SHANGHAI (Reuters) - It was shaping as a win in the Communist Party's quest to contain a longtime nemesis, the Roman Catholic Church.

In July 2012, a priest named Thaddeus Ma Daqin was to be ordained auxiliary bishop of Shanghai. The Communist body that has governed the church for six decades had angered the Holy See by appointing bishops without Vatican approval. Known as the Chinese Catholic Patriotic Association, it was now about to install Ma, one of its own officials, as deputy in China's largest Catholic diocese.

"The anticipation was he would be a yes man," says Jim Mulroney, a priest and editor of the Hong Kong-based Sunday Examiner, a Catholic newspaper.

Instead, standing before a thousand Catholics and government officials at Saint Ignatius Cathedral, Ma spurned the party: It wouldn't be "convenient" for him to remain in the Patriotic Association, he said. Many in the crowd erupted into thunderous applause. People wept. Ma had switched sides - and a crisis was under way.

The priest soon disappeared from public view, instructed by the late bishop Aloysius Jin Luxian to move to a mountainside seminary outside Shanghai, where he has been confined for 20 months. He was stripped of his new title, questioned by officials for weeks and required to attend communist indoctrination classes.

Ma's renunciation of the association forced into the open a struggle that had been playing out for years. The Catholic Church in China is divided into two communities: an "official" church answerable to the Party, and an "underground" church that swears allegiance only to the Pope in Rome. The most contentious issue between them is which side controls the ordination of bishops.

There are tentative signs a thaw may be possible. New leaders have been appointed in both the Vatican and China since Ma defied the Patriotic Association.

The Chinese government has privately signaled it could appoint Ma as the next full bishop of Shanghai, a position now vacant, and release two long-jailed bishops loyal to the Vatican, according to a source close to the Holy See. This person said several people had conveyed that message to a Vatican official in private meetings.

Any change in Ma's status is likely to be gradual, the Vatican source said, given opposition from the Shanghai government, still furious over Ma's repudiation of the official church.

The source declined to specify the identities of the people carrying the messages to the Vatican. Since the Vatican and China have no official ties, unofficial emissaries from Beijing pass messages to the Vatican either directly to Rome or through the Vatican's Charge d'Affaires in Hong Kong. The emissaries are in contact with government or Communist Party authorities in China, said Father Jeroom Heyndrickx, from Catholic University in Leuven, Belgium, who has previously acted as an unofficial emissary between Rome and Beijing.

"I'm a little positive this time," the Vatican source said. "If this will happen, certainly the Vatican will take some steps for China. After that I think it will be possible to start a dialogue."

China has yet to send any public signal that it is willing to resume a dialogue with the Vatican, and some hardliners in the Catholic Church oppose any accommodation with China.

Beijing's impasse with the Catholic Church also coincides with a broader crackdown against dissident groups - including Christians who go to "house churches", rights lawyers, academics and activists - that have resulted in a spate of trials and detentions.

China's State Administration for Religious Affairs did not respond to requests for comment.

"THERE ARE RELATIONS"

Pope Francis has been silent on the standoff, but he told the Italian daily Corriere della Sera this month he has exchanged letters with Chinese President Xi Jinping, the first acknowledgment of communication since both men took office in late 2012. "There are relations," Francis said, without elaborating on the exchange.

Vatican watchers speculate Francis could visit Beijing this summer during a tour of Asia. If so, it would be the first by a pope to Chinese territory since the Communists took power in 1949. Since then, there have been no bilateral diplomatic relations.

The Vatican's new Secretary of State, Pietro Parolin, has also sounded an optimistic note. In February, he told Avvenire, the newspaper of the Italian Bishops' Conference, that he is hopeful "trust and understanding among the parties might increase." He added: "This might be concretely realized in the resumption of a constructive dialogue with political authorities" in China.

The Vatican did not respond to requests for comment.

The enduring rupture, however, suggests any end to the standoff over bishop appointments may be a long way off. Ma's rebuff still stings, says Anthony Liu Bainian, the layman who is the honorary chairman of the Patriotic Association.

"He deceived the bishops and cheated the government as well as the public," Liu said in an interview, in his first public remarks on the Ma case. "How can you then take on the responsibility for such a large diocese as Shanghai? This clearly shows that (Ma) was under the influence of foreigners."

Reuters went to Sheshan Seminary and met with Ma, who said that while he is allowed to chat with visitors as part of his pastoral duties, he cannot accept media interviews.

HUNGER FOR SPIRITUALITY

For the Vatican, the stakes in China are enormous: A population of nearly 1.4 billion lives in a society that hungers for spirituality at a time when Catholicism's traditional stronghold in Europe is flagging.

The stakes are high for the Communist Party, too. The Catholic Church is perhaps the largest non-party institution in Communist-led China. The church has been in China since Jesuit missionaries first arrived in 1534, longer than the party, and it is growing.

China officially recognizes five religions - Buddhism, Taoism, Islam, Christianity and Catholicism - and supervises them through state-run associations. The officially atheist government is wary of any organisation that might challenge its moral authority, especially those tied to a foreign entity.

The Communist Party tried to force Catholics to join the Catholic Patriotic Association when it was established in 1957. Clergy and laity who refused to renounce ties with the Vatican were imprisoned, beaten and some were even killed. The campaign drove Catholics loyal to the pope underground, causing a split that remains today.

But nearly six decades of state control and sometimes brutal oppression has failed to eradicate the underground Catholic community. Membership today is about evenly divided between those who attend China's official and underground churches. The number of Catholics has risen from an estimated 8 million in 1988 to about 12 million today, according to Anthony Lam, a senior researcher at the Holy Spirit Study Centre in Hong Kong, an organ of the Diocese of Hong Kong.

China's State Administration for Religious Affairs counts 5.3 million Catholics as belonging to the Patriotic Association, which oversees 70 bishops and approximately 6,000 churches nationwide.

But the lines are beginning to blur. Many underground churches are allowed to operate with the tacit approval of local officials. A new generation of Catholics, less angered by a bitter past, will go to Mass at both underground and official churches.

For Beijing, the ordination of bishops in the roughly 110 bishop seats in China is its main lever of control over the church. Rome, however, sees the ordination of "illicit" bishops as a trend that will weaken the validity of the Catholic Church in China.

QUIET DETENTE

Ma was born in 1966 to a staunch Catholic family in Shanghai. His grandfather and father both yearned to be priests but were frustrated by the Communist takeover and later the Cultural Revolution of 1966-1976. Ma's family lived directly opposite St. Ignatius Cathedral, a gothic building built by French Jesuits between 1905 and 1910.

Ma began attending Mass daily with his parents at St. Ignatius after China eased government controls on religion in the late 1970s. He studied at the Sheshan Seminary and became a priest in 1994, going on to serve in each of Shanghai's Catholic churches.

Ma always worked with the official church. He had risen to become the vice-chairman of Shanghai's Patriotic Association.

For most of the last decade, the party and the Vatican tried to accommodate each other's views on the crucial issue of bishop appointments (except in 2006 when the two sides clashed over the appointment of three bishops). A bishop in China's official church is supposed to be "elected" by local priests, nuns and some laymen, and the government and the Vatican usually agreed on the choice.

That arrangement began to break down in 2010, when the Patriotic Association appointed four bishops who had not been approved by the Vatican. Rome excommunicated three of them, a move that hadn't been taken against a Chinese bishop since 1951. Beijing called the excommunications "unreasonable and rude".

After that, local authorities sent police to escort Vatican-appointed bishops to attend official church ordinations and detained other bishops loyal to Rome ahead of the ceremonies.

Yet a truce still seemed possible. On July 4, 2012, three days before Ma's ordination, a spokesman for the government's Religious Affairs Bureau said China was "willing to enter into consultations with the Vatican on issues including the ordination of bishops."

AN EXTRAORDINARY SCENE

Then, on July 7, 2012, came Ma's ordination. By all accounts, it was an extraordinary scene at Saint Ignatius Cathedral that day. Scores of priests and nuns had gathered outside the cathedral to protest against the participation in the ceremony of Vincent Zhan Silu, a bishop loyal to the Patriotic Association who had been ordained without approval by the Vatican.

Ma had been close to Shanghai's official Bishop, Aloysius Jin Luxian, who died on April 27, 2013 at the age of 96. Jin himself had walked a fine line between Beijing and Rome, spending nearly three decades under house arrest, in reeducation camps and in prison before joining the official church.

Jin was criticized at times for being too close to the government after his release from prison. But his accommodation with the government seemed to have soured when Zhan was one of those named to help officiate at the ceremony.

Jin convened a meeting of Shanghai's priests and nuns and told them to "act according to your conscience" when it came to attending the ordination.

"Bishop Jin was so furious," said Cardinal Joseph Zen, a Shanghai-born former bishop of Hong Kong. "He called all the priests and said: 'I did all I could but they are still trying to impose this illegitimate bishop (Zhan), so I will do all my best to humiliate this fellow.'".

And, from the view of the official church, that is what transpired. Shanghai Bishop Jin and two other bishops performed the "laying on of hands" ritual that is meant to invoke the Holy Spirit during an ordination. Zhan and two other bishops were also supposed to perform the ritual. But Ma prevented them from putting their hands on his head by rising from his knees and hugging the three bishops instead. Zhan did not respond to requests for comment.

Ma then strode to the pulpit, and referring to the crowd of priests and nuns outside, said: "Today, from our diocese, there are several brothers, sisters, priests and nuns who were not able to attend due to various reasons. I would like to say, I love them."

He spoke about the need to focus on pastoral duties - working with parishioners - in his new role as bishop, as opposed to the bureaucratic duties that come with the job as a Patriotic Association bishop.

"Therefore, starting from this day of consecration, I will no longer find it convenient to be a member of the Patriotic Association," he said.

MUST 'TRULY REPENT'

It isn't clear what led Ma to turn against the Patriotic Association that day. Priests who knew Ma said that while he was close to Jin the official bishop, he also admired the Shanghai underground bishop, Joseph Fan Zhongliang, who died on March 16. And both of those bishops objected to Zhan's participation in the ceremony.

The Patriotic Association's honorary chairman Liu, who wasn't in attendance that day, was furious. "When they told me about this matter, I said: 'It's finished, it's finished," he said in the interview. Ma's actions "violated church regulations."

Asked whether Ma could eventually be a full bishop, as the Vatican source has suggested, Liu said that Ma was "a talented person" but has to "truly repent. He first has to understand and recognize his mistake."

Beijing has to take a stricter line with Catholics than other religions because of past actions by the church, Liu said, referring to former Pope John Paul's sweeping apology in 2000 for the Church's history of violence, persecution and blunders.

"Especially now that foreign ruling powers want to contain the development of China, they must also want to use religion to sow discord," Liu said.

The Vatican tried to look for a diplomatic solution after Ma's act of defiance. In October 2012, three months after the St. Ignatius ceremony, Rome proposed "a new way for dialogue", calling for a "bilateral commission for relations", similar to ones between China and Taiwan and between the Vatican and communist Vietnam.

The author of the proposal, Cardinal Fernando Filoni, is a China expert who heads the Vatican department that deals with missions. In a letter to Beijing outlining his proposal, Cardinal Filoni listed the stumbling blocks to better ties: the "sharpened control of the state over the Church" since 2010 and the "heavy interference of the civil authorities over the appointment of bishops." Bishop Ma's detention was "the latest worrying sign," he wrote.

Filoni declined to comment for this report. He told the Italian news agency Ansa last October that he had not heard a reply from Beijing.

THE JESUIT POPE

Ma's "patriotic education" classes ended last August, according to the source close to the Vatican. The Patriotic Association, meanwhile, has not ordained any bishops for over a year, a development the source called "a good signal".

The change of leadership in Rome may help, Vatican watchers say. They note that Pope Francis is a Jesuit, the first-ever pontiff from the Catholic order that established the church in China. According to Cardinal Filoni, Pope Francis has in his room a statue of "Our Lady of Sheshan" - the Chinese icon of Mother Mary whose main shrine is at the seminary outside Shanghai.

Archbishop Parolin, the new secretary of state, was the Vatican's chief negotiator with China in 2007.

"The Vatican, by appointing this man as a secretary of state, that in itself is a statement that it wants dialogue, and I think China understands this," said the Catholic University of Leuven's Heyndrickx.

The Vatican has previously signaled a willingness to cut diplomatic relations with Taiwan - a condition China has imposed for the resumption of diplomatic ties with the Holy See. In 2005, the-then Vatican Secretary of State, Angelo Sodano, said the Vatican was ready to move its diplomatic office from Taiwan to Beijing if China agreed to uphold religious freedom.

A Taiwanese foreign ministry spokeswoman, Anna Kao, said Taiwan and the Vatican maintain official diplomatic ties and Taipei has "heard no news to the contrary".

Ma remains at the Sheshan Seminary. He regularly posts blog items for the faithful, mostly excerpts from scripture and greetings to his flock.

In a December 6 post, shortly after the death of Nelson Mandela, the priest cited one of the South African liberation leader's most famous quotations: "Freedom is indivisible; the chains on any one of my people were the chains on all of them, the chains on all my people were the chains on me."

His quarters, which he shares with a half-dozen priests, overlook a lush bamboo forest. In one room, a photo of the retired Pope Benedict hangs on a wall and a small Chinese flag sits on a desk.

(Additional reporting by Philip Pulella in Rome, Paul Mooney and Greg Torode in Hong Kong and the Beijing Newsroom. Editing by Bill Tarrant