From the beginning, the SPFTZ has been a pilot zone not only for trade but also for broader reform. There have been four major areas of institutional reform over the past year. This includes reform of the foreign investment, financial, trade, and legal and regulatory systems. Of these, financial innovation attracts the most interest.
The People’s Bank of China and three regulatory commissions on banking, securities, and insurance have adopted 51 new regulations underpinning a new financial architecture in the SPFTZ. These include a free trade accounts system that enables eligible organisations and individuals to enjoy the same regulatory rules on their yuan as apply to foreign currencies. Cross-border payments, receipts, and exchange related to direct investment by enterprises can be processed directly by banks. Eligible individuals can now make various kinds of overseas investments, including securities investment. Financial institutions in Shanghai can also independently price the foreign currency deposits of enterprise clients. And banks can directly provide cross-border RMB settlement services in current accounts and direct investment accounts to their clients.
All these features are aimed at loosening capital controls in the SPFTZ, while maintaining them for now in most of the rest of China. Similar arrangements are in place in Tianjin, Fujian and Guangdong FTZs. But the impacts of financial market changes cannot be confined to small geographic areas. As such, they will likely affect the capital controls in China as a whole.
In fact, research by the authors shows that the impact of capital controls in China is lower since the SPFTZ. Capital flows have increased rapidly since the SPFTZ. The price spread between the CNY (the onshore exchange rate of RMB) and CNH (the offshore exchange rate of RMB in Hong Kong) has also shown a tendency to diminish. Furthermore, a formal price test — analysing the combination of onshore RMB interest rates, offshore US dollar interest rates and non-deliverable forward (NDF) exchange rates — indicates that there was a regime break in China’s capital controls when the SPFTZ started.
These spill-over effects are more as the result of intentional policy design than of a careless failure of planning. Chinese reform is generally characterised by its evolutionary strategy, where tentative policy experiments in confined areas are only replicated in other areas when they succeed. Although financial architecture usually occurs organically, in that it gradually results from a myriad of individual agreements, China can still find ways to trial reforms while avoiding an unfavourable impact on its whole economy.
That the SPFTZ is expanding to 120 square kilometres and three similar FTZs in Tianjin, Fujian and Guangdong are operational proves that loosening capital controls is in accordance with the purpose of the central government. Beijing may gradually abandon its current policy of a stable RMB and capital controls to a floating currency and liberalised capital market.
A liberalised capital market is a part of the broader objective of the new generation of Chinese leaders, whose aim is to create a more structurally balanced, domestic demand driven, environmentally friendly, and equitable form of economic development. In this sense, the SPFTZ heralds the ‘new normal’ that will characterise China in the coming decades.
Daqing Yao is an Associate Research Professor at the Institute of World Economy at the Shanghai Academy of Social Sciences.
John Whalley is Professor in the Department of Economics, Western University.
The authors are grateful to the Ontario Research Fund and the Centre for International Governance Innovation for financial support. This article refers to the materials from the authors’ recent paper: Daqing Yao and John Whalley, ‘An Evaluation of the Impact of the China (Shanghai) Pilot Free Trade Zone (SPFTZ)’, NBER Working Paper No. 20901.