Shanghai free-trade zone to test financial reforms in China

When Premier Li Keqiang showcased China’s plans for more market economic reforms and a reduction in the role of state sector at a recent global forum, he highlighted a proposed free-trade zone in Shanghai.

Li said China plans to prioritise “easier investment access and greater openness in trade in services” in the zone, whose full name, the China (Shanghai) Pilot Free Trade Area, reflects its national and international significance.

It combines four existing free-trade zones and port districts into a new area that the city government said it will use to promote trade in financial services and logistics, and develop trading zones for steel, cars, chemicals and jewellery.

Analysts differ over its expected speed and scope of development, but they all agree that the 29-square-kilometre zone marks a crucial step in China’s economic reform.

“It will carry the same expectations as China’s first opening up and reforms in the late 1970s and when the country joined the World Trade Organisation in 2001,” the official China Daily said on Wednesday.

Speaking in Shanghai this week, World Bank President Jim Yong Kim hailed the zone as a “positive development” that “will allow China to become more competitive.” Its most important long-term role will be to test financial policies that can underpin the next phase of China’s development.

Free exchange of currency

“The key thing is to see whether the central government will allow the free exchange of the renminbi [currency],” Guo Hongyu, an expert in finance at Beijing’s University of International Business and Economics, said.

A plan to build Shanghai into an international financial centre by 2020 would be “meaningless” without liberalisation of the currency exchange mechanism, Guo said.

“Capital must circulate freely if you aim to become an international financial centre,” she said.

Ministry of Commerce spokesman Shen Danyang said on Tuesday that the government has approved the suspension of several regulations on foreign investment in the free-trade zone for three years from October 1.

The government will officially launch the zone on September 29, Shen said, but it is not expected to publish detailed plans for several months, leaving debate open about how far and how fast the ruling Communist Party should go.

The party’s 205-member Central Committee is expected to discuss the zone at a meeting scheduled for November to approve a new raft of economic reforms.

Concerns over free-trade zone

One reason for the party’s caution over liberalising currency exchange in Shanghai is a fear that it could fuel a stampede of speculators keen to profit from different rates inside and outside the zone.

Setting rules for banks and companies operating in the zone, and how they link to those outside it, will be “complicated” for the government, Standard Chartered Global Research said in a recent briefing note.

“On the one hand, if the authorities restrict the companies to conduct all their business only within the zone, the impact will be very small,” it said.

“On the other hand, if the freed-up financial services within the zone are 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.” Li promised to adopt a “negative-list approach” in Shanghai, meaning that foreign trade will be allowed in all services, including new industries, unless specifically restricted. China currently uses a “positive list” of sectors that are open to foreign trade.

Yet China Daily quoted two Shanghai-based economists as saying the zone’s “negative list” contains more than 10,000 restrictions, rendering it “meaningless” without severe cuts.

Such problems mean the other Chinese cities queuing to develop similar free-trade zones might have a long wait until the party can judge the success of Shanghai’s pilot policies.

Over the next decade, the expansion of more open economic policies to new zones, and eventually to the whole country, could prove crucial to the party’s efforts to hold on to the political power it has held since 1949.

Standard Chartered said it has “yet to be convinced that such zones will be the driver of reform in China.” The party must also persuade foreign businesses and governments, as well as China’s 1.3 billion people, that it can improve the rule of law, protect financial interests, expand social freedoms and continue rapid economic growth.

Many analysts and dissidents see loosening the party’s stranglehold on legal, judicial and security organs as the key to both economic and political reform.

“Using Shanghai, such a big metropolis and China’s financial centre, for the FTZ experiment is actually doing an experiment in judicial independence,” said Wu Qiang, a political scientist at Beijing’s Tsinghua University.

“It will have long-term strategic significance,” Wu said.