VZCZCXRO7044
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #4549/01 3510457
ZNR UUUUU ZZH
P 160457Z DEC 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 1408
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 03 BEIJING 004549 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EAP/CM AND E/YON 
TREASURY FOR OASIA/DOHNER/WINSHIP 
TREASURY ALSO FOR IMFP/SOBEL/MOGHTADER 
NSC FOR LOI 
 
E.O. 12958: N/A 
TAGS: ECON EFIN CH
SUBJECT: CHINA/ECONOMY/CURRENCY: CONCERNS ABOUT ECONOMY, 
RMB BASICALLY STABLE 
 
THIS CABLE IS SENSITIVE BUT UNCLASSIFIED.  NOT FOR 
INTERNET DISTRIBUTION. 
 
¶1. (SBU) Summary: In meetings with visiting Fed Governor 
Warsh, Chinese researchers and bankers expressed concern 
that the U.S. economic downturn would become a protracted 
recession.  They worried about the impact on ChinaQs 
economy, and expected problems such as rent-seeking and 
corruption to spring from ChinaQs plans to stimulate 
growth through fiscal and monetary measures.  Central 
bank officials continue to affirm that Chinese financial 
institutions are not experiencing liquidity problems, and 
stressed that despite the recent depreciation of the RMB 
there had been no fundamental change in exchange rate 
policy.  ICBC notified of its desire to buy a controlling 
stake in a California-based bank.  End Summary. 
 
 
 
¶2. (SBU) On December 3, 2008, Federal Reserve Bank 
Governor Kevin Warsh met with Development Research Center 
(DRC) Director Xia Bin, China Securities Regulatory 
Commission (CSRC) Vice Chairman Yao Gang, PeopleQs Bank 
of China (PBOC) Vice Governor Yi Gang, Industrial and 
Commercial Bank of China (ICBC) Chairman Jiang Jianqing, 
China Banking Regulatory Commission (CBRC) Chairman Liu 
Mingkang, and Bank of Beijing Executive Directors Bruno 
Houdmont and Bashar Samra (representatives of ING 
detailed to BoB).  Discussions focused mainly on the 
causes, impact, and policy responses to the current 
global financial crisis, and related concerns including 
bank liquidity, economic reform, and exchange rate 
policies. 
 
Rising Concern about the Global Economy . . . 
--------------------------------------------- 
 
¶3. (SBU) Chinese banking and government officials 
expressed concerns that the U.S. financial crisis would 
lead to a protracted and severe U.S. recession.  Most 
interlocutors viewed the Chinese economyQs prospects as 
closely tied to the U.S. economyQs and thus pressed Warsh 
for his views on when the U.S. economy would recover. 
CSRC Vice Chairman Yao  expressed concern about the 
impact of deteriorating U.S. consumer credit on financial 
stability and household consumption.  Yao was also 
interested in the current debate on and prospects for 
reform of the U.S. financial regulatory structure, 
particularly in light of the Federal ReserveQs provision 
of liquidity to non-bank financial institutions.  DRCQs 
Xia explained that while a housing bubble, compensation 
systems and high leverage had all contributed to the U.S. 
financial crisis, an important cause was global 
macroeconomic imbalances.  ICBC Chairman Jiang worried 
about the loss of confidence in China and the global 
economy.  Even sound firms are afraid to invest due to 
the uncertain outlook.  Individuals are cutting back 
their consumption - not because of insufficient income 
but because of their deteriorating outlook.  He stressed 
it is therefore important for the Chinese government to 
sustain confidence. 
 
. . . and Rapidly Deteriorating Chinese Economy 
--------------------------------------------- -- 
 
¶4. (SBU) Chinese officials generally agreed that economic 
data in October had dropped more quickly than they 
expected with power generation declining, something 
unprecedented in many years.  Most expect real GDP growth 
for 2008 Q4 and early 2009 to be lower than the 9% real 
growth (y/y) for the third quarter.  The Chinese stimulus 
package will help offset the decline in external demand 
with domestic growth; for 2009, China could still achieve 
9% GDP growth if the situation in the U.S. doesn't worsen. 
DRCQs Xia Bin was confident that China can maintain at 
least 8 percent real GDP growth in 2009.  The rise of 
government revenues as a percent of GDP, a roughly 
balanced budget, and continued urbanization give China 
ample room for fiscal stimulus.  While Xia believes China 
needs to pursue more consumption-led growth, he stressed 
this will remain difficult in the short-term. 
 
¶5. (SBU) PBOCQs Yi noted that the main channel for 
contagion of the U.S. and European financial crises has 
 
BEIJING 00004549  002 OF 003 
 
 
been through trade, although ChinaQs diversification of 
export markets away from the U.S. and Europe over the 
past few years has helped cushion the impact.  Yi also 
believes that ChinaQs high household savings and banks 
capital adequacy ratios give both households and 
financial institutions a cushion to help absorb the 
decline in external demand. 
 
Supporting Growth Presents Challenges 
------------------------------------- 
 
¶6. (SBU) DRCQs Xia is concerned that the four trillion 
RMB stimulus package could encourage corruption and rent- 
seeking and would present an opening for supporters of 
greater state-directed economic planning.  With Premier 
Wen Jiabao aware of these risks, the government is trying 
to find appropriate ways to strengthen oversight of 
additional spending.  Xia predicted that the December 8-9 
government economic work conference would focus on 
measures to increase domestic demand and consumption, 
including: raising the threshold for the personal income 
tax; stimulating the housing market by cutting interest 
rates further, and/or lowering the minimum down payment 
for purchases of second homes; and increasing pensions 
for retirees. 
 
¶7. (SBU) Bank of Beijing executives said that while 
regulators are encouraging banks to maintain lending 
growth, they are not yet forcing banks to make loans that 
the banks do not deem commercially viable.  However if 
the economic downturn worsens, they expect banks will 
face more pressures to lend.  Mr. Samra believed that 
real estate is the major risk for banks, though BoBQs 
exposure to real estate is relatively small at only 14% 
of assets.  While BoBQs borrowers had been sensitive to 
interest rate hikes, they were less certain whether 
interest rate cuts would spur increased borrowing given 
the deteriorating outlook. 
 
Exchange Rate to Remain QBasically Stable 
------------------------------------------ 
 
¶8. (SBU) PBOCQs Yi said the U.S. government Qshould not 
worryQ as there has been no change in exchange rate 
policy.  He noted that in the second half of 2008, the 
RMB-USD rate has been Qbasically stable,Q but in the 
context of a strong USD that had caused the RMB to 
appreciate significantly on a nominal and real-trade 
weighted basis.  Yi added that in the near term the RMB 
was likely to remain Qbasically stableQ against the US 
dollar, and in this context fluctuations in either 
direction were Qperfectly normal.Q  Over the long-term 
China is still committed to the goal of a convertible 
currency. 
 
PBOC Taking Steps to Maintain Bank Liquidity 
-------------------------------------------- 
 
¶9. (SBU) PBOCQs Yi said liquidity remains ample in China; 
in fact just three months ago there were concerns about 
excessive liquidity.  November data will show very large 
increases in bank lending.  According to Jiang, the solid 
growth in the real economy allowed Chinese banks to grow 
rapidly while paying less attention to QfakeQ financial 
derivatives than their western counterparts.  Only 
foreign banks, which are a tiny portion of ChinaQs 
banking sector, have experienced liquidity problems. 
Through moral suasion, PBOC and CBRC encouraged Chinese 
commercial banks to resume normal lending to the foreign 
banks.  Also, the PBOC has established a facility to 
provide liquidity similar to the Federal ReserveQs TAF 
(term auction facility).  Foreign banks can use Qwhatever 
they haveQ as collateral for this facility, including 
foreign assets.  This will allow foreign banks who need 
RMB liquidity to borrow foreign currency from their 
parent banks, and use the borrowed funds as collateral 
for an RMB loan from the PBOC, without requiring approval 
from the State Administration of Foreign Exchange to 
bring the foreign currency into China. 
 
Macro Stimulus Consistent with Structural Reform? 
--------------------------------------------- ---- 
 
¶10. (SBU) PBOCQs Yi said the economic downturn is an 
 
BEIJING 00004549  003 OF 003 
 
 
opportunity for further structural adjustment of the 
economy.  China can speed the transfer of resources out 
of some sectors and enterprises, although certain 
ministries, SOEs, and local governments will resist this. 
To promote this, China needs to accelerate its efforts to 
strengthen its social safety net, as it is much more 
efficient to support directly household incomes than prop 
up inefficient enterprises. 
 
¶11. (SBU) Yi also stressed the importance of maintaining 
progress on reforming Chinese banks into more 
commercially-oriented entities, particularly by 
emphasizing good corporate governance and risk management; 
the former was gradually improving, the latter was much 
better.  The Qgood newsQ is that ChinaQs banks are closer 
to international standards; the Qbad newsQ is that this 
is making them more pro-cyclical.  However, despite the 
priority on sustaining growth it will not be possible for 
the Chinese government to press banks to lend to 
particular borrowers. 
 
Committed to Reform, but Pace Will Slow 
--------------------------------------- 
 
¶12. (SBU) CSRCQs Yao stressed that, while the U.S. 
financial crisis has raised doubts among some people 
about whether to continue financial opening and reform, 
Chinese leadership are committed to continuing but first 
need to analyze the reasons for and implications of the 
U.S. financial crisis. 
DRCQs Xia said current problems might lead to Qfine- 
tuningQ of the pace of financial reform and opening, but 
the policy and overall trend would not change.  As ICBC 
Chairman Jiang noted, Qit is lucky that Chinese banking 
reform over the past few years occurred in such a good 
environment. 
 
ICBC Seeks Controlling Stake in California Bank 
--------------------------------------------- -- 
 
¶13. (SBU) ICBC, the largest bank in China, believes that 
now is a good time to pursue foreign investment through 
mergers and acquisitions (M&A). ICBC is interested in 
acquiring small U.S. banks to expand its network and 
learn more about the US market.  Mr. Jiang mentioned 
interest in a controlling share of East-West Bank in 
California, and asked Governor Warsh whether the Federal 
Reserve would have regulatory concerns.  Warsh responded 
that while foreign investors would have to comply with 
U.S. banking regulations, the Federal Reserve has an 
Qopen mindQ towards foreign investment, and recommended 
that ICBC discuss any specific proposal with the 
appropriate Federal Reserve staff. 
 
COMMENT: Balancing Rebalancing 
------------------------------ 
 
¶14. (SBU) Chinese economic policy makers continue to 
grapple with how to cushion the macroeconomic downturn in 
an efficient manner without undermining progress made in 
modernizing the financial sector and rebalancing the 
economy. They appear well aware that more market-oriented 
banking and banking supervision practices tend to be more 
pro-cylical and appear intent not to repeat the heavy 
handed moral suasion on banks to prop up state 
enterprises which occurred in prior cyclical downturns. 
They also appear committed to continue to resist pressure 
rising from vested interests to use the U.S. financial 
crisis as a pretext for backsliding on financial and 
exchange rate reforms, though the pace of financial 
liberalization and RMB appreciation will certainly slow. 
ICBCQs proposed investment in East-West Bank could be the 
second test, after China MinshengQs request to increase 
its stake in San Francisco-based bank UCBH Holdings, of 
whether the Federal Reserve will allow Chinese banks to 
take more than a 5-10 percent equity stake in U.S. banks. 
 
PICCUTA