Shanghai Free-Trade Zone: Two Years Later

By Jiye Xue, a PhD student in the Department of Decision Sciences & Managerial Economics, Chinese University of Hong Kong Business School

Carrying with it a lofty hope of the nation, the Shanghai Free-Trade Zone (SFTZ) has been up and running for almost two years. Already, some trials have proven successful within the zone. For example, by the end of 2014, 12,000 new enterprises, of which more than 1,600 are foreign-funded enterprises, have opened in the zone. From January to August 2014, the total export value in the SFTZ reached RMB500.4 billion, a 9.2 percent year-on-year increase, higher than the national average of 8.6 percent. However, there are voices criticizing the development of the zone for not having moved along as well as expected. They point out, for instance, that the negative list used to limit the development of certain sensitive industries, such as the production and supply sector for power, gas and water, is quite exhaustive, even after it has been shortened recently. In view of these two contradictory assessments, let me try to explore the status of the SFTZ from an impartial perspective (being a student myself) and share my outlook of the future of the zone.

Steady Progress

First, let’s examine the rapid development of China’s cross-border e-commerce in the SFTZ. Since the prices for certain consumer products such as infant formula, cosmetics, and electronic goods are currently quite high in mainland China compared with those abroad, more and more people in China have turned to online shopping to acquire these types of goods via cross-board delivery. However, due to the lack of sufficient support and regulation by the government, cross-border e-commerce has always led to legitimacy issues (smuggling) and quality concerns (fake products).

In light of this, new branches of some giant international e-commerce companies have been set up in the SFTZ. For example, Amazon launched its direct shipping for China’s cross-border online shoppers in October 2014. The platform enjoys the advantage of product authenticity guarantee, competitive pricing, transparent taxes, convenient logistics and customer service. “I look forward to working with our Shanghai partners to realize the incredible opportunity of developing the best cross-border shopping experience possible for not only customers in China but also around the world, and establishing Shanghai as a recognized international cross-border e-commerce center,” Diego Piacentini, Amazon’s senior vice president of International Consumer Business, told China Daily. The confidence of Piacentini is grounded in the rapid development of China’s cross-border e-commerce. Total sales for cross-border e-commerce increased from RMB900 billion in 2009 to RMB4 trillion in 2014.

“I believe that the Guangdong free-trade zone can play a key role in connecting with Hong Kong and Macau to drive the financial and trade developments in the Pearl River Delta region.” – Jiye Xue

Next, a hot and controversial issue of the SFTZ surrounds financial reform and innovation. Initiatives such as cross-border RMB sweeping, which allows companies to repatriate their cash from onshore to offshore, have been developed to promote RMB internationalization. Other major financial reforms, such as the liberalization of interest rates and the loosening of restrictions on capital accounts, are also progressing gradually in the free-trade zone. These measures aim to accelerate China’s capital market development while boosting domestic services and innovations. In the long run, this will contribute to the eventual full convertibility of the RMB, which is definitely a significant breakthrough that China is committed to achieving.

Although there are still restrictions that seem to curb the progress of financial innovation, the reason behind the “slow down” or “restriction” needs to be understood. Financial reforms that focus on China’s long-term economic rebalancing should be treated in a most discreet and cautious manner. As the current domestic interest rate is significantly higher than that in developed countries, international hot money often seeks to flow across the border to make profits from the interest rate difference. This turns out to be a huge regulatory challenge for the Chinese government. Imagine a large amount of hot money floods the zone. It is bound to create domestic asset price bubbles, and the amount of foreign exchange reserves is likely to shoot up further. In particular, the real danger of hot money is the possibility of diving asset prices or even a financial crisis when a massive capital withdrawal occurs.

Opening China’s financial market would lead to substantial capital outflow and overseas investments. Therefore it is a must to carefully control cross-border financial flows. It is important to remember that historically, any reform took time and could hiccups are not uncommon along the way.

A Promising Future

Now, let me try to paint a future picture of the SFTZ in three aspects. Firstly, the zone should continue to promote cross-border e-commerce by further lowering related tax rates and improving customer shopping experience. Secondly, the SFTZ should gradually and steadily ease its rules on investment, streamline its administration and restructure its financial system in line with international standards. Lastly, as a pilot, the SFTZ will undoubtedly act as a testing ground for new policies. It is not just a service center for Shanghai, but an example for the rest of the nation. But it will take several years to reach scalability so that the model can be copied and extended nationwide.

In fact, after Shanghai opened its free-trade zone, more and more cities have launched their own plans to build free-trade zones to reflect their different economies and locations, including Guangdong, Fujian and Tianjin. I believe that the Guangdong free-trade zone can play a key role in connecting with Hong Kong and Macau to drive the financial and trade developments in the Pearl River Delta region. So far, the free-trade zone chapter in China’s economic reform has only just begun. The SFTZ, along with other free-trade zone regions, should work together to deepen China’s economic and financial development and growth.