New free-trade zone opens up China to the world

The US Federal Reserve surprised the world when it announced that it was deferring a widely-anticipated plan to begin "tapering" its quantitative easing programme. The decision was widely welcomed by investors and helped push emerging market equities - which had been under pressure over the summer - higher.

Meanwhile, China continues to deliver positive surprises. Lately, indicators such as the Purchasing Managers Indices, industrial production, exports, power consumption and retail sales all beat predictions. Personally, after three years in Shanghai, I have started to pay less and less attention to these figures, instead trying to see behind them: are there new policies that have had a real effect? How much does the global environment impact them? What does the leadership of China, who very likely has a say about some of the figures before they are released, want to signal?

Economic acceleration can help build confidence in the future, especially when the government is expected to launch important reforms during the Third Plenum of 18th Party Congress in November.

In any case, these indicators are all supportive to the market sentiment, and our Chinese stock investments have benefited.

Beyond the global macro story, one specific development is worth highlighting: the Shanghai Free Trade Zone (FTZ), which has taken shape quickly after years of seemingly endless discussions on how to really promote Shanghai as a leading financial center. Initially approved by the State Council in July, the project has received very strong backing from the Chinese Premier Li Keqiang and was recently dubbed “a positive and critical development” by the World Bank President upon his visit to China.

The FTZ is China’s first free trade zone, it spans around 30 square kilometres located in Pudong, and accounts for RMB1trillion worth of commercial transactions. While the figures are impressive its primary purpose in reality is to act as a testing ground for reforms by the Central Government, in the very Chinese way - as Deng Xiaoping said - of “crossing the river by feeling the stones”. The project plans to loosen controls on capital flows and expand foreign investment. The FTZ officially opened on September 29.

Financial institutions incorporated in the area – foreign and domestic alike - will not be subject to interest rate ceilings on deposits and will be able to use fully convertible RMB. This is a major step, as financial liberalisation nationwide-  if successfully implemented later on - would have profound implications on the way Chinese companies operate and how the whole Chinese economy is financed. Furthermore, several regulatory entry barriers such as approval procedures for foreign enterprises will be removed. It is another attempt to reduce the role of state bodies and to create a better market environment.

More as a symbol of liberalisation than actually having real implications, it has even been rumoured that certain foreign websites which are currently blocked in Mainland China, including Facebook, YouTube, the New York Times will be accessible in the FTZ.

There are several examples of reform initiatives in China that have been started as local experiments, before being applied to larger or nationwide areas. The Shanghai FTZ might well be the latest and is worth monitoring closely for that reason.