Surf & Turf

This island of 8.11m people has had its up and downs over the years. As Morgan Stanley Chief Economist Andy Xie noted in a November report: "One can still see many unfinished buildings from 10 years ago." China's version of Hawaii was designated as a province and the country's only province-wide special economic zone in 1988, but it has been a hard road to prosperity. With GDP hovering around US$10bn (13.15% up on 2003), Hainan is hardly an economic giant. Cut adrift from Guangdong, which fate (and aggressive investment promotion) has since made rich, islanders have been trying to reconnect with it ever since.

Two years ago, the US$542m "Guangdong-Hainan" railway opened to traffic, state media hailing it as "the country's first cross-straits railway". In fact, it is more ferry service than railway, with monster ferries carrying rolling stock over the water. More ambitiously, Hainan officials since announced they would study the feasibility of building a 30km bridge or tunnel to ford the Qiongzhou Strait, which separates the island from the Mainland.

There is an oddly retro feel to the place, a throwback to a time when Chinese officialdom – now in smile mode everywhere else – used to glower endlessly at strangers and their documents. While investment promotion officials in Hangzhou or Dalian now happily drop what they are doing to squire business journalists around, the boss of the island's big development zone insisted on an official letter, formally chopped, before discussion of any sort might be entertained.

Suspicion greeted calls to zone tenants, too, like the pharmaceutical company spokeswoman who posited the theory that China Economic Review could be a ruse for consultants sneaking in to scoop up proprietary information – as if that were a worse prospect than a magazine passing their information to a much wider audience.

There is a quirkiness to Hainan, and while it would be rash to draw too close a link between old-fashioned bureaucratic stiffness and sluggish investment flows, there is a sense that all is not well. Just last month Xinhua reported, "Hainan island province … lagged behind other open cities in the Pearl River and Yangtze River delta areas, because of various factors," adding that, "reality has prompted Hainan to readjust its plan and define a new objective for future development."

Lush green garden
China's official news agency was skimpy on details, but the report did offer an uplifting thought from Wang Qishan, secretary of the Hainan Provincial Committee of the Communist Party of China: "The Hainan SEZ … will be turned into an all-season lush green garden as well as a scenic tourist resort."

Five years ago agriculture, mostly tropical fruit and forest products, counted for roughly 40% of the economy, industry half that – and tourism around 15%. Today, the logos of Sheraton, Marriott and other international chains pop up all over the landscape, a sign that tourism – much of it focused on resorts around Sanya, Hainan's second city on the island's south coast – is grabbing a bigger share of GDP. Having breached the 12m mark, Hainan's annual visitor count keeps climbing – a welcome trend after plummeting 67% during 2003's SARS outbreak.

While a tropical climate and sandy beaches make tourism development a natural attraction, there is lots going on in the surrounding sea: offshore natural gas fields ensure it has fuel to produce cheap electricity in abundance, and a rich fishery sustains growing export activity.

The island's two big industrial parks are the government-run Haikou Free Trade Zone and Yangpu Development Zone, originally a private initiative built by Hong Kong Construction Ltd (and its forerunner Kumagai Gumi.) While First Auto Works might arguably be the government park's best known tenant, Yangpu's most famous would have to be a joint venture of Asia Pulp & Paper, the company at the center of one of Asia's most spectacular collapses in the 1998-99 regional financial crisis – when APP and its Indonesian parent Sinar Mas Group stacked up debts of US$13.4bn. Too big to let die, APP was bailed out and in 2002 charged into Hainan with plans to build a 600,000-tonne annual capacity pulping plant – not normally the sort of industry resort islands go looking for. (Its Hainan operation became APP's sixth China venture.)

Reconfiguration time
With another of the sweeping reconfigurations China is famous for, Haikou, the island's capital and major city, was merged with neighboring Qiongshan in 2002, virtually doubling the capital's population to 1.6m. In area, Haikou suddenly sprawled out from its original 236sq km to 2,305sq km, its new ambition to become a world-class coastal resort area and hideaway for second home buyers from Guangdong and anywhere else in the neighborhood.

While that project unfolds, the province continues to work at broadening its income base. Haikou Free Trade Zone, and Meian Science & Technology Industry Park, the island's only national-class development areas, were integrated in 2000 and now operate under unified management "to avoid unhealthy competition", as one official put it.

The official said the zone enjoyed "healthy growth". Last year drew RMB3.6bn in new investment commitments – 23 new projects altogether, 13 of them pharmaceutical ventures. In the tradition, most of that investment was domestic, South Korea's Samsung being one exception with the opening of an island base for its fiber optics division.

Excluding numbers from the local First Auto Works plant (FAW Haima) – which makes Mazda look-alikes – the official said zone output value grew 34.4% yearon- year in 2004, to RMB2.95bn, amounting to 11.7% of Haikou's total output.

Pharmaceuticals dominate
Pharma is the big deal in the zone, generating 60% of output. The official source credited the SARS outbreak, so devastating to island tourism, with getting things off the ground. By his lights, six of nine medicines commonly used to combat the virus were developed and produced on the island.

Pharmaceutical and high technology investors pay no profits tax in their first two years of operation and have a gentle ride after that – paying only half the normal tax rate for an additional seven years. But while the tax regime may be friendly, and Hainan has ambitions to build a big base of biotech and IT companies, talent remains in perennially short supply as locals with the requisite skills keep migrating to the booming Mainland to chase opportunities.

The sustaining hope is that, as rising costs start squeezing more companies on the Mainland, Hainan will begin to be a more cost-competitive and environmentally friendly opportunity for companies and people alike.

The big manufacturer in Haikou is FAW Haima Motor, which licenses Mazda technology to make its Fumeilai sedans, up to 60 vehicles on a good day. Another manufacturer that comes up in conversation is transformer maker (and Amex-listed micro-cap) JST, or Jinpan International Ltd, described as a Sino-American joint venture.

The fact is, foreign investors have been a tough draw, the official said, explaining that major shipping routes bypass the island. And while Hainan is blessed with many fine ports, none can match the throughput levels of competing ports on the mainland because Hainan's economy is comparatively so small. The island is confronted by a chicken and egg problem. Port traffic is not sufficiently large to foster development of a logistics and transport hub of any scale, and no single industry on this vast, largely empty island has achieved enough scale to create the need for port infrastructure that might attract more traffic. Ultimately the foreign investment story comes down to Hainan itself – a comparatively small economy cut off from bigtime Guangdong.

Hence growing interest in a bridge or tunnel to the mainland, linking the island to Leizhou Peninsula, which reaches out from Guangdong proper, stopping 22km short of the mark.

Hainan Governor Wei Liucheng talked up the project again in February, telling the Third Hainan Provincial People's Congress that US$2.4m had been allocated for a feasibility study. Wei had been enjoying a good few months of late. In November, he emerged from a trade fair in Hong Kong to announce 161 investment projects covering nine sectors – including technology agriculture, tourism and logistics – adding up to US$12.5bn in new commitments.

Wei credited the new Pan-Pearl River Delta Region Cooperation and Development Forum – a talking shop for bundling Hong Kong and southern provinces into a more integrated economic region – with spurring investment. Hong Kong, he added with some satisfaction, had just become the province's biggest offshore investor. Certainly, the city never did Guangdong any harm.