SHANGHAI — Local government officials on Sunday officially launched Shanghai’s Free-Trade Zone, or FTZ, a testing ground for China’s highly anticipated economic reforms.
The 11.2-square-mile zone encompasses a shipping port, duty-free zone, logistics zone and an international airport. According to a statement by China’s Ministry of Commerce, the FTZ will represent a significant “upgrade” of China’s economy, though exactly how it will operate and how much of an impact it will have on the country’s wider economy is still unclear.
“We know the FTZ will be a bit different from other places [in China] as the administrative controls will be simplified and business will be opened up to international investment and private investment, that’s the basic idea,” Zhou Hao, a China economist with ANZ Bank, explained.
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Since first being flagged in July, the idea of the FTZ has caused much excitement in China and abroad. So much so that property prices in the vicinity of the zone have risen 30 percent and, on the Shanghai Composite Index, $45 billion of market value has been added to stocks that have the word “Shanghai” in their name — regardless of any affiliation with the FTZ itself.
New Chinese Premier Li Keqiang is widely credited as being the FTZ’s biggest supporter and has drawn comparisons to former paramount leader Deng Xiaoping, the architect of China’s economic opening of the early Eighties. Deng’s “sweeping market economy” reforms paved the way for unprecedented decades of growth in the country.
Only the most optimistic China watchers are willing to predict the opening of the Mainland’s first FTZ will lead to changes as dramatic as Deng’s reforms, though many are cautiously hopeful that Shanghai’s FTZ is the first step on the long road to further economic reform.
“I think the Shanghai FTZ is definitely a test field for some new mechanisms the government has in mind for the future. Because they think it’s too risky to roll out these mechanisms across China overnight, they selected the Shanghai FTZ to test whether the government will be able to regulate the market effectively and whether the new regulation system will be welcomed by investors from China and around the world,” said Vincent Wang, a partner at Davis Wright Tremaine in Shanghai.
Commerce Minister Gao Hucheng certainly indicated the FTZ was crucial for China’s next wave of reform and opening-up in a speech at Sunday’s launch. “[The FTZ] follows the trend of global economic developments and reflects a more active strategy of opening-up,” he said.
Many details are still to be revealed, and China’s Ministry of Commerce has said that it will take three years for all FTZ regulations to be rolled out. The major reforms to be tested include cutting administrative red tape and liberalizing financial transactions.
“The regulations we have seen so far are largely about the financial services sector and, for me, the most important thing is the relaxed rules on foreign companies establishing subsidiaries here in Shanghai,” said Claudio d’Agostino, a Shanghai-based partner at DLA Piper. “What this means is that most won’t need to go through an approval process but can just register their companies in the zone. The problem, however, is that they’ll be miles away from the city center.”
The other most significant development within the FTZ will be the relaxation of foreign capital regulations, allowing foreign currency to flow freely in and out of the zone.
Two elements hoped for but not included in the FTZ launch were a suspension of tariffs and a uniformly low, 15 percent corporate tax rate. Both are policies that would help the FTZ compete with regional powerhouses, such as Hong Kong and Singapore.
Given the focus on financial rather than trade incentives within the FTZ at this stage, experts believe there are negligible benefits for foreign fashion and luxury goods companies in moving their Mainland China operations or manufacturing within the FTZ, as opposed to one of China’s many existing bonded trade zones.
“I think from the trade perspective there won’t be different systems in the FTZ compared with the bonded trade zone,” Zhou Hao said.
According to Wang, the main benefit of setting up operations within the FTZ for these kinds of companies would be the ease of accessing capital, for those without substantial holdings within China.
“If you are a company that doesn’t accumulate large amounts of funds in China and requires frequent supply of funds from your global headquarters, then moving your company to operate within the FTZ makes good sense because foreign capital regulations will be relaxed and you will be able to freely get in and out the funds you need for the business,” he said.
Despite the lack of tariff incentives within the FTZ, Susan Kohn Ross, chair of the international trade practice at Mitchell Silberberg & Knupp, believes those importing raw materials and manufacturing within the zone may find some advantages.
“For luxury goods, the ability to import raw materials and manufacture in the FTZ allows for a lower cost of duty, plus the company only pays duty on withdrawal of the goods for sale in the domestic market,” she said. “Many luxury goods carry with them high rates of duty, and being able to wait to pay those duties until the goods are actually sold to a domestic buyer or avoided altogether with a foreign sale can provide a huge cash-flow benefit to the seller.”
Having said this, as with any attempts at new regulation or reform in the Middle Kingdom, Ross and other experienced China-watchers also believe the smart money is on taking a wait-and-see approach
“China has been exploring a wide variety of economic reforms and the establishment of the Shanghai FTZ has been touted as an example of those reform efforts. However, until we know exactly what will be permitted in the FTZ and when, the creation of the Shanghai FTZ seems more of a move by China to provide its companies with options which are comparably available in other parts of the developed world,” she said.