place their benefits in higher priority than the benefits of Chinese people.

That explains why Chinese government censors and control Internet in China. The Chinese

government also violently punish people whose actions can harm the leading party.


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L. Bureaucracy Quality: rating of 2 out of 4

In China, the bureaucracy quality is low. When new leaders want to restructure the

government to make it more efficient, the restructuring plan will be faced with many barriers

because no one wants to give up his power37. In addition, the government’s reactions for

complaints of foreign firms, due to complicated licensing process, are extremely slow35.

V. Aggregate Financial, Economic, and Political Risk Rating

CPFER(China) = 0.5 (FR + ER + PR) = 0.5 (47.5 + 43.5 + 48) = 0.5 (139) = 69.5

MEDIUM RISK

VI. Summary

Among the three factors, political is the main reason that make China be rating as medium

risk for doing business. There are three key problems in the political system of China: the

vagueness of laws, the corruption, and the border conflict. In order to deal with the vagueness of

China law and the corruption, foreign investors should consider to have a local partner / agency to

work with the Central Government and local governments. However, foreign firms should be

aware that the side effect of the border conflicts between China and other countries would not

easily be solved, potentially creating the sales decrease for their product.


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VII. References

1 CIA World FactBook

2 BBC Country Profile

3 "A giant cage." The Economist. The Economist Newspaper, 6 April. 2013. Web.

12 June 2013.

4 Tatlow, Didi Kirsten. "A System Afraid of Its Own History." The New York

Times. The New York Times, 16 September 2010. Web. 12 June 2013.

5 LaFraniere, Sharon. "Alarmed by Independent Candidates, Chinese Authorities

Crack Down." The New York Times. The New York Times, 4 December 2011. Web. 12

June 2013.

6 "Vote as I say." The Economist. The Economist Newspaper, 16 June. 2011. Web.

12 June 2013.

7 Drysdale, Peter. "The Chinese People’s Trust in Their Government." East Asia

Forum. N.p. 25 July 2011. Web. 12 June 2013.

8 Orlik, Tom. "Charting Chinese Unemployment, Inequality." Real Time

Economics. The Wall Street Journal, 10 Dec. 2012. Web. 16 June 2013.

9 Bradsher,Keith. "Chinese Graduates Say No Thanks to Factory Jobs." The New

York Times. The New York Times, 4 January 2013. Web. 16 June 2013.

10 "China Ranked the 6th Most Optimistic Country Last Quarter." China Internet

Watch. N.p., 19 Mar. 2012. Web. 17 June 2013.

11 Richburg, Keith B. "Getting Chinese to Stop Saving and Start Spending Is a

Hard Sell." Washington Post. N.p., 05 July 2012. Web. 17 June 2013.

12 "China Will Ensure Baby Milk Safety to Boost Consumer Confidence."

Bloomberg.com. Bloomberg, 31 May 2013. Web. 17 June 2013.

13 Rapoza, Kenneth. "The China Miracle: A Rising Wealth Gap." Forbes. Forbes

Magazine, 20 Jan. 2013. Web. 12 June 2013.

14 Abrams, Stan. "Expropriation Risk in China: How Much Should We Worry About

the Alipay Transfer?" Business Insider. N.p., 31 Mar. 2011. Web. 17 June

2013.

15 Jiang, Chengcheng. "Why Foreign Businesses in China Are Getting Mad." Time

Magazie. N.p., 9 September 2010. Web. 17 June 2013.

16 Anderlini, Jamil. "Xi Vows to Protect Foreign Business." Financial Times.

N.p., 8 Apr. 2013. Web. 17 June 2013.

17 Monga, Vipal. "Getting Profits Out of China Can Be Hard." The Wall Street

Journal. The Wall Street Journal, 16 Ferbruary 2012. Web. 17 June 2013.

18 Mcmahon, Dinny. "China Clarifies Tax Rules; Foreign Companies Benefit." The


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Wall Street Journal. The Wall Street Journal, 16 July 2012. Web. 17 June

2013.

19 Yuanyuan, Hu. "Overdue Payment Volume Rises." Overdue Payment Volume Rises.

N.p., 15 Apr. 2010. Web. 18 June 2013.

20 "In China’s Shipping Industry, Contracts Are Not Guarantees, Shipowners Are

Furious." GCaptain. N.p., 6 Sept. 2011. Web. 18 June 2013.

21 Wong,Edward. "Wary of Islam, China Tightens a Vise of Rules." The New York

Times. The New York Times, 18 October 2008. Web. 12 June 2013.

22 "Settlers in Xinjiang: Circling the wagons." The Economist. The Economist

Newspaper, 25 May. 2013. Web. 12 June 2013.

23 "China: 20 Sentenced in Terrorism Case." The New York Times. The New York

Times, 2 August 2012. Web. 18 June 2013.

24 "Murder mysteries." The Economist. The Economist Newspaper, 6 April. 2013.

Web. 18 June 2013.

25 Areddy, James T. "In China, Crime Is Kept Quiet, Except on TV." The Wall

Street Journal. The Wall Street Journal, 28 May. 2011. Web. 16 June 2013.

26 "China's Factories Hit by Wave of Strikes." BBC News. BBC, 28 June 2010.

Web. 18 June 2013.

27 Barta, Patrick. "Neighbors Grow More Wary of China." The Wall Street

Journal. The Wall Street Journal, 13 January 2013. Web. 12 June 2013.

28 "Q&A: China-Japan Islands Row." BBC News. BBC, 29 Apr. 2013. Web. 12 June

2013.

29 "Fantasy Frontiers." The Economist. The Economist Newspaper, 8 Feb. 2012.

Web. 12 June 2013.

30 "On the Naughty Step." The Economist. The Economist Newspaper, 2 Feb. 2013.

Web. 12 June 2013.

31 Leonhardt, David. "As China’s Currency Rises, U.S. Keeps Up Its Pressure."

The New York Times. The New York Times, 2 August 2012. Web. 18 June 2013.

32 "France Criticises China's Anti-dumping Probe into EU Wine." BBC News. BBC,

06 June 2013. Web. 18 June 2013.

33 Beaumont, Peter. "China's Falun Gong Crackdown: 'The Persecution Is Almost

Underground'" The Guardian. Guardian News and Media, 18 July 2009. Web. 19

June 2013.

34 Phan, Alan, Dr. "42 Years of Business in America and China." Thai Ha Books,

2011. Web. 18 June 2013.

35 Bradford, Harry. "U.S. Firms Growing Impatient With Chinese Bureaucracy,

Survey Says." The Huffington Post. TheHuffingtonPost.com, 22 Mar. 2011. Web.

19 June 2013.

36 Nakata, Hiroko. "Firms Move Some Eggs out of China Basket | The Japan


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Times." The Japan Times. The Japan Times, 19 Dec. 2012. Web. 12 June 2013.

37 Roberts, Dexter. "China Inches Toward a Slimmer Bureaucracy." Business

Week. N.p. 15 February. 2013. Web. 18 June 2013.


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VIII. Appendix 1 – China statistic from CIA World Factbook

Budget surplus (+) or deficit (-): -1.6% of GDP (2012 est.)

Current account balance: $213.8 billion (2012 est.)

Current account: $213.8 billion

Exports of Goods & Services: $2.05 trillion

External debt: $770.8 billion

Foreign Debt Service: N/A

Foreign Reserves: $3.312 trillion

GDP - real growth rate: 7.8% (2012 est.)

GDP (purchasing power parity): $12.61 trillion (2012 est.)

GDP per capita: $9,300

GDP: $12.61 trillion

Imports: $1.817 trillion

Inflation rate (consumer prices): 2.6% (2012 est.)

Official exchange rate 2011: 6.46



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IX. Appendix 2 – China Statistic from World Bank

Budget Balance: N/A

Current account balance (% of GDP): 2.8%

Current account: $201,714,192,224.8

External debt: $685,418,102,000

Foreign Debt Service: $38,729,236,000

GDP growth (annual %): 9.3%

GDP per capita: $5,444.8

GDP: $7,318,499,269,769.4

Inflation, consumer prices (annual %): 5.4%



Total reserves in months of imports: 19.9

Exports of Goods & Services: $2,296,098,645,524.4

X. China Statistic from ICRG

GDP per head average 2011: $15,392

GDP per head average 2012: $16,357

ICRG - China

Documents

economic risks

political risks

economic risk factors

financial risks

government stability

government unity

civil warcoup

civil disorder