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Cablegate: Commerce U/S Lavin Meets Ndrc Vice Chairman Zhang,

DE RUEHBJ #5779/01 2130852
P 010852Z AUG 06






E.O. 12958: N/A

1. (SBU)Summary: Franklin L. Lavin, Department of Commerce
Under Secretary (U/S) for International Trade on July 28,
2006 held separate meetings with National Development and
Reform Commission (NDRC) Vice Chairman Zhang Xiaoqiang and
State-owned Asset Supervisory and Administration Commission
(SASAC) Vice Chairman Shao Ning. U/S Lavin during his
meeting with NDRC Vice Chairman Zhang stated there is a
growing perception that China is allowing political
considerations to influence its economic policy. He said a
recent joint letter from Commerce Secretary Gutierrez and
Energy Secretary Bodman demonstrates Washingon's support
for Westinghouse's bid in China's nuclear power plant
competition. NDRC Vice Chairman Zhang said the Chinese
Government is enacting policies that reflect the changing
nature of China's market rather than being protectionist.
He stated Beijing appreciated the Westinghouse letter's
significance, but reiterated the long-term support of the
competing companies host governments is a key criteria in
the competition. U/S Lavin closed by inviting NDRC
participation in a venture capital forum, while Vice
Chairman Zhang closed by encouraging Washington
participation in energy talks to be held in Beijing.

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2. (SBU) During his meeting with SASAC Vice Chairman Shao,
U/S Lavin stated that it is important for Washington to
learn as much as possible about how China's SOE system
operates. He said there is a need for China's stated owed
enterprises (SOEs) to make dividend payments to the Chinese
Government, rather than simply plow profits back into the
enterprise. This would level the playing field between the
SOEs and foreign companies doing business in the China.
SASAC Vice Chairman Shao said he agreed with this point. He
stated that the Chinese Government is working to establish a
system that would facilitate such payments. The system also
will allow SASAC to better manage the sell-off or spin-off
of subsidiaries from SOEs. End Summary.

--------------------------------------------- ------------
Under Secretary Lavin Meets With NDRC Vice Chairman Zhang
--------------------------------------------- ------------

Zhang Defends Recent Foreign Investment Restrictions
--------------------------------------------- -------

3. (SBU) U/S Lavin, accompanied by Clark T. Randt, U.S.
Ambassador to China, on July 28, 2006 met NDRC Vice Chairman
Zhang Xiaoqiang to discuss a broad range of bilateral trade
and investment issues. U/S Lavin started the meeting by
stating that some in the United States perceive that the
Chinese Government is increasingly allowing political issues
to influence investment decisions in China. Vice Chairman
Zhang said that Beijing, since the beginning of its opening
and reform period, has sought to promote the introduction of
advanced management techniques, high-technology, and foreign
capital into the Chinese market. Beijing's evolving
economic policies must reflect the changing nature of
investment activity in China while also protecting the
environment and promoting energy efficiency.

4. (SBU) Vice Chairman Zhang said that in previous years
mergers and acquisitions (M&A) accounted for about five
percent of foreign direct investment (FDI) in China. M&A
activities in 2005 accounted for 20 percent of China's FDI.
Vice Chairman Zhang stated many Chinese government and
industry observers have commented that if left unchecked,
this trend could damage China's economic security. To avoid
this type of damage, the NDRC is placing restrictions on
foreign investment in the financial, energy, and heavy
machinery equipment sectors. Vice Chairman Zhang said that
the Chinese Government has closely studied the U.S.
Government's response to 9/11. Beijing has noted that
following 9/11 Washington placed restrictions on foreign
investment in several sectors, including agriculture,
energy, transportation, banking and finance, and high-
technology. The Chinese Government similarly believes it is
important to protect its economy from foreign threats.

BEIJING 00015779 002 OF 006

5. (SBU) U/S Lavin stated Washington understands Beijing
must ensure that it protects China's economic security when
formulating investment policies. In some recent cases,
however, it appears Beijing is protecting domestic
businesses rather than the country's economic security. The
steel and automobile sectors in particular, are growing
areas of concern in that regard. U/S Lavin noted that cross
border investment can help countries avoid bilateral trade
frictions, such as antidumping charges. Vice Chairman Zhang
said that China's automobile and steel sectors have always
been open to foreign investment. China's automobile
industry has largely been built through joint ventures with
the world's leading automobile manufacturers, including
General Motors, Volkswagen, and Nissan among others. China
only has one brand of automobile that is not foreign. Vice
Chairman Zhang said that foreign interest in participating
in China's steel sector is relatively recent since the
sector has expanded only in the past several years to the
degree necessary to attract foreign investment. Arcelor and
Mittal, two of the world's leading steel makers, now have
significant investment in Chinese steel enterprises. U/S
Lavin said that Beijing's achievement ensuring foreign
investment in these sectors is laudable, and certainly
contributed to the past twenty years of China's economic
growth. The concern among many U.S. investors and
businesses is that the appearance of a growing economic
nationalism in China may prevent similar success stories
during the next twenty years.

Zhang, Lavin Discuss Westinghouse, JCCT Commitments
--------------------------------------------- ------

6. (SBU) U/S Lavin said that he wanted to ensure that
Beijing understands the significance of a recent joint
letter from Commerce Secretary Gutierrez and Energy
Secretary Bodman to the Chinese Government supporting

Westinghouse's bid to build nuclear power plants in China.
This type of joint letter is rare and should be taken as a
signal of the U.S. Government's firm commitment to
Westinghouse. Vice Chairman Zhang stated that the Chinese
Government took note of the positive attitude of the U.S.
Government towards Westinghouse's bid. Beijing believes
that the company selected to participate in China's nuclear
power program needs to have the firm backing of its

7. (SBU) Vice Chairman Zhang said he is aware that in the
past some contracts between U.S. companies and Chinese
counterparts have been nullified because of political
factors. In many cases, Beijing has been willing to accept
these decisions because the contracts were relatively small.
Zhang said that in the case of the nuclear power program,
however, anything short of a full, long-term commitment by
the U.S. Government would be unacceptable. U/S Lavin stated
that Washington wants to ensure that Westinghouse is able to
compete for the contract on normal business terms. Beyond
the joint letter, the U.S. Government's long-term commitment
to peaceful nuclear power programs abroad has been futher
demonstrated by the recent passing of Congressional
legislation supporting U.S. participation in India's nuclear
power program.

8. (SBU) U/S Lavin stated that the U.S. Government
appreciates the efforts the NDRC has taken to date in
communicating with U.S. medical device companies. Company
representatives indicate that solid groundwork has been laid
for future cooperation. U/S Lavin said that the U.S.
Government is pleased that the Chinese Government continues
to take positive steps following the recent Joint Commission
on Commerce and Trade (JCCT) talks in Washington to enable
express delivery services to expand their business in China.
The development of these businesses in China will inevitably
expand the country's economic growth. U/S Lavin stated that
Washington also has been pleased with Beijing's neutral
stance on the type of 3G cell phone technology to be used in

BEIJING 00015779 003 OF 006

China. Vice Chairman Zhang said Beijing remains committed
to enacting postal reform that promotes a healthy business
climate for express delivery services and other related
businesses. Beijing will allow the market to determine the
best 3G cell phone technology for Chinese customers. Vice
Chairman Zhang stated for a particular cell phone technology
to be successful in China, it will need to be advanced and
reliable, provide good return on investment for the
companies employing it, and will have to adhere to China's
information security laws.

Zhang Presses For More U.S. Hi-Tech Exports

9. (SBU) Vice Chairman Zhang stated one of the most
important discussions held during the recent JCCT dialog was
that regarding the need to increase U.S. exports to China.
As stated during the JCCT, Beijing believes the lifting of
U.S. export restrictions on high technology (hi-tech) civil
use computer equipment and components is the most immediate
way to increase U.S. exports. The Chinese Government
estimates it would lead to a 20 billion U.S. dollar annual
increase in U.S. exports to China. Vice Chairman Zhang
stated Beijing has learned that Washington is considering
amending its export regulations to make them more
restrictive. U/S Lavin stated that he questioned whether
the lifting of export restrictions on hi-tech sales would
have as significant an impact as Beijing suspects. It also
is important to note that the United States is a leading
exporter to China of other items, such as cotton and
soybeans. Additionally, during the first five months of
2006, overall U.S. exports to China have grown by some 36.5
percent. U/S Lavin stated these facts point to the
improving competitiveness of U.S. products in the Chinese

10. (SBU) Vice Chairman Zhang said despite rising U.S.
exports to China during the first part of 2006, the Chinese
Government still maintains U.S. companies are missing out on
hi-tech opportunities in China. Chinese Government
statistics indicate that in 2005, foreign businesses
exported some 200 billion U.S. dollars worth of hi-tech
products to China. The United States accounted for only
around six percent of this trade. Vice Chairman Zhang
stated that U.S. companies could capture the bulk of this
trade if Washington would ease export restrictions. U.S.
trade success in other areas, such as agricultural products,
is laudable, but pale in comparison to the potential of the
hi-tech field. U/S Lavin stated that several U.S. hi-tech
products could be exported to China if provided adequate
market access. These products include clean coal technology
developed by General Electric and fiber optic cable made by
Corning. U/S Lavin stated that if the Chinese Government
and Chinese businesses want to have a voice in the U.S.
export regime, they should provide written comments on the
pending revised export regulations. These regulations are
currently in a public comment period, but to date, Beijing
has not participated in the process. Vice Chairman Zhang
said that he would encourage the Chinese Government and
Chinese businesses to participate in the proposed export
regulation comment process.

Zhang Promotes Energy Talks, Lavin Venture Capital Forum
--------------------------------------------- -----------

11. (SBU) Vice Chairman Zhang stated the Chinese Government
hopes to build upon the rapport established by Chinese
President Hu and U.S. President Bush during their meetings
in Washington and on the margins of the G8 in Moscow. The
recent strengthening of bilateral political and economic
ties is a positive development for the people of both
countries. To that end, Vice Chairman Zhang closed by
encouraging U.S. participation in a Five Party Energy
Ministerial dialog proposed by Beijing. U/S Lavin said that
he appreciated the opportunity to meet with Vice Chairman
Zhang and other senior Chinese economic and trade

BEIJING 00015779 004 OF 006

policymakers. He said the Department of Commerce would like
to extend a formal invitation to the NDRC to attend a
venture capital forum to be held in the United States. The
forum will be similar to one hosted by the NDRC several
years ago. U/S Lavin closed his remarks by stating that he
hoped that the NDRC would accept the invitation and that
Vice Chairman Zhang would lead the Chinese delegation to the

12. (U) Chinese Participants:

-NDRC Vice Chairman Zhang
-Chen Bin, Vice Director, Department of Industry, NDRC
-Li Bin, Deputy Director General, Department of Foreign
Affairs, NDRC
-Wang Dong, Deputy Director General, Department of Foreign
Capital Utilization, NDRC
-Zhou Wangjun, Deputy Director General, Department of
Prices, NDRC

13. (U) United States Participants:

-Franklin L. Lavin, Under Secretary of Commerce for
International Trade
-Clark T. Randt, United States Ambassador to China
-Cheryl McQueen, Director, Office of the Chinese Economic
Area, Market Access & Compliance
-Matthew Dauphinais, Special Assistant, Office of the Under
Secretary of Commerce for International Trade

-Barry I. Friedman, Senior Commercial Officer, U.S. Embassy
-Robert S. Luke, Economic Minister Counselor, U.S. Embassy

--------------------------------------------- ------------
Under Secretary Lavin Meets With SASAC Vice Chairman Shao
--------------------------------------------- ------------

Shao Provides SOE Reform History, Explains SASAC's Role
--------------------------------------------- ----------

14. (SBU) On July 28, 2006 U/S Lavin met with SASAC Vice
Chairman Shao Ning to discuss the Chinese Government's
progress in reforming its SOE system. Vice Chairman Shao
began his comments by stating that SASAC has only been a
government office since 2003 and is in the early stages of
its work. The most significant achievement to date in SOE
reform occurred in 1998 when Beijing severed the financial
tether binding the Central Government, Chinese state-owned
banks, and SOEs. This resulted in a large number of SOEs
going bankrupt because they were no longer guaranteed bank
loans to cover operating losses, but it ensured the
financial viability of those SOEs that survived. Vice
Chairman Shao said that the next stage of reform would
result in further closure or sale of numerous large SOEs.
This should leave each Chinese Province retaining only 10 to
20 of its large SOEs while the Central Government should be
left with less than 100, down from its current portfolio of

15. (SBU) U/S Lavin said that it is very important for the
U.S. Government to learn as much as possible about how
China's SOE system operates given the close economic ties
between the two countries. In particular, it would be
helpful to know the scale of Central SOE's that SASAC
oversees and SASAC's management role in these enterprises.
Vice Chairman Shao stated that the State Grid Company with
some 1.3 million employees is the largest SOE in SASAC's
portfolio. Meanwhile, two energy SOEs, Sinopec and
PetroChina, are the leaders in terms of revenue and profit.
Vice Chairman Shao said that SASAC's role in managing its
SOEs is best illustrated by using PetroChina as an example.
SASAC has no role in PetroChina's decisions where to drill
for oil or natural gas. That type of decision is left to
PetroChina's professional managers. By contrast, if
PetroChina decided that it wanted to go into the real estate

BEIJING 00015779 005 OF 006

or other non-core business areas, the enterprise must have
SASAC's approval.

Shao Admits Approving Non-Core Business Ventures
--------------------------------------------- ---

16. (SBU) U/S Lavin said that Vice Chairman Shao's
explanation of SASAC's role in managing its SOEs raises a
question regarding Baosteel's role in the competition to
purchase the Guangdong Development Bank. Baosteel has
teamed with French Bank, Societe Generale (SocGen), in that
competition. SocGen has little experience operating in
China and small financial resources compared to its U.S.
competitor, Citibank. U/S Lavin stated that this fact,
coupled with Baosteel's previous lack of financial sector
experience, is leading some to suggest Baosteel's role is
merely to lend its strong ties to the Chinese Government to
a company too weak to win on its own merits. Otherwise, it
is unclear why Baosteel would launch a foray into a field
that is clearly divorced from its core business interests.
Vice Chairman Shao stated that SASAC approved Baosteel's
request to participate in the Guangdong Development Bank
competition. Baosteel presented its case to SASAC as one of
wanting to invest on-hand cash reserves rathe than that of
evolving into a financial services or banking enterprise.
Baosteel stated that margins in the steel sector are
currently so tight that further investment in steelmaking
would be unprofitable, but investing in the banking sector
provided opportunity for significant returns.

Shao Supports Siphoning SOE Dividend PaymentsTo Beijing
--------------------------------------------- ----------

17. (SBU) U/S Lavin stated that this situation pointed to
the need of SOEs to return some of their profits back to
their shareholders, most notably the Chinese Government,
rather than simply plow them back into the enterprise. In
the United States and other countries this is one of the
ways shareholders earn a return on their investment in a
company. This type of system also would serve the purpose
of leveling the playing field between China's SOEs and
foreign companies trying to do business in the Chinese
market. Vice Chairman Shao said that he agreed with this
assessment. Dividend payment is one of the next steps in
SOE reform, but SASAC first must develop a mechanism to
facilitate these transactions. To this end, SASAC is
working to establish a state asset operation budget system.
Vice Chairman Shao said that this system would create a
means for SOEs to make dividend payments to the Chinese
Government. The new budget system also would enable SASAC
to have more flexibility in managing the sell-off or spin-
off of subsidiaries from SOEs. U/S Lavin closed by
encouraging SASAC to remain in close contact with U.S.
Embassy Beijing as it develops this system. For his part,
Vice Chairman Shao closed by welcoming further interaction
with U.S. Government and U.S. business officials because
SASAC is solicitous of international comments on China's SOE
reform process.

18. (U) Chinese participants:

-SASAC Vice Chairman Shao Ning
-Zhang Zhonglin, Deputy Director General, Bureau of Planning
and Development, SASAC
- Yan Xiaofeng, Director General, Bureau of Foreign Affairs,

19. (U) United States participants:

-Franklin L. Lavin, Under Secretary of Commerce for
International Trade
-Cheryl McQueen, Director, Office of the Chinese Economic
Area, Market Access & Compliance
-Matthew Dauphinais, Special Assistant, Office of the Under
Secretary of Commerce for International Trade

-Barry I. Friedman, Senior Commercial Officer, U.S. Embassy

BEIJING 00015779 006 OF 006


20. (U) U/S Lavin cleared this cable prior to departing


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