BOOSTING CHINESE DOMESTIC CONSUMPTION PROBLEMATIC, SAY EAST

UNCLAS SECTION 01 OF 04 SHANGHAI 000380 SENSITIVE SIPDIS DEPT FOR EAP/CM NSC FOR LOI, SHRIER STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI, MAC/OCEA TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP TREASURY FOR IMFP -- SOBEL/CUSHMAN STATE PASS CEA FOR BLOCK STATE PASS CFTC FOR OIA/GORLICK MANILA FOR ADB USED E.O. 12958: N/A TAGS: ECON EFIN EINV PGOV PREL CH SUBJECT: BOOSTING CHINESE DOMESTIC CONSUMPTION PROBLEMATIC, SAY EAST CHINA FINANCIAL CONTACTS ¶1. (SBU) Summary: China's decentralized investment approval process aids the entry of foreign businesses into the China market, in the view of ConGen contacts in Shanghai's financial sector. However, problems with official approval of investment projects and the varying quality of government cadres impede the process. In the longer term, China's plans to develop the service sector and advance domestic consumption will be hindered by the government's unwillingness to embrace political opening and rural land reforms. The contacts also commented on recent corruption cases and the Rio Tinto case, using the latter as an example of what can happen when a foreign company publicly embarrasses the Chinese leadership. End Summary. ¶2. (SBU) ConGenOffs met with four financial sector contacts on August 27. Two of the contacts are investment advisors, one focused on the securities markets and the other facilitating Sino-foreign mergers and acquisitions. Another is the chief economist of a foreign financial firm. The fourth heads a joint-venture securities firm. ============================ Local Governments Make Deals ============================ ¶3. (SBU) While China presents the image of a unified foreign investment approval system, the reality is that local governments in East China have great leeway to approve projects, according to these financial professionals. Local authorities have many reasons to say yes to investments, but central-level officials have many more reasons to say no. Some central-level officials openly admit that their hands are tied, one said, and privately advise him to reconfigure deals so that they can be approved by local authorities without review from the center. ============================================= =========== Government Officials Not Cut From the Same Cloth Anymore ============================================= =========== ¶4. (SBU) Government officials vary widely in capacity and predisposition. One contact said that, in the Central Government, there was a higher quality in the "C's," referring to the relatively new commissions such as the China Banking Regulatory Commission, than in the "M's," the ministries. He was impressed with the quality of government officials with whom he had recently served for several months on a Central Government-sponsored legal reform advisory committee. These present and former officials were willing to debate the issues at length, maintaining articulate and informed positions. He said government officials come in all stripes these days, from market-oriented to protectionist and nationalistic. ========================================== Corruption Crackdown Politically Motivated ========================================== ¶5. (SBU) The financial professionals viewed recent SHANGHAI 00000380 002 OF 004 anti-corruption cases in the Chinese media as posturing by the Communist Party ahead of the 60th anniversary of the founding of the People's Republic of China on October 1. (Note: The contacts were referring to the case of Huang Guangyu, the founder of the Gome electronics chain, who was detained in November 2008, and to the August 2009 news that several high-ranking officials had been detained in an investigation into criminal gangs in Chongqing, among others. End note.) One suggested that the authorities needed to launch periodic crackdowns on corruption to sate the anger of the masses over official misdeeds. He did not see major corruption cases breaking in Shanghai, since Party Secretary Yu Zhengsheng has been very good at keeping in Beijing's good graces, and would not cross Hu Jintao like former Shanghai Party Secretary Chen Liangyu did before his downfall in 2006. ============================================= ========= China Slowly Moving Towards Domestic Consumption . . . ============================================= ========= ¶6. (SBU) There was some debate over whether China is moving towards an economy driven by domestic consumption. Those who agreed pointed to the vast changes over the past ten years in the landscape for Chinese retail consumers. In the 1990s, for example, the securities market advisor said, foreign retailer Carrefour was "a freak show" for most Chinese, but now business is booming at Carrefour hypermarkets in Shanghai, with Chinese buying mainly locally produced products. The investment advisor said second- and third-tier cities are bursting with consumption activity. And the securities firm executive said his company is recommending to clients to buy into consumption-related stocks, including automobiles and white goods, because of the potentially strong medium-term growth. The macroeconomist, however, offered a contrarian analysis, saying that most of the government-led economic stimulus measures announced in late 2008 had been misguided, flowing into unneeded infrastructure rather than helping push domestic consumption. ============================================= . . . But Services Sector Growth Stymied . . . ============================================= ¶7. (SBU) Nonetheless, China faces some hurdles regarding domestic consumption growth. One contact said, ultimately, service sector growth is restricted by lack of political reform. The Central Government understands it would need to permit enhanced political freedom and a loosening of control over political debate before the service sector can take off. However, the leadership is unwilling to take these steps, even though it means sacrificing the development of China's service sector. (Note: This connection has been made by other analysts in light of the recent Green Dam incident, in which the Ministry of Industry and Information Technology attempted to place controls on domestic computer access to the internet. End note.) SHANGHAI 00000380 003 OF 004 ============================================= ====== . . . And Rural Incomes Restricted by Land Policies ============================================= ====== ¶8. (SBU) Rural land reform is needed to stimulate greater domestic consumption and growth, according to the securities firm executive and the investment advisor. However, many officials fear that providing peasants with the right to sell land use rights would go badly, with discontented and eventually landless peasants ripe for social unrest. The government assumes that the peasants would sell away their land use rights for too little compensation, said the securities firm executive, but he thought that peasants are smarter than that. Chinese officials draw an analogy with the social unrest involving state-owned enterprise employees in the late 1990s, who were paid for early retirement, but began protesting a few years later to get another payout. There was general agreement that the internal jockeying prior to the 18th Party Congress in 2012 would make all players very conservative on this front. ================== The Rio Tinto Case ================== ¶9. (SBU) The Rio Tinto case was raised as an example of the dangers a foreign firm faces if it crosses the Communist Party. Rio Tinto's real problem had been to humiliate publicly the Chinese leadership, the macroeconomist said. Beginning in early 2009, he explained, the Chinese side attempted to take the lead in negotiations over international iron ore prices, claiming this right as the single biggest purchaser of iron ore worldwide. However, commodity prices began to rise again, and one by one importers in other Asian countries agreed to pay higher prices. At this point, rather than giving the Chinese a face-saving way out, Rio "twisted the knife" by demanding China agree to a higher price, and "made the Chinese leaders look stupid in public." The arrests and charges of stealing state secrets, in this context, are the Chinese side's "negotiating tactics." ¶10. (SBU) In actuality, said the macroeconomist, what Rio did is common practice in the industry. Other companies take the same Chinese officials out to the same restaurants; by the Rio standard they could also be prosecuted. (Note: According to Western media, Chinese officials raided Rio Tinto's Shanghai offices on July 5 and detained four employees, who are being investigated for bribing Chinese steel industry officials during iron ore price negotiations. On August 11, Chinese prosecutors formally charged the Rio Tinto employees with infringing trade secrets and bribery, without raising the more serious charges involving state secrets. End note.) ======= Comment ======= SHANGHAI 00000380 004 OF 004 ¶11. (SBU) These contacts see clearly the linkage between political and economic reform, and the unfortunate likelihood China's leaders will back away from any initiative in this regard until after the 18th Party Congress in 2012. This could begin to have a tangible impact on East China's economic growth, especially given the Shanghai government's goal to develop its service sector to counteract the export downturn and, by 2020, to turn the municipality into an international financial center. CAMP