China

China to set up free trade zone in Shanghai

Area to test govt overhauls such as currency convertibility, interest rate liberalisation
Published: July 6, 4:02 AM

SHANGHAI — China has taken another step towards loosening its capital controls and making its currency more freely convertible by approving the creation of a new kind of free trade zone.

The State Council, or Cabinet, said it was establishing a pilot zone in Shanghai to test some of the government’s financial overhauls, including interest rate liberalisation and full convertibility of the yuan, according to local reports.

Analysts say the free trade zone will not only promote interest rate liberalisation and currency convertibility but will also allow “financial product innovation” and the raising of money abroad or investment in foreign stocks by corporations.

Since taking office this year, Premier Li Keqiang has been promising bold changes aimed at overhauling the economy and improving the nation’s global competitiveness.

In May, a State Council meeting presided over by Mr Li said that, by the end of the year, the government would outline a plan for full convertibility of the yuan and make it easier for Chinese individuals to invest. Still, many analysts say they believe that the currency will not be fully convertible until 2015 to 2018.

“The State Council expects this experiment as an essential step towards upgrading China’s economy,” said Mr Qu Hongbin, an economist at HSBC in Hong Kong. “It also expects the pilot’s eventual national roll-out.”

It is unclear exactly how the free trade zone would operate, but businesses and traders in the zone would probably be more free to import and export goods without customs approvals, and to convert foreign currency into yuan more freely.

The approval of the free trade zone is a lift for Shanghai, which in 2009 won State Council approval to become a financial centre to compete better with Hong Kong, London, New York and Tokyo.

Although China has the world’s second-largest economy, the government maintains strict controls over capital flows and cross-border investments. It also has tight control over interest rates. This is done in part to guard against perceived threats from international currency speculators and to prevent huge inflows or outflows of money from rocking the banking sector and the economy.

But it is moving ahead with plans to integrate with the global economy more fully by loosening controls over interest rates and cross-border trade and investment deals. Analysts say loosening of those controls could strengthen the financial system and make it more efficient. The overhauls could also make it easier to trade the yuan, setting the stage for it to rival the United States dollar some day as a reserve currency. The government controls its value and, beginning in 2005, Beijing began allowing the yuan to strengthen against a basket of other major currencies, including the dollar.

Analysts say the experimental zone is another move towards allowing the global financial markets to determine the value of the yuan,

After years of spectacular economic growth, China’s economy has been showing signs of weakening this year, and economists are warning about looming risks in the banking industry. THE NEW YORK TIMES