Cablegate: Frb Governor Warsh Told Rmb Appreciation Gradual, No Stock

VZCZCXRO6017
RR RUEHCN RUEHVC
DE RUEHGH #0777/01 3410831
ZNR UUUUU ZZH
R 070831Z DEC 07
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 6509
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7027

UNCLAS SECTION 01 OF 03 SHANGHAI 000777

SIPDIS

SENSITIVE
SIPDIS

STATE PASS FEDERAL RESERVE BOARD FOR GOVERNOR
WARSH/AHMED/JOHNSON/SCHINDLER; SAN
FRANCISCO FRB FOR CURRAN/LUNG; NEW YORK FRB FOR DAGES/CLARK
STATE PASS CEA FOR BLOCK
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/READE
USDOC FOR 4420
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND MCQUEEN
TREASURY FOR EXEC - TSMITH, OASIA/ISA -DOHNER/BAKER/CUSHMAN
TREASURY FOR WRIGHT AND AMB HOLMER
TREASURY FOR SOBEL AND MOGHTADER
NSC FOR MCCORMICK AND TONG

E.O. 12958: N/A
TAGS: EFIN EINV PGOV CH
SUBJECT: FRB GOVERNOR WARSH TOLD RMB APPRECIATION GRADUAL, NO STOCK
COLLAPSE BEFORE OLYMPICS

REF: A. SHANGHAI 679

B. SHANGHAI 251

SHANGHAI 00000777 001.2 OF 003

(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels or via
the internet.

1. (SBU) Summary: According to the Shanghai branch of the
People's Bank of China (PBOC), RMB appreciation will continue at
a gradual pace without any dramatic revaluations in the near
future. Federal Reserve Governor Kevin Warsh, in Shanghai
November 18-20, was also told that the PBOC is closely watching
the sub-prime mortgage problems in the United States due to the
"close relationship" between the USD and the RMB. Shanghai
Stock Exchange senior officials said there is government support
for not allowing the stock market to crash before the 2008
Beijing Olympics. Blocking Chinese companies from listing on
stock markets overseas is a temporary measure designed to help
both the Chinese stock markets and companies in China. The
Chinese Financial Futures Exchange's (CFFEX) first product,
stock index futures, will not be launched without State Council
approval as no Chinese official wants to get blamed should its
launch lead to a stock market collapse. Once it is launched,
Qualified Foreign Institutional Investors (QFII) will be allowed
to allocate 10 percent of their quota to invest in CFFEX
products. End Summary.

2. (SBU) Federal Reserve System Board of Governors Member Kevin
Warsh met with Shanghai-based financial officials including the
People's Bank of China (PBOC), the Shanghai Stock Exchange
(SSE), and the China Financial Futures Exchange (CFFEX) during
his November 18-20 visit to Shanghai. Governor Warsh also met
with Bank of Communications (BOCOM) Chairman Jiang Chaoliang,
local and foreign financial services businessmen, Citibank CEO
Richard Stanley and Standard Chartered Senior Economist Stephen
Green during his visit. Embassy Beijing Finatt accompanied
Governor Warsh during his meetings in Shanghai. This cable
reports on Governor Warsh's meetings with the Shanghai PBOC, SSE
and CFFEX. Other meetings will be reported septels.

--------------------------------------------- -
Shanghai PBOC -- We Want to Be Like the NY Fed
--------------------------------------------- -

3. (SBU) Governor Warsh met with PBOC executive Vice President
Hu Pingxi, PBOC Director General Luo Yong, PBOC Deputy Director
General Liu Yongfen, and China Foreign Exchange Trading System
(CFETS) President Xie Duo on November 20. Hu said that the PBOC
established its Shanghai branch in August 2005 hoping that it
would play the same role in China that the New York Federal
Reserve Bank plays in the United States. Close to China's
financial markets, the Shanghai PBOC is assisting in the attempt
to turn Shanghai into an international financial center by
encouraging financial institutions to move here. It conducts
open market operations, monitors and regulates the financial
markets, tests "innovative products," and conducts international
exchange and communications.

--------------------------------------------- --------
RMB to Appreciate Gradually, No Abrupt Moves Expected
--------------------------------------------- --------

4. (SBU) PBOC's Hu expressed concern about interest rate
decreases in the United States while the PBOC is raising rates
in China. The U.S. Dollar is "closely related" to the value of
the RMB and so the PBOC is "paying attention" to the possible
side-affects in China of fallout from the sub-prime mortgage
problems in the United States. Finatt noted the importance of a
flexible currency exchange rate regime to a country's ability to
set a monetary policy that reflected its own needs. Governor
Warsh added that "increasing exchange rate flexibility will help
us establish greater equilibrium in otherwise volatile times."

5. (SBU) Hu said that the RMB will continue to appreciate
gradually without any "abrupt" moves. Due to China's size and
"complicated economic factors," the PBOC cannot afford to move
in a "radical way." Hu expects the exchange rate to decline,

SHANGHAI 00000777 002.2 OF 003

with "small bounces up" after periods of decline in order for
Chinese businesses to try to avoid losses due to RMB
appreciation.

--------------------------------------------
No Stock Market Collapse Before The Olympics
--------------------------------------------

6. (SBU) SSE Executive Vice President James Liu, noting that the
SSE Composite Index (SCI) had risen approximately 100 percent in
2007, said that there had been a flood of new investors entering
the stock market (Ref A). These new investors have no
experience with a market that may decline as fast, or faster,
than it has risen. Liu said that the SSE, the China Securities
Regulatory Commission (CSRC), and others throughout the
government are focusing on educating investors about the risks
of investment. (Note: Econoff recently spotted a Chinese "red
letter banner" at a securities firm warning investors that "Bull
Markets Have Risks." While the markets have been up as much as
130 percent this year, more than half of investors have actually
lost money. End note.)

7. (SBU) Liu said that if there was a market crash, there might
be pressure -- both on and from some parts of the government --
to bail out retail investors. However, Liu said, "I would hope
we wouldn't do that. I would advise against it. Consequences
need to be learned." Liu added, "Besides, next year we are
holding the Olympics, so we won't let the market tumble before
that time. The Olympics are definitely a consideration."
(Comment: While many interlocutors have speculated that the
Chinese Government would not permit the stock market to crash
prior to the August 2008 Beijing Olympics since this could lead
to massive protests, this is the first time that post has heard
an official explicitly state it. End comment.)

--------------------------------------------- -----------
The Benefits of Listing at Home: We Can Take Care of You
--------------------------------------------- -----------

8. (SBU) SSE's Liu noted that the Chinese Government had "put a
stop" to Chinese companies listing outside of China. This is a
temporary measure that "will not last forever." The CSRC is
hoping that Chinese companies that might have wanted to list
overseas would list in China. Liu approved of this move since
he believes that the majority of Chinese companies that listed
outside of China were undervalued by foreign investors and have
not performed well.

9. (SBU) Liu said that Chinese companies that had listed
overseas "did not know what they were getting into, were not
prepared, and suffered from a lack of understanding of United
States corporate culture." Listing first in Shanghai, and then
overseas, gives Chinese companies a chance to function in a more
forgiving environment. "If they get into trouble here in
Shanghai, we can work with them," said Liu.

--------------------------------------------- -----
Stock Exchange Still Dominated by Retail Investors
--------------------------------------------- -----

10. (SBU) The share of the market controlled by institutional
investors, such as pension funds, insurance companies, and
broker-dealer trading, has risen from roughly 10 percent to
about 38 percent this year -- a healthy trend, said SSE's Liu.
However, more than 90 percent of trading is done by individual
retail investors. On high volume days, trading by institutional
investors only accounts for 2-3 percent of volume. This means
the market is controlled by retail investors and institutional
investors "have no voice in setting the market." This even
applies to trading done by non-Chinese Qualified Foreign
Institutional Investors (QFII) who "throw away everything they
know about the market and all of their research to follow the
market's momentum created by retail investors," complained Liu.

--------------------------------------------- -------------
The Timetable to Launch Stock Index Future Still Sensitive

SHANGHAI 00000777 003.2 OF 003

--------------------------------------------- -------------

11. (SBU) (SBU) CFFEX CEO Zhu Yucheng said that the timing of
the launch of CFFEX's first product, a stock index future, is
still very "sensitive." (Ref B) When CFFEX would actually
launch the stock index future is a decision that would be made
at "the highest levels of government." Zhu said that given the
overheating on the two Chinese stock markets, launching the
equities future product might be the trigger for increased
volatility and uncertainty. "If the futures product does not
start successfully, 140 million investors will scold me and
criticize the government," he said. (Note: Other contacts have
told us that delays have been caused by no official wanting to
be responsible for launching a product that might cause a
collapse, however temporary, of the markets. The decision to
launch the index futures product is in the hands of the State
Council who most likely do not understand the concept of
futures, and therefore are also reluctant to initiate the new
product. End note.) Zhu added that he and his staff are
closely studying the how the Chicago Mercantile Exchange had
"defended their products before Congress so that maybe we can
use their arguments."

---------------------
The Goal is Stability

---------------------

12. (SBU) Attempting to insure stock market stability and avoid
volatility, CFFEX's Zhu said that the as yet unlaunched stock
index futures product was intentionally designed with a large
contract size so that its main customers would be institutional
investors. CFFEX's goal is to set the price so high that
private investors would not speculate. Qualified Foreign
Institutional Investors (QFFI) will be allowed to invest up to
10 percent of their quotas, said Zhu.

----------------------------
Other Products in the Future
----------------------------

13. (SBU) Noting that fund managers familiar with the planned
stock index futures product have complained that its proposed
structure is not optimal for allowing them to hedge risk,
CFFEX's Zhu said that in response to these concerns CFFEX hopes
to launch a broader series of financial derivatives should their
current product prove successful. CFFEX plans to launch
interest rate, foreign currency, and national bonds futures
products as well.

14. (U) The delegation did not have an opportunity to clear on
this report.
JARRETT

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