Wheels of progress move slowly in Shanghai FTZ

Other localities should study outcomes, drawbacks of experimental area

According to recent reports, officials in Liaoning Province have submitted their application with central authorities for the establishment of a free trade zone (FTZ) in Dalian. Local media also say provincial leaders have been in close contact with the Ministry of Commerce on the matter.

In December, the State Council gave its nod on the creation of three new FTZs, to be located in Guangdong Province, Fujian Province and Tianjin respectively. This marked a dramatic expansion of China's FTZ coverage, which began with the creation of Shanghai's FTZ in September 2013.

Not to be left out, several other cities have applied for such zones of their own - Xi'an, Wuhan and Lanzhou are said to be actively campaigning for local free trade areas. With zones like the one found in Shanghai promising eased access to foreign capital, reduced barriers to trade and smoothed avenues to overseas markets, it's hardly surprising that so many are looking for a spot on the bandwagon.

However, those seeking to replicate the Shanghai FTZ should look critically at its results to date. True, the zone has seen some breakthroughs, the so-called "negative list" meant to simplify investment approvals being a prime example. Various measures aimed at facilitating trade and supporting the full convertibility of China's capital account have also been rolled out.

The goals and priorities of the government appear quite easy to interpret from reforms being tested in Shanghai's FTZ. Statistics, however, hint at another story.

According to reports, some 3,000 financial institutions had established a presence in the Shanghai FTZ by September 2014, although many have yet to conduct any substantial business. Indeed, by September 2014, the zone's credit scale had reached just 83 billion yuan ($13.3 billion).

Right now, the zone's biggest problem seems to be limited connectivity with the wider world. As the Chinese mainland's emerging financial center, the Shanghai FTZ also looks short of policy supports when compared against the world's other finance and trade hubs.

Capital restrictions limit fund transfers from free trade accounts (FT accounts) - that is, accounts established within the Shanghai FTZ - into Chinese bank accounts outside the zone. Current regulations dictate that any such transfers should be denominated in the renminbi. Transfers of this sort are also subject to the same supervision standards as other cross-border deals. Limits are similarly in place on how much money can be moved from onshore bank accounts into FT accounts. Such restrictions appear at odds with the FTZ's goal of promoting financial liberalization.

What's more, authorities have offered few preferential tax policies in the Shanghai FTZ, making it a less favorable location for multinational companies to establish regional headquarters. Despite the central government's intentions to turn the zone into an offshore financial center, the zone still offers almost none of the incentives found among the world's 60-odd financial hubs. For example, at FTZs in the US, Panama and Chile, exemptions are made on customs duties on goods. No such policies exist in Shanghai, which may explain the muted interest in the local FTZ.

According to reports, some 10,455 enterprises had been established in the zone by the end of June, yet less than one-third had paid any taxes; suggesting that most of these companies were not engaging in any business.

The problems mentioned above may be traced back to the Shanghai FTZ's dual management by municipal authorities and the central government. Policies related to foreign exchange and taxes in the zone are under the control of a wide array of agencies, bureaus and departments. Scattered management, regulatory mismatches and vested interests may be delaying the introduction of more efficient, effective policies.

In comparison, many of the world's major FTZs operate under the oversight of a single institution.

As the Shanghai FTZ develops, further reform efforts are required. Moving ahead, authorities should consider placing the zone under the direction of just one entity.

In the meantime, additional tax breaks and financial incentives should be introduced. Greater financial openness with the outside world would also promote the zone's international profile. Such efforts will help the zone grow into a laboratory for financial reforms that can benefit the entire country.