Shanghai's pilot free trade zone is intended as a showpiece for possible broader reform in China. US investors have high expectations, as well as doubts, as Yuwei Zhang reports from New York.

More than 90 policies cover five major economic areas. There's a 10-page "negative list" putting 18 major sectors (with 1,067 subcategories) of business off-limits to foreign investors.

The list also has 190 special regulations, which outline additional sectors closed to foreign investors.

Welcome to the China (Shanghai) Pilot Free Trade Zone), a 29-square-kilometer project launched late last month that's raising expectations — and doubts — within the nation and overseas.

The FTZ is frequently likened to the Shenzhen Special Economic Zone, which since its establishment in 1980 has boosted manufacturing and exports and attracted overseas investments. Some predict the FTZ will threaten Hong Kong's position as an established financial hub.

"If we think about the Shanghai free trade zone as a test market — as Shenzhen was — so what's learned in Shanghai can be rolled out to the rest of the country, that would be a very big deal, that would be truly a ‘reform and opening up' 2.0," said Carlos Gutierrez.

He's the former US secretary of commerce, now a vice-chairman of the Albright Stonebridge Group, a global strategy firm led by Madeleine Albright, the former US secretary of state.

"I don't think it's unrealistic to have high expectations," Gutierrez said in an interview with China Daily. "China has always exceeded expectations."

Located on the outskirts of the coastal metropolis of more than 23 million people, Shanghai's FTZ is expected to explore ways to reduce government intervention and open up the world's second-largest economy to international investment.

"This is in line with global economic trends and reflects a more active strategy of opening up," said Commerce Minister Gao Hucheng at the zone's inauguration ceremony.

The timing of the zone's formation — just before the Third Plenum of the 18th Central Committee of the Communist Party of China — also has been widely discussed.

Experts believe that the zone is a testing ground for policies and procedures that will expand into other parts of the country. They also believe that the FTZ represents a commitment by the country's new leadership to deepening market-oriented reforms and boosting the economy.

"In the buildup to the Party's Third Plenum, there has been much speculation over the policy priorities and reform initiatives," said James Sinclair, managing partner of InterChina, a Shanghai-based strategy and merger-and-acquisition advisory firm that focuses on China.

Bulls vs bears

"The establishment of the Shanghai FTZ has been feeding this speculation," added Sinclair, who has lived in Shanghai for the past decade. "The China bulls are using the FTZ to project their hope for sweeping reforms ahead. The China bears remain skeptical, pointing to the FTZ's lack of detailed policies and initiatives, and concern about the prospects of the Third Plenum unveiling meaningful reforms."

Gutierrez said that the creation of the FTZ shows that the new leadership is serious about economic reform, and the project is one way for the nation to "offset" the pressure of losing manufacturing competitiveness because of wage increases.

"They are serious about reform and they understand that manufacturing is changing. As wages increase, manufacturing may go overseas, so China needs another growth engine," said Gutierrez. "And that growth engine could be the combination of a more open economy and more liberalization of financial services and other services."

As many link the rationale behind the creation of the new zone to the new leadership's economic reform agenda, Bo Chen, who advised the government on the zone, said that it was also driven by slower economic growth in China and "foreign aggression".

The influence of the Trans-Pacific Partnership Agreement is one example of that aggression, Chen wrote in a recent online commentary. Initiated in 2005, the TPP requires member countries to eliminate all tariffs and open their agricultural and financial services as part of the pact's bid to build a unified market in the Pacific Rim by 2020.

Membership in the trade pact grew significantly after the United States signed up in 2008.

The TPP was not immediately welcomed by some Asia-Pacific countries. Japan and Vietnam were persuaded by the US to join the negotiations, and China said that it would consider doing so in the July round of the US-China Strategic and Economic Dialogue.

"Despite rumors about what reforms the FTZ may herald, its long-term policy objectives will generally remain consistent with the requirements of the TPP," said Chen.

A close look at the zone shows that it does offer some policies that might attract foreign investment, especially when every global company wants a success story in China.

Blueprint for change

A government blueprint of the FTZ shows more than 90 policies. The policies, which cover five major areas, are:

Transforming government functions

Easing restrictions on foreign investment

Facilitating international trade by further opening the service sector

Deepening financial reform

Improving the regulatory and taxation systems

"While previously other similar zones, including the Shenzhen Special Economic Zone, focused on ‘incentives' by adopting favorable income tax policies, customs and (value-added tax) breaks, the Shanghai FTZ is intended to be a testing ground for a largely free and open economy as measured by international standards," said Steven Zhang, managing director at New York-based Fund Tax Services LLC.

But Zhang, a Shanghai native, said the FTZ's tax policies will be "expected to be in line with the direction of overall tax reform in China and international practice.

"They will remain subject to study and adaptation, so as not to erode the tax base and to align with China's overall tax system for foreign investment," he said.

Norm Page, a partner at Davis Wright Tremaine LLP, a US business and litigation law firm, and chair of the firm's China practice in Shanghai, said that financial leasing companies will be encouraged to start up in the FTZ. That will include factoring activity (selling of accounts and collecting debt).

"China wants to help small and medium-sized enterprises (SMEs) get more access to financing. SMEs are the biggest source of job growth in both China and the US," said Page, who has lived in Shanghai for seven years.

In one major difference from China's other economic zones, which emphasize manufacturing, the Shanghai FTZ focuses more on the finance industry. That's an area that Chinese and Western economists have argued should be liberalized to boost the economy.

Banking regulators have already moved to allow 11 financial institutions, including the Industrial and Commercial Bank of China, Bank of China, Citi (China) and DBS (China), to set up branches in the zone.

The idea that these foreign banks can participate in equity and capital markets freely in the FTZ will mean more capital for the economy, which "also takes stress off the central bank", said Gutierrez.

"The next big opportunity is, in general terms, services — specifically financial services — and to open up financial services can be the next engine for economic growth for China," said Gutierrez, who served as vice-chairman of Citigroup Inc's institutional clients group.

Christopher Wells, a partner at Bingham McCutchen, a global law firm with offices in China, said that lifting some restrictions on financial services is just a very "modest" change.

"All financial markets that compete with Shanghai — Hong Kong, Singapore, Frankfurt, New York, London, Paris, Los Angeles, San Francisco and Sydney — already allow this and have allowed it for decades," he added.

The FTZ will create conditions to test yuan convertibility under the capital account, market-determined interest rates and international use of the Chinese currency within the FTZ. Citigroup is one of those institutions that plan to set up a branch in the zone.

Watershed moment

Gregory Chin, a professor of political economy at York University in Toronto, Canada and a former Canadian diplomat in Beijing, said the new policies in financial services for the zone mark "an important watershed moment" in Shanghai's efforts to build a greater role as a hub for onshore renminbi business as well as cross-border renminbi business.

"For a long time, especially since China entered the World Trade Organization, foreign banks and financial interests have wanted more room to operate inside the Chinese market, especially in the Shanghai area," said Chin.

"Foreign financial institutions see enormous business potential inside China, especially if they can expand into more areas of renminbi-based lending and other renminbi-denominated financial activities."

Sophii Weng, an economist with Standard Chartered Bank in New York, said the Shanghai FTZ is still in "conceptual territory", even with certain new policies in the banking sector. She said the blueprint for the banking sector lacks "details".

Contact the writer at yuweizhang@chinadailyusa.com

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