VZCZCXRO6017
RR RUEHCN RUEHVC
DE RUEHGH #0777/01 3410831
ZNR UUUUU ZZH
R 070831Z DEC 07
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6509
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7027

UNCLAS SECTION 01 OF 03 SHANGHAI 000777 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS FEDERAL RESERVE BOARD FOR GOVERNOR 
WARSH/AHMED/JOHNSON/SCHINDLER; SAN 
FRANCISCO FRB FOR CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK 
STATE PASS CEA FOR BLOCK 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/READE 
USDOC FOR 4420 
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN 
TREASURY FOR EXEC - TSMITH, OASIA/ISA -DOHNER/BAKER/CUSHMAN 
TREASURY FOR WRIGHT AND AMB HOLMER 
TREASURY FOR SOBEL AND MOGHTADER 
NSC FOR MCCORMICK AND TONG 
 
E.O. 12958: N/A 
TAGS: EFIN EINV PGOV CH
SUBJECT: FRB GOVERNOR WARSH TOLD RMB APPRECIATION GRADUAL, NO STOCK 
COLLAPSE BEFORE OLYMPICS 
 
REF: A. SHANGHAI 679 
 
     ¶B. SHANGHAI 251 
 
SHANGHAI 00000777  001.2 OF 003 
 
 
(U) This cable is sensitive but unclassified and for official 
use only.  Not for distribution outside of USG channels or via 
the internet. 
 
¶1. (SBU) Summary: According to the Shanghai branch of the 
People's Bank of China (PBOC), RMB appreciation will continue at 
a gradual pace without any dramatic revaluations in the near 
future.  Federal Reserve Governor Kevin Warsh, in Shanghai 
November 18-20, was also told that the PBOC is closely watching 
the sub-prime mortgage problems in the United States due to the 
"close relationship" between the USD and the RMB.  Shanghai 
Stock Exchange senior officials said there is government support 
for not allowing the stock market to crash before the 2008 
Beijing Olympics.  Blocking Chinese companies from listing on 
stock markets overseas is a temporary measure designed to help 
both the Chinese stock markets and companies in China.  The 
Chinese Financial Futures Exchange's (CFFEX) first product, 
stock index futures, will not be launched without State Council 
approval as no Chinese official wants to get blamed should its 
launch lead to a stock market collapse.  Once it is launched, 
Qualified Foreign Institutional Investors (QFII) will be allowed 
to allocate 10 percent of their quota to invest in CFFEX 
products.  End Summary. 
 
¶2. (SBU) Federal Reserve System Board of Governors Member Kevin 
Warsh met with Shanghai-based financial officials including the 
People's Bank of China (PBOC), the Shanghai Stock Exchange 
(SSE), and the China Financial Futures Exchange (CFFEX) during 
his November 18-20 visit to Shanghai.  Governor Warsh also met 
with Bank of Communications (BOCOM) Chairman Jiang Chaoliang, 
local and foreign financial services businessmen, Citibank CEO 
Richard Stanley and Standard Chartered Senior Economist Stephen 
Green during his visit.  Embassy Beijing Finatt accompanied 
Governor Warsh during his meetings in Shanghai.  This cable 
reports on Governor Warsh's meetings with the Shanghai PBOC, SSE 
and CFFEX.  Other meetings will be reported septels. 
 
--------------------------------------------- - 
Shanghai PBOC -- We Want to Be Like the NY Fed 
--------------------------------------------- - 
 
¶3. (SBU) Governor Warsh met with PBOC executive Vice President 
Hu Pingxi, PBOC Director General Luo Yong, PBOC Deputy Director 
General Liu Yongfen, and China Foreign Exchange Trading System 
(CFETS) President Xie Duo on November 20.  Hu said that the PBOC 
established its Shanghai branch in August 2005 hoping that it 
would play the same role in China that the New York Federal 
Reserve Bank plays in the United States.  Close to China's 
financial markets, the Shanghai PBOC is assisting in the attempt 
to turn Shanghai into an international financial center by 
encouraging financial institutions to move here.  It conducts 
open market operations, monitors and regulates the financial 
markets, tests "innovative products," and conducts international 
exchange and communications. 
 
--------------------------------------------- -------- 
RMB to Appreciate Gradually, No Abrupt Moves Expected 
--------------------------------------------- -------- 
 
¶4. (SBU) PBOC's Hu expressed concern about interest rate 
decreases in the United States while the PBOC is raising rates 
in China.  The U.S. Dollar is "closely related" to the value of 
the RMB and so the PBOC is "paying attention" to the possible 
side-affects in China of fallout from the sub-prime mortgage 
problems in the United States.  Finatt noted the importance of a 
flexible currency exchange rate regime to a country's ability to 
set a monetary policy that reflected its own needs.  Governor 
Warsh added that "increasing exchange rate flexibility will help 
us establish greater equilibrium in otherwise volatile times." 
 
¶5. (SBU) Hu said that the RMB will continue to appreciate 
gradually without any "abrupt" moves.  Due to China's size and 
"complicated economic factors," the PBOC cannot afford to move 
in a "radical way."  Hu expects the exchange rate to decline, 
 
SHANGHAI 00000777  002.2 OF 003 
 
 
with "small bounces up" after periods of decline in order for 
Chinese businesses to try to avoid losses due to RMB 
appreciation. 
 
-------------------------------------------- 
No Stock Market Collapse Before The Olympics 
-------------------------------------------- 
 
¶6. (SBU) SSE Executive Vice President James Liu, noting that the 
SSE Composite Index (SCI) had risen approximately 100 percent in 
2007, said that there had been a flood of new investors entering 
the stock market (Ref A).  These new investors have no 
experience with a market that may decline as fast, or faster, 
than it has risen.  Liu said that the SSE, the China Securities 
Regulatory Commission (CSRC), and others throughout the 
government are focusing on educating investors about the risks 
of investment. (Note: Econoff recently spotted a Chinese "red 
letter banner" at a securities firm warning investors that "Bull 
Markets Have Risks."  While the markets have been up as much as 
130 percent this year, more than half of investors have actually 
lost money.  End note.) 
 
¶7. (SBU) Liu said that if there was a market crash, there might 
be pressure -- both on and from some parts of the government -- 
to bail out retail investors.  However, Liu said, "I would hope 
we wouldn't do that.  I would advise against it.  Consequences 
need to be learned."  Liu added, "Besides, next year we are 
holding the Olympics, so we won't let the market tumble before 
that time.  The Olympics are definitely a consideration." 
(Comment: While many interlocutors have speculated that the 
Chinese Government would not permit the stock market to crash 
prior to the August 2008 Beijing Olympics since this could lead 
to massive protests, this is the first time that post has heard 
an official explicitly state it.  End comment.) 
 
--------------------------------------------- ----------- 
The Benefits of Listing at Home: We Can Take Care of You 
--------------------------------------------- ----------- 
 
¶8. (SBU) SSE's Liu noted that the Chinese Government had "put a 
stop" to Chinese companies listing outside of China.  This is a 
temporary measure that "will not last forever."  The CSRC is 
hoping that Chinese companies that might have wanted to list 
overseas would list in China.  Liu approved of this move since 
he believes that the majority of Chinese companies that listed 
outside of China were undervalued by foreign investors and have 
not performed well. 
 
¶9. (SBU) Liu said that Chinese companies that had listed 
overseas "did not know what they were getting into, were not 
prepared, and suffered from a lack of understanding of United 
States corporate culture."  Listing first in Shanghai, and then 
overseas, gives Chinese companies a chance to function in a more 
forgiving environment.  "If they get into trouble here in 
Shanghai, we can work with them," said Liu. 
 
--------------------------------------------- ----- 
Stock Exchange Still Dominated by Retail Investors 
--------------------------------------------- ----- 
 
¶10. (SBU) The share of the market controlled by institutional 
investors, such as pension funds, insurance companies, and 
broker-dealer trading, has risen from roughly 10 percent to 
about 38 percent this year -- a healthy trend, said SSE's Liu. 
However, more than 90 percent of trading is done by individual 
retail investors.  On high volume days, trading by institutional 
investors only accounts for 2-3 percent of volume.  This means 
the market is controlled by retail investors and institutional 
investors "have no voice in setting the market."  This even 
applies to trading done by non-Chinese Qualified Foreign 
Institutional Investors (QFII) who "throw away everything they 
know about the market and all of their research to follow the 
market's momentum created by retail investors," complained Liu. 
 
--------------------------------------------- ------------- 
The Timetable to Launch Stock Index Future Still Sensitive 
 
SHANGHAI 00000777  003.2 OF 003 
 
 
--------------------------------------------- ------------- 
 
¶11. (SBU) (SBU) CFFEX CEO Zhu Yucheng said that the timing of 
the launch of CFFEX's first product, a stock index future, is 
still very "sensitive." (Ref B)  When CFFEX would actually 
launch the stock index future is a decision that would be made 
at "the highest levels of government."  Zhu said that given the 
overheating on the two Chinese stock markets, launching the 
equities future product might be the trigger for increased 
volatility and uncertainty.  "If the futures product does not 
start successfully, 140 million investors will scold me and 
criticize the government," he said.  (Note: Other contacts have 
told us that delays have been caused by no official wanting to 
be responsible for launching a product that might cause a 
collapse, however temporary, of the markets.  The decision to 
launch the index futures product is in the hands of the State 
Council who most likely do not understand the concept of 
futures, and therefore are also reluctant to initiate the new 
product.  End note.)  Zhu added that he and his staff are 
closely studying the how the Chicago Mercantile Exchange had 
"defended their products before Congress so that maybe we can 
use their arguments." 
 
--------------------- 
The Goal is Stability 
 
--------------------- 
 
¶12. (SBU) Attempting to insure stock market stability and avoid 
volatility, CFFEX's Zhu said that the as yet unlaunched stock 
index futures product was intentionally designed with a large 
contract size so that its main customers would be institutional 
investors.  CFFEX's goal is to set the price so high that 
private investors would not speculate.  Qualified Foreign 
Institutional Investors (QFFI) will be allowed to invest up to 
10 percent of their quotas, said Zhu. 
 
---------------------------- 
Other Products in the Future 
---------------------------- 
 
¶13. (SBU) Noting that fund managers familiar with the planned 
stock index futures product have complained that its proposed 
structure is not optimal for allowing them to hedge risk, 
CFFEX's Zhu said that in response to these concerns CFFEX hopes 
to launch a broader series of financial derivatives should their 
current product prove successful.  CFFEX plans to launch 
interest rate, foreign currency, and national bonds futures 
products as well. 
 
¶14. (U) The delegation did not have an opportunity to clear on 
this report. 
JARRETT