Shanghai FTZ to herald major financial reforms

Although the government has not yet given out details or set out a timeline for the newly established pilot free trade zone (FTZ) in Shanghai, the move has caused quite a stir in the world's second-largest economy.

There has been discussion and speculation regarding possible policy changes and reform measures in the FTZ. Among a spate of sectors, financial markets are the main focus of attention.

The core of the FTZ lies in reforming the financial sector, not trade, said Qiu Xiaohua, the country's former top statistician, at the ongoing 17th China International Fair for Investment and Trade, held in the southeastern city of Xiamen.

Qiu said the FTZ may give a green light to the establishment of foreign-funded and joint venture banks, while allowing Chinese banks to conduct offshore businesses.

"It's all about freeing up China's financial market, its exchange rate and interest rate," he added.

Qiu is not alone. In fact, it is widely believed that the FTZ will experiment with yuan convertibility and opening the capital account.

According to Lian Ping, chief economist at the Bank of Communications, the Shanghai municipal government is proposing to trial capital account liberalization within the zone, while promising to curb risks. Yet the proposal has to go through a string of ministries including the central bank.

"This is a major breakthrough in China's financial reform, a jump toward freeing up foreign-exchange controls," Lian said.

Meanwhile, he also warned that together with opportunities come risks. Once the account is opened, arbitrageurs can easily cash in on the cross-border capital flows in the FTZ.

"If capital floods out of the country, it will drag down the prices of yuan-denominated assets, and weigh on markets of stocks, bonds, foreign exchanges and real estate," Lian explained.

Analysts agreed that the opening of the capital account will be very cautious. The government is likely to press ahead with it step by step, lifting bars on sub-accounts regarding capital inflow and direct investment at first.

Meanwhile, the launch of the FTZ also signaled the new government's determination to see through domestic reform, said Hong Xiaodong, deputy director of the department of World Trade Organization affairs at the Ministry of Commerce.

"The FTZ is not about preferential policies. It is rather about testing whether a policy works or not. And it should be possible to replicate it elsewhere after a certain period of time. If not, there is no need to do this," Hong said.

He also noted that the spillover effect of the FTZ should be measured by tallying how many policy changes are made and extended to other places.

"The FTZ is a national strategy, and I think we all know what it will wind up with," Hong said, apparently referring to a previous pilot, Shenzhen, which after more than three decades of reform and opening up, has turned from a small coastal village into a manufacturing powerhouse.

His optimism seems to be shared in the market. China's long-time bearish stock markets have rallied in recent weeks. The benchmark Shanghai Composite Index, which has obviously been fueled by the news, went up by 3.39 percent Monday, the biggest daily gain in the year.