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FM AMEMBASSY BEIJING
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RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 BEIJING 000352

SENSITIVE
SIPDIS

STATE PASS USTR
TREASURY PASS LOEVINGER

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD CH
SUBJECT: CHINA: S&ED II DATES AND TOPICS; RMB APPRECIATION; ECONOMIC
SITUATION

This cable is Sensitive but Unclassified (SBU) and for official use
only. Not for transmission outside USG channels.

¶1. (SBU) SUMMARY: During a January 25-28 visit to advance
preparations for the U.S.-China Strategic and Economic Dialogue II
(S&ED II), the U.S. Economic Track staff delegation met with key
economic ministries, economists, and U.S. industry representatives.
The delegation proposed to their Ministry of Foreign Affairs (MFA)
and Ministry of Finance (MOF) interlocutors the week of May 10 for
the Dialogue and agreed to exchange outcomes in early March. The
group made progress on the public agenda, although the Chinese side
noted that it would have difficulty openly including exchange rates
and relative prices on the agenda, and resisted listing discussion
of China's indigenous innovation policy. Officials were open to
continuing private discussions about RMB appreciation, but
reiterated China could not be seen as caving to foreign pressure on
the currency issue. Turning to China's economic situation, contacts
noted that economic overheating and real estate asset bubbles
remained an area of concern for Beijing's economic policymakers.
END SUMMARY.

¶2. (SBU) The delegation met: Ministry of Commerce (MOFCOM) American
and Oceanic Affairs Director General (DG) He Ning; Ministry of
Finance (MOF) External Economic Cooperation DG Zou Jaiyi; National
Bureau of Statistics (NBS) DG Li Xiaochao; China Construction Bank
(CCB) Chief Economist Erh-Cheng Hwa; National Development and Reform
Commission (NDRC) Cong Liang; State Administration for Foreign
Exchange (SAFE) Capital Controls Deputy DG Chu Yumei; UBS economist
Wang Tao; Central Finance and Economic Leading Group (CFELG) Vice
Minister Liu He; MOF Assistant Minister Zhu Guangyao; Chinese
Academy of Social Sciences (CASS) Professors Huang Ping and Xiao
Lian; Chinese Institute for Contemporary International Relations
(CICIR) Professor Da Wei; China Center for Economic Research (CCER)
Scholar Lu Feng; Development Research Center (DRC) Scholar Tang Min;
Managing Director of Hill and Knowlton John Holden; Oshkosh Senior
Director of Business Development Jennifer Thompson; Akin, Gump,
Strauss, Hauer & Feld LLP Partner Spencer Griffith; and IBM Global
Services Deputy Chief Representative She Duan Zhi.

¶3. (SBU) State Department Deputy Assistant Secretary for China and
Mongolia David Shear and Treasury Department Executive Secretary and
Senior Coordinator for China and the S&ED David Loevinger led the
State-Treasury S&ED II planning trip to Beijing. The Economic Track
delegation also included: Economic Minister Counselor William
Weinstein; Treasury Attache David Dollar; Senior Advisor to the
Treasury Under Secretary-designate for International Affairs Raji
Jagadeesan; Director of Treasury's Office of East Asia Chris
Winship; State Department Deputy Director, Office of Monetary
Affairs David Meale; Assistant to the U.S.-China Strategic and
Economic Dialogue Casey Owens; Deputy Financial Attache to China
(incoming) Tim Dorsett; and Embassy EconOffs.

S&ED Planning
--------------

¶4. (SBU) On preparations for the Economic Track of the S&ED, neither
MFA nor MOF officials replied to the U.S. proposal to hold the
Dialogue during the week of May 10, and reiterated China's
preference for late May. In a meeting with MOF Assistant Minister
Zhu Guangyao, the two sides agreed to exchange proposed Economic
Track outcomes in early March. Searching for mutually acceptable
phrasing for the public agenda, MOF DG Zou Jiayi, observing that the
two sides were "quite close" on most points, said the most difficult
area for MOF was exchange rates and relative prices. She preferred
not to use exchange rates in the document, as that would attract too
much focus, but said the term relative prices was too narrow. Zou
also mentioned that the Ministry of Science and Technology (MOST)
did not want to discuss the indigenous innovation issue at the S&ED,
but hoped to be able to discuss it bilaterally prior to the S&ED;
Zou agreed to convey USG views back to MOST.

Exchange Rates/RMB Appreciation a "Political Issue"
--------------------------------------------- ----

¶5. (SBU) Officials demonstrated little outward receptivity to the
message of RMB appreciation. MOFCOM DG He Ning rejected U.S. calls
for RMB appreciation, claiming that political pressure from the
economic situation in the United States and other countries should
not be shifted onto China in the form of a call for RMB
appreciation. He pointed out that in 2009 Chinese exports to the
United States had dropped 12 or 13 percent, vice an only four
percent drop in imports from the United States, without any change
in the exchange rate. State Council Economic and Financial Leading
Group Vice Minister Liu He noted the currency issue was no longer an
economic issue, but more of a "political issue for both sides." Liu
explained that exports, while slower, had still helped China

BEIJING 00000352 002 OF 002


successfully create new jobs this year, keep the unemployment
rate--and thus the political system--fairly stable.

¶6. (SBU) Assistant Finance Minister Zhu Guangyao agreed that both
China and the United States faced political constraints and
pressures with regard to the exchange rate, and urged Washington and
Beijing to maintain open communication to manage this issue and keep
it out of the public eye as long as possible. Zhu also pointed out
that China was worried about inflows of hot money, stemming at least
in part from low U.S. interest rates.

¶7. (SBU) On the other hand, private economists agreed that Chinese
officials likely favored a return to gradual appreciation of the
RMB, despite the possibility of attracting speculative capital
inflows. UBS economist Wang Tao, for example, expected a move
mid-year, with a near-term goal of five percent appreciation by
year-end 2010. China Construction Bank Vice President/Chief
Economist Hwa Erh-cheng agreed that the exchange rate was a
"challenge" for the People's Bank of China (PBOC), and even though
the PBOC might be forced to allow appreciation, it would only be
incremental because the international environment remained fragile
and the export recovery was not strong. Predicting that the RMB
would rise about three percent in 2010 and five percent in 2011, Hwa
concluded that it was unlikely to be a "one-shot" change (e.g. a
jump appreciation). China knows it needs to increase domestic
demand and consumption to stabilize growth and adjust economic
structure in 2010, so the exchange rate issue must eventually be
"part of the equation." However, Hwa asserted that the Chinese
Government "will not be influenced by a Dialogue."

Rising Housing Prices/ Overheating
---------------------------------

¶8. (SBU) On an overheating economy, Vice Minister Liu He pointed to
asset bubbles as a potential problem for China's recovery and noted
that people are withdrawing money from banks to invest in assets.
Liu did not yet see the problem as serious. As a reaction to the
trend, the China Banking and Regulatory Commission (CBRC) has
instituted requirements to deter speculation, and the State Council
has ordered measures to tighten credit and mandated monitoring of
state-owned enterprise (SOE) investment in real estate. NBS DG Li
Xiaochao noted that the real estate sector is important to the
economy because it boosts both consumption and investment; however,
housing prices jumped 7.8 percent in December, which was a worrisome
sign of over-investment and speculation in real estate. On
inflation, Li claimed that, although 2009 saw negative inflation,
November and December numbers turned positive. Bad weather in
December and January, together with the government's proactive
fiscal policy, had generated inflationary pressure.

¶9. (SBU) CCB Vice President/Chief Economist Hwa Erh-cheng said the
Chinese Government is actively trying to cool the real estate
market. Because private companies have been blocked from investing
in the service sectors, more investment has flowed to real estate,
increasing housing prices by as much as 50 percent in coastal
cities. Further adding to the problem, SOEs have out-bid private
companies, pushing up land prices. To deter speculation, Hwa said,
the CBRC has required banks to disburse loans to real estate
suppliers rather than buyers. The market has started to believe
that the government will continue to tighten monetary conditions to
control overheating.

¶10. (U) The delegation cleared this cable.

HUNTSMAN