What's in store for Shanghai new trade zone?
- By Li Wei, Robert Minikin and Stephen Green
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E-mail Shanghai Daily, September 16, 2013
The new China (Shanghai) Free Trade Experiment Zone is expected to officially open late this month, comprising the Waigaoqiao Free Trade Zone, Yangshan port, the Pudong Airport area and the Waigaoqiao Logistics Bonded Zone.
The 28.9-square-kilometer zone will be a “national-level entity,” meaning it won’t belong to Shanghai alone. The idea behind this zone is to create an area for more liberal trade and subject to less financial and business regulation than the rest of China. Many are speculating as to how the zone will function; authorities are yet to release details. We present some of our own thoughts on the subject.
Q: How will the new zone be different from the original special economic zones?
A: The original zones in Shenzhen and other regions were set up in the 1980s as areas where foreign companies — and later, domestic firms — could invest, enjoy lower taxes, face limited trade barriers and enjoy a supportive bureaucracy.
The zones were focused on attracting firms that would manufacture for export, although as the economy developed, many firms established in these zones turned to selling to China. The zones were used by economic reformers to demonstrate the benefits of freer markets, and, as they got richer, to make local governments strong supporters of more liberal reform. However, as national-level regulation became more business-friendly for manufacturers in the past 20 years, the special economic zones lost much of their specialness.
The unification of corporate tax rates in the 2000s also removed one of their main advantages.
The new free trade experiment zone in Shanghai is going to be different, although we will not know exactly how until it is up and running in 2014. We believe it will be different in the following broad areas:
Investment regulations
The basic idea appears to be that firms registering in the zone will be able to operate in a significantly simpler and freer regulatory environment. The central government has committed to suspending current foreign direct investment regulations for the zone, meaning that license approvals will be easier to obtain, the scope of business restraints should be relaxed and full foreign ownership will be allowed in more sectors than currently permitted. We believe the regulatory and legal environment will be set up so that firms can engage in any activity that is not proscribed, unlike at present, where they can engage only in activities that are explicitly allowed.
Tariffs
The new zone could allow duty-free imports and re-exports.
Services
Another difference is that the authorities may allow hospitals and schools to be set up in the zone.
Financial services
A key difference is that the new zone will include both manufacturing and financial services — the latter which were excluded from the special economic zones. The Shanghai government is said to have initially proposed that the zone host greater interest-rate liberalization, freer cross-border lending and foreign debt quota reform, among others policies.
Renminbi convertibility
There is discussion of allowing free convertibility of the renminbi within the new zone — rather like the renminbi in Hong Kong. Were that to materialize, it would make the zone, at least partly, an offshore financial center, potentially somewhat like Hong Kong.
Q: Money moves around more easily than factories, so how will the boundaries of the new zone as an offshore financial center be managed?
A: We do not yet know to what extent the new zone will operate as an offshore financial center. Banks and other financial services firms are looking at establishing a presence in the zone, but it is yet to be decided whether they will be allowed to open branches or new legal entities there. What they will be allowed to do is still very unclear.
If authorities restrict companies to conducting all their business only within the zone, the impact would be very small. On the other hand, if freed-up financial services within the zone were accessible to any firm in China that merely sets up a representative office in the zone, China would basically have opened up its capital account. We believe the rules about what banks can do, how firms can take advantage of these rules and how banks in the zone relate to banks outside of the zone will be complicated.
Q: Who will run the new zone?
A: We do not know who originally came up with the idea, but the policy of creating a free trade experiment zone is now firmly associated with Premier Li Keqiang, with support of the senior party leadership. Senior leaders seem to see it as a way to get around the natural tendency of bureaucracy to resist any reforms that restrict administrative powers.
In this respect, the new zone is positioned very much in the same vein as Deng Xiaoping’s special economic zones were. It is interesting to note that one individual who originally backed the establishment of the Shenzhen and other Guangdong special economic zones was a certain Xi Zhongxun, the father of the current Party Secretary Xi Jinping.
Shanghai Vice Mayor Ai Baojun was recently appointed to head the new zone. He has experience in the steel industry, which suggests that the zone will be focused more on industry and trade, rather than on financial services. But we will have to wait and see.
We believe the State Council may set up some kind of coordination office in order to bring regulators like the People’s Bank of China, the China Banking Regulatory Commission and the State Administration of Foreign Exchange together to decide policy.
Q: Who will be next?
A: Cities now appear to be falling over themselves to follow Shanghai. Local media have reported that Tianjin, Guangzhou, Xiamen, Qingdao and a number of other cities have expressed interest in setting up their own versions of the free trade experiment zone. We think the Shanghai zone will have to run for a year or two before the State Council and the other regulatory bodies approve any more.
Q: Will these zones be the vector for reform in China?
A: Other cities may well set up zones over time, and a patchwork of zones with liberal business regulation, more open investment rules and freer yuan convertibility would definitely be a good thing. However, we are yet to be convinced that such zones will be the primary driver of reform in China. Their expansion will take time, their scale will be small compared with the broader economy and it is unlikely that the zones will have a major impact on activity outside of them.
Moreover, it is worth bearing in mind that the People’s Bank of China has a clear plan to open up the capital account, for example, across the whole country in the next 5-10 years. Premier Li has made simplifying and eliminating regulation countrywide one of the priorities of his administration.
Q: What is the difference between the new Shanghai zone and the existing Qianhai zone in Shenzhen?
A: The Qianhai zone opened in August 2010. It is just across the border from Hong Kong and is now under construction. While the new zone in Shanghai will be a testing ground for China’s economic reform, Qianhai will focus more on complementing Hong Kong.
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