VZCZCXRO3208
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DE RUEHBJ #7696/01 1150016
ZNR UUUUU ZZH
P 250016Z APR 06
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 3705
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 007696 
 
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SENSITIVE 
SIPDIS 
 
USDOC FOR DAS LEVINE AND ITA/MAC/AP/MCQUEEN 
TREASURY FOR OASIA/ISA KOEPKE AND DOHNER 
STATE PASS CEA FOR BLOCK 
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SAN 
FRANCISCO FRB FOR CURRAN; NEW YORK FRB FOR DAGES/CLARK 
STATE PASS USTR STRATFORD/WINTER/MCCARTIN 
 
E.O. 12958: N/A 
TAGS: EFIN EINV CH
SUBJECT:  NEW CAPITAL ACCOUNT LIBERALIZATION MEASURES SET 
THE STAGE FOR MORE OUTWARD INVESTMENT,INCLUDING THE QDII 
PROGRAM 
 
 
THIS MESSAGE IS SENSITIVE BUT UNCLASSIFIED.  PLEASE HANDLE 
ACCORDINGLY.  NOT FOR DISTRIBUTION OUTSIDE USG CHANNELS. 
 
¶1.  (SBU) Summary.  China's financial authorities recently 
announced a series of capital account liberalization 
measures and provisions for introducing the long-awaited 
qualified domestic institutional investor (QDII) program. 
By allowing more forex to leave China and opening up the 
country's tightly restricted capital account, these 
regulatory adjustments may help address the pressures from 
China's burgeoning foreign exchange reserves, which reached 
US$ 875.1 billion as of March 31, 2006.  Deputy 
Administrator of the State Administration of Foreign 
Exchange (SAFE) Wei Benhua suggested that the QDII program 
is likely to be relatively small at first.  Other officials 
similarly indicated that the new policies would be 
implemented in a gradual way.  While the new measures are 
clearly a welcome signal and may represent a major new 
policy shift, these statements indicate that the impact of 
the new measures will be limited in the near term.  End 
Summary. 
 
New Liberalization Measures 
--------------------------- 
 
¶2.  (U) Over several days in mid-April, the Chinese 
Government issued a series of new measures to ease capital 
controls and lay the groundwork for more outward 
investment.  On April 13, A "Notice on Adjusting the 
Management Policies of Foreign Exchange in Current 
Accounts," issued by the People's Bank of China (PBOC) and 
the State Administration of Foreign Exchange (SAFE) on 
April 13 and due to take effect on May 1 simplifies 
approval procedures for forex accounts and payments. 
According to the notice, "the new rules have been launched 
in order to further satisfy the foreign exchange demand of 
domestic institutions and individuals and to facilitate 
trade development."  Institutions will no longer need to 
obtain SAFE approval to establish, modify, or close their 
forex accounts; instead they may apply directly to banks. 
 
¶3.  (U) In addition, the amount of forex that institutions 
may retain will rise.  Previously, the amount of forex a 
company could keep in its account was limited to between 50 
percent or 80 percent of the forex income of the previous 
year.  Starting May 1, a company may keep an amount equal 
to the sum of 80 percent of its forex income and 50 percent 
of its forex expenditure from the previous year.  For 
institutions with new accounts, the initial cap will be 
raised from US$ 200,000 to US$ 500,000. 
 
¶4.  (U) SAFE also indicated that Chinese citizens may 
purchase at least US$ 20,000 in foreign currency each year, 
and may obtain additional forex with a certificate that 
proves their need.  To obtain foreign currency, domestic 
residents need to provide only their identity card. 
 
¶5.  (U) On April 18, the PBOC, the SAFE, and the China 
Banking Regulatory Commission (CBRC) jointly issued 
measures allowing commercial banks to invest their clients' 
funds offshore.  Effective immediately, "This will widen 
domestic residents' investment channels in a positive and 
orderly way, and is a key measure toward helping to balance 
the international balance of payments," according to the 
statement released by the three agencies. 
 
¶6.  (U) PBOC official statistics indicate that deposits at 
China?s financial institutions totaled US$ 3.965 trillion 
at the end of March 2006, with personal deposits accounting 
for US$ 2 trillion of that amount.  "Today the investment 
channel for domestic institutions and residents is 
relatively narrow, and it has been difficult to use the 
international financial markets to improve the asset 
portfolio, spread investment risk and improve the return on 
funds," the statement noted. 
 
¶7.  (U) Under the new rules, commercial banks must obtain 
regulatory approval to invest their clients' funds 
offshore, and will be assigned quotas, which may later be 
adjusted according to China's international balance of 
payments situation.  Banks are required to hedge their 
 
BEIJING 00007696  002 OF 003 
 
 
foreign exchange risk for their offshore investments, and 
must report their capital flows to SAFE periodically.  The 
commercial banks must clearly inform their clients of the 
investment risks and the performance of their investments. 
 
¶8.  (U) The rules also require the commercial banks to 
have a custodian bank that will be responsible for all the 
assets invested offshore.  The domestic custodian bank must 
also assign another qualified foreign financial institution 
to handle offshore settlements and hold the securities in a 
separate account. 
 
¶9.  (U) Wu Dingfu, Chairman of the China Insurance 
Regulatory Commission (CIRC), announced last week that the 
State Council has approved plans to allow local insurers to 
purchase foreign currencies with their own yuan-denominated 
funds to invest overseas.  "A pilot program will be 
launched in the first half of this year," Wu confirmed, 
adding "CIRC will chose one or two insurance firms to start 
the pilot program."  In September 2005, CIRC authorized 
domestic insurers to invest a maximum 10 percent of their foreign 
exchange capital in overseas stocks of Chinese companies. 
 
Implementation is the Key 
------------------------- 
 
¶10.  (SBU) Despite these encouraging policy announcements, 
Econoff contacts agreed that the key lies with 
implementation.  A senior executive at an economic 
consulting firm pointed out, "Chinese individual investors 
are unfamiliar with overseas bond markets," and added that 
even Chinese banks themselves are not good at analyzing 
higher yielding but more risky overseas investment products. 
He concluded it will take about two or three years before 
the market matures.  Ha Jiming, Chief Economist with CICC, 
agreed that implementation would be slow.  He noted that 
some of China's insurance companies have already been 
allowed to participate in China IPOs in Hong Kong, but he 
expects investment in stocks and bonds will be allowed in 
other overseas markets as well. 
 
SAFE's Wei Predicts QDII Before Year End 
---------------------------------------- 
 
¶11.  (SBU) Wei Benhua, Deputy Administrator at SAFE, 
advised Econ Mincouns that these steps do indeed signal a 
new effort to expand outward investment options, especially 
for the Qualified Domestic Institutional Investor (QDII) 
program.  He indicated that banks and insurance companies 
will be confined to fixed income products in overseas 
markets, but securities firms and investment funds will be 
able to invest in overseas stock markets as well. He 
pointed out that any institution, domestic or foreign, that 
is registered in China could qualify as a QDII. 
 
¶12.  (SBU) As for implementation of the new outward 
investment measures, Wei confirmed that implementing 
regulations must be issued before they can begin.  Wei 
indicated that the QDII program will be phased in over time, 
with an approach that will likely seek a balance between 
the QDII and QFII (Qualified Foreign Institutional Investor) 
programs.  This would imply the QDII program will initially 
match the size of the QFII program, which currently has a 
quota of US$ 10 billion, US$ 6 billion of which has been 
issued to 39 QFIIs.  Wei said he hopes the QDII can be 
launched before the end of the year. 
 
Gradual Process 
--------------- 
 
¶13.  (SBU) In a similarly cautious vein, the China 
Financial News cited SAFE Assistant Administrator Li 
Dongrong as saying "We must be clear-headed in the process 
of steadily pushing forward capital account liberalization, 
refrain from being rigid and conservative, but prevent any 
blind and rash moves."  Qi Bin, Director General of the 
Research Department at the China Securities Regulatory 
Commission, informed a group of U.S. Federal Reserve 
officials during a mid-April meeting not to anticipate a 
flood of investment overseas in the near term.  Instead, 
"gradualism" remains the focus in implementing the 
 
BEIJING 00007696  003 OF 003 
 
 
regulations, according to Qi. 
 
¶14.  (U) Currently, no domestic institution has yet been 
granted a QDII license, although the China Securities 
Journal reported recently the National Council for Social 
Security Fund would likely become the first organization to 
receive a license during the second quarter of this year. 
Indeed, in late March, Hong Kong Exchanges & Clearing Ltd. 
announced it admitted China's Social Security Fund to its 
settlement system, which appeared to pave the way for 
Chinese institutions to invest in overseas securities.  The 
creation of the account removes a technical hurdle for the 
council to make overseas investments through the QDII program. 
 
Comment 
------- 
 
¶15.  (SBU) This series of new measures may represent the 
most significant policy shift so far in the Government's 
efforts to liberalize its tight currency control.  This 
could open the way for Chinese institutions and individuals 
to obtain higher returns and diversify their investment 
portfolios through investing overseas.  There may also be 
new opportunities for U.S. financial firms to provide 
investment management and related financial services. 
However, in keeping with China's gradualist policy 
approach, these new steps are likely to be implemented 
slowly and in a limited way.  China's forex reserves are 
growing at a slower pace, but still increased by US$ 20 
billion in the first quarter.  If, as suggested, the QDII 
program will only have a quota of US$ 10 billion, the 
Government will need to accelerate the implementation 
process. 
 
SEDNEY