Author: Huang Qifan
Source: China Institute for Innovation & Development Strategy

The Hainan Free Trade Port is set to commence its fully enclosed operation by the end of this year, a significant event prepared for several years and a milestone in China’s free trade port and pilot free trade zone development.

As a free trade port, it is built upon five fundamental policies: first, a corporate income tax rate trending towards 15%, as global free ports typically have rates below 15%; second, a personal income tax rate also trending towards 15%; third, zero tariffs; fourth, zero barriers in service trade, meaning comprehensive liberalization. The RCEP agreement with 15 Southeast Asian countries has already achieved zero barriers in service trade, and Hainan aims for near-zero barriers not only with these countries but also globally; fifth, as a free port, tax exemption on repatriated profits from overseas investments, a policy consistent with Hong Kong’s. These five policies will provide historic, long-term impetus for Hainan’s economy and China’s free port development.

After the customs closure, what industrial sectors should Hainan prioritize for development? In addition to industries developed over the past 10-20 years, at least five matters hold significant national importance and will greatly advance Hainan’s industrial growth.

First, Hainan should promote the integration of domestic and international trade, achieving “same production line, same quality, same standard” for domestic and foreign trade, and eliminating market access barriers. Despite differences in taxation and regulation, decades of reform and opening up have seen foreign trade enjoy more preferential policies while domestic trade follows conventional rules, creating a disconnect between them. The 20th National Congress of the CPC proposed advancing the integration of domestic and foreign trade to unify rules, systems, and standards. As China works towards this goal, Hainan should implement it comprehensively in one step.

Hong Kong’s uniqueness lies in having no rule differences among its internal trade, trade with the mainland, and international trade. In the United States, procedures are identical whether a trading company ships goods from New York to Los Angeles or to Paris and London. In contrast, significant disparities exist between China’s domestic and foreign trade. Therefore, the State Council decided to achieve integration of domestic and international trade by 2030, a goal also outlined in the report of the 20th National Congress. As a free port, Hainan’s island trade, trade with the mainland, and global trade should achieve a trinity of seamless, undifferentiated connectivity. In other words, Hainan Island should be the birthplace of China’s integration of domestic and foreign trade. According to the national plan for this integration, we should advance the 2030 development target to be achieved in Hainan by 2026. This will boost Hainan’s trade development, attract numerous domestic trading companies to register there, and facilitate alignment with global integrated trade rules.

Second, Hainan Island should vigorously develop service trade. As emphasized in the 20th National Congress report, the integrated development of service trade and goods trade is crucial for China to become a world trading power. Currently, global service trade accounts for about 25% of total trade volume, with Europe and the US reaching 30% to 40%. In contrast, China’s service trade represents only about 13% of its global trade, amounting to $1 trillion, which is insufficient compared to over $6 trillion in goods trade, indicating significant room for growth. This is why the central government holds an annual service trade fair in Beijing—to promote this very agenda.

It is essential to understand that the core purpose of China’s 22 pilot free trade zones is to promote service trade development. Treating a free trade zone merely as a development zone or a simple bonded area would be a gross underutilization of the policy—akin to “using suit fabric to make a shirt”. Therefore, the core of a free port lies in service trade, which must be vigorously developed. Hainan’s foundation in goods and industry is relatively weak, making goods trade a secondary aspect. However, if Hainan elevates its service trade, what would that encompass? It includes various logistics related to manufacturing supply chains, global logistics, R&D, supply chain finance, various market access inspection and certification bodies, green and low-carbon services, digital services, wholesale, retail, sales, after-sales services, as well as education, healthcare, and other human resource management services for industries, plus professional consulting from accounting and law firms. In summary, once the ten major sectors of producer services cross borders, they constitute high value-added service trade. Currently, a large portion of China’s $1 trillion service trade consists of labor-intensive services like tourism and receiving foreign guests. We still lack truly high-value-added, talent-intensive cross-border service trade composed of producer services. Hainan should strive to excel in this area and learn from Hong Kong. When Hong Kong describes itself as an international financial and trade center, it specifically adds a “service center,” which refers to the producer services within service trade that serve manufacturing and the real economy. The development of such services domestically is still insufficient. The Fourth Plenary Session proposed strengthening the development of producer services and modern services during the “15th Five-Year Plan” period. Hainan must advance in this area, as producer services encompass 10 major categories, 35 medium categories, and 171 sub-categories, and can draw lessons from the Hong Kong model.

Third, Hainan should clearly position itself as a bridge and hub for economic exchanges between Southeast Asia and the Chinese mainland. China and 15 Southeast Asian countries have jointly formed RCEP. Trade barriers among these countries will be eliminated, achieving zero tariffs, and service trade will also have no barriers. Enterprises of different ownership types will enjoy equal national treatment, providing a level playing field for all businesses. As China’s free trade port, Hainan Island will be the first to implement RCEP policies with these Southeast Asian countries, forming a massive trade hub. For the whole of China to conduct RCEP transactions with Southeast Asian nations, Hainan Island will become the central transaction base.

Fourth is the Belt and Road Initiative (BRI). China’s investment scale in the BRI has been expanding, continuing for 15 years now. Currently, China’s BRI investments are not limited to Hainan but are nationwide. However, a problem exists: RMB settlement along the BRI routes accounts for only about 5%, while RMB settlement for China’s cross-border trade with the world has reached 22%. Why, then, is USD used for BRI investments and trade when it should ideally be conducted in RMB? The reason is that BRI partner countries have acquired substantial RMB but lack effective channels for its reflow, unsure how to use it. Hainan Island should establish a system to facilitate the reflow of RMB held by BRI partner countries back to China. Although part of mainland China, as a free port, if Hainan constructs a financial reflow system, it would provide strong support and bring significant benefits to China’s BRI development.

Fifth, China is focusing on promoting RMB internationalization. The 20th National Congress report proposed advancing RMB internationalization in an orderly manner. For decades, RMB internationalization was often described as “prudent advancement,” but the 20th Congress report changed this to “orderly advancement,” clearly implying intensified efforts.

Global currency status correlates with GDP status and can be divided into three tiers. The US GDP accounts for 24% of the global total, but the USD’s share in global currency clearing, settlement, and reserves reaches 50%-60% (60% as a reserve currency, 50% in clearing/settlement), far exceeding its GDP share. The second tier comprises general developed countries, including the EU, Japan, South Korea, and over 30 others, whose GDP share roughly matches their currency status. For example, Japan’s GDP was 14% of the global total in 1975, with the Yen at about 13%-14% of global currency share; now Japan’s GDP share has fallen to less than 4%, and the Yen’s clearing/settlement share has also dropped to 3%-4%. This characterizes the second tier. The third tier encompasses over 150 developing countries, whose combined GDP accounts for half the global total. However, the total currency clearing volume of these 150+ countries constitutes only 5% of the global total, and China is unfortunately among them. Currently, China’s GDP is slightly below 20% of the global total. For decades, RMB clearing share remained at 2%-3%. With the 20th Congress’s call for orderly advancement of RMB internationalization, this share has rapidly increased to 6%-7% in recent years. In summary, if China’s GDP share reaches 20%, its currency share should correspondingly rise to that level, at least comparable to major economic powers like France, the UK, and Japan. By 2050, if China becomes a world economic power with a 25% global GDP share but its currency status remains at 5%-6%, it would be substandard and fail to meet the strategic requirement of being a financially strong nation. This is a process the entire nation will advance.

As a free port, Hainan Island should play its due role in China’s RMB internationalization process. Learning from experiences in places like Hong Kong, it can establish an offshore RMB fund pool, promote the use of RMB and other currencies. In this process, Hainan can explore various methods comprehensively, enabling domestic finance to go global, with Hainan becoming a vital base and key node for RMB internationalization.

To summarize my points: First, Hainan Island should integrate service trade with goods trade, focusing on developing service trade; second, achieve integration of domestic and foreign trade; third, build an RCEP development base; fourth, become a Belt and Road reflow base. Hainan’s investment and trade volume related to the BRI might not be large, but if domestic companies register in Hainan and earn returns from BRI investments, repatriating profits to the mainland would be taxable, whereas reflowing them to Hainan would be tax-free. Under the enclosed operation, returns on outbound investments remitted back to Hainan are tax-exempt, similar to Hong Kong. In terms of preferential policies, Hainan already possesses six of the ten major advantages compared to Hong Kong. As for Hong Kong’s unique property tax and inheritance tax on personal housing, these are not yet implemented in China, so no comparison is made. In short, Hainan’s policies—15% corporate tax, 15% personal income tax, zero tariffs, and tax exemption on repatriated investment returns—are indeed aligning with Hong Kong’s. I believe that integrating the five suitable development directions discussed with Hainan’s tax and preferential policies will undoubtedly elevate Hainan’s development to a new level over the next 5-10 or 15 years.