German companies in China: Enthusiasm is giving way to realism

German companies remain focused on the growth market China: 71 percent of companies intend to increase their investments in the People's Republic of China. Nevertheless, the optimism is waning somewhat as the business environment becomes more difficult.

After the challenging first year of COVID-19 in 2020, German companies' business in China recovered: 2021 turned out to be better than the prior year. Specifically, 63 percent of companies reported sales growth of more than five percent for 2021 and 48 percent reported similar growth for profits. These are the findings of the "German Business in China: Business Confidence Survey 2021/2022" of the German Chamber of Commerce in China in cooperation with KPMG.

The figures demonstrate that China is an enormously significant market for German companies and one which will also expand further. Expectations for 2022 are also optimistic as 60% of respondents expect sales to grow by more than five percent and 41 percent expect profits to rise by more than five percent.

The business environment in China's market is becoming more difficult for German companies. Respondents viewed the preferential treatment for local competitors as the most significant regulatory challenge – the consequence of the trend towards self-reliance within China. The strategic economic aim of the dual circulation policy promoted by China's government is to reduce dependence on foreign companies.

Companies report a lack of transparency, buy local practices and preferential treatment for domestic companies, e.g., for public tenders. In addition, China's companies are becoming ever more innovative. Meanwhile 49 percent of respondents believe that their Chinese competitors will become innovation leaders in their sector in the next five years (prior year: 41 percent).

Adding to this, the previous reasons for business in the People's Republic of China for German companies are losing relevance. For instance, only 51 percent of companies now view domestic consumption growth as the major opportunity for their business in China. In the prior year, 73 percent held this opinion. Now only 39 percent cite rising demand for foreign brands as a business opportunity; this a significant decline of 26 percentage points since 2019. 

Despite these developments, there continues to be major interest in China's growth market. Of the companies surveyed, 96 percent intend to remain active in the country and only 4 percent are considering leaving China. China remains an important investment location: 71 percent of participants intend to further increase their investments in the People's Republic of China over the next two years. The main focus of investments is on new production facilities and expanding research and development. 

Companies that are not investing in China or are reducing their investments there specify as the main reasons for this current travel restrictions, diminishing expectations regarding market growth and growing local competition. As the reason for their decision, 30 percent specify the politicisation of the economy – significantly more than in the previous year's survey (12 percent).

Roughly half of the companies in China see major challenges in finding and retaining qualified staff and in rising personnel expenses. In addition, 42 percent cite travel restrictions as an obstacle. In the opinion of respondents, these are detrimental to mutual understanding and impede both foreign investments and the economic growth of the country. Furthermore, rising raw material and energy prices and supply chain problems are also affecting China.

A further significant challenge for German companies is the decoupling of the West from China, and vice versa; diverging legislation, norms and standards are continually being introduced – for instance, the Due Diligence Act (better known as the Supply Chain Act) in Germany and the Export Control Law, Data Security Law and Cybersecurity Law in China. The introduction of the Social Credit System in China can also be added to this list. All of this poses an enormous challenge, especially for German medium-sized companies; they frequently operate as suppliers to large German groups but do not have sufficient resources to set up and maintain a global risk and compliance management system.