China's latest economic showpiece, the Shanghai Free-Trade Zone, opened for business on 29 September, amid much fanfare. The new project promised an extensive battery of deeply consequential reforms for the long-term, but offered few concrete details for the present. Nearly three months later, a clearer picture of the reality on the ground is beginning to emerge.
IHS Global Insight perspective | |
Significance | The new Free-Trade Zone (FTZ) is billed as the "experimental field" for the next phase of China's economic reforms. Given the importance attached to it by the central leadership and the range of reforms promised ahead of its inauguration, the FTZ's current status is likely a strong indicator for the direction and pace of economic reforms for the next 3–5 years. |
Implications | Nearly three months in, the policy measures delivered have been modest and few foreign companies have moved in. The most consequential financial reforms are still stalled at the central government level. Geographically, the FTZ is located far from the city centre and severely lacking in infrastructure, and there are no current plans for large-scale redevelopment. |
Outlook | Financial sector reforms promised at the recent Third Plenum are still likely to be implemented within the next 3–5 years, although their pace will probably be slower than expected. Moreover, given Shanghai's slow start, it is doubtful if the FTZ will present any obvious advantages over other similar projects likely to be launched within the next few years. Even in Shanghai, the FTZ may be bypassed for the far more convenient city centre. |
|
The container pier of the Yangshan Port of the Shanghai FTZ on 29 October 2013. |
PA.18055025 |
According to its original conception, the Shanghai Free-Trade Zone (FTZ) is to involve a full spectrum of liberalising initiatives, ranging from greater access to the Chinese market for foreign firms in the service sector, to financial sector reforms such as the liberalisation of interest rates and the internationalisation of the renminbi. For many Chinese planners, the real significance of the FTZ lies in the domestic reforms that it will supposedly necessitate, such as a comprehensive overhaul of China's economic regulatory regime and the marketisation of the country's financial system. The FTZ, therefore, is to be a test-bed for the next phase of Chinese reforms, and policies designed for the FTZ are to be adopted nationwide if successful. In addition, the FTZ and others like it were probably designed with China's potential membership in the US-led Trans-Pacific Partnership in mind, lest China is marginalised from what is likely to be the most important regional trading organisation in Asia-Pacific.
The FTZ two months later
However, to date, the policy measures delivered have been modest. Essentially, the only significant new initiative implemented is the "negative list" system for foreign investors, in which sectors closed to foreign investment are explicitly enumerated, leaving everything else theoretically open. Under the existing regulatory regime for the rest of the country, foreign investment is allowed only in a defined range of sectors. But with 190 sectors currently on the negative list, investors have complained that the FTZ is in fact very similar to the rest of the country. Notably, Shanghai leaders do not dispute that point. Instead, they urge patience, promising that the list will be shortened annually over the next three years. Meanwhile, they point to the streamlined investment registration process, which has reduced the amount of time needed to set up a new business from more than a month to a few days.
Of far greater interest to potential investors are further openings in the financial services sector. Here, reforms appear to be stalled at the central government level. Although the government has promised further capital-account openings and the marketisation of the renminbi at the recent Third Plenum of the Central Committee, the central bank has yet to issue detailed rules for the FTZ. On this point, Shanghai leaders have made clear that the municipal government has no interest in taking up any local initiatives. As one senior FTZ official put it, "The detailed plans on financial reforms will be worked out by the central government, and the Shanghai government will mainly work with the central government for their implementation."
Lacklustre investor response
As a result, relatively few foreign companies have registered in the FTZ to date. Although more than 2,000 businesses have reportedly registered in the FTZ, around 80% of these are domestic firms, while many of the rest are believed to be subsidiaries of Chinese companies registered outside the mainland. As of 15 December, only nine Taiwanese businesses, for example, have registered in the FTZ. Most overseas investors do not yet see many benefits to moving in. For financial service firms, in particular, there is little incentive to sign up until they are given the same market access as Chinese entities.
In short, as one Chinese critic observed, the FTZ in its current form amounts to little more than an amalgamation of various existing tariff-free zones in Shanghai, designed for trans-shipment trade and export processing, the oldest of which dates back to 1990. A key impetus for the FTZ appears to be Shanghai's slowing growth. In 2011, Shanghai's GDP growth rate of 8.2% ranked second to last in the country. By 2012, growth had fallen to a last-place 7.5%. The FTZ has at least succeeded in arresting the decline – Shanghai's GDP growth rate for 2013 is expected to reach 7.6%, according to municipal government data.
Much of that growth appears to have come from the real estate sector, which leads the pack at 13.3%. Real estate prices within the FTZ have risen as much as four-fold, although the four sub-areas of the FTZ are located in the remote outskirts of Shanghai, between 25 to 60 km away from the city centre. Currently, these areas are largely industrial zones severely lacking in commercial infrastructure, and the municipal government has announced no plans for a major redevelopment of the areas. Most of the domestic firms currently registered in the zone are believed to be angling for potential real estate plays, although by the fourth quarter, fixed-asset investments had fallen into negative territory, probably reflecting market disappointment as details of the new zone became known.
Outlook and implications
Nearly three months in, the FTZ authorities have only delivered some modest administrative streamlining, while the far more consequential financial sector reforms still appear very much up-in-the-air. Although financial sector liberalisation along the lines promised at the recent Third Plenum is still likely to be implemented within the next 3–5 years, the pace is probably going to be slower than commonly expected, as resistance from affected domestic sectors will be stubborn. Within the next 1–3 years, IHS expects some relaxation of existing rules to facilitate the transfer of renminbi out of the country, but tight controls on the inflow of foreign currencies will likely remain in place.
Given Shanghai's slow start, it is doubtful if the FTZ will present many obvious advantages over other similar projects already being considered. At present, at least half a dozen municipalities and provinces including Tianjin, Guangdong, Zhejiang, Chongqing, Hebei, and Fujian have applied to set up FTZs, and we expect at least 1–2 of these to be approved in 2014. Even in Shanghai, given the widespread expectation that policies adopted in the FTZ would soon be propagated to the rest of the city, investors have few incentives to move into the FTZ considering its significant inconveniences.