Paulson crusades for greater opening of China's cloistered financial markets

When U.S. Treasury Secretary Henry Paulson makes a pitch Thursday for China to drop barriers to trade, he'll be doing so from the gleaming Shanghai Futures Exchange, where only a handful of commodity futures are traded, by local brokers.

The setting illustrates the progress and limitations in China's ambitions become a world financial power. Just last week, the country's growing heft in international markets hit home when a 9 percent drop in Shanghai triggered declines around the globe.

But China needs to do far more to open its financial sector and underdeveloped capital markets, for the sake of its own well-being and global stability, Paulson said in comments in Tokyo this week.

Paulson met Wednesday in Beijing with Chinese Vice Premier Wu Yi, a former trade minister, China's most powerful woman and a key point person for dealings with Washington.

Paulson did not make any public comments in Beijing, but in Tokyo on Tuesday he told Japanese officials that the U.S. has three main goals in its economic dialogue with Beijing: opening China's services sector to foreign investment, improving environmental protection and speeding up Chinese economic reforms.

"Their capital markets are underdeveloped relative to their economy," Paulson told reporters after a meeting at the Tokyo Stock Exchange. "As China moves ahead, there will be less risk for the world economy and benefits for Japan and the whole world," he said.

Such goals have gained urgency given mounting pressure from the Democratic-controlled Congress on the Bush administration to address the U.S. trade deficit with China, which hit a record US$232.5 billion (EUR 176.6 billion) last year.

Paulson, a former head of investment powerhouse Goldman Sachs, has urged China to loosen currency controls that keep the yuan from rising more quickly in value against the dollar. The system, critics say, makes Chinese goods cheap and adds to the trade imbalance.

China's leaders acknowledge that the country's financial markets are a work in progress. Just a week ago, Premier Wen Jiabao rued the "many problems" needed to build up the industry. But they have balked at more drastic reforms that they say might damage the country's fragile financial systems.

But Beijing has domestic politics of its own to consider. With an eye toward a once-in-five-years Communist Party congress in the autumn, leaders are focusing on quality-of-life social issues like free rural schooling, health, housing and pollution.

Major initiatives that might placate Washington will likely be on the back burner.

"It certainly is possible China could open even further but I would be surprised if they did so ahead of next fall's Party Congress," said Nicholas Lardy, a China expert at the Peterson Institute for International Economics, a Washington think tank.

"Even if I am wrong and they do move sooner to open, I don't think it will mitigate problems on the trade and exchange rate front," he said.

In January, a major government financial policy conference in Beijing focused on rural lending and on China's management of its more than US$1 trillion in foreign exchange reserves. There was scant mention of market-opening issues.

China made broad commitments to open its financial markets as a condition for joining the World Trade Organization. In December, the banking industry opened to full foreign competition, though foreign investors wanting stakes in Chinese banks are limited to 25 percent.

Many other restrictions remain. Foreigners are largely barred from directly trading in yuan-denominated shares that form the bulk of the share markets. A few select foreign institutions have been given quotas that amount to only a few percent of market capitalization.

The futures markets, which only trade futures in copper, aluminum, natural rubber and fuel oil, are closed to foreign participation.

Foreign insurers want Beijing to remove obstacles that limit their ability to set up nationwide operations and that cap foreign ownership of a Chinese insurer at 50 percent, the AP said.

Beijing also faces pressure to open up and expand its bond market, a step that would relieve pressure on banks, which currently provide nearly all corporate financing, and would create new ways to hedge risks.

While at Goldman, Paulson visited China dozens of times and is well acquainted with China's financial movers and shakers.

But given the Democratic-led U.S. Congress's preoccupation with protecting American jobs, it is unclear how much political mileage Paulson can get out of lobbying on behalf of Wall Street, says Edward Gresser of the Washington-based Progressive Policy Institute.

"On the Congressional side, I think the main focus is on piracy issues and currency rates rather than on market access," Gresser says. "Congress has been willing to give him some space to operate on China policy, but I have a feeling they are now beginning to look for results."

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