China's Shanghai Port Zone Tests Xi on Easing Yuan Controls

Updated on
  • Smaller area to feature eased capital controls, no tariffs
  • Policy makers have backtracked on liberalizing yuan movements

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China is making another attempt at keeping Shanghai at the cutting edge of economic reforms after its latest try in 2013 floundered.

The State Council, the nation’s cabinet, will soon unveil plans for a “free-trade port” in the world’s biggest shipping hub, according to Chen Bo, an adviser on the proposal who researches free trade zones at the Huazhong University of Science and Technology in Wuhan. President Xi Jinping had floated the concept last month as part of the Communist Party’s pledge to “develop new models and new forms of trade.”

The port will feature eased capital controls, no customs duties and minimum clearance procedures compared with the Shanghai Free-Trade Zone, which was established in 2013 as a laboratory to test financial deregulation. It will also be smaller: About 18 square kilometers (7 square miles), or roughly 15 percent the size of the previous area.

“The FTZ has performed below expectations and lagged its lofty objectives,” Chen said. “The free port needs to carry out capital account liberalization to emulate the freest ports in the world such as Hong Kong and Singapore. This is crucial.”

The policy will provide another clue as to whether Xi intends to accelerate market-friendly reforms after he became one of China’s most powerful leaders ever at a leadership reshuffle last month. Past pledges to open up, particularly on currency flows, have left investors frustrated.

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The Shanghai municipal government and Commerce Ministry didn’t reply to faxed queries on the plan’s details and timetable.

The Commerce Ministry in October said it was “actively” coordinating with Shanghai’s municipal government to set up the port. It has gained momentum in recent weeks, with Wang Yang, a member of China’s most powerful political body, touting the concept in the party’s People’s Daily newspaper.

“It’s going to be of a smaller-scale, more specific and freer,” Chen said, adding that he expected the central government to release a final plan early next year at the latest.

Despite the terminology, Shanghai’s FTZ was designed more as a free-market zone subject to less regulation and more transparent governmental oversight, rather than an area of zero duties on goods and services. Among other things, it allowed foreign companies to own warehouses, set up health insurance operations and establish joint ventures to handle shipping cargo. 

‘Smaller, Nimbler’

The free-trade port would better live up to the designation, said Cao Heping, who advised the government on the original FTZ proposal and saw the new plan. The smaller size within the existing FTZ -- including the Yangshan seaport and Pudong airport areas -- would allow cargo to be stored and transferred without duties, he said.

“The free port will be a smaller, nimbler and better version of the FTZ,” said Cao, director of the Department of Development Economics at Peking University. “It’ll be like a second attempt at catalyzing financial reforms because we haven’t done well enough on the first try.”

The free port zone will also make it easier for foreign professionals to obtain work permits, according to Bai Ming, deputy director of International Market Research Institute under the Commerce ministry.

The Shanghai FTZ has been among the biggest disappointments of Xi’s first term, particularly after Premier Li Keqiang pitched it as a model for the “upgraded Chinese economy.” The government failed to deliver on tax cuts and eased restrictions on yuan convertibility in the zone.

The American Chamber of Commerce in Shanghai found in a 2015 survey that almost three-quarters of respondents saw no tangible benefits for their businesses from the FTZ. In April, the zone’s first director was sentenced to 17 years in prison for accepting $6.5 million in bribes over a period that overlapped with his time in charge.

‘Key Constraint’

China for years has maintained a closed capital account, meaning companies, banks and individuals can’t move money in or out of the country except in accordance with strict rules. The limit for individuals is currently $50,000 a year, while corporate investments need government approval.

Chinese policy makers backtracked on promises to increase the yuan’s convertibility after a stock market crash in 2015, while a subsequent currency devaluation spurred outflows.

While the free port plan could mean less red tape and business costs, liberalizing the capital account in the area will be difficult, said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong.

“China’s national policies on the capital account remained a key constraint on what was allowed to flow between the FTZ and the outside world,” Kuijs said. “It is not clear to me how this fundamental constraint is solved in the case of a ‘free port.’"

In addition to the Shanghai FTZ, China has established 10 such others throughout the country. When unveiling the “free trade port” on Oct. 18, Xi also pledged to “grant more powers to pilot free trade zones to conduct reform.”

Andrew Collier, managing director of Orient Capital Research, is waiting to see if anything is different on the ground.

“Let’s see if China has changed its tune and created a genuine free-trade zone this time,” he said.

— With assistance by Amanda Wang, and Charlie Zhu

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