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Why Shanghai’s free trade zone matters even though no one knows exactly how it will work

Reuters/Carlos Barria
What matters is what’s on the horizon.
By Lily Kuo
ChinaPublished Last updated This article is more than 2 years old.

Shanghai’s newly opened free-trade zone is a test-bed of sorts for economic reforms that might roll out across the country. And it’s raising a lot of expectations. Former US treasury secretary Hank Paulson wrote in the New York Times that the zone proved Chinese leaders “clearly understand that their growth model needs to change” and is a sign the country’s economy is back on track. Hu Shuli, editor of Caixin Media, a respected business news group, said the free trade area may be the start of China’s third wave of economic reforms (link in Chinese)—the first two being Deng Xiaoping’s policies in the late 1970s and 1980s and China’s 2001 entry into the World Trade Organization.

That may be over-optimistic. Since the Shanghai free trade zone opened last month, foreign banks and investors haven’t been satisfied with the level of detail released on how the zone will operate. (Here’s a cheat sheet of what we know so far.) At this point only two foreign banks (paywall) are planning to open branches in the zone: Citigroup and Singapore’s DBS.

One issue, critics say, is that officials haven’t clarified how banks in the zone will be able to set different interest rates from those in the rest of China. Officials, however, have been clear about what’s not allowed via a list of over 1,000 banned areas for business—like pornography or golf.

“Unfortunately, we will likely not know until the end of the year and possibly early next year what, besides rhetoric, is the real draw of the [free-trade zone] when the government begins to release its implementation rules and regulations,” Timothy Lamb, managing director of JLJ, a firm that helps international companies enter China, told Quartz.

It’s all about the vision

But the free-trade zone does say something about China’s long-term reform goals, according to Daniel Rosen, of the advisory firm Rhodium Group. And those clues are important ahead of a major Communist party meeting next month, when officials will release China’s economic agenda for the next decade. ”For now, the most important element of the nascent zone is that it signals so clearly what Beijing thinks the new end point for regulatory conditions should look like,” Rosen told the Council on Foreign Relations.

So if that is the end point, what does it look like? The focus is on creating a new, globally recognized shipping hub; services industries like law and architecture; and baby steps towards opening up China’s financial system, including allowing foreign banks to connect directly with Chinese investors and perhaps an oil trading exchange.

China’s State Council has said that some Chinese and foreign companies will be allowed to invest in firms set up in the zone, like banks, travel agencies, insurers, or shipping operations. These firms will have more access to new loans and should in turn drive more domestic spending. As we previously reported, foreign banks will be able to operate in the zone without a Chinese partner. Firms may even be allowed to convert renminbi freely into foreign currencies.

The Shanghai free-trade zone also seems to signal that special economic zones will continue to be one of the ways the country tests out new policies. The Shanghai zone is most often compared to a special economic zone created in Shenzhen, which ushered in reforms and industrial growth in the 1980s. ”Beijing knows not to exhaust itself with a full debate of changing the rules across the board for the whole nation, but rather, to use the old playbook and make new reforms a privilege for the most deserving, then expand the new rules little by little until they are predominant,” Rosen said.

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