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China faces 鈥榗ritical juncture鈥 with progressive initiatives
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The China (Shanghai) Pilot Free Trade Zone, built on four existing bonded zones in the city, will move Shanghai closer to becoming a global financial, trade and shipping hub.
A free trade zone allows goods to be imported, manufactured and exported without being subjected to tariff and non-tariff barriers. The government has said the Shanghai free trade zone will provide world-class transport and communications, and a tax-free environment for domestic and foreign enterprises as a major hub for their supply chains in Asia.
The move comes as China is facing unprecedented challenges from home and abroad.
Against the backdrop of slowing global demand, rising trade protectionism and stagnant trade negotiations, major economies in the world are actively pursuing alternatives. For example, the trans-pacific partnership involves the US, Japan and 10 other Pacific nations. Many of China’s trading partners have concluded free-trade agreements with each other.
Domestically, China is at a critical juncture after 30 years of rapid growth. Favorable conditions such as demographics and World Trade Organization dividends are diminishing, but new growth drivers have yet to be developed.
“Reform pays the biggest dividend,” Premier Li Keqiang said in March. “It’s time to find a new pilot program. Shanghai must fuel reform through opening-up, and there is huge potential to realize this.”
We think Shanghai’s pilot free trade zone will play a useful role in China’s new round of reforms and opening-up policies in the coming decade. Success will be crucial to invigorating the Chinese economy and unleashing its growth potential. By imposing a more proactive opening-up strategy, the new zone will also help China adapt to global economic and trade developments, speed up domestic financial and institutional reforms, and foster global competitiveness.
Moreover, we see the longer-term benefits of the free trade zone from the reform dividend perspective — policy innovations, rather than preferential policies, to improve efficiency.
We believe the objective of setting up the free trade zone in Shanghai encompasses the following potential goals:
To explore new ways for China to further open up its economy and integrate with the rest of the world.
To create a test bed for administrative reforms, including decentralization and reduction of controls and approvals for trade and investment.
To create a test bed for key financial reforms, including capital account liberalization and renminbi convertibility.
To promote trade, particularly in services, shipping, finance and investment sectors.
The free trade zone will also upgrade Shanghai’s core competitiveness and boost its status as a global financial, trade, shipping and logistics center.
Shanghai has the third-highest per-capita income — 85,000 yuan, or US$14,000 — among the 31 provinces and provincial-level municipalities on the mainland.
However, the city’s gross domestic product growth rate has mostly lagged behind the national rate since 2009. The free trade zone will revitalize the city’s economy and provide fresh impetus to many sectors.
Various other governments, including Guangdong Province and the city of Tianjin, are now seeking approval from the State Council, or China’s Cabinet, for the establishment of their own free trade zones.
We think the areas related to financial innovation, reduction of investment controls and approvals, simplification of customs procedures and an internationally competitive tax regime are worth watching.
In particular, we think the new Shanghai zone will implement major financial reforms. Rhetoric from local government and policymakers suggests that interest rate liberalization and full currency convertibility will be tested in the zone before a nationwide rollout.
The draft proposal also suggested allowing more private capital in the state-dominated banking sector, reducing restrictions for the establishment of foreign bank branches and insurance companies, promoting cross-border use of the renminbi in trade and investment, improving access to capital-raising and investment abroad for Chinese companies, and allowing more financial innovation.
There is also speculation that foreign commodity exchanges will be allowed to establish futures delivery warehouses to create a commodities trading hub. Financial reform that will equip the city to handle offshore trade and financial transactions is a necessary step to becoming a global trading and business hub.
With regards to investment liberalization, various changes have already happened in anticipation of the zone’s opening. In fact, foreign enterprises will be given pre-establishment national treatment, which means they will be treated the same as Chinese companies. The suspension will last for three years, starting from October 1. Foreign investment will also be evaluated with a “negative” list approach, simplifying the previous categorization of industries open to foreign capital.
Few industries are expected to be in the negative list. Furthermore, local authorities are considering a new mode of intellectual property administration. The Shanghai Intellectual Property Office said it will offer a one-stop service, adopt internationally high standards and practice strict enforcement.
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