Learning from the failure of Shanghai’s FTZ

It’s been nearly a year since China’s first free trade zone was launched last year by Chinese Premier Li Keqiang along with a flurry of lofty promises. Located in Pudong district of Shanghai, the zone in its current state is split up in four different quadrants totaling an area of 29 square kilometers. Aptly referred to as the ‘China (Shanghai) Pilot Free-Trade Zone’, the project is slated to be expanded to a sprawling 1,210 square kilometers upon on its completion, however hopefully by that point the Zone will live up to its promises.

The conception of the Free Trade Zone was to use it as a new frontier to test numerous economic and social reforms for the changing Chinese economy. The area within the zone is technically considered to be immune from Chinese law, which in turn exempts the business transactions within from normal rules and regulations. The zone was to relax financial requirements for corporate establishment, allowing foreign enterprises to operate in China with little red tape. Further promises on developments on arbitration, foreign currency exchange and taxes were made, signaling many potentially lucrative opportunities for businesses within the Free Trade Zone.

Purported to be a ‘Mini-Hong Kong’, the Zone was part of an effort to reinforce Shanghai’s image as a global financial center. So far, according to figures released by the Shanghai government, nearly 10,445 businesses have already registered in the zone, and of that about 12 percent are foreign companies. Foreign banks have also opened up branches in hopes to take advantage of the relaxed rules on currency exchange. Bankers hoped to take advantage of new rules that would remove the time consuming and costly practice of needing to have all currency transactions approved by the State Administration of Foreign Exchange.

At this point however it seems the foreign banks, as well as most other companies that were seeking to operate in this Zone have been severely let down. While it was understood that these reforms and changes would take some time to come in effect, the near total lack of substantive changes has led to dismay and cynicism amongst bankers and many others. “They [the government] promised the world to us but have delivered almost nothing,” said Richard Cant, the regional director for law firm Dezan Shira & Associates in Shanghai. Regulators have given some leeway, in that companies in the zone are able to open special accounts to enable international cash flows, however these transfers are anything but free and open. Financial authorities still regularly monitor currency transfers closely and even retain the power to suspend them, and contrary to promises made earlier the transfer cost is still subject to the rate put out by the Bank of China. Many have given up hope, and the chance of this project living up to its potential as a mini-Hong Kong seems to be a far cry at this point. Stocks have reflected this notion of fading enthusiasm as well. Prices for the Shanghai Waigaoqiao Free Trade Zone Development Co. stock rose from RMB 14 per share in late July 2013 to an all-time high of RMB 64 in the days before the Free Trade Zone’s opening. Earlier this month it dropped back down to RMB 28.

In all fairness, investors should have been wiser and showed a little more caution when considering whether to buy into the Free Trade Zone. For the past two decades, Chinese policy makers have maintained a reserved approach to any financial reforms that have potential to destabilize the economy. The idea that the foreign exchange regulators in the Chinese government would suddenly allow funds to quickly enter and exit the country was nothing more than wishful thinking, especially considering the relentlessly tight grip the government holds on such affairs. Media and analysts have also noted that there seems to be a disagreement between the central government in Beijing and city government of Shanghai on just how fast these reforms should come. Shanghai is eager to have the Zone functioning at full financial capacity in order to bring much desired business to the city, however authorities in Beijing remain apprehensive. Authorities in the capital don’t want to give Shanghai too much of a head start over other regions in China, and have responded with indifference by acting slow on governing regulations for this project.

All the bold government promises for reform and the ensuing disappointment aside, this tale of broken promises for Chinese market liberalization was routine and predictable. While an innovative and potentially beneficial project, the high hopes and tall tales proclaimed by the government provided severe skepticism amongst those who have been doing long term business in China. Over the past 14 years that ET2C has operated in China, we have noticed that these types of promises from the government are routinely one-sided, and do little to serve the interests of foreign companies. Instead of waiting for a market liberalization that may never come, we have worked tirelessly on understanding the bureaucracy of China and how to manage the red tape that comes along with it. Although an idea like the Shanghai Pilot Free Trade Zone is good in theory, ET2C remains committed to more pragmatic solutions for our customers to help them succeed in China, and more broadly across Asian markets.