How Free are China's Free Trade Zones?

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Free-trade zones are the flavor of the month in China, driving real-estate investors into a frenzy despite a lack of detail over how they will work and what kind of trade will be freed. There's deep debate over how much business will change in the heavily restricted mainland market.

Shanghai's zone made the biggest splash when it was approved in July and officially announced at the end of September, just before the weeklong National Day holiday that began on October 1.

Local reports suggest that prices of property in and around the free-trade zone have jumped 15 to 20 percent since the July announcement. But it remains to be seen if those gains are warranted by the fundamental business prospects of the zone. Some critics have suggested that driving up property values, rather than easing trade, is the real effect of the zone's creation.

"Many people got excited about this, and they contrasted it with the various policy restrictions elsewhere, with this going in the opposite direction compared to the tightening," said Robert Ciemniak, the founder and chief analyst at Real Estate Foresight, an independent property research company. "Without knowing what's really in the plans there, it's speculation."

There has been a proliferation of free-trade zones, both potential and confirmed, supported by various factions within the government, Mr. Ciemniak said. The coastal cities of Dalian and Xiamen have been proposed as possible sites. Wuhan, Tianjin and Ningxia are also vying to develop zones of their own.

"There is politics playing out inside [the government]," Ciemniak said. "Some will work out well, but some will not."

Guangdong Province, which borders Hong Kong, is already attempting to develop the Qianhai area next to Shenzhen, China's wealthiest city in terms of per capita income. However, despite its attempts to lure financial companies, takeup of space from banks and other industry players has been poor, with companies saying they don't see the need to open secondary locations when Hong Kong is already a free-trade port.

The Shanghai zone covers 29 square kilometers, or 11 square miles, but doesn't include Pudong, a former marshland that was developed into a financial center in the 1990s. Many of those buildings remained empty for years and have only recently begun to fill up.

Shanghai property has been the laggard in the last year among the four "Tier 1" cities in China, and its prices were eclipsed in September by those in Beijing as the most expensive in the country. Shanghai posted growth of just 8.9 percent in the 12 months through September, according to data from the brokerage Soufun, compared with 26.9 percent for Beijing, 24.8 percent for Guangzhou and 21.2 percent for Shenzhen.

HSBC had a comparatively rosy outlook on prospects for the zone to revitalize Shanghai's growth, which it noted has been behind the national average since 2008.

So far, the main announcement of what's officially known as the China (Shanghai) Pilot Free Trade Zone has been that it will open up investment in six key service sectors: banking; shipping; commercial services, including value-added telecommunications; professional services, such as law firms and human resources; cultural services such as entertainment; and social services, including education and medicine.

But there's also a 10-page "negative list" of activities. Those on the black list include investment in most kinds of media, with many restrictions on financial and insurance operations as well.

"We are not sure whether the FTZ as announced accelerates reforms or contains reforms," Commerzbank analysts Ashley Davies and Liu Peiqian asked. "For the reform hopeful, is the glass half empty or half full?"

From their report:

"On the surface the development of the Shanghai FTZ is a sign of a commitment to reform in China. However, expectations of ongoing reform were already in place. What the free trade zone does is limit the reforms to a small geographical area and possibly subject to quotas. As such it may reflect a compromise between the forces pushing for a more open China and those that wish change to proceed more slowly."

China is seeking to make Shanghai a global financial center by 2020, something that will be sped up by an experiment within two to three years to allow full convertibility of the Chinese currency, the yuan, in the zone, as well as interest-rate deregulation. But with authorities warning at the same time that the yuan will only be allowed to trade freely if "risk is controlled," it's not clear quite what that means.

"To us this suggests investment quotas will apply to the free trade zone," the Commerzbank analysts said. "If so, then the Shanghai FTZ will be exceedingly complicated. China will almost need two regulators to monitor capital flows - one for China and one specifically for the FTZ."