China Presses Ahead with Macroeconomic Adjustment Measures

October 31, 2004 | BY

clpstaff &clp articles

An overheating economy is the subject of recent macroeconomic adjustment measures issued by the government and affects foreign-invested projects.

By Tang Zhengyu, Rachael Wellby and Wu Min, Sidley Austin Brown & Wood, Shanghai

In a recently published study of economic growth in China, the International Monetary Fund concluded that "China has continued its rapid economic growth and integration into the global economy", but warned that "despite recent indications of moderation in the fast pace of investment and economic growth, a soft landing of the economy is not yet assured".1 Ma Kai, head of the Chinese National Development and Reform Commission, echoed the IMF's sentiments. He stated that "the initial achievements are the first stage and more must be done to meet requirements to improve macroeconomic control".2

In the first half of 2004, China's GDP increased by 9.7%, significantly more than the full-year target of 7%. However, the IMF reported that indicators suggested that economic activity was beginning to slow, and predicted that growth should ease to around 7.5% in 2005 over 2004. While the issuance of new bank loans was reported to remain high, with a year on year increase of 29% by the end of July, the IMF assessment that "improved lending practices have contributed to a decline in the reported ratio of non-performing loans to total loans" is good news for China's economic policy makers.

China's determination to adopt cooling measures was perhaps most evident recently when, for the first time in nine years, interest rates rose by 0.27 percentage points. The hike was described by the People's Bank of China as necessary "in order to make greater use of economic measures in resource allocation and macro-adjustment".3

Since the end of 2003, China has implemented a range of macroeconomic adjustments in response to concerns over its overheating economy. What are the important legal implications for foreign-funded projects of key macroeconomic adjustment measures?

What are Macroeconomic Adjustments?

China's macroeconomic adjustment policy aims to utilize market, administrative and legal measures with a view to cooling and restructuring a volatile economic environment that has seen irresponsible lending and misallocation of capital into unsound or dubious investment projects. Specific measures taken include greater credit control, reducing lending, raising reserve requirements and tightening investment. The steel, aluminium and cement industries are among the overheated sectors that are specifically targeted in these measures.

Effective land management, in order to protect primary farmland and ensure the efficiency of land use in industrial and commercial projects, has also been a major focus of the macroeconomic measures. To this end, the government recently announced the State Council, In-depth Reform of Land Management Decision,4 which aims to strengthen land management regulation. Premier Wen Jiabao stated that "land management should be further tightened since the achievements scored in land management are still in the primary stage, and misuse of land has not been eradicated".5

Prohibited and Restricted Projects

In line with China's macroeconomic adjustment policies, new regulations have been issued that aim to improve lending practices and credit control in the banking sector. The regulation aims to ensure that only those projects proceed that are not detrimental to China's macroeconomic plan. The Issues Regarding Better Coordination and Balance between Industry Policies, Lending Policies and Control of Credit Risks Circular 6 details criteria for the classification of projects as "prohibited" or "restricted".

An outright prohibition on the continuation of certain commercial projects is imposed. Prohibited projects include those that:

• gravely pollute the environment;

• materially endanger production safety;

• produce substandard products; or

• consume excessive amounts of energy or raw materials.

Additionally, restrictions are imposed on projects that:

• have excessive production capacity;

• utilize outdated technology;

• damage the environment;

• are energy inefficient; or

• do not enhance the macroeconomic environment.

The consequences of a commercial project falling within the new classification of a "prohibited project" are severe:

• construction of all prohibited projects must cease;

• completed projects must close within an agreed timeframe;

• financial institutions must not extend new credit to the projects; and

• loans must be repaid in full (on terms to be agreed with the lendor).

Projects classified as restricted are subject to the following requirements:

• authorities must investigate, identify areas of non-compliance and require corrective measures be taken;

• if a project is undergoing the approval process, the process must stop and an investigation commenced; and

• during any investigation, financial institutions must not extend new credit to the project.

Legal Implications

The impact of the circular on specific foreign-invested projects that fall within the definition of "restricted" or "prohibited" projects should not be underestimated. Prohibited projects will be subject to closure, whereas restricted projects will be subject to government investigation and the prospect of compliance with a potentially onerous requirement to take whatever remedial measures are deemed necessary. For projects granted credit from Chinese banks, the consequences of having operations forcibly closed while at the same time still being required to repay financing in full could not be much worse.

Force Majeure?

For project contracts (such as joint venture agreements and technology licence agreements) executed prior to the date on which the circular was issued (April 30 2004), the consequences of the circular may be considered as unforeseeable circumstances, which may be caught by any force majeure provision.7 Force majeure provisions frequently include language relating to events such as "government actions or inaction" or "change of law". If such language is included, the parties may rely on force majeure provisions to excuse their failure to perform related contractual obligations. In the absence of an express force majeure provision, it may be argued under PRC law that the project contract is deemed to contain an implied force majeure provision.

It is also important to note that the parties will not be able to rely on the operation of force majeure provisions sparked by issuance of the circular to excuse any existing or previous delay caused by unrelated circumstances. However, where the impact of the circular on the project contract is so material that the purpose of the contract is defeated (for example, if the project is prohibited and required to close), the parties may be entitled to rescind the contract.

Given that the party's knowledge of the provisions of the circular is assumed in relation to any contract entered into after April 30, neither party to a contract executed after this date will be able to rely on the issuance of the circular as an unforeseeable circumstance entitling the parties to rely on a force majeure clause.

Conclusion

In the short term, macroeconomic adjustments will have negative repercussions on existing or planned foreign-invested projects that find themselves caught within the category of "restricted" or "prohibited" projects detailed in the circular. Already, it is reported that over 70,000 projects have been examined pursuant to the circular and associated adjustment measures. Of these, 472 have been ordered to cease and 2,882 have been suspended or given a timeframe within which to take specific steps to remedy areas of non-compliance. Additionally, 872 projects have been cancelled at the approval stage.8

However, the implications of a recent decision (State Council, Reform of the Investment System Decision)9 designed to streamline (and in some cases remove) approval procedures for investment projects, will likely provide some comfort for investors in China.

Many investment or construction projects, whether government or privately funded, are subject to stringent "examination and approval" procedures as a prerequisite to their commencement. By raising the investment thresholds at which approval is required,10 the decision means fewer privately funded projects are subject to any form of approval requirement. In addition, the approval process itself has been simplified to involve the submission of fewer documents.

Whatever the short-term effect of the macroeconomic adjustments, given that their principal long-term aim is to balance and stabilize an overheating economy, there is little doubt that the successful implementation of the adjustments can only improve the investment environment in China that will in turn benefit all investors, domestic and foreign alike.

Endnotes

1 IMF Concludes 2004 Article IV Consultation with the People's Republic of China.

2 Report to the Standing Committee of the National People's Congress, August 26 2004.

3 Press release, October 28 2004.

4 State Council, October 21, 2004 (GuoFa[2004]28).

5 Teleconference on strict land management, October 28 2004.

6 Jointly issued by the State Development and Reform Commission, the People's Bank of China and the China Banking Regulatory Committee on April 30 2004 and supplemented by the List on the Prohibition of Repetitive Low-grade Construction on Certain Current Industries.

7 Under PRC law, force majeure refers to situations or circumstances that cannot be foreseen, avoided or overcome.

8 National Development and Reform Commission Report on the Results of the Clean-Up of Fixed Asset Investment Projects, September 17 2004.

9 State Council, July 16 2004 (GuoFa[2004]20). The Decision is supplemented by the Verification of Foreign-invested Projects Tentative Administrative Procedures, issued on October 9 2004 by the National Development and Reform Commission.

10 To US$50 million for "restricted" projects and US$100 million for projects classified as "encouraged" or "prohibited".

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