Market liberalization ostensibly formed the key plank of China’s third plenary session of the Communist Party on November 9, a boon for emerging-market bulls.
The development of the mainland’s first free-trade zone (FTZ) in Shanghai will roll out the all-important economic reforms that international investors have been waiting for.
Capital-account convertibility, interest-rate liberalization, renminbi cross-border usage and foreign-exchange management are some of the reforms expected to be tested in the zone before becoming national policy – not without tweaks from Beijing if needed.
However, with policy surrounding the zone, and indeed the third plenum, all sketchy, the success of the FTZ – and the speed at which reforms will take place – have come under scrutiny. More questions than answers have surfaced.
Here are some issues awaiting clarification that could cause some hiccups along the way without redress.
The role of Shanghai as an effective, offshore RMB hub in the mainland has been brought into question as monitoring money flow from the within the zone to the rest of China will prove challenging.
As Qinwei Wang, China economist at Capital Economics, says: “If companies in the zone are able to borrow offshore, without regulations, this money could easily flow out of the zone into other regions, and capital inflows would continue to increase.
“Financial services, for instance, are not as easy to monitor as the manufacturing sector. I am very concerned of the arbitrage opportunities that will occur and this will really weigh down on the progress of the zone.”
As a result, “progress of China’s liberalization programme will actually be a lot slower than what most people expect”, says Wang.
As Nicola Mayo, partner at Linklaters based in Shanghai, says: “How can you interact from the zone with the rest of China? So far, it’s a complete blank page.”
Perhaps tight policy will be needed to stop money intended for the zone seeping out, but only further information on policy measures will identify how Beijing plans to do this.
While the FTZ has drummed up a lot of excitement inside and out of China, one challenge is ensuring incentives are aligned between key players, both in the state and private sector.
Chi Lo, senior strategist at BNP Paribas based in Hong Kong, says: “[This is] the single most-important issue in determining whether the FTZs will be able to deepen China’s structural reforms.
“[But] it is not like back in the 1980s, when Deng Xiaoping created the first special economic zone in Shenzhen. Back then, incentives were aligned between the central and local governments and with economic agents.
“Today, though, incentives for stakeholders are different. For example, some enterprises will not want to see reforms and risk losing money through rent-seeking opportunities.”
He adds: “Because of this, there will be a lack of focus and nothing major will be able to be done. I don’t see the FTZ as a game-changer.”
As it stands, the FTZ in Shanghai is made up of four areas encompassing a modest 29 square kilometres of land – a modest space for all the services that Beijing hopes to accommodate. Some companies waiting on the sidelines before setting up shop – as they await more clarity on policies – might lose out on getting their own space as speculators are already moving in.
As Kathy Kaiyuan Xu, head of international business at Shenyin & Wanguo Securities Company, points out, if you are registered in the zone you should have a physical presence there. “If you are going to be providing some sort of service, like a securities service which we aim to offer there, you’ll need to be there in person to face your clients,” she says.
“Perhaps other operations and back-office work can be conducted elsewhere.”
While some argue that registering in the zone but being wholly based outside could be acceptable, differences between the areas could potentially lead to logistical issues.
“Each of the four different areas that make up the zone is overseen by different tax and customer offices,” says Li Wei, economist at Standard Chartered based in Shanghai. “There is no basic framework bringing the areas together.”
While upfront minimum capital requirements to set up shop in the zone have been relaxed, or abolished, for non-financials to streamline the application process for businesses – and encourage expansion – there have been some unintended consequences.
Wei argues there are a lot of businesses being set up by individuals speculating that the companies they register will be worth something more to someone else once the zone is up and running.
“All they intend on doing is to resell their company name or even their registration number at a later date, especially as there are no capital requirements,” he says.