(SBU) SHANGHAI FINANCIAL SECTOR SEES CHINESE INVESTMENT AS

UNCLAS SECTION 01 OF 05 SHANGHAI 000119

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E.O. 12958: N/A
TAGS: CH ECON EFIN PGOV PREL
SUBJECT: (SBU) SHANGHAI FINANCIAL SECTOR SEES CHINESE INVESTMENT AS
KEY TO RECOVERY


1. (SBU) Summary. China 's stimulus program emphasizes capital
investment, particularly in railways, subways, roads, and
airports, say a variety of Shanghai financial sector
professionals. Shanghai has been quick to seek support for
previously rejected World Expo and other projects. At the same
time, our interlocutors suggested that some thought is being
given to spreading investment to inland and rural China. Bank
lending will be key to the stimulus, suggested several bankers.
However, the People's Bank of China (PBOC) is also concerned
that excessive credit growth could lead to inflation. The
United States was blamed for the financial crisis, and potential
trade protectionism was cited as an aggravating factor. U.S.
banks may emerge from the crisis to find the China market less
welcoming. End summary.


2. (U) This is the first of two reports based on Beijing
Finatt's February 19-20 meetings in Shanghai. This first report
covers macroeconomic issues, and the second covers financial
service sector trends.

============================
Stimulus Package Focuses on Capital Investment
============================


3. (SBU) China 's stimulus program needs to emphasize
investment, since only investment can make up for falling
exports, Lian Ping, chief economist of Shanghai-based Bank of
Communications, one of China's top five banks, told the Finatt
delegation. Of the "three horses" that power the Chinese
economic "cart" (san1 ma2 che1),said Lian, exports are falling,
consumption is maintaining its share, and therefore investment
must make up the difference. Lian explained that this is the
same approach used with success during the Asian Financial
Crisis. Ding Guorong, chairman of Shenyin & Wanguo Securities,
one of China's largest securities firms, said that in his
optimistic scenario, the stimulus program will bolster the
Chinese economy for 12 months, until exports rebound again in

2010.


4. (SBU) Our interlocutors agreed that the stimulus targets
railways, subways, roads, and airports--which they explained
have the greatest potential for bolstering economic growth.
Steve Lee, CEO of HSBC Jintrust Fund Management Co., said that
medical infrastructure was also among the focal points of the
stimulus plan. As for particular sectors, Lian Ping and Ding
Guorong specifically pointed to the Central Government's 10
industry support plans as having an impact--Ding exclaimed that
these plans had far exceeded the financial sector's
expectations.


5. (SBU) Lian said that the RMB 4 trillion (approximately
US$586 billion) stimulus is already having an impact. Ding
similarly predicted that China's market has reached bottom, and
the economy will see quarter-on-quarter rises for the next three
to four quarters. At the same time, Lian said that the Central
Government's contribution to the stimulus--RMB 1.18 trillion
(approximately US$173 billion) over two years, or equivalent to
only around 3 percent of GDP per year--does not surpass
international norms; the full stimulus will be filled out by
matching funding from local governments, local banks, and
private investment. Lian agreed that, contrary to the views of
some government officials, China could easily allow budget
deficits above 3 percent of GDP, and even as high as 5 percent
without raising concerns about their sustainability or China's
creditworthiness.

============================
New Policies May Benefit Interior Cities
============================


6. (SBU) Some of the investment may be directed to central and

SHANGHAI 00000119 002 OF 005


western China through innovative policies, explained Shanghai
Financial Services Office Director General Fang Xinghai. For
instance, Beijing is considering moving the headquarters of
Chinese corporations to interior cities, since in theory these
companies do not need to be based in the capital. Sinopec,
China's leading petrochemical firm, could be headquartered in
the Anhui provincial capital, Hefei. There are good prospects
for domestic-led growth in Hefei, said Fang, with the urban area
having doubled in recent years, but this was built on migrant
worker remittances, which now may fall off.

============================
Shanghai Quick To Seek Support for New Investment
============================


7. (SBU) Given the emphasis on investment in the stimulus
program, the Shanghai Municipal Government has been delighted to
find that many major projects put on hold by the Central
Government in 2007 have now been approved, said John Tan, a
Shanghai-based managing director of Standard Chartered Bank.
For instance, Shanghai has received the go-ahead for several
previously rejected World Expo projects, as well as the Disney
theme park, said Tan. In fact, Shanghai officials have called
Standard Chartered to ask for project proposals, said Tan, and
Fang Xinghai has asked Standard Chartered for a letter on viable
projects that he can use in talks with Beijing

============================
Boosting Consumption Will Take Longer
============================


8. (SBU) The contribution of domestic consumption to GDP is
very hard to change, admitted BoCom's Lian. The national plan
to promote purchase of household electrical appliances in the
countryside is one example of a program that could have an
impact, said Lian. Luo Yang, PBOC Shanghai Head Office
International Department Director General, acknowledged U.S.
concerns that China increase domestic demand, and said that
"China understands this responsibility." Wang Kaiguo, Chairman
of Haitong Securities, also one of China's largest securities
firms by several measures, offered a broad endorsement of the
government doing more to help China's 800 million farmers who do
not have enough medical care, roads, and other infrastructure.

============================
Relying on Banks for Policy Support . . .
============================


9. (SBU) Several interlocutors emphasized that China's banks
would support the government's economic turnaround policies,
including BoCom's Lian and Raymond Yin, executive director of
Beijing Gao Hua Securities Company, a joint venture with Goldman
Sachs. Lian said that banks are healthy, with high capital
adequacy ratios and low non-performing loans (NPLs),and thus
are able to support both fiscal and monetary policy easing.
Compared with the time of the Asian Financial Crisis, said Lian,
the banks are better prepared. Yin commented that banks have an
obligation to lend as a way of giving something back to society
after years of high profits. (Comment: PBOC officials have
expressed similar sentiments. End comment.)


10. (SBU) As a result, said Gao Hua's Yin, banks will probably
face higher levels of non-performing loans in the future--and
regulators are prepared to accept this. For instance, PBOC
officials have told Yin that the China Bank Regulatory
Commission is privately saying that it is acceptable to have a
rising level of NPLs, as long as a bank's NPL ratio
declines--this can be achieved simply by raising the overall
level of lending. If later a slack economy causes NPLs to
spike, said Yin, the CBRC has promised not to blame the banks.


SHANGHAI 00000119 003 OF 005



11. (SBU) Banks are also contributing to the macroeconomic
stimulus by acquiescing to lower interest rate spreads, even
though this also puts their bottom line at risk, said Gao Hua's
Yin. PBOC's Luo said that banks, despite excess liquidity, are
still keeping the interest rate on deposits at the maximum
ceiling allowed because they assume that customers will quickly
switch banks if the interest rates are lowered. Banks also want
to keep their level of deposits steady to maintain market share
in advance of the eventual economic recovery. In addition, Luo
explained, banks are helping keep the entire financial market
stable by competing in terms of service quality, not through
interest rates. In the early 1990s, banks offered high deposit
rates to compete for customers, and the result was large losses,
said Luo.

============================
. . . But Keeping Watch on Monetary Expansion
============================


12. (SBU) Bank lending appeared to be too high in January, said
PBOC Shanghai Head Office Statistics and Research Department
Deputy Director General Liu Mingzhi. However, said Luo, the
PBOC cannot issue orders to the banks to rein in lending, and
instead has released some public notices indicating concern.
Over the next two months or so, the PBOC will collect and
analyze banking sector data, said Luo, and some new policies may
result. In particular, said Luo, the PBOC is tracking
discounted bill lending--if this lending subsides, lending could
go forward on a more stable basis. (Comment: The rise in
discounted bill lending appears to be due to interest rate
arbitrage. Companies can borrow through discounted bills and
earn a higher interest rate in corporate CDs. Some corporate
borrowers also appear to be using low interest rates on
discounted bills to speculate in the stock market, accounting
for its recent rise. Due to the sharp fall in interbank rates
and interest paid on excess reserve, discounted bills offer
banks the highest return for parking funds short-term. End
comment.)


13. (SBU) Our interlocutors agreed that monetary authorities
should remain vigilant to avoid an upsurge in inflation. PBOC's
Luo said this is a major future concern, but that inflation does
not look very serious for now. Nonetheless, the PBOC has
carried out some open market operations in recent days to absorb
liquidity. This is a signal to the market that the PBOC does
not want to see another credit fueled boom and bust cycle.
BoCom's Lian Ping separately agreed, saying that the government
for now is saying it wants to "stabilize" the monetary base, not
"tighten" it. Lian summarized a variety of factors that could
eventually lead to inflation: interest rates have dropped,
required reserves have been lowered, PBOC bill issuance has been
decreased, and the national credit quota has been eliminated.
Lian commented that inflation has always resulted from
overlending, especially in an environment of international
inflation induced by substantial monetary easing.


14. (SBU) An additional concern brought by the monetary
expansion is whether freed-up liquidity is flowing toward
speculative investments, said BoCom's Lian. There are some
signs that the extra liquidity is funding the run up in values
of stocks, postage stamps, and gold and silver coins. Real
estate has not been affected, said Lian, although real estate
values are still rising to some extent. Nonetheless, concluded
Lian, most of the liquidity is going to three areas: 1) large
government projects, 2) less cyclical businesses, and 3)
short-term funding needs--the latter explaining the rise in
discounted bill lending.


15. (SBU) Gao Hua's Yin provided an insight into a possible
policymaker perspective on the flood of liquidity into the
market. He said that one of Gao Hua's advisers, Beijing

SHANGHAI 00000119 004 OF 005


University professor Song Guoqing, is highly optimistic that the
surge in the monetary base could bring 9 percent growth by the
end of 2009. Yin said that Song's views may not be mainstream,
but they represent the "pure monetary school" of economic
policymaking.

============================
Many Blame the United States for the Global Financial Crisis
============================


16. (SBU) Several interlocutors emphasized that the United
States was the source of the current financial crisis. Shenyin
& Wanguo's Ding put it most starkly, calling it "the collapse of
the U.S. 'fairy tale.'" Shanghai financial official Fang said
that the global financial crisis is a result of the "profligacy
of U.S. consumers," which in turn has "destroyed confidence in
the U.S. dollar." Haitong's Wang said that he "used to think
that the United States has the best technology and military, but
not since the financial crisis started."


17. (SBU) But our interlocutors also held out hope that the
resolution to the crisis would emanate from the United States.
Fang speculated that the years ahead will be a difficult time
for trade and investment, with "no anchor" for the global
currency system; however, eventually the U.S. dollar will be
reestabilished as the primary, but not sole, global currency.
Other interlocutors offered more general comments, calling the
recovery of the United States essential to world recovery
(Haitong's Wang),and saying that what the United States does
next in the crisis is very important, because the two sides have
closer and closer ties (PBOC's Luo). Several interlocutors
noted concerns that the United States is entering into even
greater financial turmoil from a consumer finance induced
"second wave" of the crisis. (Comment: Concern about the United
States entering a "second wave" of the crisis has become
increasingly prevalent in Chinese media. End comment.)

============================
Concerns Over Possible U.S. Protectionism
============================


18. (SBU) Several interlocutors raised concerns about the "Buy
American" clauses in the U.S. economic stimulus program. The
PBOC's Luo said that the United States is right to want to avoid
the mistakes of the 1930s--since the United States made that
mistake then. Protectionism could undermine future economic
growth, said Shenyin & Wanguo's Ding, and " if there really are
buy local provisions, this will be bad for China."


19. (SBU) At the same time, some interlocutors offered a more
nuanced understanding of the political backdrop in the United
States. The PBOC's Luo said he noticed that Treasury Secretary
Geithner was careful to qualify his statement concerning Chinese
currency manipulation by saying he was quoting President Obama.
Luo also said he understood that this statement was being made
to Congress, implying that he knew it was said for political
purposes. Gao Hua's Yin said that there was shock when
then-Treasury Secretary Paulson was reported as blaming China
for the global financial crisis, but that this calmed down with
Paulson's subsequent correction. "We do understand American
politics, that even Obama has to be a politician," said Yin.


20. (SBU) Haitong Chairman Wang admitted that he thinks of the
United States as a good place to invest, especially now when
valuations are so low. However, his concern is whether or not
Haitong could hold onto senior managers following an
acquisition, given Chinese banks' lack of knowledge of U.S.
culture and laws. Shenyin & Wanguo Chairman Ding also affirmed
that, even though Chinese securities markets are performing
relatively well, his company is interested in greater
cooperation with U.S. firms.

SHANGHAI 00000119 005 OF 005



============================
U.S. Banks May Find Doors Harder To Open
============================


21. (SBU) Citi China CEO Andrew Au noted that Citi is
increasingly viewed as "part of the U.S. Government," which may
make Chinese clients want to hold back on revealing information
to Citi. Au also said that "the gap is widening" in terms of
branch approvals for Citi vs. HSBC and Standard Chartered: over
the past four years, Citi has had three branch approvals, while
the others have had ten each. Citi's last branch approval was
for Dalian, in December 2007; Citi's current Chongqing branch
application and others are still under review by the PBOC. In
effect, said Au, where there used to be a 50/50 split in branch
approvals for European and U.S. banks, there is now closer to a
70/30 split in Europe's favor.


22. (SBU) Haitong's Wang offered a different comparison of U.S.
and European banks. Wang said Chinese banks have been generally
unsuccessful in opening branches in the United States, despite
more than ten years of trying, while China itself is open. In
addition, the first phrase U.S. securities firms use in
negotiations with potential partners is "I'm going to eat you
up," said Wang--the U.S. side demands a 49 percent share the
first year, a 51 percent share the second, and 100 percent
ownership the third. Singaporean and European banks, on the
other hand, are less aggressive, willing to hold minority
shares, and seek to start small and grow.

============================
Comment
============================


23. (SBU) Many of these February 19-20 Shanghai interlocutors
reflected expectations that China's economic stimulus plan would
be effective in reviving China's economy in advance of an
anticipated 2010 rebound in global trade, but Gao Hua's Yin hit
a more cautionary note. There are signs that things are getting
better in the first two weeks of January, said Yin, but that is
primarily because of government-supplied liquidity, and final
demand is not rising. Some factories are back up and
running--for instance, in steel there has been some
restocking--but overall electricity demand has not rebounded.
On the export side, said Yin, following the Lunar New Year
multinationals have found no new orders. For instance, CIMC,
the world's largest container maker, has had no orders since
November, said Yin. Domestic Chinese demand appeared to have an
uptick during Lunar New Year, but there was also heavy price
discounting, said Yin; consumers are scaling back, taking a
domestic trip rather than an international one.


24. (SBU) The surge in bank lending appears to have taken
monetary officials by surprise and raised concerns that this
will generate another credit boom and bust. As a result, it is
likely that they will be more reluctant in the near term to ease
monetary conditions further, despite the rise in deflation.


25. (U) Beijing Financial Attache David Loevinger has cleared
on this cable.
CAMP