China Economic OutlookChina Next Five Years Projection: Opportunities and Challenges

Dr. Marcus LeeEconmomic Advisor to Chinese Municipal Governments

Chief Economist, Hampton Court Investment Bank

1. China Economic Outlook

Historical Background

China’s composition of aggregate demand remains heavily tilted toward investment and exports.

In 2009, gross fixed capital formation accounted for 47.5% of China’s GDP, while private consumption provided 35.6%.

China is a relatively open economy, with exports accounting for about 36% of GDP, according to the World Bank Development Indicators.

China Economic Outlook 2011

China’s economy is approaching a structural turning point at which:

1) GDP growth: down 2) Inflation: uptrend 3) Investment’s share of GDP: decrease 4) Private consumption: up 5) Cost of Capital: up

2. Existing Challenges

1. Income Inequality

Wealth at the coast: manufacturing and financial sector

Comparison of per capital income: Guizhou US$1,900 vs Shanghai US$11,500

Migration: 260 million workers relocate to coastal

2. Excess labor supply

push down wages, help growth rate of 11% and inflation of 2%

Miracle has ended. Young rural worker dry up. Rise of cost of living

In medium term, china growth and inflation 6% +/-

3. Inflation

Although higher global commodity prices are important factor to push up Chinese inflation, monetary expansion is also blame.

China’s CPI y/y increase: March 5.4% June 5.5%

banks’ required reserve ratio to a record-high 20.5%

only managed to sterilize about two-thirds of the valuation-adjusted capital inflow in Q1 2011

3. China 12th Five Years Plan

The 12th Five Years Plan

Focus: Quality vs Growth

3 Key Themes: i) Economic Restructuring Ii) Social Equality Iii) Environment Protection

Policy Directions

Shift from “Growth at any cost” toward a more balance growth under the “Harmonious Society” (和谐社会 )

Financial Crisis: aware need of change of growth model.

Overreliance on investment and export to consumption-led growth. Increase consumption by raising income and social benefits.

Restructuring Economy

Financial crisis impact – layoff of millions of factory worker. more stable growth model

Unsustainable – High growth rate, large global trade and fx imbalances which led to tensions b/w china and its major trading partner.

Inefficient use of resources – over heating investment in certain sector

12th FYP Policies Focus

Support lower GDP Growth – 7% Consumption driven economy Upgraded industries Creation of more “National Champions”

Strategic Emerging Industries (SEI)

There are Seven SEI:

1. Biotechnology 2. New Energy 3. High End Equipment Manufacturing 4. Energy Conservation and Environment 5. Clean Energy Vehicles 6. New Materials 7. Next Generation IT

China Government prepare to spend more than RMB4 trillion on these industries in the next 5 years.

Consumption

Inclusive Growth: benefits wider community

Reduce dependency on export, surplus and maintain an artificially weak currency

Consumption: Rise from 35% of GDP (2010) to 40% within 5 years. (Compare to US 71%, Brazil 63%, India 54%)

Social Equality

Changed from “Strong State, Wealthy People (国富民强 ) to “Wealthy People, Strong State” (民富国强 ).

Reducing Rich and Poor Gap in Urban/Rural by Urbanization, Reform of outdated Household Registration System

Provide Social Safety Net: Basic Health Care coverage and rural land distribution

Increase minimum wages by 40% by 2015.

Environment Protection

Mandatory energy emissions target of 17%. Hold local government officers accountable: water

consumption per unit of GDP, % of GDP invested in environment etc

Carbon tax by 2013, Carbon trading system by 2015

15% of energy from non-fossil fuels by 2020, Cap on domestic coal production, increase support for nuclear and hydropower

4. Sector Watch

1: Healthcare

Healthcare Reform: expand basic access, modernize infrastructure, improve delivery, invest in healthcare IT.

Pharmaceutical Consolidation: Change 13,000 small distribution to 2 national level (RMB100 billion revenue)and 20 regional level companies (RMB10 billion).

Biotechnology: Innovation, high-end medical devices, patented medicines. Gov will spend RMB12 billion for R&D in new drugs. (2011-2015)

2: Energy and Environment

Annual Growth 15-20% Gov will invest RMB3 Trillion (2011-2015)

Consolidation of Coal Sector: 11000 to 4000 companies, with 8-10 control for 60% of all production.

Nuclear and Hydropower: 11 to 25 nuclear power plants by 2015.

3 out of 7 SEI is devoted: Energy Efficiency and Environment, New Energy, New Energy Vehicles. Battery cell technology to produce 1 milion by 2015.

3: Technology

Move from “Made in China” to “Designed in China”.

Next Generation IT: information networks, mobile communication and internet, cloud computing etc.

R&D: Invest in core electronic devices, integrated circuits, life sciences, space, marine, earth sciences and nanotechnology.

5. Policy Implications

Risks

government still believes that the road to consumption-led growth runs through more investment

Upside Risk: Consumption accelerates as per capita GDP

exceeds US$5,000.

Downside Risk: Nonperforming loans increase earlier than

anticipated, pulling forward the expected recapitalization of the banking sector.

Interest Rates and Inflation

maintain a tightening bias, and we expect three more interest rate hikes in 2011, bringing the one-year deposit rate to 3.75%.

Demand-side pressures will keep inflation near 5% y/y into Q3

but the CPI will decelerate to 3.5% by December as food and oil prices moderate.

Impact for Foreign Companies

Industrial Upgrading: preferential policies maybe bias to domestic firm. Use partnership with local firm for better access.

Changes of business environment: expect cost to rise: minimum wage hikes, value added tax, raw material price, environment tax.

6. Conclusion

Rhetoric vs Reality

Despite new FYP aims to increase the share of consumption in GDP, it is still struggling.

The details of the new plan reveal continued reliance on investment, including public housing, to support growth..

Closing Note

No rebalancing of growth in 2011 as the government prioritizes investment for at least another year.

Continue monetary tightening through Q3 2011

Allow the RMB to appreciate 4-6% throughout the year.

The “proactive” fiscal policy for 2011 will be looser than government accounting implies.

Thank you

Dr. Marcus LeeManaging Director

Hampton Court Investment Bank168, Yin cheng Zhong Road, Bank of Shanghai, 21st floor, Shanghai 200120The People’s Republic of ChinaTel: (8621) 5116-7122Fax: (8621) 5116-7116Email: contact@hamcot.com Website: www.hamcot.com