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Cablegate: Secretary Paulson Discusses Bond Market, Equity

VZCZCXRO8511
OO RUEHCN RUEHGH RUEHVC
DE RUEHBJ #5566/01 2342245
ZNR UUUUU ZZH
O 222245Z AUG 07 ZDK
FM AMEMBASSY BEIJING
TO RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
RUEHC/SECSTATE WASHDC IMMEDIATE 1194
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 02 BEIJING 005566

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: SECRETARY PAULSON DISCUSSES BOND MARKET, EQUITY
CAPS WITH CBRC CHAIRMAN

BEIJING 00005566 001.2 OF 002


SUMMARY
-------
1. (SBU) Summary: In an August 1 meeting with Secretary
Paulson, China Banking Regulatory Commission (CBRC) Chairman
Liu Mingkang reported that China is making significant
efforts to step up its AML enforcement efforts, noting that
banks are &getting a lot tougher.8 Second, he reported
that the government, including the CBRC, is ramping up its
efforts to meet environmental targets on pollution abatement.
Third, Chairman Liu reported how the government is promoting
bond market development. Fourth, on rebalancing growth, he
noted President Hu,s view that GDP growth of 6 percent a
year would be sufficient if it could be sustained and
geographically balanced, saying that the emphasis now is on
quality rather than speed. He also noted the need to achieve
better macroeconomic balance between investment and
consumption. Finally, he emphasized the significant steps
China has recently taken to reduce net exports through tax
reform. End Summary.

Bond market development ) a role for foreign credit rating,
auditing, and accounting agencies
--------------------------------------------- --

2. (SBU) Chairman Liu emphasized that to support the
development of China's corporate bond market, there is a need
for high quality credit rating, auditing, and accounting
agencies. He acknowledged that there are a number of foreign
credit rating, auditing, and accounting agencies that would
like to operate in China but are currently unable to do so
due to equity caps. He suggested we put this issue on the
agenda for SED III.

3. (SBU) Chairman Liu further noted that bond market
development would need to involve the development of a robust
secondary market with participation from strategic
institutional investors, and noted that more institutional
investors from the United States would play a welcome role.
He added that foreign trust companies could play a bigger
role in helping to channel QDII funds to places like New York
and London.

CBRC to issue assessment on equity caps ahead of March 2008
NPC
--------------------------------------------- --

4. (SBU) Liu noted that CBRC has established a task force to
assess the performance of 24 foreign bank joint ventures
(JVs) involving 33 foreign strategic investors. The
assessment will be finished by next March, ahead of the
National People's Congress, with the aim of providing
proposals on reforms, including changes in equity caps, to
the State Council. Chairman Liu noted that the last
assessment in 2004 recommended that equity caps be raised
from 15 to 20 percent. (Comment: Liu's comments appear
intended to signal that raising equity caps in banking is
possible in the medium-term but not by SED III. End comment).

5. (SBU) Secretary Paulson also asked if China had considered
opening the market to foreign non-bank institutions wishing
to do RMB financing. (Comment: Current regulations require
that the controlling shareholder of a foreign bank in China
must be a commercial bank. End comment). Chairman Liu
responded by pointing to the successful turn around of
Shenzhen Development Bank (SDB) by Texas Pacific Group, a
non-bank financial firm that won control of SDB. End
Comment.)

Officials prefer tax reform over currency appreciation
--------------------------------------------- ----

6. (SBU) Secretary Paulson commended the steps China has
taken to reduce export tax rebates and introduce new taxes on
resource intensive exports, but argued that changes in
China,s currency policies are still needed, noting that it
would be more efficient to address large current account
surplus through the use of market-determined price mechanisms
rather than administrative measures.


BEIJING 00005566 002.2 OF 002


7. (SBU) Chairman Liu responded that Chinese senior officials
believe there are three reasons why adjusting tax policies is
preferable to more rapid currency appreciation for promoting
a reduction in external imbalances. First, China's poor
would bear the burden of more rapid appreciation. He
specifically mentioned the potential for job losses among
migrant workers who work for multinational corporations
engaged in low value-added processing trade. Second, he
argued that currency appreciation is a blunt policy
instrument ) while changes in tax policy can target specific
sectors of the economy that are problematic (i.e. heavily
polluting or export intensive). Third, he argued that, for
targeted sectors, the impact of the tax changes dwarfs that
of currency appreciation. He noted that the currency has
appreciated 9 percent over about two years, while the tax
changes raised steel exporters, costs 19 percent overnight
(reflecting the repeal of a 9 percent subsidy combined with
the introduction of a 10 percent tax). Chairman Liu reported
that China would conduct a post-assessment of the tax changes
to determine their impact on net exports.

China seeks advice on environmental consequences of lending
--------------------------------------------- ----
8. (SBU) Chairman Liu asked for U.S. assistance in
identifying the environmental consequences of lending to
different sectors, including any benchmarks or standards that
China could use to help systematize environmentally-conscious
bank lending. David McCormick committed to follow up on this
issue with the CBRC.

9. (SBU) Secretary Paulson's delegation cleared this cable.
Piccuta

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