By Michael Martina

WASHINGTON When an alleged Chinese spy balloon traversed the United States in February, some U.S. officials were confident the incursion would galvanize the U.S. bureaucracy to push forward a slate of actions to counter China.

Instead, the U.S. State Department held back human rights-related sanctions, export controls and other sensitive actions to try to limit damage to the U.S.-China relationship, according to four sources with direct knowledge of U.S. policy, as well as internal emails seen by Reuters.

The delays to items on the department's "competitive actions" calendar, a classified rolling list of steps the Biden administration has planned related to China, have alarmed some U.S. officials and revealed a divide between those in the U.S. government pushing for tougher action against China and others advocating a more restrained approach.

While the State Department signaled U.S. displeasure over the balloon by postponing Secretary of State Antony Blinken's scheduled visit to Beijing, an internal State Department message reviewed by Reuters shows senior U.S. officials delaying planned actions against China.

Rick Waters, deputy assistant secretary of State for China and Taiwan who leads the China House policy division, said in a Feb. 6 email to staff that has not been previously reported: "Guidance from S (Secretary of State) is to push non-balloon actions to the right so we can focus on symmetric and calibrated response. We can revisit other actions in a few weeks."

The sources said many measures have yet to be revived. The decision to postpone export licensing rules for telecom equipment maker Huawei and sanctions against Chinese officials for abuses of Uyghurs, has damaged morale at China House, they said.

President Joe Biden's administration has sought to prevent a further deterioration in ties with China's Communist government, which many analysts say have hit the lowest point since they began in 1979.

Former diplomats and members of Congress from both parties have argued that the U.S. must keep channels of communication open with Beijing to avoid misunderstandings and navigate crises.

But the sources said the current policy hews too closely to an earlier strategy of engagement that enabled China to extract concessions in exchange for high-level dialogues that often yielded few tangible results.

Speaking to Reuters on condition of anonymity for fear of repercussions, they said Blinken had largely delegated China policy duties to Deputy Secretary of State Wendy Sherman, the United States' second ranked diplomat.

In response to questions from Reuters, a senior State Department official said that under the Biden administration, the State Department had "coordinated with the interagency on a record-setting number of sanctions, export controls, and other competitive actions" toward China.

"Without commenting on specific actions, this work is sensitive and complex, and obviously sequencing is essential to maximize impact and make sure our messaging is clear and lands precisely," the official said.

Sherman did not respond to a request for comment.

Testifying before the Senate Foreign Relations Committee on Feb. 9, she said the department was "modernizing" its work and would "keep pushing back against the PRC's (People's Republic of China) aggressive military, diplomatic, and economic practices."

'KEEPING CHANNELS OPEN'

In late March, Waters told a staff meeting that the State Department would "move on" from the balloon incident with China, following guidance from Sherman who was eager to reschedule the Blinken trip, two of the sources said.

One Chinese official confirmed to Reuters that a renewed Blinken visit would be more likely if the U.S. accommodated Beijing's wish to shelve the issue, adding that China had conveyed it did not want the FBI to release details of its investigation into the downed balloon.

The two sources said the FBI report had originally been anticipated for mid-April release.

The FBI declined to comment on any report. The State Department told Reuters it had never discussed the issue with the bureau and declined to comment on discussions with China over the matter.

Asked about the release of the FBI report at a May 2 Senate Foreign Relations Committee hearing, Daniel Kritenbrink, the department's top diplomat for East Asia, said: "I absolutely support making sure that people are aware of what happened."

He added that the department was committed to managing competition between the U.S. and China.

"Part of that, in our mind, has to involve senior-level communication, keeping channels open," Kritenbrink said.

Craig Singleton, a China expert of the Foundation for Defense of Democracies, said the State Department was "caught in a trap of its own making," forgoing actions aimed at maximizing U.S. leverage in its eagerness to resume high-level exchanges.

"This decision, while well-intentioned, strengthens China's hand," Singleton said.

DELAYS TO HUAWEI CONTROLS

China House - formally the Office of China Coordination - was launched in December as a reorganization of the department's China desk, intended to sharpen policies across regions where China's expanding influence challenges the U.S. and its allies.

The four sources Reuters spoke to for this story all voiced concern that the State Department risked failing in its efforts to rebuff what many in the West view as China's ambition to displace the U.S. as world leader.

China's embassy in Washington declined to comment.

The sources said the Commerce Department's Bureau of Industry and Security had prepared rules to revoke Huawei-related export control licenses, even those covering less sensitive technology. The departments of defense and energy were ready to back the changes in late February, but Sherman did not support stricter rules as the State Department was seeking to revive Blinken's visit, they said.

The four agencies on the End-User Review Committee that decides such actions did not vote on the matter because of State Department opposition, they said.

"The licensing rule has been written. There is draft Federal Register language," one source said.

State Department officials declined to comment specifically on the licensing rules. One official said that Sherman did not call the Commerce Department to delay any Huawei actions.

Commerce told Reuters it does not comment on deliberations about specific companies, and that it works with other parts of the government to "continually assess our export controls."

The defense and energy departments did not respond to a request for comment.

The State Department also pushed off sanctions against Chinese officials, including some at the Central Committee's United Front Work Department bureau responsible for policies in Xinjiang, where the U.S. government says Beijing is committing genocide against Muslim Uyghurs.

China denies all abuses.

Those sanctions, prepared and delayed for the first time in October 2022 and delayed again in mid-January because it was deemed too close to Blinken's visit, have yet to be released, three of the sources said.

Resistance to such actions has contributed to staffing struggles at China House, with vacancy rates as high as 40%, the four sources said.

Senior officials acknowledged morale problems at China House, but denied they were linked to policy.

"We are in the midst of a re-org. It's hard," one of the senior department officials said.

The State Department has struggled with staffing and morale issues left over from a Trump administration-era hiring freeze.

But some staff recently have requested reassignment, said the sources, who argued that the delays signaled to working-level officials that China actions are not a priority.

"Even when we are on the one-yard line, we debate whether we should cross," another source said.

(Reporting by Michael Martina; Editing by Don Durfee and Suzanne Goldenberg)