The value of actual FDI was US$38.4 billion in the first seven months of this year, an increase of 15 per cent over the same period last year. The value of contracted FDI rose 40 per cent to US$82.7 billion.

The importance of foreign-invested companies to the overall economy continued to increase. Last year, they accounted for 31 per cent of industrial output and 55 per cent of national exports. By the end of June, China had 480,000 such firms with a total investment of US$535.3 billion.

Among the big-ticket projects announced this year was a plan by Ford, the world's second biggest carmaker, to build a new plant in China with its Mazda Motor affiliate, part of a US$1.5 billion investment to catch up with its larger rival General Motors.

GM, Toyota and Volkswagen also announced multimillion-dollar plans to increase capacity at their joint ventures in China.

Siemens, the world's fourth-largest mobile phone maker, said in July it would triple the number of engineers at its Beijing telephone network equipment venture, with the aim of taking market share in China from rivals such as Huawei.

Foreign companies regarded the measures to cool the economy announced by Beijing in the spring as short term, and no deterrent to investment.

The good news for the government this year is that FDI is diversifying away from building offices and factories into mergers and equity investment.

The first half of the year saw two landmark deals. One was the purchase by Anheuser-Busch of Harbin Brewery Group for US$737 million, and the other the purchase by US private equity group Newbridge Capital of management control of Shenzhen Development Bank through an 18 per cent stake for 1.2 billion yuan.

'Mergers and acquisitions are joining the mainstream of foreign investment in China,' said JP Morgan Chase. 'There should be more in the pipeline over the next 12 to 18 months. They are gaining momentum in China.'

Private equity firm Carlyle Group intends to spend almost US$1 billion this year in China, including a US$400 million investment in China Pacific Life Insurance.

Beijing is keen to encourage such investment since it opens up a new and lucrative channel for capital, from institutions and wealthy individuals scouring the world for good returns. Such acquisitions account for about 70 per cent of foreign investment globally, compared with 10 per cent in China.

What has made China more attractive is a wider choice of exit strategies, such as sales to a strategic investor or a stock listing, and a wider range of potential partners, including entrepreneurs starting new companies.

But another channel Beijing is keen to encourage - sale of non-performing loans (NPLs) from the state banks - is not functioning well.

Since 2001, only a handful of transactions involving foreign buyers have been finalised because of public opposition to sales to foreigners, a weak institutional system and complex bureaucratic procedures.

Foreign bankers say the number of deals is too few to have a positive impact on the economy and that the value of the debt deteriorates the longer it is unsold. By contrast, Taiwan has held more than 25 auctions since founding its NPL market in 2002, with two thirds of the investment from foreign buyers.

A survey of 94 senior executives with offices in Hong Kong published earlier this year by PricewaterhouseCoopers found that 95 per cent believe foreign investment in China will continue to increase over the next three years. Respondents said 26 per cent of their investments were profitable and 72 per cent were expected to become profitable in the next five years.

The survey found five major challenges - a complex and developing legal and political environment, foreign exchange controls, lack of knowledge of the local business environment, poor management and complex tax regulations.

In addition, 82 per cent said it would be difficult to exit their investments, especially to liquidate their stakes in a tax-efficient way and complete complex procedures to repatriate capital.

Asked what they would do differently, respondents said they would conduct more thorough initial planning and risk-reward analysis and better due diligence.

Other pitfalls awaiting investors are the fight for high-level staff and battles with the Chinese tax authorities.

The growth in foreign investment has been so rapid that the supply of qualified managers who can work comfortably in Chinese and western corporate cultures has not kept pace. As a result, foreign firms find it hard to retain senior staff offered more lucrative posts elsewhere.

The State Administration of Taxation (SAT) is struggling to keep up with the tax sophistication of foreign investors. It said 55 per cent of them reported losses on their operations but, of these, two thirds were actually making money.

Companies avoid taxes through transfer pricing - importing parts and raw materials from parent companies or partners abroad and reporting higher-than-actual prices, and exporting products to them at low prices. Thus they make a 'loss' at home and a 'profit' abroad.

Another way is to borrow more money from banks to increase the percentage of loan capital, with the interest to be paid deductible from the income that incurs tax.

Foreign investors can expect more aggressive investigation of these practices as the SAT aims to match the skills of their accountants.