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Hainan, an Island Paradise for Foreign Trade and Investment

Summary

As Hong Kong’s economy continues to decline, retail, tourism, and foreign investment dollars have assumed a newfound importance to the Chinese economy. An up-and-comer is rising from the shadows to challenge Hong Kong’s regional stature in the form of an island paradise. The newly designated free trade port of Hainan and Beijing’s aptly named Master Plan strive to usher in a new center for global trade and investment for the island-province.

One of the most widely trafficked tourist destinations in the world, home to the largest concentration of premier resorts of any Chinese city, host to some of China’s most prestigious events, and a launchpad for space exploration missions – with 930 miles of coastline, the island-province of Hainan is increasingly regarded as one of China’s most beautiful and bustling special economic zones (SEZ).

Since first designated as an SEZ in 1988, Hainan has commanded a special role in China’s development; however, the nation’s leadership has begun to direct the island province as a key shopping tourism hub over recent years. Since 2014, Hainan has seen rapid growth in foreign and domestic tourism, rising investment from foreign and domestic sources, and consistent GDP growth performance – placing Hainan at the forefront of China’s grand economic master plan. Considering its newly appointed status as a free trade port in 2020, Beijing may well be molding Hainan into the ‘Pearl of the Orient 2.0,’ or a modern hub for trade and investment in and out of China.

Setting the Stage for Global Business Development

As part of Deng Xiaoping’s “Opening Up and Reform” policy shortly before the turn of the 21st century, China designated a series of SEZs geared towards the facilitation of international trade. Among these zones were familiar cities like Shanghai and Shenzhen, chosen for their coastal location and proximity to key trade routes. Yet, while the island may be strategically located along major maritime trade routes, Hainan stood out as the only provincial-level SEZ to be among the first five locations selected for elevated status. 

Chinese SEZs offer a bevy of privileges, from tax breaks to autonomous capital controls, and are primarily used as sandboxes for market-based economic frameworks. These incentives have largely been successful in attracting foreign investment, which has in turn transitioned China’s SEZs into formidable economic powerhouses that have contributed an aggregate 45% of national FDI and 22% of national GDP growth since the group’s inception.

In modern days, SEZs are typically likened to Hong Kong, a city long considered a bastion for foreign pivots into the Chinese market. By establishing precedent for the de facto integration of capitalism into China’s unique “socialism with Chinese characteristics” economic framework through decades of trial and error, Hong Kong walked so that SEZs could run.

Hong Kong’s 99-year lease to Britain ended in 1997, which returned the prodigal city into the fold of Chinese sovereignty. Due to the stark mismatch of ideologies between the two regions that spanned nearly all areas from political systems and judicial processes to economic modals, Beijing and London devised the One Country, Two Systems governance framework. This model would allow Hong Kong to retain certain characteristics that deviated from traditional Chinese systems. Of particular importance was its right to maintain a market-based economy, which from that point until the 2010s, allowed the city to cash in on its position as both a hub for domestic and international tourism as well as a launching pad for MNCs developing APAC operations to deliver stable GDP growth and massive foreign investment, which then continued to turn its economic engine.

Yet, sporadic periods of socio-political unrest as well as the recent up-cropping of major Chinese megalopolises like that of the Pearl River Delta have served to undermine tourism and foreign investment in Hong Kong. Gradually, national priorities have shifted towards the development of Mainland cities, and with an arsenal of unfettered favorable economic policy and nearly uncapped domestic investment, foreign investors have turned inland. The icing on the cake then lies with strict Chinese capital controls that traps and redistributes inbound investment within Mainland shores towards city- and provincial-level economies. As a result, Hong Kong’s weighted contribution to national GDP began to taper in the early 2010s with the rise of domestic substitutes that began overtaking the global hub.

Hong Kong FDI & Contribution to GDP Wanes as National Priorities Change

Sources: National Bureau of Statistics, The China Guys 

Now, following a series of policies that undercut public confidence in Hong Kong’s autonomy from the Mainland and culminated in a sweeping National Security Law that formally undermined the city’s role in the “One Country, Two Systems” framework in mid-2020, the ‘Pearl of the Orient’ has been steadily losing its sway over aspiring MNCs. In a final blow to the city’s independent stature, the United States removed Hong Kong’s “special status” as democracies around the globe began to formalize its premature re-integration into Beijing’s direct oversight through legislature and political maneuvers.

The Master Plan for Hainan

In the vacuum created by a declining Hong Kong economy, Beijing has determined the best path forward to be bolstering retail tourism, trade, and investment back home by diverting significant resources to its powerful SEZs – and chiefly among them, the island paradise: Hainan.

In just the three year period spanning 2017-20, China has opened visa-free travel to Hainan for 59 countries, laid plans for a US$2.5 billion highway loop in Hainan for the express purpose of accelerating the island’s ascension to an international tourism and consumption hub, and established Hainan as a Free Trade Port in 2020.

To solidify its commitment to developing Hainan, China devised a Master Plan. The Plan outlines a series of campaigns that leverage infrastructure investment, reduced economic controls, and tax advantages, among other incentives, to whet the appetite of investors on all sides of the pond for years to come. The Master Plan continues on to propose the longer-term objectives of establishing a fully liberalized free trade port by 2025, creating a world-class business environment by 2035, and fostering the island’s strong international influence by 2050.

Goal #1: Establish a Free Flow of Trade

In 2020, China designated Hainan as a Free Trade Port (Hainan FTP), laying the grounds for the development of a series of tax and legal system changes aimed at introducing zero-tariff policies and a new import and export system, simplifying foreign trade while strengthening the management of goods between Hainan and mainland China. While implementation will occur between the present and 2025, government bureaus have already moved to action and in November announced the removal of tariffs, duties, and value-added taxes from a variety of inbound raw materials. 

Goal #2: Lower Barriers to Market Entry for Foreign Investment

As an SEZ, Hainan manages its own Negative List, also known as the master list that gives permission for foreign participation on an industry-by-industry basis. Originally earmarked for release by the end of 2020, Hainan’s refreshed Negative List is widely anticipated to drastically lower barriers to market entry across China’s strategic industries.

Goal #3: Open the Flow of Key Production Factors

Certain financial sectors and economic resources will be reformed and expanded to include foreign investors while immigration policies will be adjusted to attract foreign talent, academic initiatives, and business activity. Meanwhile, transportation regulations will be relaxed in terms of shipping and airspace, storage costs will be kept at a minimum through subsidies to establish Hainan FTP as a regional logistics hub, and the island’s digital economy will be cultivated and opened up to foreign operators.

Additionally, China will seek to loosen tax laws within Hainin FTP. By enacting zero-tariff laws and allowing for import tariff exemption for key industries, lowering the income tax for enterprises incorporated within Hainan as well as certain qualified individuals, and reforming the overall tax regime within Hainan FTP to reduce the tax burden on locally-operated enterprises across the board, Hainan will become an attractive hotspot for both national and international companies. Between 2020-25, Hainan’s corporate income tax (CIT) and individual income tax (IIT) will max out at 15% for all “encouraged” industries outlined within the Negative List, which is significantly lower than the comparable national rates that stand at 25% and up to 45%, respectively. By 2035, CIT benefits are expected to expand beyond encouraged industries and influence a wider scope of the economy while new IIT rates will be applicable to anyone residing and working in Hainan for at least half of the fiscal year.

Evidence of Hainan’s Economic Potential

China’s effectiveness in cultivating Hainan into a key economic hub is evident in the region’s strong economic performance. The island’s average year-over-year GDP growth has clocked in at 9.1% since 2017, which is one-third greater than the comparable rate of 6.6% across the Mainland. While it remains a far distance from economic giants like Shenzhen in terms of contribution to overall Chinese GDP, the strength and consistency of Hainan’s economic growth when compared to Mainland Chinese benchmarks is striking.

Perhaps more striking is the comparison between the island’s net +1.1% GDP increase over the first three quarters of 2020 amid the pandemic versus the projected -24.8% contraction of Hong Kong’s GDP by end of the year. Additionally, while Hainan has seen a year-over-year 102% increase of foreign-funded enterprises as well as a 108% increase in the use of foreign capital year-over-year, Hong Kong’s foreign direct investment dollars fell 34.4% from US$104 billion to US$68.4 billion in 2018, and the trend does not seem to be slowing. The island’s economic resiliency over Hong Kong and growing foreign direct investment also serves as an omen of its eventual displacement of Hong Kong as China’s go-to hub for trade and investment, alike.

A New Economic Hub

This has all been rounded off by recent policy changes affecting duty free shopping in Hainan. Duty free shopping has been one of the primary lures of domestic tourism to Hainan, especially as travel has been restricted to domestic-only travelers due to the pandemic. To recover some of the money spent by its overseas tourists and reduce the dollar-displacement pressures levied by US-China trade tensions, China has tripled its quota for duty free shopping in Hainan to CN¥100,000 (US$15,226), expanded the duty free product catalogue, and removed limits on the quantity of duty free items that can be purchased by consumers. As socio-political tensions continue to rise and effects of the pandemic squeeze the economy, big names in retail have begun to pull out of Hong Kong while turning their gaze to retail space at malls on Hainan’s Haitang bay strip. Ever cognizant that the Chinese consumer market is still one of the quickest growing and most profitable sources of revenues for global brands, many may determine it worthwhile to invest in Hainan as the island’s economy begins to eclipse that of alternative tourist and trade hubs in the region.

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