China: The Tough Leg of the Trip

Published on September 24, 2015

On Friday, September 18, China’s President Xi Jinping chaired a meeting with senior officials slated to accompany him on his upcoming trip to the United States, now under way.

Beijing split the trip into three segments, the just concluded West Coast meetings with business leaders, the summit with President Barack Obama, and the United Nations meetings. Officials discussed more than 20 economic and geopolitical topics expected to be on the agenda in the second segment, the summit between Xi and President Barack Obama, and these were then narrowed down to eight key issues.

*** The top eight issues Beijing will focus on at the summit will be China’s inclusion of the RMB into the IMF SDR basket, RMB currency policy, China’s pace of US Treasury bond purchases and sales, the state of China’s economy, trade and a potential Bilateral Investment Treaty between the countries, Cybersecurity, tensions over the South China Seas, and Taiwan. ***

*** While the atmosphere will be polite, with the US President hosting two dinners for China’s President and first lady Peng Liyuan, Xi has vowed not to shy away from the tough issues, and Chinese officials have little expectation for any major breakthroughs at the summit given the level of mutual suspicion between the two countries over each side’s strategic intentions. Beijing remains fearful of Obama’s “pivot” towards Asia, and Washington is wary as ever of China’s growing influence in the region and around the world. ***

*** For the third leg of the trip, the United Nations meetings on September 26-28, China will proudly showcase its global presence in front of UN Secretary-General Ban Ki-moon, who to the delight of Chinese officials has called Xi on the record a “great leader,” and make a geo-political show of solidarity with Russia’s President Vladimir Putin and Iran’s President Hassan Rouhani. Putin has been invited by Xi to stay at, what is proudly reminded, the “Chinese-owned” Waldorf Astoria Hotel in New York. Xi, Putin, and Rouhani are expected to agree to meet again within the next three months. ***

The Eight Topics

Beijing’s position and expectations on each of the eight topics on the agenda in the meeting with President Obama include:

* China’s Economy

Xi has dismissed outside worries about huge capital outflows from China, and will point to China’s continued large trade surplus and sound (albeit, granted, softening) economic fundamentals. He will assure that all policy actions will be taken to avert any risk of a financial market meltdown, as well as appropriate measures taken to address economic risks and avert a hard landing.

While there has been discussion of targeted fiscal and tax measures (see SGH 9/17/15, “China: Additional Fiscal Stimulus if Needed”), Beijing will however continue to resist any calls for massive stimulus despite strong downward pressure on growth, and believes as measures to stabilize the economy gradually come into effect, China will achieve its annual economic growth target of 7% this year, despite continued market skepticism over 2015.

There is of course a possibility GDP targets could be lowered to a 6% handle going forward, but that does not constitute official Chinese policy.

* RMB policy

Xi will reiterate that China’s recent adjustment to the RMB exchange rate mechanism was aimed at giving market forces more power, and that although the RMB has depreciated in the short term, prospects are still rosy for a robust RMB in the longer term as China’s economy continues to gain momentum. That will meet with continued exhortations from the US side reminding Beijing that a “free” floating currency should be allowed to appreciate as freely as it is allowed to depreciate.

Xi will also reiterate that China has no intention of causing a currency war or using RMB depreciation as a tool to boost exports, reminding of China’s ample FX reserves and sound economic growth that in theory should leave little or no basis for a significant future long term RMB depreciation. Xi will vow to keep the exchange rate basically stable at a reasonable and balanced level, and express unwavering determination for reform, including liberalization of the exchange rate regime and capital account, and support for growth of a spot RMB market.

As we have written in previous reports, the RMB will be kept steady and relatively strong through the last ten days of September and during Xi’s visit to the US. The intent of economic officials is to manage the RMB central parity rates against the USD to around 6.3500, but they may be under greater pressure from market forces and broader risk aversion to achieve that than originally expected, and so achieving that may be a bit of moving target. The direction and intent to stabilize, nevertheless, remains clear.

* US Treasury Holdings

Chinese officials continue to believe the US side is worried about China dumping large amounts of US Treasuries, even though truth be told this concern may perhaps be played a bit as a point of leverage.

President Xi will repeat to Obama what Finance Minister Lou Ji Wei told US Treasury Secretary Jacob Lew a few weeks ago, namely that China has no intention of dumping US Treasuries (see SGH 9/11/15, “China: Fed, Treasuries, RMB, and the G-20 Meeting”). In the meantime Chinese officials deny media reports recently that China cut $30.4 billion of its US Treasury holdings in July.

Granted, we would assume there may be more substantial liquidation of other US denominated assets than Treasuries.

* The SDR Basket:

The inclusion of the RMB into the IMF SDR basket is one of the foremost issues President Xi and Beijing will push for with Obama and other world leaders.  It will also be one of the less contentious topics.

Senior Chinse officials expect Obama to acknowledge China’s recent efforts at financial market reform, including the opening up of the currency markets, and to support – in principle – China’s efforts to include the RMB in the SDR basket.

* Bilateral Investment Treaty

US officials for their side are hoping to conclude negotiations to sign a Bilateral Investment Treaty (BIT) with China at some point during the rest of Obama’s presidency.

Xi will promise to work with Obama and give further clear instructions to both negotiating teams to move forward. He has, from what we understand, already ordered the Chinese side to substantially cut the second “negative list” to under 100 objections, but will continue to hold out on a deal for concessions from the US over its treatment, and public characterization, of Chinese enterprises, as well as of China’s political and military motives.

* Cyber security

Last but not least on economic and business issues to be discussed especially from the US side will be the highly charged accusations back and forth over cyber security breaches, government policies, and controls.

In anticipation of that, before his visit, Xi dispatched a special envoy, Meng Jianzhu, a member of the Political Bureau of the CPC Central Committee and head of the Commission for Political and Legal Affairs of the CPC Central Committee, to Washington. The two sides met and reached some points of consensus on combating cybercrimes.

Meng stressed China’s firm stance against cyber-attacks and commercial cyber-espionage – and that anyone conducting such acts in Chinese territory is in violation of the laws of China and subject to legal liability. And to show good faith, XI has prepared and is willing to sign a cyber security agreement with the US. Of course that is highly unlikely to come even close to putting this politically contentious issue to rest.

* South China Sea

Xi also does not expect to reach common view with Obama on China’s activities in the South China Seas, the hottest geopolitical flashpoint between China and the US, and will reiterate that the South China Sea, especially Nansha (China’s name for the Spratly Islands), is China’s territory.

China’s official position on the South China Seas will not change, namely that China is committed to: one, finding a peaceful solution to disputes through dialogue and consultation on the basis of international law, and; two, advancing COC consultations toward early agreement and a rule-based and proper management of differences.

Xi will furthermore reiterate that the US should live up to its pledge of not taking sides on the issue.  While politely “open” to constructive US suggestions, Xi will stress that China is determined to defend its islands in the South China Sea “at all costs” and to warn that US military aircraft or ships should not enter within 12 nautical miles of China’s artificial islands, or risk escalating tensions.

And for what it’s worth, Chinese sources continue to dismiss recent US media recent reports that China is building a third airstrip in the Nansha Islands, calling them rumors.

* Taiwan

From Beijing’ perspective Taiwan is, and has long been, the most important and sensitive strategic issue in Sino-US relations, and Xi will warn the Obama Administration to be especially careful in its characterization of any discussion over Taiwan.

Beijing predicts that the Democratic Progressive Party’s (DPP’s) Presidential candidate, Tsai Ing-wen, is highly likely to win Taiwan’s presidential election in January, 2016. China will ask the US to work with China to prevent any escalation in the movement towards “Taiwan independence” and it will reiterate any formal declaration of independence from Taiwan would be seen by China as a cause to go to war.

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