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Shanghai Free Trade Zone. The New Chinese Miracle?

Freemont Group
02 December, 2013

Ever since Deng Xiaoping’s in the 70’s had the realization that the planned economy is not working, China has been on a different course. We have all seen the ongoing liberalization of China, and we all know that their economy is becoming more open and competitive.

This is being manifested today with a real Free Zone, an area in which government intervention is reduced, and business is aimed to thrive.

These ideas are a blue print for further liberalization of China so the world is excitingly watching.

What are the main characteristics?

The Free zone itself consists of 4 areas in Shanghai totalling 29 square kilometres.

The red carpet is rolled out for foreign service businesses like financials, trading companies, architecture and law firms, travel agencies and even bars.

Foreign companies in the zone will be able to invest in domestic fund markets and issue Renminbi-denominated bonds and experience waived taxes and streamlined customs to encourage the transport of goods. There are even plans to set up an international crude oil futures trading platform.

What are the main expected reforms?

  • Financial reforms: The zone will make use of market-based interest rates and Yuan convertibility on the capital account. The zone is expected to pioneer China’s attempts to promote interest-rate liberalisation plus, eventually, Renminbi convertibility.
  • More investment opportunities: The zone will open up the door for foreign investors. However, not all business activities will be liberalized. There will be a “negative list”, which means that foreign investors can invest in all industries except those specifically named by the government.
  • To name an interesting example: golf. Once banned by Chairman Mao. He saw it as a bourgeois pleasure and ordered ploughing of all the nation’s golf courses. It still lingers.
  • Demonstration of decentralization of power by the government: The zone may allow Chinese companies to make foreign investments without seeking approval from central government ministers.
  • Commodities trading: The government will gradually allow foreign enterprises to participate in commodity futures trading. Given that China consumes 40% of the world’s metals and is expected to surpass the US in oil demand in four years, this could be very interesting for foreign companies.

In short: 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. And Beijing will be closely watching.

What will be the challenges?

So far the Free Zone still has its share of challenges.

First of all the free flow of capital. The idea of having an offshore RMB hub is interesting, but the Chinese government will want to control the flow of capital onto the mainland to prevent creation of unfair advantages in areas outside of the Free Zone. This arbitrating role can seriously limit progress and so far even the ways to interact with mainland China are unclear.

Secondly, there are a lot of vested interests. The current situation is very favourable for existing local companies and local governments. They are the major stakeholders in this phase. All good ideas aside, the question remains if powerful stakeholders will want this to be an extreme game changer.

The third potential bottle neck is the lack of available space. The total area of 29 square kilometres of land seems way too small for housing all the activities that Beijing intends to allow. While potential business license holders are lining up on the sideline, waiting for the regulatory smoke to clear, speculators have already started buying up companies and subsequent real estate (every company needs physical presence, so space is limited). Driving up prices and (contemporarily) influencing the business climate for businesses that are looking for investment opportunities.

One final aspect that is obscuring the attractiveness is that the 4 different zones are all overseen by different tax and customer offices, with no basic frame work bringing the areas together.

What do we think?

The fact that China is taking steps to liberalize the country is very positive. We are strong believers in less government intervention.

It remains to be seen if China will be able to maintain the road to freedom and prosperity, and if vested interests are willing to give up their current immense power and return it to the market.

The fact is that China is on the way to becoming more free and decentralized. The West is currently on a road of less freedom and more centralization.

China is growing. The West is declining. You do the math.

About the Author

Freemont Group

Freemont Group is a comprehensive provider of fiduciary services, including corporate formation and administration, trust, fund formation, legal-and tax services. Contact: info@freemontgroup.com


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