The Shanghai Free Trade Zone: the opportunities and challenges for Hong Kong
17 December 2013
The newly-established Shanghai Free Trade Zone enjoys many of the privileges long exclusively enjoyed by Hong Kong. Far from proving a competitor to the city, however, this latest mainland economic new development could provide a whole host of new opportunities.
When the mantle of power passed to the Xi-Li administration in November 2012, the incoming government made clear its intention to deepen reform and allow market forces to play a greater role in raising overall productivity. The communiqué of the Third Plenary Session of the 18th CPC Central Committee, which closed on 12 November this year, reinforced this, clearly stating that deepening economic reform remained its priority. It also singled out, as a key issue, the proper handling of the relationship between the government and the market and the importance of letting the market play a decisive role in the allocation of resources. The communiqué concluded with a call for the transformation of government functions in order to allow them to better meet development needs.
Part of this transformation came on 27 September this year, with the State Council’s announcement of the General Plan for the China (Shanghai) Pilot Free Trade Zone (FTZ), with the FTZ officially launched on 29 September. Although many of the regulatory measures have yet to be finalised and liberalisation is unlikely to be delivered overnight, there is no doubt that the establishment of the FTZ will send an important message with regard to China’s latest round of opening up to the outside world and the deepening of its reforms. Put simply, this message is this – China will continue to reform and to follow a market-oriented direction in terms of its economic development. The launch of the FTZ gives by far the clearest indication yet of the general direction of this likely economic restructuring programme.
Implications beyond Shanghai
The true significance of the FTZ is outlined elsewhere in the communiqué: “In line with the new realities of globalisation, we must promote the orderly and free-flow of international and domestic production factors, widen market access for foreign investors and speed up the development of free trade zones.” The establishment of this first FTZ, then, represents a true milestone along the mainland’s opening up process and one likely to have implications well beyond Shanghai in the long term. As part of its initial General Plan for the FTZ, the State Council indicated that it wished to learn replicable lessons from this pilot, with a view to establishing similar free trade zones elsewhere on the mainland.
In light of this commitment, it is not difficult to foresee that the economic and reform lessons learnt from the Shanghai FTZ will be applied on a far larger scale in the future. Inevitably, such moves should help improve efficiency and productivity, produce a tangible payout in terms of a “reform dividend”, and take the mainland’s economic development to a new level. As the established international trading platform for China, Hong Kong will undoubtedly benefit from the new opportunities set to emerge.
A number of the characteristics of the proposed FTZ – its open market, its freedom from the majority of tariffs and its liberal investment policies – will give it a great deal in common with the current policies operated in Hong Kong. Inevitably, this could see Hong Kong facing fresh competition in those areas where its free trade environment has traditionally given it a unique advantage. In the long run, though, it seems highly likely that the city will gain more from the mainland’s continuing economic expansion than it actually risks losing to any new competitor.
It is widely held that these new policies will give the mainland’s economy increased scope for growth, with private companies, in particular, likely to flourish. As a result, Hong Kong, as an important international trading platform, should find greater demand and further development opportunities for its highly-regarded international financial and commercial sectors.
Distinct catchment areas
There are a number of factors that make Hong Kong an important trading platform and a flourishing cargo transhipment sector. Chief among these are its strategic location, its free port policy, its high quality infrastructure, its efficient customs clearance procedures and its transparent legal system. Over recent years, the territory has also become well-established as a regional logistics hub. It seems entirely possible that the Shanghai FTZ may develop similar strengths in the future, increasing its status as a potential competitor to Hong Kong.
Despite any apparent overlap, each city will have its own distinct catchment area and its own particular strengths in term of services. This will nurture a degree of “division of labour” between the two centres. As a transhipment centre, most of the goods handled by Hong Kong originate from the Pearl River Delta (PRD). According to China’s Customs statistics, nearly 80% of the mainland exports to Hong Kong between January and September 2013 were PRD-originated. It seems likely, then, that much of this existing and long-standing trade will remain focussed on Hong Kong, while Shanghai develops its own proprietary trading relationships.
As a regional distribution centre (RDC), Hong Kong has the capacity to provide a higher level of value-added services and to handle more high-value goods and bulk cargo than any other centre in the region. Hong Kong also distributes a substantial number of high-value commodities for retail purposes. While the city will inevitably continue to develop as a preeminent electronics and garments RDC for wider Asia, it is also looking to develop its import/export portfolio of higher value items, notably luxury items, wines and pharmaceuticals.
Overall, as its manufacturing sector completes its transformation and upgrade programme, the mainland will see far greater levels of imported high-value-added goods. With economic growth set to be driven by domestic consumption rather than exports, there will clearly be a greater demand for imported consumer items. This new reality will see China – and, indeed, the whole of Asia – require the development of a new generation of distribution centres to meet growing domestic consumer demand across the region.
Removal of professional service barriers on the mainland
Apart from the free flow of goods, the opening up of the service sector is another important concession for the new FTZ. At present, while many of the major obstacles preventing Hong Kong service suppliers operating on the mainland have been removed, there remain a large number of less substantial bars to entry.
One of the key issues here is the disparities between Hong Kong and the mainland in terms of trade structures and management systems. In a move to ease the problem, the FTZ has adopted a “negative list” of areas prescribed for foreign investment. Investment was only previously possible in specified pre-agreed areas.
The change from a system of “examination and approval” to a streamlined “record filing” approach will also clear the way for Hong Kong service providers to enter the mainland market. This change will facilitate Hong Kong firms in establishing a foothold in the FTZ and, subsequently, develop service networks in the Yangtze River Delta and beyond in line with the new and increasing emphasis on both globalisation and all-China development.
Rmb market implications
Aside from its reduction in trade restrictions, the FTZ will also enjoy a number of Rmb convertibility privileges, including the wider use of the Rmb for cross-border businesses and the adoption of market-oriented interest rates on a first-to-do and first-to-try basis. This will make the FTZ the first “offshore Rmb centre” based within Chinese territory. While this development, again, represents an increased level of competition for Hong Kong, the higher level of Rmb internationalisation and the wider use of the Rmb in the international market should have a compensatory impact on Rmb transactions in the city.
As an international financial centre, Hong Kong has long played a pioneering role in China’s financial reform and Rmb internationalisation programme, giving it a substantial track record in this area. Its pedigree in this sector gives it the “first mover” advantage in terms of global offshore Rmb business. Tellingly, Hong Kong’s Rmb business continued to grow even after the launch of apparently competing offshore Rmb business agreements in both London and Singapore.
In terms of Rmb cross-border trade settlements, Hong Kong still accounts for about 80% of China’s transactions in this area. Overall, the Rmb trade settlements handled by Hong Kong increased from an average of Rmb31 billion per month in 2010 to Rmb219 billion per month in 2012. In the first half of 2013, the figure reached a truly impressive Rmb280 billion per month.
The development of free Rmb convertibility in the Shanghai FTZ will provide another channel for the flow of offshore Rmb capital back to the mainland. It will also generate more opportunities for Hong Kong, by giving the Rmb in Hong Kong more channels for the repatriation of cross-border investment and by increasing activity in the overall Rmb business sector.
Regional development a must for Hong Kong’s competitiveness
A more market-oriented and growing mainland economy will undoubtedly be good news for Hong Kong and will only elevate its status as an international trading platform. Despite this, though, Hong Kong would be well-advised to boost its own competitiveness. In terms of its RDC role, for instance, Hong Kong needs to continuously improve both its global transport links and ensure that its operating costs remain competitive across the whole region.
In the longer term, there are other benefits that may accrue to Hong Kong should the Shanghai FTZ model be extended to other areas of the mainland. One likely beneficiary here is Guangdong, which is reportedly seeking permission to establish a Nansha-Qianhai-Hengqin FTZ, which would, ultimately, extend further to include Hong Kong and Macau.
If Guangdong’s ambitions prove successful, Hong Kong would play an active role in this new FTZ, especially given its close trade and geographical ties with Guangdong. With the favourable conditions extended through such an FTZ arrangement, Hong Kong would benefit hugely from integrating its functions as an internationally renowned commercial centre while serving as the front end of such a liberalised and globally-appealing business region.
- Mainland China
- Mainland China