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China gives green light to pilot free trade zone in Shanghai

Photo: Shanghai has been given the green light to set up a pilot free trade zone.
Shanghai has been given the green light to set up a pilot free trade zone.

The State Council Executive Meeting has in principle passed The General Plan for the Establishment of the China (Shanghai) Pilot Free Trade Zone. This is a signal given by China of its latest round of opening up to the outside world. It is believed that the focus of this pilot zone is not confined to Shanghai but on gaining experiences which can be copied in other cities. Liberalisation of the service sector will play a key role in the free trade zone, providing a massive impetus driving the development of China’s trade in services.

I. Characteristics of the free trade zone

1. Signal of new round of opening up to the outside world

Establishment of the Shanghai free trade zone is a signal given by the central government of its latest round of opening up to the outside world. Looking back, the opening of the Shekou Industrial Zone in Shenzhen in the 1980s served as a trailblazer for reform in China. The opening of Pudong in the 1990s fuelled reform in Shanghai and in China at large. And since China entered the WTO in 2001 and began to participate in global economic cooperation, its liberalisation has propelled reform and generated great benefits for the development of the country.

In the last decade or so, China has gradually evolved into a gigantic world factory, with trade in goods making significant progress. However, in recent years, as labour and land costs spiralled, China’s competitive edge has been undermined. To make matters worse, China’s trade in services is relatively backward. As such, China needs to open further to the outside world. Establishment of the Shanghai pilot free trade zone is a crucial move in catching up with new global economic and trade developments, opening further to the outside world, promoting enterprise transformation, and injecting new vitality into the economy.

2. Focus of free trade zone not confined to Shanghai

While Shanghai stands to benefit significantly from the establishment of the China (Shanghai) Pilot Free Trade Zone, the focus is more on nationwide reform and development. This can be reflected in the name of the free trade zone: firstly, the word “China” goes before the word “Shanghai”, which is in brackets; secondly, the word “pilot” qualifies the free trade zone. This clearly indicates that Shanghai is only a pioneer in implementing reform and opening-up policies as a free trade zone, with the experiences so gained to be replicated in other cities or regions in the future.

The establishment of the Shanghai free trade zone aims to provide an impetus for the setting up of a pilot free trade zone offering investment and trade facilitation, highly efficient supervision, and a regulated legal environment of international standards. It will serve as a testing ground for the implementation of reform and opening-up policies where the experiences gained can be replicated and popularised. It can also play an exemplary role in actively driving and serving the whole country, as well as promoting the joint development of different regions. This pilot zone can help enhance China’s global competitiveness in the world market, provide a new platform for cooperation with other countries, create new room for economic growth, and build an “upgraded version” of China’s economy. 

3. System innovativeness is essence

Compared with the various kinds of bonded zones in China, free trade zones mean more preferential policies and greater degree of liberalisation. And in the case of the Shanghai free trade zone, its significance is even more far-reaching. When Han Zheng, member of the Chinese Communist Party Politburo and party chief of Shanghai, was conducting a study mission in Pudong, he expressed that the essence of the China (Shanghai) Pilot Free Trade Zone is innovativeness of the system and not preferential policies.

The major significance of the free trade zone does not only lie in customs tariff exemption, reduction and liberalisation, but also in freedom to trade, freedom to invest and freedom to provide services in the region. Under the Decision of the State Council on the Reform of Investment System, foreign investors investing in China have to obtain approval from government departments at different levels. But in the pilot free trade zone, where investment project management is concerned, the principle of national treatment will apply, whereby both domestic and foreign-invested projects involving in fixed asset investment will be subject to management by filing only and all the relevant administrative approval items specified in the above State Council document will not apply. Meanwhile, where administration over the establishment and changes of foreign-invested enterprises is concerned, for modern services under the encouraged, permitted and first-mover categories, examination and approval of contract and memorandum and articles of association will be waived and replaced by filing management. As such, all related administrative approval will be revoked. Administration over the offshore investments of Chinese enterprises operating in the free trade zone will also undergo changes, i.e. the filing system will apply to offshore investment in general projects.

4. Decentralisation and supervision go hand in hand

While the free trade zone was given the green light by the State council in principle, the implementation plan has not yet been promulgated. The implementing details have yet to be countersigned by 20-odd departments and commissions. As different departments may have their own views, further coordination is required. While efforts must be made to proactively explore innovative modes of economic, trade and investment management by the government and further liberalise the service sector, action has to be taken to prevent all kinds of risks. Countersignature and approval will be prudent, and the main difficulty lies in adjusting the degree of policy liberalisation. While it is easy to open up as it benefits all, greater degree of liberalisation will put the formulation and supervision of policies to the test. For instance, the launch of the offshore Rmb business helps divert domestic funds and reduce the pressure of inflation, yet at the same time it brings about the risk of massive yuan outflow and money laundering. Hence, supporting policies for the free trade zone, especially policies in the financial sector, must be introduced progressively at a steady pace with the easy ones first and difficult ones later.

II. Policy expectations

The biggest expectations of the business community for the pilot free trade zone in Shanghai fall on the new system for investment management, further liberalisation of the service sector, Rmb capital account convertibility, interest rate marketisation, exchange rate marketisation, and offshore finance.

It is planned that liberalisation of the Rmb capital account will be introduced in the free trade zone on a first-mover basis and steps will be taken to gradually implement financial innovation such as full convertibility. Full Rmb convertibility will be made available to corporations in the free trade zone; action will be taken to phase in full Rmb convertibility, such as encouraging domestic capital to engage in offshore investment and offshore financing; and the free trade zone will play a pivotal role in China’s negotiations in joining the Trans-Pacific Partnership Agreement (TPP). The zone can be expected to serve as China’s first window opening to the outside world after joining TPP.

Where trade is concerned, an innovative supervision mode, namely “first line: opening up gradually and fully; second line: safe and highly efficient control over free movement of goods within the zone” will be introduced in the Shanghai free trade zone. “First line” refers to national border. “Second line” refers to the boundaries between domestic markets, which is also the spatial boundary of the free trade zone. “Opening first line and monitoring second line” is the mainstream thought currently adopted by various bonded areas in China in exploring the feasibility of upgrading to free trade zones. Under this innovative supervision mode, it is proposed that first-line supervision will focus on the supervision of people, with check points only responsible for routine inspection and quarantine. In particular, Customs will no longer carry out batch supervision but will conduct targeted, electronic supervision by category. By using this mode, people and goods within the free trade zone can flow rapidly and efficiently. In sum, procedures will be simplified, costs will be lowered, and the mode of “a zone within national territory but outside customs territory” will be realised in the free trade zone.

III. Liberalisation of services: the bright spot

1. Promoting development of trade in services

Free trade zones in the international arena are developing along a common track, that is, their emphasis is shifting from trade in goods to trade in goods and trade in services, with more importance attached to the development of trade in services.

Liberalisation of trade in services will be the highlight of the Shanghai pilot free trade zone. Its first-mover advantage in financial innovation, including interest rate marketisation, exchange rate marketisation, opening of the financial sector to the outside world, product innovation and offshore Rmb business, is bound to attract the most attention.

China is acclaimed as the “world factory”. While its trade in goods has been achieving a surplus for over 20 years, its trade in services is weak, registering trade deficit year after year.

With the establishment of the Shanghai free trade zone, efforts will be made to take full advantage of the inflow of foreign investment in the service sector to highlight the exemplary role of foreign services enterprises. It will also serve to provide new service offerings for the various sectors in China, fill the vacuum in the service sector, and enhance service standard and quality through continued learning in such areas as technology, R&D, management, business concept and directions, marketing tactics, and service attitude.

2. Promoting regulation of trade in services

Currently, China does not have any specific legislation governing the service sector, foreign investment in trade in services, and service import and export, and no unified regulatory regime has yet been formed. Efforts should be made as soon as possible to set up a sound legislative system for trade in services and formulate a set of operable laws and regulations to ensure the healthy and orderly development of services trade.

As the regulatory regime for trade in services in China has lagged behind, there is no supportive institutional environment for promoting the opening of the financial service sector. In particular, legislation in trade in services is seriously lagging behind. In recent years, although China has promulgated the Commercial Banking Law and Insurance Law, in view of the extensive scope and development requirements of trade in services, there are still many gaps to be filled. At present, the level of legislation is rather low and there is hardly any coordination, undermining the uniformity and transparency of legislation in trade in services.

from special correspondent Qi Xiaozhai, Shanghai

Content provided by Picture: HKTDC Research
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