HKMA SAYS CHINESE REGULATORS MOVING BACKWARDS ON

C O N F I D E N T I A L SECTION 01 OF 03 HONG KONG 000134

SIPDIS

SIPDIS

STATE FOR EAP/CM AND EEB/IFD/OMA;
TREASURY FOR MCCORMICK, DOHNER, HOLMER, OASIA

E.O. 12958: DECL: 01/18/2018
TAGS: ECON EFIN HK CH
SUBJECT: HKMA SAYS CHINESE REGULATORS MOVING BACKWARDS ON
LIBERALIZATION

Classified By: EP Chief Laurent Charbonnet, Reasons 1.4 b/d


1. (C) Summary: Hong Kong Monetary Authority (HKMA)
officials share U.S. concerns about tighter restrictions
emanating from the Chinese Securities Regulatory Commission
(CSRC) and said CSRC officials score political points for
resisting U.S. demands. HKMA is lobbying the Chinese Banking
Regulatory Commission (CBRC) to relax its three-year
operations requirement before an incorporated foreign bank
can issue RMB-denominated subordinated debt to increase its
capital. Chinese requirements that foreign banks move their
debit and credit card data processing operations to Mainland
China are driven by fear of losing access to individuals,
financial data. Hong Kong-based analysts agree that Chinese
officials should tolerate a higher long-term rate of
inflation given China's continued high growth. While the
Chinese Central Bank's inflation target of 3% is too low and
the risks of a disinflationary drop in external demand is
rising, the balance of risks call for further monetary
tightening, preferably through a stronger exchange rate.
Former Beijing Mayor Wang Jishan is expected by almost all
analysts to take over the financial portfolio as Vice
Premier. While Wang is expected to oversee the financial
regulatory agencies, and will be a more decisive leader able
to resolve interagency disputes impeding reforms, analysts
question whether financial regulators will be consolidated
into a unified agency. End Summary.

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HKMA Concerned Financial Liberalization is Slipping
============================================= ======


2. (C) U.S. Embassy Beijing Minister Counselor for Financial
Affairs David Loevinger, Deputy Financial Attach Hugo Yon
and ConGen Hong Kong Econoff met with Hong Kong-based
analysts and senior HKMA officials to discuss recent
developments in financial services and in the Chinese
economy. HKMA Deputy Chief Executive Peter Pang and
Executive Director Julia Leung (protect) echoed U.S. concerns
that the CSRC is tightening restrictions on foreign financial
services companies, credit rating agencies in particular.
The CSRC is trying to protect Chinese securities companies.
CSRC officials have boasted to HKMA officials about resisting
U.S. demands and a change in leadership, and particularly at
the CSRC, is probably the only way to reverse this position,
said Pang.


3. (C) HKMA also shared U.S. concerns about continued
obstacles to foreign banks, ability to issue their own
credit and debit cards (foreign banks can now only do so
through joint ventures with Chinese banks). While the China
Banking Regulatory Commission has granted incorporated
foreign banks licenses to issue cards, the People's Bank of
China continues to require these banks to move their data
processing to Mainland China. HKMA officials lamented that,
for purposes of data processing, Hong Kong is not considered
part of China (M-C Loevinger noted that his mid-January
conversations with officials in PBOC's payments bureau
confirm that this remains the PBOC's position). Leung
attributed this reluctance to "privacy" concerns; both the
concern that other governments would get access to
information about Chinese consumers and fears that Chinese
authorities would lose access to financial data. She added
that Chinese officials note that after the U.S. government
began to access SWIFT data, the European Commission required
European banks to safeguard personal data of European
citizens by moving their data operations to Europe. Even
more worrying to HKMA was a report that the CBRC would
require all foreign banks incorporated in China to process
data domestically (not just credit and debt card
transactions). While Loevinger noted that one large foreign
bank would ultimately agree to move its data processing
operations Leung suggested that the U.S. and HK governments
and foreign banks maintain a unified position for now to at
least allow foreign banks to maintain data operations in Hong
Kong (close hold).

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HKMA asks Chinese Govt. to Relax RMB Debt Requirements
============================================= =========


4. (C) HKMA officials welcomed the SED agreement to allow
foreign banks to issue RMB-denominated debt. They are asking
the central government to relax prudential regulations on the
ability of foreign banks incorporated in China to issue
RMB-denominated subordinated debt to meet their capital
requirements. Current regulations require three years of

HONG KONG 00000134 002 OF 003


Chinese operations before subsidiaries of international banks
are allowed issue this debt to grow their business. HKMA is
advocating that time spent as Chinese branches of
international banks, rather than just time as subsidiaries,
should count towards that three year requirement. Leung
added that it is always easier to ask the central government
to reinterpret the rules than to ask for change. (Beijing
FINATT Comment: Given increased difficulty in gaining
approval from the State Administration of Foreign Exchange to
bring in foreign exchange to expand banks, capital, the
ability to issue RMB-denominated subordinated debt is
increasingly important to foreign banks. End comment).

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HK-Based Analysts See Chinese Inflation Risks
=============================================


5. (U) Discussing the risks of inflation on the Mainland and
necessary monetary policy responses, Hong Kong-based analysts
from JP Morgan and Citi both expected inflation rates to fall
as the impact of temporary agricultural supply shocks wanes,
but to remain moderately high due to continued buoyant
monetary conditions. Asianomics, Jim Walker believes current
investment already in the pipeline will continue to drive
rapid economic growth and encourage accelerating inflation.
All agreed that the Chinese government has historically been
excessively adverse to moderate rates of inflation, given
that most emerging economies with sustained high rates of
growth have also had moderate levels of inflation (Comment:
particularly those with rigid exchange rates. End comment).



6. (U) Analysts all felt that the People's Bank of China
current inflation target of 3% is too low. Citibank's Huang
Yiping noted however that the official inflation figures
underestimate the true level by at least 1.5 percentage
points and agreed that the recent adjustment by the World
Bank in the size of China's economy at purchasing power
exchange rates was an indication that inflation has been
underestimated for an extended period. Huang noted that
administrative controls were keeping prices down and the CPI
basket under-represents key components of the economy, with
higher than average inflation rates, including housing,
health care, and services. JP Morgan's Frank Gong agreed, but
estimated that 6% inflation would be tolerable. The current
rate of 6.9% worries Chinese policymakers, he said, and was
the inspiration for additional price controls on fuel.
(Note: The Chinese Government subsequently announced price
controls on several agricultural products). However,
tightening rhetoric has yet to be supported by significant
policy measures to restrain the credit or investment growth.
Chinese inflationary expectations are on the rise and will
spur continued inflationary pressure as well as hoarding of
price-controlled goods.


7. (U) Continued RMB appreciation is the right response to
accelerating inflation, said Gong. The debate in Chinese
policy circles is no longer about whether to allow the RMB to
strengthen, it is about whether it is better to allow a
one-off adjustment or to continue to allow gradual
appreciation. Over the past two months, the RMB has
appreciated by 1% per month against the U.S. dollar (a 17%
annualized rate); it is clearly a coordinated policy shift
since the National Party Congress in October. Huang noted
that a discreet one-off appreciation that falls short of what
market participants believe is needed to achieve expectations
of two-way risk (Huang's clients tell him this would need to
be an increase of 15-20%) would only encourage additional
capital inflows and that an increase in the rate of
appreciation is more likely to foster an orderly adjustment.
All were disappointed by the government's increased use of
price controls as it would add to distortions in the economy
and dampen price signals necessary to encourage agricultural
production and reduce investment in energy-intensive sectors.


8. (U) Analysts thought that the PBOC's shift in 2007 away
from sterilization bonds and toward reserve requirements as a
way to soak up liquidity was driven by the PBOC's declining
net income as interest rate spreads have narrowed (and in
some maturities inverted) between U.S. dollar and
RMB-denominated bonds. Most felt that scope for further
increases in reserve requirements is increasingly limited
(with perhaps room for a cumulative increase of 100-200 basis
points) given the adverse impact on commercial banks, net
income.

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HONG KONG 00000134 003 OF 003


China's Biggest Worry? U.S. Slowdown
=====================================


9. (U) Analysts agree that China's biggest worry now isn't
inflation, but slowing external demand, particularly from a
rapidly slowing U.S. economy. If the global economy does
slow, the central government's strong fiscal position will
allow it to loosen fiscal policy to boost domestic demand.
It's hard to imagine Chinese domestic demand slowing in the
near term, said Huang. JP Morgan is predicting slightly
slower Chinese growth in 2008 said Gong, but he expects the
central government to resort to fiscal stimulus if the growth
rate falls below 9%. Both Huang and Gong thought that public
infrastructure to reduce bottlenecks would continue to be
productive investments and the best fiscal response, if
needed.


10. (C) Wang Jishan is widely expected to be appointed as
Vice Premier in charge of financial policy in the next
government. Analysts and officials were optimistic Wang's
experience in the financial sector (as CEO of China
Construction Bank) and his decisive style would allow him to
effectively coordinate the sometimes inconsistent policies of
the financial regulatory agencies. Gong predicted that a
government reorganization would place Wang in charge of all
of the financial regulatory bodies. HKMA officials hope
Wang's appointment means there will finally be one hand on
the financial policy tiller and that his presence would lead
to speedier financial liberalization.


11. (C) Beijing Minister-Counselor for Financial Affairs
Comment: CSRC's comments to HKMA that they gain politically
by resisting U.S. demands highlights the occasional dilemma
of engaging China bilaterally through high-level foray that
seek agreement to specific USG requested "deliverables."
Both foreign financial services contacts and Chinese
government officials have stressed that in some circumstances
high level U.S. advocacy of policy changes can delay their
implementation. Discussions with HK-based analysts highlight
how the weakening of the U.S. economy and shift in U.S.
monetary policy have made the Chinese monetary policy
decisions more difficult. Coincident indicators of inflation
and investment remain high. Household and business surveys
point to rising inflationary expectations. And most
importantly, there has been an historical tendency to boost
investment when new central and local government officials
take office, as they will this March. All of these factors
strengthen the case for monetary tightening. However,
mainland monetary officials are likely to be cautious about
tightening, given the uncertainty about external demand,
particularly in the U.S., and the risks of an extended
downturn. Moreover, the decline in U.S. interest rates has
increased the cost to the PBOC of sterilized intervention,
leading the PBOC to pass on the cost increasingly to
commercial banks through greater use of reserve requirements
paying lower interest rates. To limit the adverse impact on
banks, income, monetary officials have had to maintain high
intermediation spreads through ceilings and floors on deposit
and loans rates, respectively. And just as reserve
requirements and lending quotas hurt the most efficient
banks, floors on lending rates hurt the most efficient and
credit worthy borrowers.


12. (U) Beijing Financial Minister-Counselor for Financial
Affairs David Loevinger cleared this message.

Cunningham