China’s Free Trade Zones: What you need to know
China launched its Free Trade Zone (FTZ) Program in 2013 to accelerate the country’s reform and opening up. There are now 12 Free Trade Zones with the most recent and largest being Hainan FTZ established in April 2018. While FTZs are relatively new, the principle of a zonal based approach to economic development in China is not. Ever since Deng Xiaoping began to liberalize the economy in 1978, zones have served as important test beds for economic reform before being rolled out more widely. FTZs are the latest – and most ambitious - iteration of this zonal based approach, and President Xi Jinping has reiterated their continued importance.
Some foreign governments argue that China does not need FTZs given the maturity of its economy and that instead preferential policies should be rolled out nationally. But the reality is that China’s FTZ program is here to stay. China has no intention to change its incremental approach to development; so our advice is to properly understand the value proposition of China’s FTZs.
Source: frontera.net
For foreign companies, there are three primary advantages of FTZs:
1. A better business environment
Improving the business environment has become a policy priority for China. It is now seen as another lever that can be pulled to mitigate against economic slowdown pressures. Improvements seen in the 2019 World Bank Ease of Doing Business Index - widely accepted as the most reliable indicator of how easy it is to do business across countries – have buoyed China’s efforts. From 2018 to 2019, China saw a stunning improvement in its ranking to 46th place from 78th. And in FTZs, the business environment remains even better than across the rest of the country and a testbed for new policies.
China’s FTZs offer foreign entities tax benefits (as low as 15% corporate tax rate), access to subsidies that would not be available in other areas of the country, faster company incorporation and acquisition of licenses, quicker import of goods and international bank accounts.
We know first-hand the speed of incorporating in a zone; Belt and Road Advisory is incorporated in Hainan FTZ and it took us less than a week from start to finish (contrasted with an average of 3 months in Beijing). The speed of incorporation is supported by a one-stop shop in which all relevant paperwork can be obtained for a prospective foreign company, cutting out the bureaucracy from having to go to different governmental departments. Hainan and Shanghai FTZs, soon to be followed by Guangdong, have introduced special free trade bank accounts which enable foreign firms to transact in foreign currencies and easily transfer money abroad. In other areas of the country, such transactions would not be possible and could come up against strict capital control limits.
Acquiring the relevant operational licenses is also easier in FTZs. For example, in Hainan FTZ, imported medical devices do not need to central government approval prior to entering in China, and the decision to grant licenses is devolved to the local level. This makes the whole process quicker and permits residents in Hainan to enjoy better quality healthcare as well as creates an entire sector of medical tourism. Certain imported items, such as cosmetics, are also permitted to enter the FTZ before bring checked for compliance with quality standards, and are only checked after. This marks a difference versus other areas of the country which require compliance checks to be undertaken before the goods have entered, significantly slowing down the process of importing into China. For exporters looking to tap into the Chinese market, FTZs offer a quicker and more reliable way of getting your product to Chinese consumers.
2. Hubs for economic liberalization
Investing in FTZs is less restrictive than nationwide, as governed by so-called foreign investment negative lists. These lists outline sectors which are restricted or negative for foreign investors. The FTZ negative list currently has 45 items on it, while the national list has 48 (both down from 100+). We expect the FTZ list to continue trending downwards; President Xi Jinping indicated towards the end of last year that healthcare and education sectors would become increasingly open to foreign participation, and FTZs would be where they start. If policies are seen to work in FTZs, then they are likely to be rolled out nationally. According to the Ministry of Commerce, 123 measures first tested in pilot FTZs have been gradually promoted and adopted nationwide.
These comparatively less restrictive investment environments are reflected in volumes of foreign investment into FTZs. In 2018, FTZs received 12.5% of all FDI into China, seeing a growth rate of over 10% compared with a national growth rate of around 3%. The Shanghai FTZ, with an area of 120 square km, generated over 40% of the total import and export of the municipality in 2018.
3 . Tap into existing ecosystems
FTZs are hubs for foreign companies, and have strong ecosystems of both domestic and foreign companies that new entrants can leverage to access local expertise, checked supply chains and prospective customers. Such a network helps firms entering China for the first time, particularly SMEs who would otherwise have difficulty finding suitable partners. As we argue in this piece, there has been no better time for foreign SMEs to enter China. FTZs also have different sectoral expertise; for example, Shanghai is focusing on financial services, Guangdong on tech, Hainan on healthcare and entertainment and Shaanxi on logistics. These present clear locations of choice for foreign firms focusing in these sectors and who want to benefit from network effects.
FTZs are good, but could be better
FTZs have already proved themselves as reliable locations for foreign firms to locate and access the Chinese market. That all said, with President Xi doubling down on the FTZ program, there remains room for FTZs to improve yet further. In particular, FTZs are often accused of being hubs for policy implementation alone, as opposed to being more ambitious through policy experimentation.
With China in the market for new ideas to help avert economic slowdown, FTZs could be leveraged to accelerated new liberalizing measures. For example, FTZs could abolish the concept of negative investment lists altogether, opening up new markets and sectors for foreign participation and driving up inward investment. Similarly, they could be used to remove other stifling regulations. We understand that Hainan FTZ is considering unfettered internet access as well as removing imported film quotas. These are the kind of regulations that would make the FTZ proposition far more compelling for foreign business.
Understand the FTZ value proposition; position your company to benefit from future liberalization
China’s Free Trade Zones are here to stay; President Xi Jinping has personally called for their expansion and accelerated development. They already present a value proposition that many foreign businesses are taking advantage of; especially given China’s desire to attract more inward investment.
Our advice – Even if your company already has established presence in China outside of a zone, research how FTZs might be relevant for your business. With the expansion and increasing liberalization of FTZs, having presence in an existing FTZ might put you at the front of the queue when new liberalizing measures directly impact and benefit your sector. At Belt and Road Advisory, we offer incorporation services in different FTZs and advise which would be the most suitable for you.