The EU-China Business Association, the European Union Chamber of Commerce in China, BusinessEurope and the Flanders-China Chamber of Commerce, with the support of Flanders Investment and Trade, organized a webinar focused on the results of the annual Business Confidence Survey 2022 of European Business in China. The survey was conducted by the European Union Chamber of Commerce in China in cooperation with Roland Berger. This webinar took place on June 28, 2022.
Ms. Gwenn Sonck, Executive Director, EU-China Business Association/Flanders-China Chamber of Commerce, welcomed the participants to the webinar and introduced the speakers. Doing business with China is not easy these times with China's dynamic zero-Covid policy, as businesspeople still cannot travel to China. Russia's invasion of Ukraine also causes supply chain disruptions with rising costs in energy and other goods. But China remains an important market for business and cannot be ignored. China surpassed the U.S. as the EU's largest trade partner in 2020 and 2021 thanks to strong demand during the coronavirus pandemic. EU trade in goods with China was worth €587 billion in 2020 and €695 billion in 2021. In the first five months of 2022 the trade reached USD345 billion, an increase of almost 9% on the previous year. China's exports reached USD226 billion, up 20%, while imports reached USD180 billion, down by 7.1%.
Ms. Bettina Schön-Behanzin, Vice President, European Union Chamber of Commerce in China, presented the results of the business confidence survey (BCS) 2022. The report is based on a survey of member companies with 61 questions on three core themes and five thematic issues. The response rate was 47% with 620 responses. The survey was conducted in February and early March, just after the Russian invasion of Ukraine and China imposing stricter Covid-19 containment measures, including the lockdown in Shanghai. Companies of all sizes are well represented in this year's BCS. Roughly half of the respondents are SMEs. Respondents came from a wide range of industries, with 40% in the industrial goods and services sector. Professional services took up 28% and consumer goods and services 20%. Most members (79%) have operated in China for more than 10 years, making them well positioned to comment on its business environment.
The key findings are:
• Businesses performed well financially in 2021, but challenges also grew. Even before Shanghai went into lockdown, the effects of the pandemic and the very strict Covid strategy were the key challenges for most businesses. Attracting and retaining top talent and urgently needed regulatory reforms were also mentioned by many companies, as well as the increasing politicization of business.
• The picture got much worse following black swan events: the Omicron outbreak in China and the war in Ukraine. To account for these events the Chamber conducted a flash survey in April.
• It is not expected that businesses will leave China altogether, but the form they take is changing. Due to the size and dynamism of the Chinese market, it is imperative to have a strong footprint in China. But there is huge uncertainty and we see the attractiveness of China as an investment destination is eroding. Companies are onshoring functions such as supply chains and IT data systems. Potential China footprints will be downsized and some will reduce head counts. Some businesses consider making investments in other markets.
Two-thirds of European businesses saw revenues increase, returning to pre-pandemic levels. In sectors such as petrochemicals, machinery and automotive we saw good performance. Revenue in 2021 also increased for businesses were face-to-face contact is very important, such as professional services and the legal sector. Profitability also took a turn for the better with four out of five companies recording positive results. Another 13% achieved a break-even. China continues to be a source of profit for many companies with 42% reporting greater EBIT margins in China than globally.
Clouds were already forming in 2021, as 60% of respondents said doing business in China became more difficult, the largest number since the question was first asked in 2014. Businesses of all sizes and operating across practically all sectors report this to be the case. Why is business getting more difficult? Covid-19 remains the top challenge, which was already the case in 2021. China's economic slowdown replaced the global economic slowdown as the second major challenge. China is still feeling the impact of the virus. In May we saw some macro data getting better but consumer confidence is still pretty low. Rising raw material and commodity prices are emerging as an issue. These challenges have only intensified since the survey was conducted. According to the World Bank the war in Ukraine has led to the largest increase in energy prices since the 1973 oil crisis. China's introduction of stringent Covid-19 measures has also led to a lower GDP growth forecast.
There is an employee exodus underway. The already low number of foreign employees in China continues to dwindle further. Almost four out of 10 members have decreased their foreign employee headcount over the past five years and 11% report that their operations do not employ any foreign nationals. For about half it is a strategic decision to localize positions, but for some it is also driven by foreign nationals being unable or unwilling to come to China. The lack of travel opportunities is really taking a toll. Quarantine requirements have just been adjusted from 14 to seven days in a quarantine hotel and three days home monitoring (7+3). It is not clear if this will be equally implemented in all cities. There are huge discrepancies from 7+7 in Beijing, 14+7 in Shanghai and in Shenyang 28+28, which is the longest. It would be a huge improvement if 7+3 would be implemented all over China.
All this has huge repercussions for businesses. The key negative impact is reduced transfer of know-how and difficulties of communicating with headquarters and this is accelerating decoupling. This is not only a problem for Europe, but a huge loss for China. China is losing invaluable expertise, which might not return. Foreigners working in China are some of the best ambassadors. They relate positive experiences when they are back in their home country. They report about what they have experienced on the ground in China, which is very important.
Market access barriers remain as reforms take a back seat to Covid. Almost half of survey respondents face direct barriers such as China's negative list or indirect barriers such as complex and time consuming administrative requirements. Twice as many respondents reported being hindered by indirect barriers than by direct market access restrictions. There is little prospect of this changing within the next five years. Two-thirds of companies report they would increase their investments if given greater market access, already witnessed in sectors such as in automotive after the lifting of ownership restrictions or the petrochemical industry, where European companies received approval to make large investments as wholly foreign-owned enterprises.
There was also little improvement in regulatory obstacles over the past 12 months, such as ambiguous rules and regulations, an unpredictable legislative environment, and discretionary enforcement. Businesses see little prospect for improvement over the next five years, as 82% expect that regulatory obstacles they face will not improve or even increase. The playing field also continues to be unequal for many (53%), but also 11% say the playing field is favorable to them. There still remains some way before a competitive market underpinned by the rule of law is developed. Key areas in which European businesses experience differentiated treatment are market access, communication opportunities with the Chinese government, access to subsidies, and public procurement opportunities. Half of respondents say business is becoming more political as in 2021 China and the EU sanctioned each other over human rights abuses in Xinjiang. There were consumer boycotts of European brands and media campaigns. Sources of pressure are the Chinese media, government and international media.
Carbon neutrality is a key priority of the Chinese government. European companies lead on decarbonization, but issues remain. They are ambitious in decarbonizing their China operations. About 90% aim to achieve carbon neutrality before 2050. Limited access to renewable energy is a key concern to decide where to build new plants, as 50% report. Other challenges are a lack of advanced decarbonization technologies, a lack of policy guidance and uncertainties over China's national carbon-trading market.
A flash survey was conducted in April, showing that the picture worsened following the black swan events as 58% of member companies decreased 2022 revenue projections. China's attractiveness as an investment destination diminished due to the handling of the Omicron outbreaks, according to 77% of respondents. It is not clear how long this unpredictability will continue. Many consider whether future investments would be better placed in other markets. Attractiveness has also decreased due to the Ukraine war. Twice as many (23% up from 11%) are now considering shifting current or planned investments out of China compared to February 2022 due to Covid-19 containment measures. This is the highest percentage recorded in the past decade. Companies are quite pragmatic. They need stable and predictable operating conditions. If this is not the case, they need a backup solution.
All this leads to growing localization as companies seek to mitigate their exposure. China operations are becoming more detached with two sets of supply chains, IT systems and data storage infrastructure: one for China and one for the rest of the world. This is very costly and difficult for SMEs. Staff positions have been at least partially localized.
Concluding remarks: old challenges remain but are superseded by new concerns. One of the concerns is: will we be knocked down tomorrow. China's economy is slowing. The property and automotive sectors are suffering and it is not clear when they will recover. Consumer confidence is quite low. European businesses are reevaluating their positions in the China market. China is a huge market and we are here to stay but no exit strategy for zero-tolerance leave headquarters no option but to look for other locations. The world cannot wait for China.
Ms. Luisa Santos, Deputy Director General, BusinessEurope, moderated the Q&A session. If you have more Chinese localized operations, how are we going to ensure that the companies in China are still following the global strategy of the company and don't become completely separated? Ms. Schön-Behanzin: We observe with big concern that more and more foreigners are leaving China and businesses are localizing all the positions from junior staff to board members, onshoring supply chains, and localizing their IT infrastructure, leading to decoupling. It is difficult to ensure that the subsidiaries here in China are fully compliant with the rules and regulations. The Chinese government must ensure that there are not more foreigners leaving because you need people on the ground who experience China. We hope the lockdown will be stopped.
Is there a difference between small and large companies in localization? Ms. Schön-Behanzin: There is no big difference, we see it across all sectors and company sizes. In a big company you have bigger teams and more opportunities to diversify. The smaller companies face the major challenge.
Does the Chinese government realize that the environment is becoming more difficult? Ms. Schön-Behanzin: It is crucial for China's future to open up and make it possible to travel again. This is only possible with vaccination. There is no exit strategy from zero-Covid and we all know Omicron or Covid will not disappear. China should push vaccinations, including imported mRNA vaccines. The Shanghai government is aware of this but their hands are tied as after the latest outbreak Beijing took over. People from the headquarter couldn't travel to China for more than three years and this is extremely dangerous. Concerning the Covid strategy, there is a policy but people have different ways to interpret it. Local governments have a lot of freedom with interpretation. Everybody is so scared that if there is one positive case in an office building or compound, the leader will be fired. They prefer to be super strict rather than opening up. There are still 120 million people who are not or not fully vaccinated and this is a huge problem.
How much is the Covid strategy impacting production in China? Ms. Schön-Behanzin: During the lockdown it had a huge impact because supply chains were completely disrupted. Not all people are back yet as it is still difficult to travel back to Shanghai from other places. Nobody wants to come and nobody can leave Shanghai. Chemical companies which cannot easily shut down are still leaving a core team in a closed loop onsite. Contingency measures make it very difficult to restart full speed. It is also still very difficult to visit customers and suppliers.
Why is vaccination not picking up? Ms. Schön-Behanzin: The problem is with people in their 70s and 80s, who are concerned about side effects. It is difficult for the government to push them to get vaccinated. China is working on its own mRNA vaccine which is now in phase III trials and could be released by the end of the year.
What is the general sentiment on the Ukraine war? Ms. Schön-Behanzin: China has no interest in acting as a mediator. There is a strategic alliance with Russia against the U.S. The saying here is that the West has started the war. China is always very pragmatic. They aligned with Russia but are no allies. They are benefiting from oil and gas imports at discounted prices. China will observe whether Russia can survive western sanctions and maybe try to look for other allies. The big concern for European companies is what would happen if China does the same to Taiwan. Many say they are very close to doing this as the West is very busy with Ukraine. We say that China has a lot of issues at the moment: Covid, lockdown, a slowing economy, a high unemployment rate, the property market is unstable, so we cannot imagine that they would take the risk to start such a war. They are sure it would not be a quick win. They studied the sanctions that the U.S. and EU imposed on Russia. They are preparing for it but are not ready yet. Another issue is supply chain risks. China is still relying to a high extent on import of high technology.
What can we expect from the Party Congress? Ms. Schön-Behanzin: Expectations are not very high. Xi Jinping will be reconfirmed for another term. There are many people in the Party who are not supporting the zero-Covid policy because they see how much it is harming the economy. China needs to grow, if it would slow down you would see an even bigger exodus of foreigners and western companies. The Chinese people are very frustrated with the lockdowns, passports are not renewed because it is too dangerous to travel abroad. Many givens are now gone. Many Chinese are extremely unhappy. If the level of frustration is rising, they have a huge problem. There will be many changes because many Party members have reached the retirement age.
Mr. Davide Cucino, Brussels Representative, European Union Chamber of Commerce in China, presented the closing remarks. Our dependence on the Chinese market is not debatable. It is a reality that has implications not only for European companies in China for the Chinese market but also for European companies in China feeding their supply chain abroad. In the past few months Covid and the war in Ukraine have brought new challenges for European businesses. China remains a major market for us where there are many opportunities, but many problems also remain.
