The more special economic zone
The landscape of capital-account liberalisation

Jul 7th 2012 | QIANHAI | from the print edition

The forwarded article was taken from The Economist at http://www.economist.com/node/21558307

You guys are welcome to comment the issues covered in the article under the main thread.

ELSEWHERE in the developing world, towns grow before the infrastructure is quite ready to support them. Things are different in Shenzhen, China’s original Special Economic Zone (SEZ), a stone’s throw from Hong Kong.

The subway station at Qianhai bay, on the city’s west coast, is spick and span, with a full complement of signs, announcements and billboards, including one for a performance by the BBC National Orchestra of Wales, sponsored by Classy Kiss milk. But only one exit is open. And it surfaces in the middle of a wasteland of dirt, scrub and puddles. It is, surely, the best connected nowhere anywhere.

This empty spot is, however, full of big ambitions. It is one corner of a 15-square-kilometre zone earmarked for experimentation by China’s cabinet. The zone has licence to try policies that are “more special” than those prevailing even in an SEZ. It aims to attract “modern service industries” rather than big-box manufacturers. It will charge only 15% corporate-profit tax and levy no income taxes on the finance professionals, lawyers, accountants and creative people it hopes eventually to attract.

These cosmopolitan folk will live in a “waterfront city”, says James Corner, whose firm won a competition two years ago to design the bay’s future landscape. Over the next couple of years, he explains, the city will build a system of “water fingers”, large parks that collect, retain and purify the streams that flow from the hinterland, allowing water to enter the bay clean and clear.

Water is not the only flow Qianhai aims to collect and retain. It also wants to attract some of the offshore yuan that have pooled outside mainland China’s borders. Over 550 billion yuan ($87 billion) now sits in Hong Kong deposit accounts; another 60 billion yuan sits in Singapore, and 35 billion more resides in customer deposits in London, according to an April study by Bourse Consult.

These yuan cannot flow freely back into mainland China, however. Banks can invest a limited amount in the mainland’s inter-bank bond market. Companies that raise yuan outside China can seek permission to invest the money in their operations inside the country. But the money can easily become bogged down in China’s exchange controls, especially when the authorities are trying to tighten credit.

Qianhai, however, will be permitted to broaden these channels. Its firms will be given help in raising yuan offshore. Hong Kong banks will be allowed to enter the zone more easily. The ground will also be laid for greater cross-border lending. “Since the mainland is targeting the gradual achievement of full yuan convertibility, Qianhai should be a pioneer for progress,” said Zhang Xiaoqiang of the National Development and Reform Commission, China’s planning body.

The plan poses some puzzles. If offshore yuan were to be lent freely to Qianhai firms, what would stop them lending the money on to the rest of the country? An easing of capital controls between Hong Kong and Qianhai would seem to require a tightening of controls between Qianhai and the rest of the mainland. Otherwise the stream of yuan inflows could become a flood.

The answer to the puzzle may lie in the timing. The Qianhai zone is not scheduled for completion until 2020, by when China’s capital controls may already be far looser nationwide. It is therefore unlikely that Qianhai’s opening up will get too far ahead of the rest of the country’s. In finance, as well as infrastructure, China likes to lay down the tracks, platforms and ticket barriers before the throngs arrive.