Beijing Reaffirms Ban on Foreign Backing of Internet Companies, Stunning Investors Anew

By Douglas C. McGill

(Virtual China News, Oct. 25) A high-level telecommunications official reiterated yesterday that foreign investment was banned in Internet companies in China.

"China will not allow inflows of foreign venture capital into the country's Internet market," Zhang Cunjiang, an official with the Ministry for Information Industry (MII), told the China Daily newspaper.

"We cannot ignore the disordered situation in the current Internet financing market, which is dominated by foreign investors," Zhang said. "Those already invested here must bear full responsibility for losses caused by clashes with government policies."

Read carefully, the China Daily interview left an opening for a possible later liberalization of foreign investment policy. It said that the ban on foreign investment would apply "pending a new ruling," adding that "until then companies bear all risks for the activities in the country."

Booming Sector

The statement muddies the already murky area of foreign investment in Chinese telecommunications companies. Last month, Wu Jichuan, the powerful Minister of Telecommunications Industry (MII), surprised many foreign companies that have invested heavily in Internet startup companies in China by declaring that their investments were illegal. He cited a 1996 law banning foreign investement in Chinese telecommunications companies, declaring that all Internet services were telecommunications services.

That pronouncement sent an immediate chill throughout the booming Internet sector in China - booming largely because many foreign companies, like Intel, Dow Jones, America Online, Newscorp, and Goldman Sachs are pumping millions of dollars into it. Overnight, promises of new investments were rescinded and expansion plans put on hold.

In the several weeks following Wu's initial pronouncement, companies scrambled to meet with their contacts at the MII and other Chinese ministries to ask for clarification of the Minister's remarks. Generally speaking, they were encouraged by the lack of follow through - there were no closures or pressure applied to any company to divest.

A Brief Warming

Some lower level officials made on-the-record comments that sounded moderate and conciliatory, such as that investors who had already put money into Chinese Internet companies would not be forced to divest.

On September 24, only nine days after Wu's statement of the ban, Yahoo!, the American Internet portal site, launched a joint venture web site with a Chinese computer maker, Founder, in Beijing - with web hosting provided by China Telecom, directed by the MII. In fact, a high level official of the MII was present at the launch ceremony where he chatted amiably with Jerry Yang, the Taiwan-born co-founder of Yahoo!

The brief period of warming has come to an abrupt end with the new official statement underlining Wu's earlier statement of the ban. At the least, it will slow the flow of foreign investment into China's Internet sector for a time; at the worst, it may herald a period of active pressure brought on foreign companies to unwind their holdings.

A Crafty Bureaucrat

The latter has already occurred elsewhere in the telecommunications sector. Earlier this year the MII decreed that foreign investors who had put money into Chinese telecommunications companies under a three-way investment scheme called "China-China-Foreign" should divest themselves of those stakes.

Political and trade analysts have noted that Wu's statements about the Internet are not necessarily best understood at face value. There are many complicated political, trade, and personal factors at work behind them.

Wu, for example, is a veteran and crafty bureaucrat who has a substantial constituency beyond the MII, including many top government officials who promote a hardline protectionism, limiting foreign investment to allow native Chinese companies to thrive on their own.

Wu has maintained a long-running and often open feud with Zhu Rongji, the Chinese premier, who favors opening China's markets widely to foreign investment and competition. Seen in this light, many believe that Wu's statements banning foreign investment in the Internet sector is a political ploy he designed to play to his hardline constituents, to strengthen his position, and to weaken Zhu's.

The WTO Angle

In addition, how the growth of Internet in China will be financed is itself rapidly becoming a key issue in multilateral negotiations, now reaching a critical point, over whether China will be admitted into the World Trade Organization this year.

When Zhu visited the United States in April, China offered major concessions to the United States in order to win WTO membership. These included allowing foreign companies to invest in large stakes in Chinese telecommunications companies - a concession Zhu offered that was said to have enraged Wu.

The restatement of the MII's ban may therefore be Wu's way of putting Zhu on notice that the future of the Internet in China must not be given away in the WTO negotiations that are set to conclude before year's end.