The Shanghai Free Trade Zone is fast approaching its one-year anniversary. Much of the recent commentary about the FTZ has been negative. It is obvious that the FTZ has not lived up to the extraordinarily high expectations many had when it was first announced. However, as is typical with the Chinese pattern of reform, things move slowly at the outset and many of the truly important reforms only become visible in retrospect.
The FTZ was announced last August by the State Council and officially established last September. Since then there has been a flurry of regulatory activity to set out the parameters for this grand experiment. An initial negative list for investment was released early on, followed by a modest revision this past July. The People’s Bank of China, the China Banking Regulatory Commission, the State Administration of Industry and Commerce, the State Administration of Foreign Exchange and other agencies have all released new rules outlining what activities would be permitted in the FTZ.
What has become apparent as the rules have emerged is that the FTZ is not intended to serve as a way to bypass China’s existing capital controls. Instead, the primary goal of the FTZ is to promote reforms in the real economy, particularly the service sector. One large breakthrough that has been made is in reducing the requirements for establishing new companies. The FTZ, along with two areas in Guangdong, was allowed to pilot a new reform which eliminated registered capital requirements, improved the annual disclosure requirement, and created a “one-stop” registration process for new companies. The registered capital reform was quickly expanded to the rest of the country, leading to a boom in new company registrations. This reform will undoubtedly accelerate the growth of private businesses in China because the old capital requirements were a barrier to small enterprises.
Barriers to foreign competition have been reduced modestly in a variety of sectors, including e-commerce, legal services, logistics, healthcare, financial leasing, and telecom. As a result, Amazon and Microsoft, two of America’s most important technology companies, have set up operations in the FTZ. As Nicholas Lardy points out in his new book Markets over Mao: The Rise of Private Business in China, it is these modern service sector industries that China desperately needs to open up and reform. While the reforms have not gone as far as many would have liked, it is still an improvement over the status quo. Officials continue to promise that more significant reductions in the negative investment list are forthcoming.
While the FTZ was not established primarily as a test ground for financial liberalization, there are still some important financial reforms underway. A system of free trade accounts was established to allow companies operating in the FTZ to convert currency and borrow from overseas more easily. In March, interest rates on foreign currency deposits by corporations were liberalized. In June, this reform was expanded to the entire city of Shanghai. The FTZ will also establish a new raw materials exchange, allowing companies to trade iron ore, metal, and energy. Several foreign banks and insurers have now set up operations in the FTZ in order to take advantage of these new reforms.
Though not operating out of the FTZ, there is a new ambitious reform underway in the form of the Hong Kong-Shanghai Stock Connect program. This new program will allow investors in Hong Kong and Shanghai to purchase securities in the other jurisdiction, subject to a quota. For the first time, individual investors, in addition to institutional investors, will be allowed to participate. This is a significant step forward in opening up China’s capital account.
Looking back over the past year, much has been accomplished. Policymakers have mapped out an ambitious series of reforms. Some of these reforms have already been expanded nationwide, proving that the FTZ is capable of fulfilling its purpose as a test bed to accelerate reforms. Yet despite a few successes, many other reforms continue to exist more in theory than in reality. This is understandable given that the large and sweeping goals set forth will take time for slow-moving bureaucracies to implement. However, there is no room for complacency as the challenges facing the Chinese economy continue to grow. The Shanghai Free Trade Zone is off to a good start, but accelerating the pace of reform will be critical for sustaining China’s economic growth.