Time of opportunities, challenges

The Shanghai Free Trade Zone, a pilot project approved by the State Council, is expected to pave the way for China's business hub to become one of the world's leading financial, trade and logistics centers.

Several decades of carefully planned development have transformed Shanghai from an industrial dinosaur filled with smoke stacks into a modern service powerhouse adorned with gleaming high-rises full of banks, multinational enterprises and large trading houses.

The city has spared no effort in expanding its infrastructure, including a complex highway network, subway system, new railway terminals, two airports and a deep-water sea port. Moreover, it has magnetized talented workers from around the country with an abundance of well-paying jobs in the growing services sector.

This sector now accounts for 61 percent of the city's economic output and provides its major growth impetus.

But Shanghai has even grander plans in store: specifically, the building of a 28 square kilometer free trade zone, which was made known to the public last year. The plan has taken on a new sense of urgency since it was approved by the State Council in June.

Although details have yet to be disclosed, pundits expect it to follow roughly the same blueprint as similar zones in Hong Kong and Singapore.

The plan has broader ramifications than its immediate impact on businesses operating in Shanghai, as it is widely seen as a precursor to economic restructuring and financial reform on a national level.

The Shanghai free trade zone project is seen as a testing ground for a series of policy-based changes that are deemed necessary to facilitate sustainable economic growth.

Tasks

The projected rewards are huge, but the challenges are daunting.

Shanghai has embarked on building itself into a global financial center while moving to restructure its economy amid a climate of slower growth. However, it is hampered by its financial structure, regulatory environment and a prevailing sense of bureaucratic inertia.

Although the Chinese economy has seen a slight revival in recent months, two straight years of moderate growth set against a background of strict policy controls have threatened to derail the push to move in ambitious new directions.

As such, the free trade zone may serve as the city's white knight. While details remain vague, analysts believe the zone will become a catalyst to bolster the city's development and spur innovation.

Shanghai's economic output has fallen below the national average since early 2011, when local authorities vowed to move away from its dependence on bulk manufacturing to the service sector.

The transformation is just beginning to pay dividends. For instance, in the first half of this year, the service sector, which encompasses property, finance, telecommunications and tourism, saw faster growth than the agricultural and industrial sectors.

The service sector edged up 1.3 percentage points from 2011-12 and grew 9.6 percent to account for 61.7 percent of the city's GDP as China accelerates its transformation into a service-oriented and consumption-based economy.

However, such sweeping change has not managed to stem an overall decline in the city's economic growth. It missed the national GDP growth by 0.2 percentage point last year.

Trade also contracted for the first time in three years, with exports falling 1.4 percent year-on-year, according to data supplied by the Shanghai Municipal Bureau of Statistics.

From January to June, trade volume shrank 3.7 percent compared with the first six months of 2011, with exports dropping 4.3 percent and imports falling 3.2 percent over the same period.

According to Michael McDonough, senior economist at Bloomberg LP, slower growth is almost a "necessity" as China moves away from its reliance on exports and shifts toward greater domestic consumption, with the private sector posited as a major growth engine.

But according to the latest data in 2011, household consumption would need to increase by almost 1.5 percent to offset a 1 percent decline in China's gross capital, McDonough said.

Trade

"I think Shanghai has been one of the slowest-growing cities in China for a while. The free trade zone will definitely boost its growth in the long run," he said.

Others hope the FTZ will catapult Shanghai to the forefront of global trade and cement its status as a world-leading financial hub.

It will also help the city cut the costs of trade and improve efficiency, said Sun Lijian, a professor of economics at Fudan University.

"Goods in the zone may be landed, handled, manufactured or reconfigured and re-exported without the intervention of customs authorities," he said.

Sun said such a tariff-free environment would foster offshore trade and offer tantalizing new opportunities to Chinese exporters keen to expand their production capabilities to other low-cost markets in the region. He added that such eased rules would also help them concentrate on the higher-value-added front and back ends of the manufacturing process.

In the coming years, Shanghai's financial reforms may support China's gradual transition toward consumption-led growth, said Dan Steinbock, research director of international business at the India, China and America Institute in the US.

"In order to support the ordinary Chinese social model, the mainland needs more sophisticated financial services. When people feel that their future is more secure, they will consume more," he said.

Convertibility

On a national level, the Shanghai FTZ could act as a trailblazer in terms of prodding other markets to open up as it helps improve China's economy. Policy makers have already signaled that they hope to hasten the convertibility of the yuan over the next few years to boost its use in trade and support wider financial reforms.

Shanghai is not presently equipped to handle offshore trade or financial transactions like its regional counterparts Hong Kong or Singapore, Sun said. Opening the door to foreign banks is conducive to jumpstarting an offshore yuan market in the free trade zone, he added.

As the free trade zone may lead to more experimentation with a fully convertible Chinese currency, the city will morph into an international financial hub faster than anticipated, Steinbock said.

Shanghai Mayor Yang Xiong has already told the city's legislators to work toward building a solid legal framework for the FTZ, as the reform measures will require about a dozen laws to be modified.

He said initial research has shown there are more than 90 detailed reform measures ready to be launched in the free trade zone, most of which will focus on innovation.

Xiamen, Tianjin and other coastal cities have submitted applications to set up FTZs, as have provinces including Jiangsu that neighbor Shanghai.

But Lu Bin, a professor with Nanjing University of Finance & Economics, expressed concern that such pioneering reforms in Shanghai could dilute the competitiveness of cities in Jiangsu that were recently granted favorable policies.

Cooperation

He said that once the FTZ eases controls on how foreign exchange is managed, another pilot zone in Huaqiao, Kunshan in Jiangsu province that is run in cooperation with Singapore will "enjoy no comparative advantage."

Kunshan, which lies on the outskirts of Shanghai, could also be negatively affected as many of the foreign multinationals that now base their headquarters there will be tempted to relocate to the new FTZ, he added.

But Jiang Hongkun, Party chief of Suzhou, sees more opportunities than challenges. "Just as Suzhou depended for its growth on the development of Pudong New Area, so the new FTZ will present us with more opportunities," he said.

Experts say the FTZ also represents a counter-challenge to other recent developments such as the Trans-Pacific Partnership. This US-led initiative is widely seen as a move to curtail China's growing influence on global trade.

Wei Jianguo, secretary-general of the China Center for International Economic Exchanges, said the partnership could be seen as the first step toward establishing an Asia-Pacific Free Trade Zone. As such, he said China could take the initiative in joining it to maximize the benefits for the region as a whole.

The Shanghai FTZ could play an active role in such a mission, as its reform measures may answer certain partnership requirements pertaining to government subsidies and intellectual property, he added.

"Today, people like to say that Shanghai is about to become a 'mini-Hong Kong.' But, over time, Hong Kong may look like a 'mini-Shanghai,''' Steinbock said.