* Report urges China be brought into arms-limitation talks
* Submarine-launched nuclear warheads seen within 2 years
* China is accused of being "most threatening" power in cyberspace (Adds Chinese president comments)
By Jim Wolf
WASHINGTON, Nov 8 (Reuters) - China appears to be within two years of deploying submarine-launched nuclear weapons, adding a new leg to its nuclear arsenal that should lead to arms-reduction talks, a draft report by a congressionally mandated U.S. commission says.
China in the meantime remains "the most threatening" power in cyberspace and presents the largest challenge to U.S. supply chain integrity, the U.S.-China Economic and Security Review Commission said in a draft of its 2012 report to the U.S. Congress.
China is alone among the original nuclear weapons states to be expanding its nuclear forces, the report said. The others are the United States, Russia, Britain and France.
Beijing is "on the cusp of attaining a credible nuclear triad of land-based intercontinental ballistic missiles, submarine-launched ballistic missiles, and air-dropped nuclear bombs," the report says.
China has had a largely symbolic ballistic missile submarine capability for decades but is only now set to establish a "near-continuous at-sea strategic deterrent," the draft said.
Chinese President Hu Jintao has made it a priority to modernise the country's navy. China launched its first aircraft carrier, purchased from Ukraine and then refurbished, in September.
"Building strong national defense and powerful armed forces that are commensurate with China's international standing and meet the needs of its security and development interests is a strategic task of China's modernisation drive," Hu said in a speech on Thursday at the opening of the Chinese Communist Party's once-every-five-years congress.
To address a wide variety of security threats, "we must make major progress in modernising national defence and the armed forces," Hu said.
That means China must "complete military mechanisation and make major progress in full military IT (information technology) application by 2020," he said.
The deployment of a hard-to-track, submarine-launched leg of China's nuclear arsenal could have significant consequences in East Asia and beyond. It also could add to tensions between the United States and China, the world's two biggest economies.
Any Chinese effort to ensure a retaliatory capability against a U.S. nuclear strike "would necessarily affect Indian and Russian perceptions about the potency of their own deterrent capabilities vis-à-vis China," the report said, for instance.
China is party to many major international pacts and regimes regarding nuclear weapons and materials. But it remains outside of key arms limitation and control conventions, such as the New Strategic Arms Reduction Treaty signed in April 2010 and the 1987 Intermediate-Range Nuclear Forces Treaty. The United States historically has approached these bilaterally with Russia.
The U.S. Congress should require the U.S. State Department to spell out efforts to integrate China into nuclear arms reduction, limitation, and control discussions and agreements, the draft said.
In addition, Congress should "treat with caution" any proposal to unilaterally reduce operational U.S. nuclear forces without clearer information being made available to the public about China's nuclear stockpile and force posture, it said.
China is estimated by the Arms Control Association, a private nonpartisan group in Washington, to have 240 nuclear warheads. The United States, by contrast, has some 5,113, including tactical, strategic and nondeployed weapons.
Beijing already has deployed two of as many as five of a new class of nuclear-powered ballistic missile submarine. The JIN-class boat is due to carry the JL-2 submarine-launched ballistic missile with an estimated range of about 7,400 km (4,600 miles).
The new submarines and the JL-2 missile will give Chinese forces its "first credible sea-based nuclear capability," the U.S. Defense Department said in its own 2012 annual report to Congress on military and security developments involving China.
The JL-2 program has faced repeated delays but may reach an initial operating capability within the next two years, according to the Pentagon report, released in May.
The Pentagon declined to comment directly on China's march toward creating a credible nuclear "triad" involving strategic bombers, intercontinental ballistic missiles and submarine-launched ballistic missiles.
The final version of the report is to be released next Wednesday by the U.S.-China commission, a 12-member bipartisan group set up in 2000 to report to U.S. lawmakers on security implications of U.S.-China trade.
The draft, in its section on cyber-related issues, called on the Congress to develop a sanctions regime to penalize specific companies found to engage in, or otherwise benefit from, industrial espionage.
Congress should define industrial espionage as an illegal subsidy subject to countervailing duties, it added.
Lawmakers also should craft legislation to boost the security of critical supply chains, "particularly in the context of U.S. government and military procurement," the draft said. (Additional Writing by Terril Yue Jones; Editing by Lisa Shumaker and Nick Macfie)