INTERAGENCY INSIGHTS FROM NDRC FINANCE DIRECTOR

S E C R E T SECTION 01 OF 03 BEIJING 020974

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E.O. 12958: DECL: 09/29/2031
TAGS: ECON PGOV ETRD EFIN EINV KPAO CH
SUBJECT: INTERAGENCY INSIGHTS FROM NDRC FINANCE DIRECTOR
GENERAL


Classified By: Minister-Counselor for Economic Affairs Robert Luke; Rea
sons: 1.4 (B/D)


SUMMARY
--------------


1. (S) The recently-promoted National Development Reform
Commission (NDRC) Director General in charge of financial
affairs (protect) offered candid and even critical comments
about the Ministry of Finance (MOF),the People's Bank of
China (PBOC),and the internal workings of the NDRC itself.
He faulted MOF for excessive focus on the accounting of
government financial flows without thinking more broadly
about the effect of changes in fiscal policy on the economy.
He criticized the PBOC for being too lenient in its approval
of corporate bond issuances. The DG spoke highly of the NDRC
itself, describing an informal atmosphere with strenuous
internal debates, and noted that its influence draws mainly
from its role as the secretariat to the State Council on
economic policy. He faulted his superiors, however, for a
lack of understanding about the necessary prerequisites for
developing a corporate bond market. The DG is a former
Humphrey Fellow and spoke warmly of the opportunity provided
to him a decade ago to study in the United States. END
SUMMARY.

UNUSUAL CANDOR
--------------


2. (S) Our NDRC contacts are generally tight-lipped and stick
to their talking points, but on September 28, a
newly-promoted DG broke this mold during a gathering with
Econ MinCouns, Finatt, and Econoff. DG Xu Lin (protect)
oversees the Department of Fiscal and Financial Affairs and
was recently a Deputy DG involved with the formulation of the
Eleventh Five-Year Plan. He spoke with notable frankness
about the challenges of coordinating economic and financial
policy with other agencies in the Chinese Government and even
within the NDRC itself.

AT ODDS WITH HIGHER-UPS ON CORPORATE BONDS
--------------


3. (S) Xu said that most of his time is devoted to overseeing
China,s (corporate) bond market. Xu lauded progress to
date, noting that market capitalization recently jumped to
around USD 13 billion (RMB 100 billion) from USD 8 billion
(RMB 65 billion) a year ago. Xu noted an important goal of
his is to increase access to the bond market for small and
private sector firms. (Comment: Almost all long-term bond
issuances are by large state-owned enterprises. End
Comment.)


4. (S) Xu stressed, however, the need to proceed cautiously,
noting that moral hazard among borrowers is a bigger risk in
the bond market than in the banking sector, despite the large
number of non-performing loans in the latter. When asked, he
gave no indication that the requirement that all bond
issuances be guaranteed by banks (a key factor for borrower
moral hazard) would be lifted soon. Xu stressed that Chinese
investors are not adept at assessing and pricing credit
risks.


5. (S) When asked about NDRC,s recent decision to postpone
large foreign currency denominated bond issuances by MOF,
China Ex-Im Bank, and China Development Bank, Xu complained
that his bosses at NDRC view bond issuances primarily as a
way to finance investment and manage overheating. In Xu's
view, his bosses should better appreciate the importance of
sovereign issues in establishing a liquid benchmark yield
curve that can be used to price corporate risk, even if the
bonds are not needed for financing.


6. (S) Xu criticized the PBOC as being too lenient in its
approval of bond issuances. (Comment: PBOC regulates the
inter-bank short-term bond market, while NDRC regulates the
long-term bond market. End Comment.) NDRC not only pays
greater attention to borrowers, creditworthiness, but bases

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its approval on the extent to which the proposed financing
promotes China,s industrial policy goals. Xu said that
prior to his arrival, the NDRC and PBOC clashed over this
issue, with the disagreement reaching the extent that NDRC
would not consider approving a bond issuance by any company
which had used the short-term bond market. Xu said he has
tried to patch things up since that time and has reversed
this policy.


7. (C) Comment: When China's corporations raise funds, they
overwhelmingly rely on bank loans. Corporate bonds provide
an alternative capital market-based means for taking on debt,
and establishing broad trade in a liquid set of trading
instruments of this sort is considered a hallmark of
financial system liberalization and development. In China,
however, corporate bonds lag far behind stocks and government
bonds as a capital market fund raising tool, mainly because
financial regulators have been concerned about the impact of
financial disintermediation on the health of China,s large
state-owned commercial banks and NDRC,s desire to channel
financing to favored sectors, firms, and projects. (Xu
admitted, for example, that sectors considered to have
excessive investment, such as steel, autos, and even basic
infrastructure, are not looked upon favorably for bond
issuance.) To date, corporate bonds have generally been
associated with specific construction projects. EIU
statistics show that as of June 2006, there were 53 financial
and corporate bond issuances traded in Shanghai with a market
capitalization of approximately USD 15 billion (RMB 118
billion). End Comment.

CRITICAL OF MOF APPROACH TO FISCAL POLICY
--------------


8. (S) Xu was critical of MOF for focusing excessively on
accounting for government revenues and expenditures rather
than thinking about the dynamic economic effects of changes
in fiscal policy, especially on a sectoral basis. Finatt
noted the view of many economists that rebalancing the
macroeconomic policy mix though tighter monetary policy and
looser fiscal policy (particularly through increased social
safety net expenditures) would help China achieve more
balanced, consumption-led growth. Xu acknowledged the need
to increase social welfare expenditures but suggested that,
given signs of overheating, the government should tighten
both monetary and fiscal policies, i.e., government policies
should be a net catalyst for reining in the economy.

CURRENCY THOUGHTS
--------------


9. (S) Xu said that when China adjusted its exchange rate in
July 2005, he was concerned that the 2.1% appreciation was
too modest. His view at the time was that a larger movement
was in order so as to create a market perception of two-way
appreciation/depreciation risk in order to limit speculative
inflows. Xu did not elaborate to what degree he may have
revised this view, but said he supports continuation of the
RMB's gradual appreciation. Xu observed that NDRC has only
one seat on the PBOC Monetary Policy Committee, occupied by
NDRC Deputy Chairman Zhu Zhixin, but stressed that that
NDRC's greater influence comes through its role of preparing
policy documents for the State Council. Xu noted that he and
his staff advise Zhu on monetary and exchange rate matters.

BOHAI EQUITY FUND
--------------


10. (C) Xu trumpeted the creation of China's first "private
equity" fund, the Bohai Industrial Investment Fund, which
will be based in Tianjin and directed by a former employee of
the Bank of China in Hong Kong. While acknowledging that the
fund will actually be composed of government money, Xu said
that the creation of such funds is an important component of
financial liberalization and could boost other alternative
financing means like venture capital. Recent Chinese and
Western media reports covered National Social Security Fund
(NSSF) Chairman Xiang Huaicheng announcing the fund on
September 20 at the Sino-French Financial Forum in Beijing.

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The NSSF, which has amassed nearly USD 29 billion, will put
approximately USD 130 million (RMB 1 billion) into the Bohai
fund.

NDRC'S INTERNAL CULTURE
--------------


11. (S) Xu described interaction at the NDRC as informal and
collegial, with people from different sections routinely
engaged in vigorous internal debate. Xu's own section has 19
people, and their work is often informed by the work of
sector-focused analysts in other departments.

BIOGRAPHICAL INFORMATION
--------------


12. (C) Xu speaks excellent English and appears favorably
disposed towards the United States, particularly as a result
of studying from 1995-96 at American University as a Humphrey
Fellow. Xu was promoted in June 2006 to his current
position. Xu would be an excellent interlocutor for visiting
USG finance and economic officials and a useful participant
in bilaterals covering financial sector issues, such as the
U.S.-China Financial Sector Working Group. (Finatt invited
him to the next session scheduled in January 2007.)


13. (U) Highlights taken from Xu's biography previously
provided to the Boao Forum:

Born: June 12, 1962; Changsha, Hunan Province.

Experience and Activities:
-- Deputy Division Director, Division Director, and Deputy
Director General in the Department of Development and
Planning at the NDRC.
-- According to the Bohai bio, Xu "was in charge of
formulating (the) national five-year development plan,
industrial policies, regional development policies, and trade
policies, (and) has been involved in formulating China's
eighth five-year, ninth five-year, and tenth five-year social
and economic development plans."
-- Member of the Chinese WTO delegation, in charge of the
negotiation on industrial policies and industrial subsidies.

Education:
-- June 1995-July 1996, Hubert Humphrey Fellow at the
American University (Washington DC)
-- 1989, M.A. in Economics, Institute of Economics, Nankai
University (Tianjin)
-- 1981, B.A., Department of Mathematics, Shaoyang College
(Hunan)
SEDNEY