TAKEAWAY: On the margin, key initiatives in the Shanghai FTZ reform package are positive for China’s structural economic outlook.
Today, China announced general guidelines for economic and financial market reform within the Shanghai FTZ. On balance, the outline was met with mixed-to-slightly-disappointed reviews from the analyst and financial media community.
While regrettably and conspicuously devoid of specific rates, quotas and other metrics that would allow analysts to quantitatively extrapolate the zone’s impact upon the broader Chinese economy, the guidelines were indeed full of key initiatives that we continue to think are positive for China’s TAIL-duration growth outlook via an infusion of capital and liquidity into the nation’s increasingly cash-strapped financial sector.
- Key positives:
- 18 service sectors will be granted access to private and foreign capital, with financial services being the most important as it relates to Chinese economic growth.
- “On the condition of effective oversight”, China will allow Chinese banks in the zone to conduct offshore business – essentially allowing them to provide banking services to foreign depositors.
- “China will push for a full-scale opening of the financial services sector to eligible private capital and foreign financial institutions.” Essentially, this will allow foreign-funded financial institutions to set up banks and team up with private Chinese banks to form joint ventures. Both initiatives will undoubtedly be supportive of increasing the supply of credit to China’s SMEs, which tend to be significantly more productive than their SOE counterparts.
- Foreign-funded mutual funds will be granted access to operate in China via the Shanghai FTZ. With the securitization of financial assets also being promoted, the presence of foreign-funded mutual funds helps address the elephant in the room surrounding China’s still-developing ABS market (i.e. “who’s going to hit the bid on the bulk of China’s pending ABS sales?”), given that Chinese banks themselves will inevitably find it difficult to broadly offload assets unto one another.
- While not specific to banking, another pro-growth reform initiative is the implementation of favorable tax policies that seek to boost investment and trade. An example of this is the Chinese government’s plan to make imported capital equipment exempt from taxes within the FTZ.
- Key negatives:
- Aside from the fact that it was light on specifics, the fact that the zone “aims to get up to international standards of convenient investment and trade, as well as full capital account conversion in 2-3 years” is disappointing. Why such a long delay? It’s not like this is China’s first rodeo with special economic zones (think: Deng Xiaoping’s Shenzhen success story).
- Moreover, “creating conditions” to “test” capital account conversion, interest rate liberalization and cross-border use of the CNY is not the same as “proceeding with” any/all of those reforms right off the bat.
All told, while not necessarily a game-changer for the broader Chinese economy, we stand counter to the consensus interpretation that today’s announcement of the specific reforms earmarked for the Shanghai FTZ amounts to little more than a policy non-event.
Rather, we continue to believe Chinese officials are embarking on a grand-strategy to [methodically] import foreign capital to offset the structural liquidity headwinds weighing on the country’s financial sector and its economic growth potential.
That, on the margin, is positive for China’s structural economic outlook (CLICK HERE for more details).
Have a great weekend,