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Cablegate: Pboc Governor and Secretary Paulson Discuss

VZCZCXRO6862
OO RUEHCN RUEHGH RUEHVC
DE RUEHBJ #5562/01 2340950
ZNR UUUUU ZZH
O 220950Z AUG 07
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 1187
RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 005562

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR EXEC - TSMITH, OASIA/ISA
STATE FOR EAP/CM
USDOC FOR 4420
NSC FOR MCCORMICK
STATE PASS USTR FOR STRATFORD
STATE PASS CEA
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON; SAN FRANCISCO
FRB FOR CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK

E.O. 12958: N/A
TAGS: ECON EINV EFIN ETRD CH
SUBJECT: PBOC GOVERNOR AND SECRETARY PAULSON DISCUSS
CURRENCY FLEXIBILITY, FINANCIAL SERVICES

SUMMARY
-------

1. (SBU) SUMMARY: On July 31, People's Bank of China (PBOC)
Governor Zhou Xiaochuan told United States Treasury Secretary
Henry Paulson that he supports using dividend payments from
state-owned enterprises (SOEs) to help rebalance China's
growth and that only a relatively small share of payments
will be used to finance new social expenditures. Zhou favors
greater currency flexibility for the sake of more autonomous
monetary policy but is concerned there is no common ground
between the somewhat more aggressive appreciation favored by
some in the Chinese Government and the massive appreciation
that the United States Congress appears to be demanding.
Zhou suggested that the United States might make more
progress in SED financial services discussions by
highlighting evidence of financial sector openness in other
emerging markets and by expediting the approval of Chinese
banks' branch applications. Finally, Zhou argued that the
structural changes needed to address our trade imbalance will
not occur overnight in either China or the United States, and
the two sides should therefore consider additional options
for managing political tensions. END SUMMARY

REDUCING IMBALANCES
-------------------

2. (SBU) Paulson asked about the prospects of having SOEs pay
dividends that could be used to finance social services to
reduce China's national savings rate (by reducing the need
for household precautionary savings). Zhou responded that
the PBOC had long supported having SOEs pay dividends to the
government and that this would start in the second half of
2007. However, despite PBOC support it appears that only
10-20 percent of SOE dividends will go to the general
treasury in MOF. The rest will go the State Asset
Supervisory and Administration Commission (SASAC). (Comment:
SASAC will reportedly use the funds to subsidize loss making
SOEs or to establish new SOEs. End comment.)

3. (SBU) Paulson asked about the scope for fiscal stimulus to
reduce public and household savings rates. Zhou said the
while the PBOC believes there is some room for greater fiscal
stimulus, the government needs to be cautious about
increasing the government debt to GDP ratio. While explicit
government debt is not high (less than 30 percent of GDP
compared to a sustainable rule of thumb level of 60 percent),
implicit liabilities from unpaid pensions, non-performing
loans, and rising public medical care costs are high.
(Comment: Government assets, such as stakes in SOEs are also
extensive, though the extent to which the government could or
would be willing to sell these assets to finance liabilities
is uncertain. End comment.)

MAINTAINING OPEN TRADE POLICIES
-------------------------------

4. (SBU) Paulson said he would lead the fight against trade
protectionism and would not support legislation that targets
China. Paulson stressed that for the Administration to do
its part to keep markets open, it is important to show that
engagement and dialogue are delivering results, particularly
in food safety, currency, capital market liberalization, and
investment. To achieve this, the SED should focus on
advancing reforms that China believes are in its interest as
well. One of Paulson's key concerns is that China will
implement reforms but not until it is too late to constrain
rising United States protectionism.

CURRENCY
--------

5. (SBU) On exchange rate policy, Paulson stressed that he
would not support any policy changes that would hurt the
Chinese economy, because this would not be good for the
United States economy. While a few companies might have been
hurt by the RMB's rise against the USD, Paulson sees no
evidence that the RMB's appreciation is adversely affecting
the broader Chinese economy. Rather, in Paulson's view, a

BEIJING 00005562 002 OF 003


stronger and more flexible currency would enhance China's
financial security by giving it more policy tools to avoid
asset bubbles and maintain financial stability, as well as
rebalance its economy towards more consumption-led growth.
Paulson stressed that international pressure on China to
change its exchange rate policy was likely to increase,
including through the IMF. While noting that the RMB had
appreciated by 9.5 percent in two years, Paulson did not
understand why the appreciation had not been 15-16 percent.

6. (SBU) Zhou responded that the PBOC had long supported
greater exchange rate flexibility, first and foremost because
it gives the PBOC greater room to adjust monetary policy.
While China's leadership could support appreciation at a
slightly faster rate, they believe this will be insufficient
to placate the United States Congress and what would placate
Congress ) a 20-40 percent revaluation, is not politically
viable in China. Thus, China's leadership believes there is
little scope for finding common ground on this issue. Zhou
said it would be helpful if Treasury could give the PBOC a
better sense of how much appreciation is needed to placate
Congress. While a new Chinese Government might revisit
exchange rate policy next year, until then there is unlikely
to be a major change in policy.

7. (SBU) Zhou added that, while United States policy makers
believe that market prices will promote needed economic
adjustments, and are advised by economists who rely on
empirical data, China's older generation of political leaders
still prefers administrative controls and fiscal changes
(such as higher taxes or subsidies) targeted on sectors of
concern over market-based policies such as interest and
exchange rates that have a broader impact. This preference
is based on their experience, even if not supported by data.
As a result, Zhou expects Chinese leaders will wait to assess
the impact of fiscal policy changes annouced in the last
several months (which raised ffective taxation on certain
export sectors that are resource intensive or highly
polluting) before making any changes to exchange rate policy.

8. (SBU) Zhou said Paulson could more effectively promote his
agenda if he addressed Chinese leaders' concerns that: 1)
greater market access for foreign firms in financial services
would adversely impact China's financial security,
particularly the ability of Chinese firms to compete with
foreign firms (Comment: Embassy interlocutors say this is a
particular concern in the securities sector. End comment.);
and 2) the United States protects its companies from
competition through prudential supervision (such as bank
licensing) and national security reviews (CFIUS) and thus
China should as well. Zhou noted that if the Fed could
accelerate its approval of Chinese banks' branch
applications, this would remove an excuse for maintaining
market access barriers in China,s financial sector and would
not threaten the safety and soundness of the Unites States
financial sector. Zhou also suggested that Paulson stress to
China's leaders that most other emerging markets do not limit
FDI in financial services, and note how open the United
States is in the financial sectors, since China's leaders
believe their own policies are the norm. Finally, he
recommended not pressing China's leaders on currency policy
unless the United States could reduce its demands to an
amount that is viewed as more politically realistic in China.

9. (SBU) Zhou said it would be difficult to reduce trade
imbalances in the near term since they are caused mainly by
high savings in China and low savings in the United States,
and it is difficult for policy changes to affect short-term
savings rates. Given this, Zhou suggested it is likely that
China will continue to accumulate large official assets and
proposed that China and the United States consider how these
investments could be made in a way that reduces bilateral
trade tensions. In addition to investing in the United
States, Zhou suggested that China could invest its official
assets in NAFTA or CAFTA companies whose products have a high
American content. Furthermore, Chinese companies do not
understand the regulatory and political investment climate in
the United State and other countries and could use advice
from United States officials.

BEIJING 00005562 003 OF 003

10. (SBU) Finally, Zhou commented that the United States SED
proposal to reduce tariffs on environmental goods is worth
pursuing. He also thanked the United States for its support
of China's membership in the Inter-American Development Bank
(IDB) and the Financial Action Task Force (FATF).


11. (U) Secretary Paulson's delegation cleared this cable.
Piccuta

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