Portfolio Investment Opportunities in Chinafc.standardandpoors.com › ... ›...

Please refer to important information, disclosures, and qualifications at the end of this material.

Morgan Stanley Smith Barney Investment Strategy

Portfolio Investment Opportunities in China

June 2011

The design of the national emblem of the People's Republic of China shows Tiananmen under the light of five stars, and is framed with ears of grain and a cogwheel. Tiananmen is the symbol of modern China because the May 4th Movement of 1919, which marked the beginning of the new- democratic revolution in China, was launched there. The meaning of the word Tiananmen is “Gate of Heavenly Succession.” On the emblem, the cogwheel and the ears of grain represent the working class and the peasantry, respectively, and the five stars symbolize the solidarity of the various nationalities of China. The Han nationality makes up 92 percent of China’s total population, while the remaining eight percent are represented by over 50 nationalities, including: Mongol, Hui, Tibetan, Uygur, Miao, Yi, Zhuang, Bouyei, Korean, Manchu, Kazak, and Dai.

National Emblem of China

The Great Wall of China In c. 220 BC, under Qin Shihuangdi (first emperor of the Qin dynasty), sections of earlier fortifications were joined together to form a united system to repel invasions from the north. Construction of the Great Wall continued for more than 16 centuries, up to the Ming dynasty (1368–1644), creating the world's largest defense structure. Source: About.com, travelchinaguide.com.

Source: About.com, travelchinaguide.com.

David M. Darst, CFA



Table of Contents

2

Section 1 Background

Section 2 Issues for Consideration

Section 3 Investing Background

Section 4 Understanding China’s Investment Potential

Section 5 Overview of the Investment Landscape

Section 6 Additional Sources and Disclosures

Dynasty (or period) Extent of Period

Length of Period (Years)

Xia c. 2070 - c. 1600 BC 470

Shang (Yin) 1600 - 1046 BC 554

Zhou 1046 - 256 BC 790

Xi (Western) Zhou 1046 - 771 BC 275

Do (Eastern) Zhou 770 – 256 BC 514

Spring and Autumn 770 – 476 BC 294

Warring States 475 – 221 BC 254

Qin (Chin) 221 - 207 BC 14

Han 206 BC - 220 AD 427

Three Kingdoms 220 - 265 AD 45

Jin (Tsin) 265 - 420 AD 155

Southern and Northern 420 - 580 AD 160

Sui 581 - 618 AD 37

Tang 618 - 907 AD 289

Five Dynasties 907 - 960 AD 53

Song (Sung) 960 - 1279 AD 319

Yuan 1280 - 1365 AD 85

Ming 1368 - 1644 AD 276

Qing (Ching) 1644 - 1912 AD 268

Republic of China 1912 – 1949 AD

People’s Republic of China 1949 – Present

The Chinese Dynasties

Source: Encyclopedia Britannica, www.britannica.com, www.chinaculture.org, www.artsmia.org.

Key Dynasty

P.8P.9P.9

P.9

P.10

P.11

P.12P.13

P.14

P.15P.16

P.17

Page 147

Page 3

Page 65

Page 95

Page 126

Page 161

The Provinces of China

Source: The State of China Atlas, 2009.

Province or City District Capital Area (Km2) Area (Miles2)

Population (MM)

Anhui Hefei 140,000 54,054 61.2 Beijing Beijing 16,808 6,490 16.3 Chongqing Chongqing 82,300 31,776 28.2 Fujian Fujian 121,700 46,989 35.8 Gansu Lanzhou 454,000 175,290 26.2 Guangdong Guangzhou 178,000 68,726 94.5 Guangxi Nanning 236,660 91,375 47.7 Guizhou Guiyang 174,000 67,182 37.6 Hainan Haikou 33,940 13,104 8.5 Hebei Shijiazhuang 187,700 72,471 69.4 Heilongjiang Harbin 469,000 181,082 38.2 Henan Zhengzhou 167,000 64,479 93.6 Hubei Wuhan 185,900 71,776 57.0 Hunan Changsha 212,000 81,854 63.6 Jiangsu Nanjing 102,600 39,614 76.3

Province or City District Capital Area (Km2) Area (Miles2)

Population (MM)

Jiangxi Nanchang 166,600 64,325 43.7 Jilin Changchun 187,400 72,356 27.3 Liaoning Shenyang 146,000 56,371 43.0 Nei Monggol Hohhot 1,200,000 463,322 24.1 Ningxia Yinchuan 66,400 25,637 6.1 Qinghai Xining 720,000 277,993 5.5 Shaanxi Xi'an 205,600 79,383 37.5 Shandong Jinan 156,700 60,502 93.7 Shanghai Shanghai 6,340 2,448 18.6 Shanxi Taiyuan 156,000 60,232 33.9 Sichuan Chengdu 487,700 188,302 81.3 Tianjin Tianjin 11,303 4,364 11.2 Xinjiang Urumqi 1,600,000 617,763 21.0 Xizang [Tibet] Lhasa 1,230,000 474,905 2.8 Yunnan Kunming 394,000 152,124 45.1 Zhejiang Hangzhou 101,800 39,305 50.6



Section 1

Background

The origin of the word “China” dates to the Qin dynasty (pronounced Ch’in), which extended for 14 years, from 221 through 207 BC. The Qin dynasty established the first centralized imperial government in China.

Origin of the word “China”

The word “Cathay,” a literary term for China, can be traced to the Khitan ethnic group, an ancient nomadic tribe that lived in Northern China. Khitan, Khitai, and Khitay are all variant spellings for the name of the people of this tribe. The word “Cathay” evolved as a European naming of Khitay.

Origin of the word “Cathay”

The word “Sino” means “Chinese.” This word is derived from the Latin word for China, “Sinae.”

Origin of the word “Sino”

3

As of early 2011, China had more people, more mega-cities, more skyscrapers, more internet users, more millionaires, and more greenhouse gas emissions than any country in the world. Despite significant differences in history, cultures, mores, and political evolution, China shares much in common with the West.

Source: Morgan Stanley Smith Barney Investment Strategy.

Source: www.etymonline.com.





BACKGROUND

China at a Glance

• China has undergone a significant transformation since it began moving toward a free market economy in 1976-1978.

• This transformation has been marked by substantial growth in China’s real GDP.

• China’s development has important implications for world trade, economic growth, global prices, capital flows, and geopolitics.

• Recent developments in China’s financial markets may open China further to foreign investment.

4

Background

• Since 1976, China’s real GDP growth has averaged 9.5% per year, three times the average of major industrialized countries. The combination of one of the lowest-cost labor forces in the world, enlightened economic policies, and increasing technological prowess has contributed to China’s economic rise.

• China’s transition from a centrally planned economy to a free market economy, which began in 1976 after the death of Mao Zedong, has transformed China into an important force in the global markets for trade and investment.

• While China’s growth path in recent decades resembles Japan’s development from 1950-1990, due to the country’s large population and geographic size, the global ramifications of China’s growth are especially profound and include China’s effects on world trade, economic growth, global prices, capital flows, and geopolitics.

• Since the 1990s, China has sustained positive trade and current account balances. China is an important participant in global financial markets through the investment of its substantial foreign reserves.

• China’s total exports exceeded those of the US in July 2006 and have continued to do so through 2010. Recent Developments• China’s GDP growth rate has decelerated somewhat and may continue to slow as China experiences a soft

landing: a gradual, not-sharp decline in GDP growth to more long-term sustainable rates. As of June 2011, Morgan Stanley & Co. Inc. Research estimated that China’s GDP growth in 2011 and 2012 would be approximately +9.0% and +9.0%, respectively.

• Authorities in China have been asked by other developing countries to strengthen the renminbi.– On June 19, 2010, China discontinued its fixed exchange rate of 6.83 renminbi per US dollar. From June

through December 2010, the renminbi appreciated +3.3%. As of June 2011, Morgan Stanley Research expected the renminbi to appreciate, with a period-end renminbi per US dollar exchange rate of 6.20 in 2011 and of 5.82 in 2012.

• On October 18, 2010, China appointed Vice President Xi Jinping as Vice-Chairman of the Central Military Commission, indicating that Mr. Xi may be the likely successor to Communist Party President Hu Jintao.

• As of April 2011, China held the world’s largest foreign exchange reserves, US$3.0 trillion, or 32% of the world’s total; Japan was second, with its US$1.0 trillion representing 11% of the world’s total.

Source: Bridgewater Associates; Bloomberg, LLC; Morgan Stanley & Co. Inc. Research; Global Insight.

Source: WorldRover.com.

Name Years in OfficeChairmen of CPC / General Secretary of the CPCMao Zedong 1949-1976

Hua Guofeng 1976-1981

Hu Yaobang 1981-1987

Zhao Ziyang 1987-1989

Jiang Zemin 1990-2002

Hu Jintao 2002-Present

Xi Jinping Next In Line (2013)

PremiersZhou Enlai 1949-1976

Hua Guofeng 1976-1980

Zhao Ziyang 1980-1987

Li Peng 1987-1998

Zhu Rongji 1998-2003

Wen Jiabao 2003- Present

Political Leaders of China, 1949 – Present



BACKGROUND

Country Statistics

5

General Information• Language: Mandarin (other important Chinese dialects include: Cantonese, Hakka, Hsiang, Wu, Min, and Kan)• Exchange Rate: Floating; US$1=Rmb 6.67 (as of Dec. 31, 2010)• 2010 Population: 1.34 billion • 2010E Economy by Sector (as % of GDP): Agriculture, 9.6%; Industry, 46.8%; and Services, 43.6%• 2009 Main Cities and Populations: Shanghai (15.6 million), Beijing (13.1 million), Tianjin (5.2 million), Wuhan (4.9 million), Shenyang

(4.4 million).Source: The World Bank; One World Nations Online; CIA World Factbook; Economist Intelligence Unit. Data are as of December 31, 2010.

Source: CEIC; Morgan Stanley & Co. Inc. Research. Estimates are as of June 2011.

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10E '11E '12E

China Real Gross Domestic ProductYear-over-Year % Change

Source: Bloomberg; Morgan Stanley & Co. Inc. Research. Estimates are as of June 2011.

Source: World Economic Outlook, by the International Monetary Fund, April 2011.

Purchasing Power Parity GDP per capita ($US) in 2010

1 Qatar 88,559 2 Luxembourg 81,383 3 Singapore 56,522 4 Norway 52,013 5 Brunei Darussalam 48,892 6 United Arab Emirates 48,821 7 United States 47,284 8 Hong Kong SAR 45,736 9 Switzerland 41,663 10 Netherlands 40,765 11 Australia 39,699 12 Austria 39,634 13 Canada 39,057 14 Ireland 38,550 15 Sweden 38,031 16 Kuwait 37,849 17 Iceland 36,621 18 Denmark 36,450 19 Belgium 36,100 20 Germany 36,033 21 Taiwan (Republic of China) 35,227 22 United Kingdom 34,920 23 Finland 34,585 24 France 34,077 25 Japan 33,805 94 China 7,519

Top Nations by GDP per Capita

Past performance is no guarantee of future results. Estimates of future performance are based on assumptions that may not be realized. This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.

US$ Billion 2007 2008 2009 2010E 2011E

Nominal GDP 3,496 4,522 4,991 5,879 6,893

Domestic Demand 3,189 4,185 4,831 5,833 7,214

Consumption 1,729 2,194 2,423 2,886 3,553

Private Consumption 1,257 1,592 1,773 2,147 2,663

Public Consumption 472 601 650 739 890

Fixed Investment 1,367 1,844 2,294 2,788 3,450

Current Account Balance 372 436 297 306 253

Trade Balance 264 298 196 183 169

Exports 1,220 1,431 1,202 1,578 1,815

Imports 956 1,133 1,006 1,395 1,646

China: Economic Forecast Summary



Geography and EnvironmentBACKGROUND

6

• China is the world’s most populated country, and is the world’s fourth largest country by geographic area, approximately the size of the United States.– The world’s four largest countries by geographic area are Russia, Canada, the United States, and

China.• China extends over an area of 9,596,961 sq km (3,705,406 sq miles), of which barely 1% is covered by

fresh water, including the Yellow and Yangtze rivers. – As of early 2011, China represented 20% of the world’s population, and it possessed 7% of the

world’s freshwater supply. • China’s 14 bordering countries are: Afghanistan, Bhutan, Burma, India, Kazakhstan, North Korea,

Kyrgyzstan, Laos, Mongolia, Nepal, Pakistan, Russia, Tajikistan, and Vietnam. Mount Everest, located on the

Nepal–China Border

Source: CIA World Factbook (June 2011).

Geographic Highlights

Highest Point Mount Everest: 8,850 m (29,035 ft)

Lowest Point Turpan Pendi: 154 m (505 ft)

Longest River Yangtze River:

6,300 km (3,915 mi)

Yangtze River, the world’s third longest river




Chinese FlagBACKGROUND

7

Taiwan (Republic of China) Political disputes continue between the

People’s Republic of China and the Republic of China over sovereignty and the

political status of Taiwan.

• The Chinese flag shown above was first flown in Tiananmen Square on October 1, 1949, the founding day of the People’s Republic of China.

• The flag was designed by Zeng Liansong, a citizen from Rui’an, Zhejiang, in response to a design solicitation for a national flag by the sixth working group of the Preparatory Committee of the New Political Consultative Conference.

• Symbolism in the Chinese flag includes:– The red color symbolizes revolution.– The four smaller yellow stars symbolize the four social classes: the working class; the

peasantry; the urban petty bourgeoisie; and the national bourgeoisie (capitalists). – The larger yellow star symbolizes the Communist Party of China, which unites the four social

classes.

Hong Kong

Macau

The Two Special Administrative Regions of the People’s Republic of China




• The Shang dynasty, also called the Yin dynasty, was the first Chinese dynasty to leave historical records.

• The Shang dynasty is known for its bronze-age culture and written records in the form of oracle bone scripts.

• Lasting nearly six centuries, the Shang dynasty is divided into three periods: early, middle, and late. – The early Shang period was relatively undocumented, but is believed to

be connected to the Erlitou culture, a neolithic culture of the central plains of northern China that is mainly associated with China’s first dynasty, the Xia dynasty.

– The middle Shang period was characterized by expansion into the northwest, northeast, and south. This expansion, which continued through the late Shang period, created a widespread network of Shang cultural sites that shared in bronze-casting styles and mortuary practices.

– The late Shang period is symbolized by the Yinxu, “Ruins of Yin,” which served as the capital of the last nine Shang kings, from approximately 1250 to 1046 BC.

• Yinxu, “Ruins of Yin”

Shang Dynasty (1600 – 1046 BC)BACKGROUND

8

Brief History Symbols, Art, and Culture

• The Beginning of the Bronze Age in China

Accomplishments• Bronze Age: The Shang engaged in large-scale production of bronze-ware vessels

and weapons. Such production required a large labor force to carry out the mining, refining, and transporting processes of copper, tin, and lead ores.

• Writing System: The first known Chinese people to leave historical records, the Shang developed a comprehensive system of writing. By 1400 BC, the oracle scripts included some 2,500 to 3,000 characters, most of which can still be read today.

Important Personages• Shang Tang (1675 – 1646 BC)

The first ruling king of the Shang dynasty, Shang Tang overthrew Jie of the Xia dynasty after 11 wars by stirring an internal rebellion amongst the Xia soldiers. His 13-year reign was well regarded by the Chinese citizenry as he lowered taxes and the conscription rate of soldiers.

The oracle bone script is the oldest known form of the Chinese written language. The oracle bones, fashioned from cattle scapulae or turtle plastrons, contained 10 – 60 characters, and were used for divination on topics relating to sacrifices, hunts, weather, harvests, sickness, childbearing, dreams, divine assistance, and prayers to various spirits.

The Shang dynasty marked the beginning of the Bronze Age in China (1500 BC – 300 BC). Bronze castings were made into ritual vessels used in worshipping ancestors, and into weapons employed in warfare.

• The Oracle Bone Script

Yinxu, “Ruins of Yin,” best symbolizes the late period (1250 – 1046 BC) of the Shang dynasty as it served as the capital for the last nine Shang kings. Discovered in 1899, Yinxu contains sophisticated bronze, ceramic, stone, and bone artifacts, palaces, shrines, tombs, and workshops of the Shang dynasty, and is considered one of China’s oldest and largest archeological sites.

Source: Encyclopedia Britannica, www.britannica.com; www.chinatoursaffordable.com; www.artsmia.org.

The First Documented Dynasty; the Bronze Age of China; and the Oracle Bone Script

Please See Page 2 for a Complete List of Dynasties



Mozi was a philosopher w h o s e f u n d a m e n t a l doctrine of undifferentiated love cha l lenged Con- fucianism and became the b a s i s o f M o h i s m .

• The Mandate of HeavenThe Zhou dynasty replaced the Shang dynasty with the belief that their reign was a “Mandate of Heaven” from the deity Tian, symbolized to the left. The Zhou replaced the Shang system of ancestor worship of the deity Di with heavenly worship of the deity Tian. The residing king was called the “Son of the Heaven.”

• Encompassing over eight centuries, the Zhou dynasty represents the single longest dynastic period in Chinese history.

• The Zhou dynasty was divided into two periods: Xi (Western) Zhou; and Dong (Eastern) Zhou. – The Western Zhou Period (1046 – 771 BC) was the age of feudalism, in

which states were ruled by lords who paid homage to the King of Zhou and recognized him as the “Son of the Heaven.”

– The Eastern Zhou Period (770 – 256 BC) was the time of the Hundred Schools of Thought, a collection of several intellectual ideologies that blossomed and changed the culture and political system of China.

• Although the Zhou dynasty officially ended in 256 BC, the succeeding Qin dynasty did not begin until 221 BC.

The Fall of Feudalism; the Rise of Monarchy; and the Golden Age of Chinese Philosophy

BACKGROUND

9


• The Zenith and End of the Bronze Age in China

Accomplishments

Important Personages

• Confucius (551 – 479 BC)

Source: Encyclopedia Britannica, www.britannica.com; www.artsmia.org.

Confucius was a philosopher who developed an ethical, social, political, and quasi-religious belief system based primarily on humanity and righteous- ness, called Confucianism.

Considered the golden age of Chinese philosophy, the Hundred Schools of Thought emerged during the Eastern Zhou period and transformed the culture and political system in China. Renowned thinkers included: Confucius who developed Confucianism; Mozi who developed Mohism; Laozi who developed Taoism; Shang Yang who developed legalism; and Mencius who expanded upon Confucianism.

Started by the Shang dynasty, the Bronze Age in China reached its zenith during and ended in the Zhou dynasty. Through technological advances and process refinements, the bronze castings were more elaborate and were used as ritual vessels, art pieces, and musical bells.

• The Hundred Schools of Thought

Zhou Dynasty (1046 – 256 BC)

• Laozi (6th century BC)L a o z i was t h e f i r s t philosopher of Taoism (Daoism), an ancient Chinese religion meaning the “way of life.”

• Mozi (c. 470 – c. 390 BC)

• Shang Yang (c. 390 – c. 340 BC)S h a n g Y a n g w a s a statesman and philosopher who believed in the rule of law and loyalty to the state, doctrines that became the b a s i s o f l e g a l i s m .

• Agriculture: The Zhou improved soil quality, developed irrigation systems, and grew a variety of grains including millet, wheat, rice, and soybeans.

• Metallurgy/Introduction of Iron: The Zhou practiced ferrous metallurgy that led to the earliest recorded blast furnaces and steel. With the introduction of iron, they became skilled at making weapons and tools.

• Political/Socioeconomic Reformation: The Zhou adopted new philosophies that transitioned China away from a rigid feudal system to a new centralized monarchical state.




• The Great Wall of China• The Qin dynasty was the first dynasty of imperial China.• Tracing its history to the early 8th century BC, the Qin empire served as a

ruling court during the Zhou dynasty, and through the leadership of Shang Yang, developed its own pattern of government as feudalism declined.

• Shang Yang, a bureaucrat in the court of Wei, standardized the local administration by combining various localities into counties, which were then organized into prefectures under supervision of the court. This system was expanded to all of China after the unification of 221 BC.

• Qin Shi Huangdi, the first emperor of the Qin dynasty, ruled strongly and accomplished much during his reign. Despite his many accomplishments, historians give mixed ratings to his reign as he imposed high taxes, banned all books that advocated other forms of government, and burned writings of the great philosophers of the Hundred Schools of Thought.

BACKGROUND

10


• The Terra-Cotta Army

Accomplishments• A Unified China: The Qin dynasty was the first dynasty of imperial China. The Qin

abolished the feudal system, and adopted the administrative system established by Shang Yang.

• Standardized Language and Writing System: The Qin unified China’s language and writing system, which had varied between geographic areas during the Warring States Period of the Zhou dynasty.

• Standardized Currency: The Qin used a circular copper coin with a square hole in the middle as its standardized currency.

• Standardized Measurements: The Qin developed uniform measurements and axle lengths to improve transportation as the ruts formed by cartwheels needed to be uniform in order for multiple carts to travel down the same road.

• Great Wall of China: The Qin made significant progress in constructing the Great Wall of China, connecting existing walls from the Zhou dynasty into one unified system with watchtowers.

• Weaponry: The Qin advanced military weaponry by creating crossbows and strengthening bronze and iron swords.


• Qin Shi Huangdi (Also known as Qin Shi Huang) (c. 260 – 210 BC)

Source: Encyclopedia Britannica, www.britannica.com; www.globalmountainsummit.org; www.chinaculture.org; www.artsmia.org.

Viewed as a strong and energetic ruler, Qin Shi Huangdi was the first emperor of the Qin dynasty and imperial China. He made several pivotal reforms during his reign, and accomplished much for China. His most notable reform was the abolishment of the feudal system and adoption of the administration system established by Shang Yang.

Qin Dynasty (221 – 207 BC)

• Shang Yang (c. 390 – c. 340 BC)Shang Yang flourished during the Zhou dynasty and established the foundation of the Qin dynasty. The Qin dynasty adopted legalism as China’s official philosophy.

The Beginnings of Imperial China; Authoritarian Rule; and Great Achievements

Discovered in 1974 by farmers digging for a water well, the Terra- Cotta Army was intended to protect emperor Qin Shi Huangdi in his resting place. Buried in three pits covering over 42 square miles, the army is estimated to number 8,000 soldiers, 130 chariots with 520 horses, and 150 cavalry horses. The site now receives over two million Chinese and foreign visitors each year.

Although it originates in the Warring States Period of the Zhou dynasty, the Great Wall of China is mainly associated with the Qin dynasty, as emperor Qin Shi Huangdi connected the existing parts of the wall to form a single system fortified by watchtowers.




• The Silk RoadThe Han’s large territorial expansion led to trade with the people of inner Asia that eventually developed into the Silk Road. With multiple routes through the mountains, the Silk Road expanded to eventually connect Asia with th e Mediterranean, North Africa, and Europe. In return for its exports of silk and gold, China imported wine, spices, woolen fabrics, grapes, pomegranates, sesame, broad beans, and alfalfa.

• The Han dynasty, the second dynasty of imperial China, lasted for four centuries and is considered the first of China’s four greatest dynasties: the Han; the Tang; the Song; and the Ming dynasties.

• The Han advanced China as a growing military, economic, and political power throughout Asia and the eastern world.

• The Han dynasty can be divided into two dynasties, Western and Eastern, separated by the rule of Emperor Wang Mang who declared his rule as the Xin dynasty. The Xin dynasty was brief, only lasting from 9 to 23 AD after Emperor Wang was overthrown by a secret society called the Red Eyebrows, a clan of peasants and descendants of the Han. Wang’s successor, Liu Xiu, who took the name Emperor Guang Wudi, restored the Han dynasty in 25 AD.

• Although the Han successfully expanded its territory through military prowess, economic and political struggles led to the rise of three kingdoms and the fall of the Han dynasty in 220 AD.

BACKGROUND

11


• Han Painting

Accomplishments• Expansion of Territory: During the rule of Emperor Wudi, the Han expanded their

rule to the west and south.• Development of the Civil Service: The Han established the civil service, and

structured a central and provincial government that laid the foundation for imperial China.

• Foreign Trade: With the development of the Silk Road, the Han engaged in trade with the outside world.

• Scientific/Technological Innovations: The Han invented the seismograph and developed paper, water clocks, sundials, and astronomical instruments.

Important Personages• Gaozu (Liu Bang) (256 – 195 BC)

Source: Encyclopedia Britannica, www.britannica.com; www.chinaculture.org; www.absolutechinatours.com; www.metmuseum.org; www.artsmia.org.

The founder and first emperor of the Han dynasty, Gaozu ruled strongly, and developed many aspects of the Chinese imperial system that endured until 1911-1912.

This mortuary vessel dates back to the Western Han dynasty (206 BC – 9AD) and represents an exquisite example of Han painting. Decorated with a fanged blue beast lunging at a mounted archer, the vessel symbolizes the bold character of the Western Han dynasty.

Han Dynasty (206 BC – 220 AD)

• Guang Wudi (Formerly Liu Xui) (c. 390 – c. 340 BC)Defeating Emperor Wang Mang of the short-lived Xin dynasty, Guang Wudi restored the Han dynasty after many brutal, blood-shedding battles, which left the country in an impoverished condition and in ruins. During his reign, Emperor Guang Wudi revitalized China’s agricultural system and rebuilt its infrastructure.

Legalism and Confucianism; Large Territorial Expansion; and the Silk Road

• Han ArchitectureThe architectural model of a central watchtower shown here dates back to the Eastern Han dynasty (25 – 220 AD). Viewed as the most important manifestation of the Han imperial order, Han architecture consisted of towered gateways and palatial complexes. The city walls symbolized power, prestige, and defense.

Key Dynasty




• The Grand CanalThe Sui constructed the Grand Canal, a water transport system that helped promote economic development and unify all of China. Today, the Grand Canal is 1,776 km (1,103 miles) long and is the world’s longest canal, connecting Beijing to Hangzhou.

• Following three centuries of political fragmentation, the Sui dynasty reunified China and restored its imperial system. Ruled by Emperor Wendi, the Sui dynasty reformed China’s political and government system, abolishing the six-officials system and establishing a new system with three departments and six boards.

• Short-lived, yet well accomplished and foundational, the Sui dynasty in many ways resembled the Qin dynasty, China’s first imperial dynasty, as it set the course for subsequent dynasties of imperial China.

• The Sui dynasty had two emperors, Wendi and his son, Yangdi. Emperor Wendi contributed to China’s political reform, while Emperor Yangdi constructed the Grand Canal. Emperor Wendi was killed by his son, Yangdi, who became a cruel leader; he was later hanged in 618 AD, marking the end of the Sui dynasty.

BACKGROUND

12


Accomplishments• A Reunified China: The Sui reunified China after three centuries of political and

government incongruity. • Centralized Government: The Sui abolished the six-officials system and established

a new system of three departments and six boards. These changes structured a process of bureaucratic promotion and made the civil service more homogeneous.

• Art: The Sui developed the world’s earliest porcelain and traded these and other goods with the outside world.

• Grand Canal: The Sui constructed the Grand Canal, a symbol of technological innovation and national unification as well as a catalyst for economic development.

Important Personages• Wendi (541 – 604 AD)

The founder and first emperor of the Sui dynasty, Emperor Wendi restored imperial China and laid the foundation for subsequent dynasties. He reformed China’s government system and launched the construction of the Grand Canal, which was completed by his son and successor, Yangdi.

Sui Dynasty (581 – 618 AD)

• Yangdi (569 – 618 AD)Viewed as an extravagant, cruel, and tyrannical leader, Emperor Yangdi acceded to the throne by killing his brothers and father, Emperor Wendi. Despite his cruelty, Emperor Yangdi was an accomplished leader as he expanded the Sui territory into the southern province and finished the construction of the Grand Canal.

A Reunified China; Political and Government Reform; and the Grand Canal

• PorcelainThe Sui crafted the world’s earliest known porcelain. Made from well-refined white kaolin clay, the porcelain was simple, pure, and elegant, and was used for rituals and as eating and drinking ware. The earliest known porcelain has been found in the Persian Gulf and Iraq, indicating the far-flung trading that occurred during the Sui period.

Source: Encyclopedia Britannica, www.britannica.com; www.chinaculture.org; www.artsmia.org.


http://upload.wikimedia.org/wikipedia/commons/0/0b/Sui_Yangdi_Tang.jpg

http://upload.wikimedia.org/wikipedia/commons/a/ad/Sui_Wendi_Tang.jpg

http://upload.wikimedia.org/wikipedia/commons/a/ad/Sui_Wendi_Tang.jpg



• Literature – PoetryThe Tang advanced classic Chinese poetry. Li Bai, Du Fu, and Bai Juyi were great Chinese poets who prospered during this dynasty. These writers combined realism and romanticism, treating topics ranging from the darkness of feudalism, to spirituality, to the celebration of natural beauty and splendor. The Complete Poetry of Tang, a compilation of Tang poetry, contains more than 48,900 poems.

• The Tang dynasty lasted for three centuries and ranks as the second of China’s four greatest dynasties: the Han; the Tang; the Song; and the Ming dynasties.

• The Tang dynasty can be divided into two periods, early Tang and late Tang, separated by the eight-year rebellion of An Lushan. Early Tang is viewed as a period of prosperity and accomplishment, Late Tang as a period of decline.

• Although Taoism was declared the official religion, Buddhism flourished and remained influential through most of the Tang dynasty. Some emperors tried to suppress the practice of Buddhism, but were unsuccessful.

BACKGROUND

13


Accomplishments• Economic Growth: Spurred among other catalysts by population movement away

from the north to more fertile land in the south, the Tang economy thrived as agricultural production and trade boomed and monetary usage increased in the forms of coinage and silk.

• Art: Literature, printing, painting, pottery, and sculpture flourished during the Tang dynasty, and established the course for subsequent dynasties.

• Standardized Currency: Using copper coins, the Tang improved China’s coinage; standardized lengths of silk were also used.

Important Personages• Gauzo (566 – 635 AD)

Source: Encyclopedia Britannica, www.britannica.com; www.metmuseum.org; www.chinaculture.org; www.absolutechinatours.com; htttp://history.cultural-china.com; www.newworldencyclopedia.org; www.artsmia.org.

The founder and first emperor of the Tang dynasty, Emperor Gauzo brought China out of bankruptcy, improved its military, expanded its territory, and standardized its coinage.

Tang Dynasty (618 – 907 AD)

• Wuhou (Wu Zetian) (624 – 705 AD)The first and only empress in Chinese history, Empress Wuhou reigned for over half a century. Considered a ruthless ruler, she reformed China’s central government system and believed strongly in symbolism and religion. For symbolic reasons, she changed the emperor’s title to “heavenly emperor.”

A Prosperous China; A Golden Age of Literature and Art; and A Clash Between Buddhism and Taoism

• Visual Art – Floral MedallionThe Tang aggrandized all forms of Chinese visual art, including sculpture, porcelain, painting, and textiles. The floral medallion shown here was ubiquitous in Tang textiles and decorative arts. The medallion originated in the eastern Mediterranean, and likely made its way to eastern Central Asia via the Silk Road.

• Woodblock Printing – The Diamond Sutra, the World’s First Printed Book

• Xuanzong (685 – 762 AD)The seventh emperor of the Tang dynasty, Emperor Xuanzong reigned during the most prosperous years (712 – 756 AD) of the Tang dynasty. During Xuanzong’s reign, the Tang strengthened the military, expanded the economy, and advanced the arts.

Key Dynasty

The Tang invented woodblock printing, a technique using wooden blocks carved with characters and coated with ink to stamp or rub the intended text onto the surface of textiles or paper. The Diamond Sutra depicted here was printed in 868 AD and is considered the world’s first printed book.




BACKGROUND

14

Song Dynasty (960 – 1279 AD)

• Song Landscape Painting• Following the Five Dynasties and Ten Kingdoms Period, the Song dynasty lasted for over three centuries and is considered the third of China’s four greatest dynasties: the Han; the Tang; the Song; and the Ming dynasties.

• The Song dynasty was divided into two periods: the Northern Song (960 – 1127 AD); and the Southern Song (1127 – 1279 AD). The Northern Song was a tranquil time characterized by philosophical and artistic development, political centralization, and economic growth; the Southern Song, a period of brutal invaders, political instability, and decline of power.

• China’s historic city Hangzhou served as the capital city during the Southern Song period and by 1200 AD, had a population of approximately 400,000, compared with Paris and Venice whose populations were 100,000.

An Age of Political Stability and Instability; An Age of Invention; and An Age of Unparalleled Chinese Art


Accomplishments• Movable Type Printing: Song artisan Bi Sheng invented movable type printing,

which supplanted woodblock printing developed during the Tang dynasty. • Architecture: Song architecture reached new heights of sophistication. The Song

were the first to document construction methods and standard units of measurements.• Banknote: The Song created the first banknote, or paper currency, and circulated it

alongside its coinage. • Gunpowder: The Song invented gunpowder and used it in rockets, guns, cannons,

and explosives.

Important Personages• Taizu (927 – 976 AD)

Source: Encyclopedia Britannica, www.britannica.com; www.chinaculture.org; htttp://history.cultural-china.com; www.newworldencyclopedia.org; www.artsmia.org.

The founder and first emperor of the Song dynasty, Emperor Taizu reigned for 16 years. Emperor Taizu created the Song Ancestor Rules and Policy, expanded the examination system, and created academies to promote discussion and thought. He also weakened the military to prevent anyone from rising to power as he did.

• Jingdezhen, China’s Porcelain CapitalTracing back to the Han dynasty, Jingdezhen was founded in 1004 by Emperor Zhenzong and is China’s porcelain capital, with a porcelain- making history of nearly two millennia. The Song reached unsurpassed adroitness and aesthetic sublimity in their porcelain making.

• Wooden Sculpture and Chinese Buddhist SculptureThe Song increased the quantity and improved the quality of Chinese wooden sculpture. Many art historians maintain that Song wooden sculpture is the best in the world. The last great movement of Chinese Buddhist sculpture occurred during the late Song period, in the 12th and 13th centuries.

• Gaozong (1107 – 1187 AD)The 10th emperor of the Song dynasty and first emperor of the Southern Song dynasty, Emperor Gaozong reigned for 35 years. He established Hangzhou (formerly known as Lin’an) as the capital city of the Southern Song dynasty.

Northern Song Southern Song

• Zhenzong (968 – 1022 AD) The third emperor of the Northern Song dynasty, Emperor Zhenzong consolidated the power of and strengthened the rule of the Song dynasty. Emperor Zhenzong initiated foreign policy with the Liao dynasty resulting in the Shanyuan Treaty, and founded Jingdezhen in 1004, China’s porcelain capital.

Key Dynasty

Song landscape painting is considered one of China’s greatest contributions to world art. The Northern Song used realism to depict nature by the 11th century, whereas the Southern Song used impressionism, which persisted through the 14th century.




BACKGROUND

15

Yuan Dynasty (1280 – 1365 AD)

• The Silk Road• Following the Song dynasty, the Yuan dynasty was first of two times in history in which foreigners reigned over all of China: the Mongols reigned over China during the Yuan dynasty, and the Manchus during the Qing dynasty.

• Mongol invader Genghis Khan conquered Asia and established the Great Khan empire. Khan’s grandson, Kublai Khan founded the Yuan dynasty in 1280 AD after the fall of the Song dynasty.

• Despite conquering imperial China, the Mongols struggled to govern the Chinese as they held different political beliefs, spoke different languages, dressed differently, and followed different customs.

The Mongol Empire; Blue-and-White Porcelain; and Marco Polo


Accomplishments• Extension of the Grand Canal : During the reign of Emperor Kublai Khan, the

Yuan rebuilt parts of and extended the Grand Canal, China’s largest water passage system that was originally built during the Sui dynasty.

• Increased Trade Activity: Via the Silk Road, the Yuan traded blue-and-white porcelain and other goods with Europeans and Middle Easterners.

Important Personages• Genghis Khan (1162 – 1227 AD)

Source: Encyclopedia Britannica, www.britannica.com; www.chinaculture.org; htttp://history.cultural-china.com; www.newworldencyclopedia.org; www.artsmia.org; www.silk-road.com; www.historyforkids.org.

Mongol invader Genghis Khan conquered Asia and established the Great Khan empire. He reigned from 1206 – 1227 AD. The Great Khan empire covered a geographical area consisting of over 20 modern-day countries, including Armenia, China, Iran, Iraq, Korea, Kuwait, Russia, and Turkey.

• Blue-and-White PorcelainThe Yuan were major producers of and the first to export blue- and-white porcelain via the Silk Road. The Yuan improved upon the techniques of past dynasties to advance the art of making blue-and-white porcelain. Europeans and Middle Easterners prized blue-and-white porcelain and it continued to be produced and traded by the Chinese through the Qing dynasty.

• Khanbaliq (also known as Dadu)Translated as “great capital” or “great residence of the Khan,” Khanbaliq, also known as Tadu, was the capital city of the Yuan dynasty. Prior to serving as the capital city of the Yuan dynasty, Khanbaliq (then known as Zhoudong) served as the capital city of the Jin dynasty until it was burned down by the Mongols in 1215 AD. Khanbaliq is located in present-day Beijing, the current capital city of the People’s Republic of China.

• Kublai Khan (1215 – 1294 AD) A grandson of Genghis Khan, Kublai Khan was the fifth leader of the Great Khan and founder and first emperor of the Yuan dynasty. The first non-ethnic Chinese emperor in Chinese history, Kublai Khan boosted agricultural output in southern China, rebuilt the Grand Canal, and extended existing highways.

Tracing back to the Han dynasty (206 – 220 AD), the Silk Road reached its zenith during the Yuan dynasty. During the Yuan dynasty, Europe, the Middle East, and Asia traded goods with each other. Venetian merchant Marco Polo traveled the Silk Road and helped spur trade between Europe, the Middle East, and Asia.

• Marco Polo (1254 – 1324 AD) Venetian merchant Marco Polo traveled throughout Asia for 24 years and served as an official in Kublai Khan’s administration for over two decades. Marco Polo documented his travels in “Il Milione,” a collection of stories from his travels throughout Asia, Persia, China, and Indonesia between 1271 and 1291 AD.




• The Forbidden City

BACKGROUND

16

Ming Dynasty (1368 – 1644 AD)Key

Dynasty

• Following the Yuan dynasty, the Ming dynasty lasted for nearly three centuries and is considered the last of China’s four greatest dynasties: the Han; the Tang; the Song; and the Ming dynasties.

• The Ming dynasty restored imperial China as the ethnic Han supplanted the Mongols and once again reigned over all of China.

• The Ming dynasty can be divided into two periods, Early Ming and Late Ming. Early Ming was characterized by a vibrant period that restored imperial China and revived China’s cultural identity and respect for traditional artifacts and craftsmanship; late Ming was characterized by internal discord and decline.


Accomplishments• Strong Navy and Standing Army: The Ming commanded a strong naval fleet and a

powerful army. • World’s Largest Economy: The Ming had the world’s largest economy, primarily due

to increased trade overseas, technological advances, the privatization of the salt and tea industries, and robust agriculture and manufacturing sectors.

• Sprouts of Capitalism: Historians believe the Ming dynasty witnessed the beginnings of capitalism in China. The Ming invested capital into ventures, which were later suppressed by the Qing.

Important Personages• The Hongwu Emperor (Also Known as Zhu Yuanzhang) (1328 – 1398 AD)

Source: Encyclopedia Britannica, www.britannica.com; www.chinaculture.org; htttp://history.cultural-china.com; www.newworldencyclopedia.org; www.artsmia.org; www.travelchinaguide.com.

The founder and first emperor of the Ming dynasty, the Hongwu Emperor restored imperial China by overthrowing the Mongol empire through the Red Turban Rebellion, an uprising staged by Buddhist monks who were ethnic Han and were affiliated with the secret society, “White Lotus.” During his reign, the Hongwu Emperor instituted military, administrative, and educationa l reforms that unified and centralized imperial China.

• The Three Schools of Painting: Che, Wu, and the EccentricDuring the Ming dynasty, three schools of painting emerged: (i) the Che, a formal approach tracing back to the Song dynasty; (ii) the Wu, a style of the intelligentsia; and (iii) the Eccentric, a form of spontaneity and freedom of expression.

• The Great Wall of China

A Restored Imperial China; A Revival of Chinese Art; and the Forbidden City

and is the world’s largest surviving palace complex. Located in Beijing, the Forbidden City served as the home of the emperors for half a century, and as the ceremonial and political center of the Chinese government. It was declared a World Heritage Site in 1987 by UNESCO and now houses the Palace Museum.

Covering over 178 acres, The Forbidden City served as the Chinese imperial palace of the Ming and Qing dynasties,

Originating in the Qin dynasty, the Great Wall of China was further developed during the Ming dynasty. Most of the existing wall can be attributed to the work of the Ming; they redesigned the watch towers, placed cannons along the walls, and used larger brick and granite rocks than used in previous dynasties.

• The Yongle Emperor (Also Known as Zhu Di) (1360 – 1424 AD)

The third emperor of the Ming dynasty, the Yongle Emperor renamed Beijing as the capital city of imperial China and built the Forbidden City, China’s imperial palace that remained the capital city through the Qing dynasty. During his reign, the Yongle Emperor repaired and reopened the Grand Canal, commissioned the exploratory sea voyages of Zheng He, and upheld the civil service examinations for drafting government officials instead of the recommendation-appointment process.




BACKGROUND

17

Qing Dynasty (1644 – 1912 AD)

• The Dragon Flag of the Qing dynasty (1890 – 1912 AD)• The last dynasty in Chinese history, the Qing dynasty was reigned over by the Manchus and was the second of two times in history where foreigners exercised dominion in China, the first being the Mongols’ reign during the Yuan dynasty.

• Unlike the Mongols, the Manchus succeeded in governing China while preserving their own cultural identity. The Manchus enacted firm policies to separate the two cultures while reigning over China; they prohibited Manchu-Chinese marriage, forced the Chinese to shave their heads and wear the queue hairstyle, continued to speak the Manchu language, and trained Manchu soldiers more intensively than Chinese soldiers.

• The first two centuries of the Qing dynasty were a time of peace and prosperity for China. The latter years were plagued with discord, including the Opium Wars, the first Sino-Japanese War, the Taiping Rebellion, the Boxer Rebellion, and the Xinhai Revolution, all of which led to the downfall of the Qing dynasty and the end of dynastic China.


Accomplishments• Strong, Organized, and Loyal Military: Building on the military

accomplishments of the Ming, the Qing commanded a world-class military with superior organization and loyalty to the emperor. They organized their soldiers in banners, each of which was a separate unit. The number of banners grew from eight to 24.

• Kangxi Dictionary: Under the reign of Kangxi Emperor, the Qin created the Kangxi Dictionary, the standard Chinese dictionary during the 18th and 19th

centuries. It contained over 47,000 characters, some of which are used today.


Source: Encyclopedia Britannica, www.britannica.com; www.chinaculture.org; htttp://history.cultural-china.com; www.artsmia.org; www.east-asian-history.net; www.1uptravel.com.

• The Zenith of Chinese PorcelainChinese porcelain reached its zenith during the Qing dynasty. The Qin made blue-and-white porcelain, pictorial porcelain-oversized platters, and magnificent porcelain vases, all of which were traded with the West.

• The Queue (Manchu Hairstyle)As a political act of submission to the Manchu, Chinese males were forced to wear their hair in Manchu style, known in English as the “queue.” It consisted of a shaved head with a long braided ponytail. Cutting or not wearing the queue was considered treason and was punished by death. The queue marked a symbolic point in Chinese history as it was only worn during the Qing dynasty.

The first and last dynastic flag in Chinese history, The Dragon Flag of the Qing dynasty symbolized authority and sovereignty and was the state flag and naval ensign through the latter part of the Qing dynasty.

The Last Dynasty of China; the Zenith of Chinese Porcelain; and the Queue

• Nurhaci Emperor (1559 – 1626 AD) The Nurhaci Emperor was the first and founding emperor of the Qing dynasty; he is credited with the creation of a written script for the Manchu language.

• Qianlong (1711 – 1799 AD) The sixth emperor of the Q i n g d y n a s t y , t h e Qianlong Emperor reigned for 60 years during a prosperous time in China.

• Kangxi Emperor (1654 – 1722 AD) The fourth emperor of the Qing dynasty, the Kangxi Emperor reigned for 61 years, making him the longest-reigning Chinese e m p e r o r i n h i s t o r y .

• Yuan Shikai (1859 – 1916 AD) Yuan Shikai was a shrewd general and politician who contributed to the end of the Qing dynasty. He later became the first President of the Republic of China.




BACKGROUND

ConfucianismThe Cornerstone of Traditional Chinese Culture

18Source: wwww.regligionfacts.com, www.travelchinaguide.com.

Confucius (551 – 479 BC) is considered one of the world’s greatest philosophers. He was born in the feudal state of Lu, in the modern-day Shandong Province. Distressed by the constant warfare between the Chinese states and by the venality and tyranny of their rulers, he urged a system of morality and statecraft that would preserve peace and provide people with stable and just government. Later tradition depicts Confucius as a person who made special study of ancient books, in an effort to restore an earlier social order. Among the many sayings attributed to Confucius, two of the most widely known are:

Confucius (551 – 479 BC)

“Everything has beauty, but not everyone sees it;” and

“A journey of a thousand miles begins with a step.”

Source: encyclopedia.com.

• The cornerstone of traditional Chinese culture, Confucianism is a belief system based on the Chinese cultures of the Xia, Shang, and Zhou dynasties. Confucianism was developed and elaborated by the Chinese philosopher Confucius.

• Confucianism was further developed by the great Chinese philosophers Mencius (372 – 289 BC) and Xun Zi (313 – 238 BC). During the Han dynasty, the first of China’s four greatest dynasties, Emperor Wu made Confucianism the orthodox doctrine of Chinese society. Throughout the Han dynasty, Confucianism was recognized as the “Han State Cult,” adopting religious and ceremonial elements such as sacrifices to Confucius.

• Confucianism struggled to co-exist with Buddhism and Taoism during the Sui and Tang dynasties, but was restored as the official philosophy of China and flourished throughout the Song and Ming dynasties. Throughout those two dynasties and the Republic of China, Confucianism abandoned the religious and ceremonial elements established in the Han dynasty and focused entirely on the teachings of Confucius.

• A revival of Confucian thought in the 10th century produced “Neo-Confucianism,” a major influence in Korea during the Choson dynasty and in Japan during the Tokugawa period.

• The five principles that embody Confucianism are:– (i) Ren, Humaneness or benevolence;– (ii) Li, Ritual norms;

• All five principles constitute virtue, de.

• The Five Classics are a collection of writings that represent the core of Confucianism education. They include: – (i) Shu Ching (Classic of History), a collection of documents and speeches dating from the later Han dynasty; – (ii) Shih Ching (Classic of Odes), a collection of 300 poems and songs from the early Zhou dynasty;– (iii) I Ching (Classic of Changes), a collection of texts on divination based on a set of 64 hexagrams that reflect the

relationship between Yin and Yang in nature and society;– (iv) Chu’un Ching (Spring and Autumn Annals), extracts from the history of the state of Lu, said to be compiled by

Confucius; and– (v) Li Ching (Class of Rites), a collection of three books on Li (ritual norms or rites of propriety).

Overview

Beliefs

The Five Classics

– (iii) Zhong, Loyalty to one’s true nature;– (iv) Shu, Reciprocity; and

– (v) Xiao, Filial piety.

http://static.newworldencyclopedia.org/8/85/Confuciusstatue.jpg



• The Five Classics, a collection of five literary works pivotal to Confucianism, are:

– (i) Shijing (Classic of Poetry);

– (ii) Shujing (Classic of History);

• The Complete Poetry of Tang is a compilation of Tang poetry containing over 48,900 poems.

• The Four Great Classical Novels, the four novels considered the greatest and most influential literary works of classical Chinese fiction, are:

– (i) Romance of the Three Kingdoms;

– (ii) Water Margin;

• Other Classics include:

– (i) The Romance of the Western Chamber

– (ii) The Injustice to Dou E

– (iii) I Ching (Classic of Changes);– (iv) Chu’un Ching (Spring and Autumn Annals); and

– (v) Li Ching (Class of Rites).

– (iii) Journey to the West; and– (iv) Dream of the Red Chamber.

– (iii) The Peony Pavilion; – (iv) The Golden Lotus;

– (v) Jin Ping Mei; and– (vi) The Scholars.

BACKGROUND

19

Chinese Literature

Source: Encyclopedia Britannica, www.britannica.com; www.travelchinaguide.com; www.china-on-site.com; www.cultural-china.com.

History of Chinese Literature• Chinese literature can be divided into four main periods:

– (i) Classical Literature, from ancient China through the Qing dynasty;– (ii) Modern Literature, from the Opium War in 1840 through the May Fourth Movement in Beijing in 1919;– (iii) Contemporary Literature, from 1919 to 1949; and– (iv) Present-Age Literature, from 1949 to the present.

• Chinese literature has had a celebrated and struggle-filled past. The most celebrated times of Chinese literature began in 500 BC, with the writing of the Shijing; the most struggle-filled times began during the Qin dynasty, with the burning of books produced by the Hundred Schools of Thought.

• The May Fourth Movement (1917 – 1921) represented an intellectual revolution and sociopolitical reform movement. Chinese students and faculty at the prestigious Peking University (colloquially known as Beida University) in Beijing abandoned the traditional Chinese literary language and created new popular fiction written in colloquial language.

• During Mao Zedong’s rule of the People’s Republic of China, Chinese literature was scrutinized and freedom of expression was suppressed as Mao believed that all forms of art should serve politics. Chinese literature was not officially tolerated and celebrated again until the mid-1980s.

Renowned Literary Works


Li Bai, Poet from the Tang dynasty

Du Fu, Poet from the Tang dynasty

Bai Juyi, Poet from the Tang dynasty

Su Shi, Poet and Statesmen

from the Song dynasty

Song Lian, Writer/Historian from

the Ming dynasty

Yuan Mei, Poet/Scholar/Artist

from the Qing dynasty



• Created by Taoist Monk Zhang Sanfeng, Wudang Martial Arts is a soft style of Chinese kung fu that includes shadow boxing and bare-hand fighting. Mr. Zhang created the style to use soft movements to conquer the unyielding, and to strengthen and unify the mind and body

• Among the different art forms of Wudang kung fu, the most renowned is Tai Chi Chuan, a style aimed to balance the body and mind through slow motions, deep breathing, and meditation. Its philosophy is based on the principles of Yin and Yang.

• Created by Buddhist monks at Shaolin Temple, Shaolin Martial Arts represents a hard style of Chinese kung fu that includes boxing, stick art, and spear art. The Buddhist monks created this style based on the movements of birds, beasts, and fish.

• Among the different art forms of Shaolin kung fu, the most prominent are: Shaolin boxing, an attack-and-defense style known for its strong and powerful technique; and Shaolin Spear Art, a style using the spear, one of China’s most ancient weapons.

BACKGROUND

20

Chinese Martial Arts

Overview of the Chinese Martial ArtsExisting for over four millennia, Chinese Martial Arts consist of various fighting styles created for self defense, hunting, and military training. The four basic moves are kicking, throwing, striking, and controlling. Chinese Martial Arts are synonymous with “Kung Fu” and “Wushu,” but Kung Fu and Wushu have evolved into distinct forms.

Alhough many forms have developed over the years, Chinese Martial Arts can be classified into two categories: hard style, and soft style. Hard style, known as “Shaolin Martial Arts,” was developed by Buddhist monks at Shaolin Temple in the region of Song Mountain. Soft style, known as “Wudang Martial Arts,” was developed by Zhang Sanfeng, a Taoist who lived during the Song dynasty. Wudang kung fu grew in popularity during the Ming dynasty.

Today, Chinese Martial Arts are practiced worldwide as a hobby and profession through organizations or schools of martial arts. Chinese martial artists participate in competition, focusing on empty-hand forms, weapon forms, choreographed forms, group practice, sparring competition, and power demonstration.

Shaolin Martial Arts

Historic Personages

Wudang Martial Arts

Historic SitesTai Chi Chuan Traditional Shaolin Martial Arts

Source: www.travelchinaguide.com, www.typesofmartialarts.com, http://kaleidoscope.cultural-china.com.

Shaolin Temple

Wudang Mountains

Shaolin Temple is a Buddhist monastery on Mount Song in Henan province; it is the home of Shaolin Martial Arts. For further information, please see page 21.

Wudang Mountains are located in the northwestern part of Hubei Province and are the home of Taoist monasteries, where Wudang Martial Arts flourished during the Ming dynasty.

Mount Emei

Mount Emei is located in the Sichuan Province of western China and is home of Buddhist and Taoist monasteries that practice Emei Martial Arts.

• Five Elders of Shaolin: The five survivors of the destruction of the Shaolin Monastery by the Qing dynasty are Jee Sin, Pak Mei, Fong do Dak, Miu Hin, and Ng Mui.

• Yim Wing-Chun: A kung fu master who was taught by Ng Mui. • Ten Tigers of Canton: A group of Chinese martial artists from

Guangdong who lived during the late Qing dynasty and were considered the best fighters in southern China.

• Hung Hei-gun: Founder of the martial arts system, “Hung Gar Kung Fu.”

• Chan Heung: Founder of the martial arts system, “Choy Li Fut.”

• Yang Luchan: Influential teacher of Tai Chi Chuan during the late 19th Century.

• Bruce Lee: Famous Hong Kong actor and Chinese martial artist from the late 20th century who founded the martial arts system, “Jeet Kune Do.”



BACKGROUND

21

Shaolin Temple

Source: “Shaolin Kung Fu,” by Peter Gwin, National Geographic, March 2011.

Shaolin Through the Ages

11th century B.C. Oldest Chinese reference to martial arts.A.D. 495 Shaolin Temple founded by Indian Buddhist monks.621 Thirteen Shaolin monks battle opponents of Tang rule.

1350s Temple sacked by marauders, one of many such events in its history.

1553 Shaolin monks help fight off Japanese pirate attacks on Chinese coast.

1898–1901 Martial artists foment the Boxer Rebellion to challenge Western influence.

1928 Warlord Shi Yousan burns Shaolin Temple, obliterating its vast library, including ancient martial arts texts.

1940s Shaolin monks ambush Japanese soldiers patrolling near the temple.

1966 The Cultural Revolution's Red Guards ravage the Shaolin Temple and beat the few remaining monks.

1972 Kung Fu TV series begins, introducing the Shaolin Temple to Americans.

1982 Martial arts champ Jet Li portrays a heroic monk in Shaolin Temple, a film that sets off a Shaolin frenzy in China.

1999 Shi Yongxin is installed as the 30th abbot of the Shaolin Temple.

2010 The Shaolin Temple is named a UNESCO World Heritage site.

• Founded by Indian Buddhist monks in the 5th century BC, Shaolin Temple is located in the Song Mountains in Henan province. As of early 2011, approximately 150 monks lived at the temple, and visiting monks from across China and abroad came to study and meditate at this purported fountainhead of Zen Buddhism.

• A popular myth holds that a fifth-century Indian mystic taught a series of exercises or forms that mimicked animal movements to the monks at the temple. The monks adapted the forms for self-defense and later modified them for warfare. Bare-handed martial arts existed in China long before the 5th century, and likely arrived at Shaolin with ex-soldiers seeking refuge.

• The temple was sacked repeatedly during its history. The most devastating blow came in 1928, when a vengeful warlord burned down most of the temple, including its library.

• From 1999 through 2010, Shi Yongxin, the abbot of Shaolin Temple, built an international business empire, including touring kung fu troupes, film and television projects, an online store selling Shaolin-brand tea and soap, and franchised Shaolin temples abroad, which include one planned as of early 2011 in Australia that would be attached to a golf resort.

• In addition to its successful commercial ventures, Shaolin Temple has helped foster an undeniable kung fu renaissance. In Dengfeng, a sprawling city of 650,000 just six miles from the temple gates, some 60 martial arts academies have sprouted in the 1990 to 2010 time period, boasting more than 50,000 students.

History and Recent Developments of Shaolin Temple

• The three principles of Shaolin Temple are: (i) chan (Zen meditation); (ii) wu (martial arts); and (iii) yi (herbal medicine).• Followers of traditional Shaolin kung fu believe that kung fu is not entirely about fighting adversaries, but about converting energy to force.

They hold that absent an adversary, kung fu is a series of movements and explain that a practitioner’s physical and mental weaknesses can become his/her own adversary. As such, followers of Shaolin emphasize in their studies and teaching that traditional Shaolin kung fu forms are more about honor and responsibility than about combat and fighting.

• Hu Zhengzsheng, a renowned instructor of traditional Shaolin kung fu, emphasizes respectfulness and a willingness to “eat bitterness,” which he describes as learning to welcome hardship and using that hardship to discipline the will and forge character.

• Breathing is critical in harnessing one’s chi, or life force. “Breathe in through the navel, out through the nose,” the late master Yung Guiwu of Shaolin Temple advised his pupils. Learning to breathe properly was the initial step on the arduous path to tapping the wellspring of the chi’s power and, in doing so, unlocking one of the universe’s hidden doors.

Shaolin Temple’s Guiding Principles and Philosophy of Kung Fu

Shaolin kung fu pupils learning to “eat bitterness.”

Pagoda forest in Shaolin Temple containing the bones of virtuous monks.

Monk seeking shelter from a snow shower in the Shaolin complex.

Monks walking in succession to pray in the Shaolin Temple.

Source: “Shaolin Kung Fu,” by Peter Gwin, National Geographic, March 2011.



BACKGROUND

Religion in China

22Source: China.org; “The Rise of the Tao,” by Ian Johnson, The New Yorker Magazine, November 7, 2010.

• The five recognized religions in China are: Buddhism; Islam; Taoism; and Christianity, which in China is treated as two faiths, Catholicism and Protestantism. Each of the five has a central organization headquartered in Beijing and staffed with officials loyal to the Communist Party. All report to the State Administration for Religious Affairs, which in turn is under the central government’s State Council, or cabinet. This form of religious control has a long history in China. For hundreds of years, emperors sought to define orthodox belief and appointed many senior religious leaders.– Buddhism was introduced to China from India around the first century AD, gaining popularity and becoming the most

influential religion in China after the fourth century. In the years after 2000, China had approximately 13,000 Buddhist temples.

– Islam is estimated to have reached China in the mid-seventh century. The Yuan dynasty (1280-1368) witnessed the height of influence of Islam. By the year 2000, China had more than 30,000 mosques.

– Catholicism was introduced into China after the seventh century, and Protestantism was introduced into China in the early 19th century. After 2000, there were more than 4,600 Catholic churches, 12,000 Protestant churches, and 25,000 other Christian places of worship in China.

– Taoism took shape as a religion during the second century, based on the philosophy of Laozi and his work, Dao De Jing. As of early 2011, China had more than 5,000 Taoist temples, up from 1,500 in 1997.

• Religion has long played a central role in Chinese life, but for much of the 20th century, reformers and revolutionaries saw it as a hindrance holding the country back and a key reason for China’s “century of humiliation.”

• The Chinese appear to be experiencing an awakening of religious belief. In cities, young urban professionals have been turning to Christianity. Buddhism attracts the middle class, while Taoism has rebounded in small towns and the countryside. Islam is also on the rise, not only in troubled minority areas but also among tens of millions elsewhere in China.

• A survey in early 2011 showed that an estimated 300 million people in China claim a faith. A broader question in another poll showed that 85% of the population believes in religion of the supernatural.

• In 2007, President Hu Jintao endorsed religious charities and their usefulness in solving social problems. The central government has also sponsored international conferences on Buddhism and Taoism.

• As China’s only indigenous religion, Taoism’s influence is extends from calligraphy and politics to medicine and poetry. The religion is loosely based on the writings of a mythical person named Laozi and calls for returning to the Dao, or Tao, the mystical way that unites all of creation. As in many other religions, Taoism encompasses a broad swath of practice, from Laozi’s high philosophy to a pantheon of deities: emperors, officials, thunder gods, wealth gods, and terrifying demons that punish the wicked.

• For much of the past two millennia, Taoism’s counterpart has been Confucianism, the ideology of China’s ruling elite and the closest China has to a second homegrown religion. Whereas Confucianism emphasizes moderation, harmony, and social structure, Taoism offers a refuge from society and the trappings of material success.

Overview

Taoism, China’s Only Indigenous Religion

Crescent Moon and Star A Symbol of Islam

Dharmacakra A Symbol of Buddhism

Yin-Yang A Symbol of Taoism

Symbols of the Religions in China

Holy Cross A Symbol of Christianity

Laozi, Creator of Taoism

Taoism

Pa-kua, the eight trigrams that form the content of the hexagrams in I Ching



Cantonese Opera

BACKGROUND

23

Chinese Opera

• A blend of music, singing, martial arts, acrobatics, and acting, Chinese opera is one of the world’s three oldest forms of dramatic art, the other two being Greek tragic comedy and Indian Sanskrit opera.

• Chinese opera traces its roots to the third century, but was first organized by Emperor Taizong during the Tang dynasty (618 – 907 AD). Emperor Taizong founded Liyuan (Pear Garden), China’s first opera school. Students of Chinese opera were called, “Disciples of the Pear Garden.” During the Yuan dynasty, a contemporary form of opera called “Jingxi” emerged.

• During the Qing dynasty, the last dynasty of imperial China, Chinese opera became popular among the mainstream population, with performances in tearooms, restaurants, and even around makeshift stages.

• Different forms of Chinese opera have emerged over the years. Beijing Opera is a popular form in northern China; Cantonese Opera, a form developed during the Southern Song dynasty, is popular in southern China.

History of Chinese OperaDeveloped during the Southern Song dynasty, Cantonese Opera is a form of Chinese Opera popular in Hong Kong, Shanghai, and the rest of southern China.

The two type of plays within Cantonese Opera are: (i) Mo, literally meaning martial arts, a play with martial arts that emphasizes war; and (ii) Mun, literally meaning intellectual, polite, and cultured, a more gentle and elegant play that emphasizes poetry and culture.

The music of Cantonese Opera either classifies as “theatrical” or “singing stage.”

The four main roles in Cantonese Opera are: (i) Sang, the male character; (ii) Daan, the female character; (iii) Zing, a painted-face character, usually a hero, general, villain, god, or demon; and (iv) Cau, a clown character.

• Today, Chinese opera remains popular in China and around the world. Revered for its brilliant costumes, make-up, and theatrical performances, Chinese opera remains one of China’s most celebrated and admired forms of art.

• The People’s Republic of China has actively encouraged Chinese opera, advocating the writing of operas recounting historical Chinese events.

• Chinese opera is studied around the world by schools and organizations such as the Chinese Opera Institute, a non-profit organization based in Singapore intended to study, celebrate, and perpetuate Chinese opera.

Chinese Opera Today

Source: www.travelchinaguide.com, The Chinese Opera Institute, www.chineseoperainstitute.com.

• The three main roles in Beijing Opera are: (i) Sheng, the male character; (ii) Dan, the female character; and (iii) Jing, a painted-face character often played by a male. Each of these three characters has subtypes whose characters have different attributes and antics.

Main Roles in Beijing Opera

Zing Cau

Source: www.pearlmagik.com.



• Traditional Chinese music can be traced back 7,000 years, to the Neolithic age.

• From the ancient imperial dynasties to the present day, music has been an integral part of Chinese art, culture, and expression.

• Traditional Chinese musical instruments can be divided into four categories:– (i) Percussion instruments;– (ii) Stringed instruments;– (iii) Plucked instruments; and– (iv) Wind instruments.

BACKGROUND

24

Traditional Chinese Musical Instruments

Source: www.chcp.org, www.travelchinaguide.com, www.beijingspectator.com.au.

Chinese Drum

• The Chinese drum is a percussion instrument that dates back to the Xia dynasty, the first dynasty of China, approximately 4,000 years ago.

• Symbolizing the power of the ruler and the destiny of the army, it is used during ceremonies, festivities, weddings, and funerals.

Pipa (Lute)

• Originally named after the loquat fruit, the pipa is a plucked instrument that dates back to the Qin dynasty (221 – 206 BC), the first imperial dynasty of China.

• It is a popular instrument in China, known for its rapid and soft notes.

Erhu

• The Erhu, also known as Huqin, is a stringed instrument that dates back to the Tang dynasty (618 – 907 AD).

• It, along with other instruments in the same string family, is an important instrument in Beijing Opera.

• Blind folk artist Liu Yanjun wrote “Two Springs Reflect the Moon” on the erhu.

Xiao (Flute)

• The Xiao is a wind instrument that dates back to the Neolithic age, over 7,000 years ago.

• It produces a soft but vibrantly moving sound.• China is credited with creating the earliest form of the flute, a

small six-holed instrument made from bird bone.

Konghou Harp-like instrument introduced to

China during the Han dynasty

i ii

iviii



BACKGROUND

25

Overview of the Chinese Calendar

The Chinese calendar dates back to 2637 BC and has been an important influence on China’s dynasties and culture through the ages. Today, the Gregorian calendar is used in the People’s Republic of China for civil purposes, but the traditional Chinese calendar is still used fo r celebrating festivals and timing agricultural activities.

The Chinese calendar is a combination of two cycles, the Ten Celestial Stems and the Twelve Terrestrial Branches. Combining two characters from each of these cycles, years are enumerated and make up a cycle of sixty years.

Every year correlates with one of twelve animals (2011 is the year of the hare/rabbit, and the next year of the hare/rabbit will take place in 2023). The character of the animal is considered to have an influence on the character of people born during that year.

1 甲子 jiazi

2 乙丑 yichou

3 丙寅 bingyin

4 丁卯 dingmao

5 戊辰 wuchen

6 己巳 jisi

7 庚午 gengwu

8 辛未 xinwei

9 壬申 renshen

10 癸酉 guiyou

11 甲戌 jiaxu

12 乙亥 yihai

13 丙子 bingzi

14 丁丑 dingchou

15 戊寅 wuyin

16 己卯 jimao

17 庚辰 gengchen

18 辛巳 xinsi

19 壬午 renwu

20 癸未 guiwei

21 甲申 jiashen

22 乙酉 yiyou

23 丙戌 bingxu

24 丁亥 dinghai

25 戊子 wuzi

26 己丑 jichou

27 庚寅 gengyin

28 辛卯 xinmao

29 壬辰 renchen

30 癸巳 guisi

31 甲午 jiawu

32 乙未 yiwei

33 丙申 bingshen

34 丁酉 dingyou

35 戊戌 wuxu

36 己亥 jihai

37 庚子 gengzi

38 辛丑 xinchou

39 壬寅 renyin

40 癸卯 guimao

41 甲辰 jiachen

42 乙巳 yisi

43 丙午 bingwu

44 丁未 dingwei

45 戊申 wushen

46 己酉 jiyou

47 庚戌 gengxu

48 辛亥 xinhai

49 壬子 renzi

50 癸丑 guichou

51 甲寅 jiayin

52 乙卯 yimao

53 丙辰 bingchen

54 丁巳 dingsi

55 戊午 wuwu

56 己未 jiwei

57 庚申 gengshen

58 辛酉 xinyou

59 壬戌 renxu

60 癸亥 guihai

The Chinese Calendar Sixty Year Cycle of the Chinese Calendar

Source: www.chinesenewyears.info.

Chinese Year Zodiac Animal Gregorian Calendar4709 Hare/Rabbit 3-Feb-11

4710 Dragon 23-Jan-12

4711 Snake 10-Feb-13

4712 Horse 31-Jan-14

4713 Ram/Sheep 18-Feb-15

4714 Monkey 8-Feb-16

4715 Rooster 28-Jan-17

4716 Dog 15-Feb-18

4717 Boar 5-Feb-19

4718 Rat 25-Jan-20

Chinese Year Zodiac Animal Gregorian Calendar4719 Ox 12-Feb-21

4720 Tiger 1-Feb-22

4721 Hare/Rabbit 22-Jan-23

4722 Dragon 10-Feb-24

4723 Snake 29-Jan-25

4724 Horse 17-Feb-26

4725 Ram/Sheep 6-Feb-27

4726 Monkey 26-Jan-28

4727 Rooster 13-Feb-29

4728 Dog 3-Feb-30



• New Year’s Eve Dinner: Normally a family-reunion dinner, the New Year’s dinner is one of the most important dinners of the year for the Chinese. Fish and dumplings are normally served, symbolizing prosperity.

• Fireworks: Right after 12:00 pm on New Year’s Eve, fireworks are launched to celebrate the coming year and drive away evil. A person who launches the first fireworks in the New Year is believed to receive good luck.

• Upside-Down Fu: Arguably the most popular Chinese New Year craft, the upside-down “Fu” means luck, happiness, and prosperity. The Chinese post the “Fu” on the front door or on the wall of the living room.

• The Door God: Believed to prevent evil from entering, the Door God is placed on each side of an entry to temples, homes, and businesses.

• Chinese Lantern: Decorated with a red-colored paper shell, the Chinese lantern is hung in the front of the door or inside the home; in some parts of China, the lantern is required for the Yuan Xiao Festival, or Lantern Festival, occurring on the 15th of the first month of the New Year.

Select Traditions And CraftsHistory of the Chinese New Year

BACKGROUND

26

The Chinese New Year

Food

According to tales and legends, the Chinese New Year started with the fight against the mythical beast, “Year.” An ox-like creature with a lion-shaped head, the “Year” came at nightfall on New Year’s Eve to harm people, animals, and property. The Chinese learned that the beast feared the color red, fire, and loud sounds. Therefore, for self protection, they started posting red Dui Lian in the front of their homes, launching fireworks, and hanging lanterns at year end, among other traditions.

Subject to some degree of debate, celebration of the Chinese New Year originates in the Shang dynasty (1766 BC – 1122 BC). Until the Han dynasty, the timing of the celebration varied from midwinter to early spring. Emperor Wu (157 BC – 87 BC) of the Han dynasty (206 BC – 220 BC) is credited with establishing the New Year as the first day of the first month of the year.

Source: www.chinesenewyears.info.

• Dumplings: Popular in northern China, dumplings are a main dish served for New Year’s Eve dinner.

• New Year Cake: A solid cake made with glutinous rice flour and sugar, New Year Cake is a popular dish in Eastern China.

• Tangyuan: A Small ball of glutinous rice flour either unfilled or filled with sugarcane rock candy, sesame paste, red bean paste, or chopped peanuts and sugar, Tang Yuan is eaten during Yuan Xiao Festival, or the Lantern Festival, the 15th of the first month of the New Year.

• LaBa Congee: A mixture of rice, nuts, and beans, LaBa Congree is usually served during the LaBa Festival, the 8th day of the last month of the year.

Dumplings New Year Cake

Tangyuan Laba Congee

Fireworks in Hong Kong Fireworks in Guiyang

Upside Down Fu Door God

Chinese Lantern, Yuan Xiao Festival



BACKGROUND

27

Lacquerware and Porcelain

Source: www.travelchinaguide.com, http://arts.cultural-china.com/en, www.chinatour360.com, The Metropolitan Museum of Art.

Lacquerware (Illustrated on the left)• Dating back to the Warring States Period (475 – 221 BC) of the Zhou dynasty (1046 – 256 BC), Chinese lacquerware

includes household utensils, handicrafts, and artworks coated with varnish made from the sap of the lacquer tree. During the Han dynasty (206 – 220 AD), lacquerware was used primarily as household utensils made from wood or bamboo; by the Qing dynasty (1644 – 1912 AD), lacquerware production reached its zenith, with hundreds of varieties and more exquisite and complex techniques, such as inlaying, color painting, etching, coromandel, cover-coating, and wrapping with jades.

• To make lacquerware, a base coat is applied to a core material, followed by extremely thin layers of the finest lacquer. After these layers dry, a final layer is added to make the lacquer strong and light, while maintaining elegant appearance and harmonious color.

• Lacquerware types include: inlaid gold and silver lacquerware (Jinyin PingTuo) of the Tang dynasty; plan lacquerware (Yise Qiqi) of the Song dynasty; carved lacquerware of the Yuan dynasty; stone-decorated lacquerware (Baibao qian) of the Ming dynasty; and Fozhou bodiless lacquerware of the Qing dynasty.

• Fuzhou, of the Fujian Province (Southeast China), has been considered the lacquerware capital.

Porcelain (Illustrated on the right)• Dating back to the Sui dynasty, Chinese porcelain, also called “fine china,” refers to a type of ceramic made of white

kaolin clay, heated in a kiln to temperatures between 1,200 °C (2,192 °F) and 1,400 °C (2,552 °F). Porcelain is admired for its purity, elegance, and material characteristics, including tensile strength and toughness.

• During the Sui dynasty, porcelain was primarily used for rituals and as eating ware. During the Song, Yuan, Ming, and Qing dynasties, porcelain was also collected as art.

• Arguably the most popular and magnificent type of porcelain, blue-and-white porcelain was first exported to the western world via the Silk Road during the Yuan dynasty. Production of blue-and-white porcelain steadily continued through the Qing dynasty, as the western world, particularly the Europeans and Middle Easterners, avidly collected porcelain.

• Among the most renowned kilns were Ru, Ding, Ge, and Jun, each with its own distinct style, craft, and class. For example, the Jun kiln was known for copper-red glazed porcelain, which contained large amounts of copper oxides. During the Northern Song dynasty, Emperor Huizong ordered that the Jun kiln be devoted exclusively to the royal family and commissioned the production of flower pots and other porcelain vessels for the imperial court.

• Jingdezhen, in the Jiangxi Province (Southeast China), has been considered the porcelain capital.

Two of the “Three Treasures” of Chinese Art



• From January 26 through April 17, 2011, the Bard Graduate Center in New York, New York presented Cloisonné: Chinese Enamels from the Yuan, Ming, and Qing dynasties.

• Displaying more than 160 items ranging from pocket- to armchair-size, the exhibition contained almost seven centuries’ worth of domestic and ceremonial enamelware. Bowls, vases, incense burners, jewelry boxes, and garden stools made of copper alloys have surfaces covered with intricate mosaic patterns and imagery in pure blues, reds, yellows, and greens.

• Cloisonné, which literally means “divided into compartments” in French, entails the application of pastes made of ground colored glass into cells that are bounded by thin strips of metal standing on edge on flat or curved surfaces. Heated in a kiln, the paste melts into enamel; sanding and buffing results in glossy surfaces.

• The Cloisonné enamel technique was most likely introduced from Byzantium into China during the Mongol Yuan dynasty (1280 – 1365 AD).

• From the late Yuan dynasty to the early Ming dynasty, Buddhist temples were the primary patrons and/or intended recipients of cloisonné. The lotus flower, a Buddhist symbol of purity, was the most frequently used motif on Chinese enamels.

• In the late 14th century and the 15th century, the schematic scrolling lotus designs of Buddhist origin were joined by more naturalistic depictions of flowers and fruit, including chrysanthemums, grapes, camellias, hibiscus, peonies, and lotuses, all of which were often used as symbols of the four seasons.

• In the second half of the 16th century, during the reign of the Wanli Emperor (1573 – 1620 AD), a marked increase took place in enamel production, together with a decline in craftsmanship. The end of the 17th century brought a resurgence of enamel production. In the last sixty years of the 18th century, during the reign of the Qianlong Emperor (1736–96 AD), growing interest took place in the arts in general and the decorative arts in particular. The unprecedented variety of forms and decoration that resulted was accompanied by a resurgence of taste for many symbols prevalent in the Ming dynasty.

• Beginning in the Yuan dynasty, Beijing has been considered the Cloisonné capital.

BACKGROUND

28

Source: Cloisonné: Chinese Enamels from the Yuan, Ming, and Qing Dynasties, by the Bard Graduate Center and the Musée des Arts Décoratifs, Yale University Press (2009); The New York Times, “When Enamel Wares Adorned China’s Imperial Courts,” February 17, 2011; www.chinaculture.org; The Metropolitan Museum of Art.

Cloisonné EnamelsOne of the “Three Treasures” of Chinese Art



• Motion pictures were introduced to China in 1896, but the film industry did not get under way in earnest until 1917. During the 1920s, film technicians from the United States trained Chinese technicians in Shanghai, which became an early filmmaking center. In the 1930s and 1940s, several socially and politically important films were produced.

• During the Cultural Revolution, the film industry was severely restricted. Many earlier films were banned, and only a few new ones were produced. In the years immediately following the Cultural Revolution, the film industry again flourished as a medium of popular entertainment.

• During the 1990s, the Hong Kong film industry experienced retrenchment, exacerbated by the Asian economic crisis which dried up several traditional sources of film finance.

BACKGROUND

Chinese Film

29

Select Chinese Cinema Classic Films

“Red Firecracker, Green Firecracker,” 1994

He Ping’s Red Firecracker, Green Firecracker (1994) is a tale of forbidden love set in China prior to the 1911 Chinese Revolution. The movie offers insights into Chinese traditions, love, and society.

“A Touch of Zen,” 1969King Hu’s A Touch of Zen (1971) is set during the Ming dynasty (1368-1644) and is considered a martial arts classic. The movie is also acknowledged for its heavy influence on another hit film , “Crouching Tiger, Hidden Dragon,” released in 2000.

“The Peach Girl,” 1931Bu Wancang’s The Peach Girl (1931) is considered one of early Chinese cinema’s great classics. The life of a peach tree is used as a metaphor for the heroin e’s development in this tragic love story.

Grauman’s Chinese Theatre

Famous Actors in Chinese Cinema

Brief History of China’s Film Industry

Grauman’s Chinese Theatre, located in Hollywood, California, is one of the most famous theatres in the world. The Chinese Theatre opened on May 18, 1927 and has hosted more movie premieres than any other theatre in the world. In 1968, it was declared a historic cultural landmark.

Source: dGenerate Films, http://dgeneratefilms.com.

“Confucius,” 1940Fe Mu’s Confucius (1940) is a portrayal of Confucius’s thought and life. The film was lost following its brief re-run in 1948, but was found again in 2001. The Hong Kong Film Archive released the film during the Hong Kong International Film Festival in 2009.

• Jackie Chan• Maggie Cheung• Chow Yun-Fat• Tony Leung• Gong Li

• Jet Li• Ge You• Michelle Yeoh• Zhang Ziyi• Liu Xiaqping



BACKGROUND

Sir Run Run Shaw

30

Sir Run Run Shaw

• Sir Run Run Shaw CBE, GBM, born on November 23, 1907, is a Hong Kong media mogul. In 1974, he was awarded the Commander of the Order of the British Empire (CBE). He received a knighthood in 1977 and the Grand Bauhinia Medial (GBM) from the Hong Kong Special Administration government in 1998.

• He was born in Ningbo, Zhejiang, China, and received his education in American-run schools. He is the youngest of six sons of Shanghai textile merchant Shaw Yuh Hsuen (1867 – 1920).

• He and his brother Runme Shaw founded the South Seas Film studio in 1930, which later became Shaw Studios. In 1967, he launched TVB (Television Broadcasts Ltd.) in Hong Kong, developing it into a multi- billion dollar TV empire ranking in early 2011 as one of the top five television producers in the world.

• His first wife, Wong Me Chun, died at age 85 in 1987. Shaw stopped filming that year. He remarried in Las Vegas in 1997 to Mona Shaw (formerly Fong Yat-wa and Deputy Chairman of TVB since 2000).

• In 2000, through his company, Shaw Brothers (Hong Kong) Ltd., he sold his unique library of 760 classic titles to Celestial Pictures Ltd..

• Shaw Studios entered a new era with Run Run Shaw’s majority investment (through his various holding companies) in the US$180 million Hong Kong Movie City project, a 1,100,000 square feet (102,000 m2) studio and production facility in Tseung Kwan O (Hong Kong). The facility’s features include: one of the largest, fully air-conditioned and sound and vibration-insulated soundstages in Asia; a full-service color lab and digital imaging facility; over 20 sound and editing suites; a 400-seat dubbing and screening theatre; executive and production office space; banqueting facilities; and visual effects and animation capabilities. This facility serves as the centerpiece of Shaw Studios and for the Chinese film industry as a whole.

• Over the years, Shaw has donated billions of dollars to charity, schools, and hospitals. His name appears on many buildings in Hong Kong and on the China mainland.

• Shaw’s daughter, Violet, lives in Hawaii and was married to the late Morgan Stanley Executive Director Paul Loo, manager of the firm’s Honolulu office for 47 years.

Source: Who’s Who 2007, by A&C Black, 2007; Shaw Studios, http://www.shawstudios.hk/who_we_are.htm.

Sir Run Run Shaw(1907 – )

Shaw Studios’ Hong Kong Movie City

Well-known Films• Blade Runner (1982)• The 36th Chamber of Shaolin (1978)• Meteor (1979)• Five Deadly Venoms (1978)Source: IMDb.com, Inc.



Eight Traditional Cuisines

BACKGROUND

31

Chinese Cuisine

Jiangsu cuisine is known for its braising and stewing, producing light, mellow, and sweet tastes. It was developed from local recipes of Yangzhou, Suzhou, and Nanjing.Notable Dishes: Three Sets of Ducks: A stewed fowl duck stuffed with a wild duck stuffed with a pigeonBraised Lions Head: Large meatballs braised in clear or red soup

Zhejiang cuisine is known for its tender and soft taste. Cooking methods include frying, quick-fry, stir-fry, braising, and steaming. Notable Dishes: West Lake Braised Fish in Vinegar: Fish braised in vinegar and sugarLongjing Shrimp Meat: Shrimp stir-fried in Longjing tea (from Hangzhou)

Fujian cuisine is known for its cutting techniques, alternative soups, unique seasonings, and meticulous execution. Served in special dishware, Fjuian dishes are clear, light, and slightly sweet and sour.Notable Dishes: Buddha Jumping Over the Wall: Shark fin soup stewed with a large variety of proteins and vegetables Jitangcuanhaibang: Clams cooked in chicken stock (jitang)

Anhui cuisine is composed of local flavors from the Yangtze and Huai Rivers. Its delicacies include river creatures and fish.Notable Dishes: Braised Turtle with Ham: Soft shell turtle stewed with ham, bamboo, garlic, ginger, and soy sauce, among other ingredientsFuliji Grilled Chicken: Tender, meat-falling-off-the-bone Dezhou braised chicken, influenced by Shandong cuisine

Guangdong cuisine is known for its delicate balanced flavor, fine and rare ingredients, and focus on dish presentation. Notable Dishes: Chrysanthemum Fish: Cut in the shape of a chrysanthemumBraised Snake Porridge: Braised meat of cobra, grimalkin, or pullet

Guangdong Cuisine

Zhejiang Cuisine Fujian Cuisine Anhui CuisineJiangsu Cuisine

Shandong cuisine is known for its strong flavor, mainly from the use of shallots and garlic. Seafood is a delicacy.Notable Dishes: Braised Abalone: Smooth, delicate, and savorySweet and Sour Carp: Crisp exterior and tender fish interior

Shandong Cuisine

Hunan cuisine is known for its spicy and sour dishes, with a heavy use of oil to produce crispness, softness, and tenderness.Notable Dishes: Stewed Fins: Fins, chickens, and pork stewed in chicken soupDong’an Chicken: Parboiled and flavored with chilies, peppers, and vinegar

Hunan CuisineSichuan Cuisine

Sichuan cuisine is known for its spicy and pungent seasonings, and its variety of cooking techniques.Notable Dishes: MaPo Tofu: Stir-fried Tofu with minced beef in spicy bean sauceGong Bao Ji Ding: The inspiration for modern day “kung pao chicken”

• Rice and flour are of the two main staples in China.– Rice is the major food source for

people rice farming in Southern China and can also be used to produce beers, wines, and vinegars.

– Flour is the major food source for people wheat farming in Northern China and can be used to produce noodles, breads, dumplings, and steamed buns.

• Tofu is a popular soy product often used as a meat or cheese substitute.

• China’s eight regional cuisines evolved as a result of resources, climate, geography, history, and other lifestyle factors.

Source: www.chinaassistor.com, www.pub.mtholyoke.edu, www.travelchinaguide.com.

Popular in east China, Shanghai cuisine is not one of the eight traditional Chinese cuisines, but is a blend of Jiangsu, Zhejiang, Fujian, and Anhui cuisines.

Shanghai cuisine is known for its use of soy sauce, sugar, and wine. Wines are used to marinate and favor meats, which are renamed “drunken” (i.e., “drunken chicken”).

Shanghai cuisine also known for Dim Sum, a Cantonese term for dishes of small portions of food. Dim Sum is also popular in Hong Kong.

Shanghai Cuisine

1 2 3 4

5 6 7 8

http://www.google.com/imgres?imgurl=http://eat.tanspace.com/photos/The_Porridge-lions-head.jpg&imgrefurl=http://eat.tanspace.com/2008/06/09/the-porridge-%25E5%25B0%258F%25E5%258A%2589%25E6%25B8%2585%25E7%25B2%25A5-in-milpitas/&usg=__nkvag9kKO9e-AVGa8zPRL6HYb7c=&h=480&w=640&sz=103&hl=en&start=3&zoom=1&um=1&itbs=1&tbnid=GLwBktFFIjHrWM:&tbnh=103&tbnw=137&prev=/images%3Fq%3Dbraised%2Blions%2Bhead%26um%3D1%26hl%3Den%26rls%3Dcom.microsoft:*%26tbs%3Disch:1

http://www.google.com/imgres?imgurl=http://3.bp.blogspot.com/_5rq9orao3Ok/Sg-vlpSngKI/AAAAAAAABEw/QYzZj1OxbGg/s320/fo%2Btiau%2Bjiang%2Bbuddha%2Bjumps%2Bover%2Bthe%2Bwall%2Bfatt%2Btiu%2Bcheung.jpg&imgrefurl=http://original-chinese-recipes.blogspot.com/2009/05/buddha-jumps-over-wall.html&usg=__b_rdFOttnGCrY5xAlMOKWinzWJg=&h=195&w=300&sz=10&hl=en&start=30&zoom=1&um=1&itbs=1&tbnid=ta2VqBV5rVWZKM:&tbnh=75&tbnw=116&prev=/images%3Fq%3Dbuddha%2Bjumping%2Bover%2Bthe%2Bwall%26start%3D20%26um%3D1%26hl%3Den%26sa%3DN%26rls%3Dcom.microsoft:*%26ndsp%3D20%26tbs%3Disch:1



Geographic Highlights Landscape

Area 154 sq km (96 sq mi)

Highest Point Lotus Peak:

1,864 m (6,115 ft)

BACKGROUND

32

Huangshan“Yellow Mountain”

• Located in the southern Anhui province of eastern China, Huangshan is a mountain range well known for its scenery, sunsets, peculiarly-shaped granite peaks, Huangshan Pine trees, hot springs, and views above the clouds.

• Encompassing 154 sq. km. of scenic area, Huangshan Mountain has a well-preserved ecosystem, with plant life covering over 82% and forests covering 56% of the area.

• Among the many peaks at Huangshan, the tallest are: Lotus Peak, or Lian Hua Feng, standing 1,864 m tall; Bright Summit Peak, or Guang Ming Ding, standing 1,840 m tall; and Celestial Peak, or Tian Du Feng, standing 1,829 m tall.

• Huangshan has been highly esteemed throughout Chinese history as the height of classic Chinese mountain scenery. The earliest reference to it, then known as San-Tianzi Du, is ascribed to Shanhai jin (The Book of Mountains and Seas). During the Tang dynasty, an imperial edict was issued to honor it with the name, Huangshan (yellow mountain), yellow being the color associated with the emperor.

• During the Ming dynasty in 1606, the monk Pumen came to Huangshan and built Fahai Meditation Temple and Wonshu Temple, connecting them by steps cut into the mountain.

• The mountain has about 140 sections open to visitors, and receives approximately 15 million visitors per year. • The core area surrounding Huangshan is uninhabited, though there are monks in monasteries and the mountaintop

hotels are staffed. Approximately 1,600 people live in the Xianyao Ting residential area, most of whom are staff and their dependents.

Source: www.china.org.cn., http://severnnaturalwonders.org, United Nations Environment Programme, www.enep-wcmc.org.

Huangshan, Anhui Province in Eastern China

Huangshan Pine Tree

Native to mountains of eastern China, the Huangshan pine tree is considered one of the wonders at Huangshan. An evergreen reaching 15 – 25 meters in height, Huangshan pine grows in little soil, in moderate to high altitudes, and on rocky crags.



• The giant panda, or panda (Ailuropoda melanoleuca, literally “black and white cat-foot”) is a bear native to south-central China. It is easily recognized by its large distinct black patches around the eyes, over the ears, and across its round body. Although it belongs to the order Carnivora, the panda’s diet is 99% bamboo (the panda spends approximately 55% of its day feeding).

• The giant panda lives in six isolated mountain ranges (Minshan, Qinling, Qionglai, Liangshan, Daxiangling, and Xiaoxiangling) in Gansu, Shaanxi, and Sichuan provinces (about 75% of the panda bear population inhabits Sichuan province).

• The panda does not hibernate, but it generally descends to lower elevations in the winter and may take temporary shelter in hollow trees, rock crevices, and caves.

• The panda is an endangered species. A 2007 report showed that 239 pandas lived in captivity inside China and another 27 outside the country. A recent survey by the State Forestry Administration (SFA) of China and the World Wildlife Fund (WWF) indicated that approximately 1,600 pandas are living in the wild.

• The greatest threat to the giant panda is restricted and degraded habitat. Population fragmentation exists on two scales: six mountain ranges separated by agricultural land; and bamboo patches of cleared lands and forest without a bamboo understory within those mountain ranges. Populations of pandas have become small and isolated, confined to high ridges, and hemmed in by cultivation.

• No conclusive explanation exists of the origin of the word “panda.” The closest candidate is the Nepali word “ponya,” possibly referring to the bear’s wrist bone, which has evolved to hold bamboo shoots for eating. Since the earliest collection of Chinese writings, the Chinese language has given the bear 20 different names, such as 大熊貓 (dà xióng māo), literally meaning "large bear cat," or 熊貓 (xióng māo), literally meaning "bear cat.”

• Loans of giant pandas to American and Japanese zoos formed an important part of the diplomacy of the People’s Republic of China in the 1970s, as it marked some of the first cultural exchanges between the PRC and the West. This practice has been termed “panda diplomacy.”

• By 1984, however, pandas were no longer used as agents of diplomacy. Instead, China began to offer pandas to other nations only on 10- year loans. The standard loan terms include a fee of up to US$1,000,000 per year and a provision that any cubs born during the loan are the property of the People's Republic of China. Since 1998, due to a WWF lawsuit, the United States Fish and Wildlife Service only allows a US zoo to import a panda if the zoo can ensure that China will channel over half of its loan fee into conservation efforts for the giant panda and its habitat.

• The giant panda is among the world’s most adored and protected rare animals, and it is one of the few in the world whose natural habitation site was able to gain a UNESCO World Heritage Site designation. The Sichuan Giant Panda Sanctuaries, located in southwest Sichuan province and covering seven natural reserves, were inscribed onto the World Heritage List in 2006.

BACKGROUND

33

Source: International Union for Conservation of Nature, http://www.iucnredlist.org; Giant Pandas, by Duncan Scheff (Heinemann/Raintree, 2002); “Global Species Programme–Giant Panda,” World Wildlife Fund, November 14, 2007; “Number of Pandas Successfully Bred in China Down from Last Year,” Xinhua News, August 11, 2007; “Pandas Gain World Heritage Status,” BBC News, July 12, 2006.

Panda Bears

Panda Bears are considered endangered species.

International Union for Conservation of Nature

Panda Bears are native to south-central China



• Hangzhou was the capital of several kingdoms, including the Wuyue Kingdom during the Five Dynasties and Ten Kingdoms Period, and the Southern Song dynasty.

• With its tea and silk industries, and its temples and pagodas adorning quiet hilltops, Hangzhou remained an important port through the middle of the Ming dynasty.

Hangzhou

BACKGROUND

34

Historical Chinese Cities“In Heaven, there is paradise; on earth, Hangzhou and Suzhou.” Marco Polo (1254 – 1324)

Suzhou

• Founded approximately 2,200 years ago during the Qing dynasty and through the centuries a center of meditative, poetic, and spiritual significance, Hangzhou is one of the Seven Ancient Capitals of China.

• Hangzhou, whose city walls were not built until the Sui dynasty in 591 AD, sits at the southern end of China’s Grand Canal, the world’s longest canal.

Historical Significance

Relevance Today• Hangzhou is a major city located in the Yangtze River Delta region, and it is the capital

of Zheijiang province in eastern China. • In 2009, Hangzhou had a population of 8,100,000. • In 1993, the Chinese government established the Hangzhou Economic and

Technological Development Zone to encourage industries including electronic information, biological medicine, machinery manufacturing, and food processing.

• Hangzhou operates an international airport, the Hangzhou Xiaoshan International Airport and a thriving river port, the Hangzhou Port.

• Possessing near mythical status in Chinese cultures, Hangzhou is a popular tourist destination and it has been frequently ranked as one of China’s 10 most scenic cities.

• In 514 BC, during the Spring and Autumn Period of the Zhou dynasty, King Helu named Suzhou the “Great City of Helu,” and established it as his kingdom’s capital city. Since then, historic Suzhou has mostly remained unchanged.

• Known as “Wu County” throughout the Qin dynasty, Suzhou served as the location of Xiang Yu’s historical uprising that contributed to the overthrow of Qin. Suzhou’s name was later restored during the Sui dynasty in 589 AD.

• Upon completion of the Grand Canal, Suzhou found itself strategically located on a major trade route, making Suzhou a hub of industry, trade and commerce.

• Dubbed the “Venice of the East,” or “Venice of China,” Suzhou is one of the oldest towns in the Yangtze Basin.

• Suzhou dates back 2,500 years, to the late Zhou dynasty and was established by the Wu, who formed villages along the edges of hills above the wetlands surrounding Lake Tai.

Historical Significance

Relevance Today• A city within the Yangtze River Delta region, Suzhou has modernized while

maintaining its cultural and historical significance in Chinese history. • In 2009, Suzhou had a population of 6,332,900. • In the 1990s, the Chinese partnered with Singapore to establish several economic

development projects, including the Suzhou Hi-Tech Industrial Development Zone, which as of late 2010 hosted over 1,500 foreign companies, 40 of which are Fortune 500 companies.

• Suzhou is a popular tourist destination and receives many visitors each year. Source: www.travelchinaguide.com, http://rightsite.asia/en.

Skyline of Modern Hangzhou West Lake

Xuanmiao Temple, Taoist Temple Built in 276

Famous Canal Street, Downtown Suzhou

Pan Gate, An Ancient City Wall Built in 514 BC



One of the First Five Special Economic Zones of China

BACKGROUND

35

Shenzhen, “The City of Ambition”

• Literally meaning “deep drains,” Shenzhen was a nondescript fishing village located alongside several rivers and streams until Paramount Leader Deng Xiaoping declared the city a Special Economic Zone (SEZ) on September 6, 1980.

• Shenzhen, a Pearl River Delta city whose roots trace back to the Ming dynasty, was selected by Deng Xiaoping as a SEZ because of its close proximity to Hong Kong, a then-prosperous British territory.

• Since 1980, Shenzhen has blossomed into one of China’s burgeoning economic power centers and has been called “The City of Ambition.”

• In 2010, Shenzhen had a population of approximately 8.9 million and a gross domestic product of 950 billion yuan (US$144 Billion).

History of ShenzhenFirst Five Special Economic Zones of China

Following the end of the Mao era in 1978, Deng Xiaoping became the Paramount Leader of China and initiated broad economic reforms. He envisioned China as a country more open to the outside world and economically robust. He encouraged foreign trade and investment through joint ventures, and aimed to increase foreign investment.

To accomplish this goal, he created Special Economic Zones in southern China on September 6, 1980. The SEZ were Shenzhen, Xiamen, Shantou, Zhuhai, and the entire province of Hainan. Deng Xiaoping envisioned these SEZs as incubators of capitalism.

The key benefit of the SEZ to foreign investors was favorable tax advantages and government regulations. In 2010 at the 30th Anniversary of the SEZ, President Hu Jintao noted that “China will always support the SEZs and remember their roles as ‘first movers.’”

• Shenzhen has evolved from a small fishing community into one of China’s most vibrant economic zones. Among several prominent economic developments, two of the most notable are:– The Shenzhen Stock Exchange (SZSE): Founded on December 1, 1990, 10 years after Shenzhen was declared a Special

Economic Zone, the Shenzhen Stock Exchange is one of China’s three stock exchanges and has ranked as the seventh largest exchange by market capitalization out of the 16 major exchanges in the Asia Pacific region. As of December 31, 2010, the SZSE had 1,174 companies listed on its exchange, with a stock market value of 8.7 trillion yuan (US$1.3 Trillion). The SZSE also operates the SME Board and ChiNext, two sub-exchanges catering to specific securities.

– Shenzhen Hi-Tech Industrial Park (SHIP): Founded in September 1996, the Shenzhen Hi-Tech Industrial Park covers an area of 11.5 km2 and encourages the biotechnology/pharmaceutical, building and construction, chemicals, medical equipment, telecommunications, and electronics industries. SHIP also established the Shenzhen Software Park to encourage the software industry. SHIP has attracted high-tech, multinational companies including IBM, Philips, Olympus, Epson, Lucent, Harris, and Thomson.

Relevance Today

Source: www.szse.cn, www.world-exchanges.org, www.ship.gov.cn, http:/english.sz.gov.cn, www.scmp.com, www.trueknowledge.com.

Source: “Quick Guide: China’s Economic Reform,” BBC News, November 3, 2006, www.china.org.cn.



Nanjing (Jiangsu Province)• Population (2009): 7.7 million• Meaning “Southern Capital,” Nanjing served as

China’s economic, cultural, and political capital through several modern historical periods, including the period up to the Chinese Civil War in 1949.

• Surrounded by the Yangtze River (a strategic trade gateway) and mountains, Nanjing boasts beautiful natural scenery.

• During the Tang and Song dynasties, Nanjing was a place where poets gathered and composed poems.

• Nanjing’s main industries include electronic information, machinery, materials, bio- pharmaceuticals, and pharmaceuticals.

Dalian (Liaoning Province)• Population (2009): 6.2 million• Dalian has been controlled by several countries,

including: Britain in 1858; China in the 1880s; Japan in 1895 during the first Sino-Japanese War; and the Soviet Union following World War II.

• One of China’s key ports located in Dalian is Port Arthur (now named Lushun), named after Prince Arthur, Queen Victoria’s son.

• Dalian Beach in 31 kilometers (18 miles) in length and serves as a popular summer destination.

• Dalian’s main industries include machine manufacturing, petrochemicals, oil refining, and electronics.

Notable Chinese CitiesBACKGROUND

36Source: ChinaToday.

Chengdu (Sichuan Province)• Population (2009): 11.0 million• Dating back to the 4th Century BC, Chengdu was the

capital of several ancient dynastic kingdoms.• In 1279, the Mongols sacked the city, killing 1.4 million

inhabitants.• Chengdu was the birthplace of the first widely used paper

money in the world.• Chengdu is the home of the Chengdu Research Base of

Giant Panda Breeding.• Chengdu’s main industries include food, medicine,

machinery, and information technology.• Chengdu is one of the preferred cities for investment in

western China; 133 of the world’s 500 largest companies multinational enterprises had subsidiaries or branch offices in Chengdu as of late 2009.

Chongqing (Direct-Controlled Municipality)• Population (2009): 28.2 million • Chongqing served as China’s wartime capital during

the Second Sino-Japanese War.• In 1997, Chongqing was named one of China’s four

directly controlled municipalities (the highest ranking level for cities in China; the other three direct- controlled municipalities are Beijing, Shanghai, and Tianjin).

• In 2005, Chongqing was named one of China’s Five National Central Cities, the others being Beijing, Guangzhou, Shanghai, and Tianjin.

• The city serves as a manufacturing center and transportation hub for Southwest China, with its main industries including iron, steel, and aluminum production, motor vehicle production, and mining.



Qingdao (Shandong Province)• Population (2007): 7.6 million• Due to its location on the Shandong

Peninsula, Qingdao is a major industrial city and foreign trade port. It is also a popular location for health resorts, due to its mild climate, beaches, and lush hills.

• Identified as a strategic port, Qingdao was a German colonial concession from 1898 to 1914, following a brief political conflict.

• Upon gaining control of the area, the Germans outfitted the fishing village with wide streets, electrification, a sewer system, and safe drinking water supplies.

• Qingdao’s main industries include mineral water, wine, and Tsingtao Beer.

Harbin (Heilongjiang Province)• Population (2009): 9.9 million• An extension of Russia’s Trans-Siberian Railway, the

Chinese Eastern Railway (constructed in 1898) connected Harbin to other port cities, transforming Harbin from a small fishing village into an industrial metropolis.

• Harbin became a major center of émigrés following the Russian Civil War and during Nazi Germany.

• Known for its long winters, which usually last seven months from October to April, Harbin hosts the annual Harbin International Ice and Snow Sculpture Festival.

• Called “black earth,” the soil of Harbin is among the most nutrient-rich in China.

• Harbin’s main industries include textile related crops, commodity grain production, and agricultural businesses.

BACKGROUND

Source: ChinaToday.

Notable Chinese Cities

Hohhot (Inner Mongolia)• Population (2009): 2.6 million • Hohhot serves as the capital of the Inner Mongolia

Autonomous Region.• The majority of Hohhot residents speak the Hohhot

dialect and understand Mandarin.• Tongdao Road, a major street in the old town area, is

decorated with Islamic and Mongol exterior designs on many of the buildings.

• A Mongolian summer festival held annually in mid- August, Naadam features traditional Mongolian sports including wrestling, horse racing, camel racing, and archery.

• Hohhot’s main industries include wool and leather goods, building materials, iron and steel products, and fertilizer.

Xiamen (Fujian Province)• Population (2008): 2.5 million• Also known as Amoy, Xiamen and the surrounding countryside are

famous for being an ancestral home to many overseas Chinese. • Xiamen was China’s main port for exporting tea in the 19th Century.• The local dialect is Amoy, also known as Hokkien, and has had a

major influence on how certain Chinese terms were translated into western languages: tê known as “tea” in English; and kiô-chap known as “ketchup” in English.

• In 1980, Xiamen was named one of the five special economic zones (SEZ) in China by the then Paramount Leader Deng Xiaoping.

• As a likely result of being named an SEZ in 1980, Xiamen has built up a highly-developed banking sector, with the presence of over 600 financial institutions.

• Xiamen’s main industries include financial services, fishing, shipbuilding, food processing, tanning, textiles, machine tool manufacturing, and telecommunications.

37



China’s Five National Central Cities

City 2009 GDP (US$ Bn)

2009 Population (Million)

Area (km2) Region

Beijing 173.7 16.3 16,808 North

Chongqing 95.6 28.2 82,300 Southwest

Guangzhou 133.4 7.8 7,434 South Central

Shanghai 218.2 18.6 6,340 East

Tianjin 109.8 11.2 11,303 North

Middle-Class Population Increase From 2010 to 2015 (Millions)

366

314

123103

694848

91

172186

0

50

100

150

200

250

300

350

400

India China Russia Indonesia Brazil

2010 2015

BACKGROUND

China’s Five National Central Cities, Emerging Cities, and Growing Middle Class

China’s Five National Central Cities and Emerging Cities China’s Growing Middle Class

Middle-Class and Above-Middle-Class Populations (Millions)

Source: Economist Intelligence Unit; Brazilian Institute of Geography and Statistics (IBGE); Instituto Nacional de Esadistica y GeografÍa (INEGI); BCG China 2010 population and income forecast database; National Council of Applied Economic Research (NCAER); “The Great Indian Middle Class,” 2004 BCG Analysis.

In their study of emerging market cities in November 2010, “Winning in Emerging Market Cities,” BCG reported that in 2005, a company had to have operations in 60 Chinese cities to reach 80% of China’s middle class, but by 2020, a company will have to have operations in 212 cities to reach 80% of China’s middle class. According to BCG, income levels of the residents living in these emerging cities will likely rise, leading to a growing middle class through 2015 and beyond.

Source: Global Urban Competitiveness Report (2009 – 2010), www.gucp.org/cn.

In 2005, the Ministry of Housing and Urban-Rural Development designated Beijing, Chongqing, Guangzhou, Shanghai, and Tianjin as China’s Five National Central Cities. These cities are charged with leading and developing China economically, politically, and culturally.

180 142 32 55 21

The Global Urban Competitiveness Project, a partnership between professors and scholars in the US, Canada, China, Britain, the Netherlands, Mexico, Italy, and Japan, among other countries, published the “Global Competitiveness Report 2009 – 2010” in July 2010, ranking the world’s top 500 cities in terms of competitiveness. Their metrics included: the size and growth of a city’s economy; output per person and per square kilometer; international patent applications; and the presence of multinational corporations. The top three cities were New York, London, and Tokyo, respectively. Of the 500 cities ranked, 65 were Chinese. As shown in the table, Chinese cities have been increasing in global competitiveness.

City2009 - 2010

Ranking2007 - 2008

RankingHong Kong 10 11

Shanghai 37 46

Beijing 59 68

Shenzhen 71 69

Macao 93 98

Guangzhou 120 119

Tianjin 165 185

Dongguan 195 214

Dalian 218 234

Foshan 219 223

Suzhou 221 243

Chengdu 222 236

Hangzhou 223 222

The Most Competitive Cities in the World

38



BACKGROUND

39

Hukou System

• The formal name of the hukou system is “huji.” Within the huji system, a “hukou” is the registered residency status of a specific individual in the system.

• A hukou or huji refers to the system of residency permits that dates back to ancient China, where household registration was required by law in the People’s Republic of China and in the Republic of China (Taiwan). Similar household registration systems exist within the public administration structures of Japan (koseki), Vietnam (hô khâu), and North Korea (hoju). In South Korea, the hoju system was abolished on January 1, 2008.

• Family registers were in existence in China as early as the Xia dynasty, the first dynasty of China. In the centuries that followed, the family register developed into an organization of families and clans for purposes of taxation, conscription, and social control.

• In 1958, the Chinese government officially promulgated the family register system to control the movement of people between urban and rural areas. With its large rural population of poor farm workers, hukou limited mass migration from rural towns to the urban cities to ensure some structural stability. Workers seeking to move from the country to urban areas to take up non-agricultural work would have to apply through the relevant bureaucracies. The number of workers allowed to make such moves was tightly controlled. Migrant workers were required to get six passes to work in provinces other than their own.

• Although an individual is technically required to live in the area designated on his/her permit, in practice as of early 2011, the system has largely broken down. After the Chinese economic reforms that started in 1978, workers were allowed to unofficially migrate without a valid permit to get a job.

• According to Chinese government statistics, the number of migrant workers in China as of late 2010 was estimated to be 120 million, approximately 9% of the population. As of late 2010, an estimated 230 million Chinese, approximately one-third of the population of the US, had left the countryside and migrated to the cities in recent years. That number was expected to reach 250 million by 2012 and surpass 300 million (and perhaps reach 400 million) by 2025. Most Chinese migrant workers come from Sichuan, Hunan, Henan, Anhui, and Jiangxi provinces.

• From the 1980s onward, an estimated 200 million Chinese lived outside their officially registered areas, with considerably less access to education and government services, and occupied in several respects a social and economic status similar to illegal immigrants. The millions of peasants who have left the countryside remained stuck at the margins of urban society, and they have been blamed for rising crime and unemployment.

• The hukou system has undergone further relaxation since the mid 1990s. The first relaxation allowed rural residents to buy temporary urban residency permits, meaning they could work legally; fees for these decreased gradually to a fairly affordable level. From 1998, hukou became inheritable through either the father’s or the mother’s line. From 2001 onwards, hukou controls were weakened. In 2003, the law on custody and repatriation were repealed.

The Hukou System of Registered Residency

Source: “China Reviews ‘Apartheid’ for 900 Million Peasants,” by Calum Macleod, The Independent, June 10, 2001; “China Rethinks Peasant ‘Apartheid,’” by Tim Luard, BBC News, November 10, 2005; “Women Migrant Workers under the Chinese Social Apartheid,” by Au Loong-yu, Nan Shan, and Zhang Ping, Committee for Asian Women, May 2007.

The “Household Register” Hukou Booklet



BACKGROUND

40

Contemporary Chinese Architecture

Source: “The Great Call of China,” Financial Times, January 7, 2011; http://en.beijing2008.cn; http://www.designbuild-network.com; http://www.stevenholl.com; http://www.architectsjournal.co.uk; http://en.expo2010.cn.

The main stadium of the 2008 Beijing Olympics, the Beijing National Stadium, also known as the “Bird’s Nest,” covers a floor area of over 258,000 square meters and can accommodate 91,000 spectators.

• Built: 2003• Architect(s): Herzog & De Meuron, Ai Weiwei• Location: Beijing

Beijing National Stadium, “Bird’s Nest”

The fourth largest building in the world by area, Terminal 3 at the Beijing Capital International Airport covers over 1.5 million square meters, has state-of-the- art facilities, and is one of China’s busiest terminals.

• Built: 2004• Architect(s): Foster and Partners, NACO, ARUP• Location: Beijing

Terminal 3, Beijing Capital International Airport

A twisted arch covering over 385,000 square meters, the China Central Television Tower is known for its anti-skyscraper design that has changed the architectural image of Beijing.

• Built: 2004• Architect(s): Office for Metropolitan Architecture• Location: Beijing

China Central Television Tower (CCTV)

Located in Pearl Spring near Nanjing, The Nanjing Museum of Art and Architecture, designed by US architect Steven Hull, aims to capture the shifting viewpoints, layers of space, and expanses of mist and water found in Chinese painting.

• Built: 2003 (Still in Progress)• Architect(s): Steven Hull• Location: Nanjing

Nanjing Museum of Art and Architecture

With 1,800 seats and covering over 70,000 square meters, the Guangzhou Opera House is China’s third largest theatre. The opera house resembles a “twin boulder,” with two stones on a subdued massif. Plans called for an opening in 2011.

• Built: 2003• Architect(s): Zaha Hadid Architects• Location: Guangzhou

Guangzhou Opera House

Named the “Oriental Crown,” China’s pavilion at the 2010 Shanghai World Expo was based on the concept of “Oriental Crown, Splendid China, Ample Barn, and Rich People.” The Chinese national Pavilion resembles a huge sculpture-like crown made from layered traditional Dougong brackets symbolizing the Chinese spirit.

• Built: 2007• Architect(s): He Jingtang• Location: Shanghai

Chinese Pavilion, 2010 Shanghai World Expo



The Longest Canal in the World

BACKGROUND

41

The Grand Canal

Source: Encarta Encyclopedia; The Cambridge Illustrated History of China, by Patricia Buckley Ebrey (Cambridge University Press, 1999); China: A New History; Second Enlarged Edition, by John King Fairbank and Merle Goldman (Harvard University Press, 2006); China’s Golden Age: Everyday Life in the Tang Dynasty, by Charles Benn (Oxford University Press, 2011); Science and Civilization in China: Volume 4, Physicals and Physical Technology, Part 3, Civil Engineering and Nautics, by Joseph Needham (Caves Books, 1986).

History of the Grand Canal

• The Grand Canal in China is the longest canal or artificial river in the world. Beginning in Beijing, it passes through Tianjin and the provinces of Hebei, Shandong, Jiangsu, and Zhejiang to the city of Hangzhou. The Grand Canal was built during the Sui dynasty (581 – 618 AD), with various earlier sections dating back to the 5th century BC.

• The Grand Canal’s total length is 1,776 km (1,103 miles). The canal’s highest elevation is 42 m (138 ft), located in the mountains of Shandong province.

The Grand Canal During the Sui Dynasty

• According to historians, the development of the Grand Canal during the Sui dynasty was attributed to the migration of China’s core economic and agricultural region, which moved from the Yellow River valley to the present-day Jiangsu and Zhejiang provinces. As such, the Grand Canal’s main role throughout the Sui dynasty was the transport of grain from the agricultural region in southern China to the capital-city region in northern China.

• With the recorded labor of five million men and women under the supervision of Ma Shumou, the first major section of the Grand Canal was completed in the year 605 AD. The Grand Canal was fully completed under the second Sui emperor, from the years 604 to 609 AD.

• Post offices supporting a courier system and an imperial roadway ran alongside the Grand Canal.

The Grand Canal from the Tang to the Yuan Dynasties

• Located near the Grand Canal, Yangzhou remained an economic zone through the Tang dynasty (618 – 907 AD), despite Chang’an serving as the dynasty’s capital city.

Uses of the Grand Canal

• From the Tang to the Qing dynasties, the Grand Canal transported mainly grain, among other commodities. As it served as the main artery between northern and southern China, the Grand Canal facilitated the development of an economic belt from northern to southern China.

• From the founding of the People’s Republic of China (1949) to early 2011, the Grand Canal transported primarily bulk goods including bricks, gravel, sand, diesel, and coal.

• The Grand Canal has also facilitated cultural exchange and political integration between northern and southern China.

China’s High-Speed Rail Network



The World’s Fastest High-Speed Rail Train and Longest High-Speed Rail Network

BACKGROUND

42

China’s High-Speed Rail Passenger System

Source: Morgan Stanley & Co. Inc. Research, “China High-Speed Rail: On the Economic Fast Track,” May 15, 2011; “Off the Rails?” The Economist, April 2, 2011; Time Magazine, www.time.com; “High Speed Around the World Maps,” International Union of Railways, December 2010, www.uic.org; “China Unveils Shanghai-Hangzhou High-Speed Railway; Eyes Network Extension,” Xinhua News Agency, October 26, 2010; “China Unveils World’s Fastest High Speed Train,” Huffington Post, December 3, 2010.

• Defined as a train traveling with an average speed of at least 200 km/h (124 mph), high-speed rail systems are used as means of faster travel, mainly throughout Europe – most notably in Spain, France, Germany, and Italy – and in Asia, most notably in China, Japan, and Taiwan.

• China’s high-speed rail network is considered the world’s most ambitious public-works project, a 21st century equivalent of the United States’ Interstate Highway System.

• In 2008, China had only 649 km (403 mi) of high-speed railways; as of April 2011, China had 8,400 km (5,220 mi), four times as much as the next-largest work (Japan). China planned to expand the network to cover 13,000 km (8,078 mi) by 2012 and 16,000 km (9,942 mi) by 2020.

• As of May 2011, China operated the world’s fastest high-speed rail train, reaching 350 km/h (217 mph) on parts of the country’s rail network.

• In December 2010, China’s high-speed rail passenger train established a new world record, traveling at 486 km/h (302 mph) during a test run of a yet-to-be opened link between Beijing and Shanghai.

• China’s network links Shanghai, China’s economic hub, to Hangzhou, the capital of east China’s Zhejiang Province, among other connections between cities. As of early 2011, the nine-stop trip from Shanghai to Hangzhou took 45 minutes and cost 98 yuan (US$14.73) for coach, and 156 yuan (US$23.45) for first class.

• The Beijing-Shanghai line, a 1,318-km rail line that cost 220.9 billion yuan (US$33.2 billion) was scheduled to open in 2012. • Although the network provides affordable travel for some Chinese, tens of millions of poor migrants who work far afield and

flock home for the Chinese new year cannot afford to travel via the rail system and instead use the bus system.• On May 15, 2011, Morgan Stanley Research published a 63-page report, “China High-Speed Rail: On the Economic Fast

Track,” which provides an overview of the largest transportation infrastructure project in history and the implications for 12 industries within China: tourism; restaurants; hotels; budget hotels; consumer staples; consumer discretionary; property; railway rolling stock; railway infrastructure; toll roads; aviation; and car rental.

China’s High-Speed Rail Network

China’s HSR Highlights

Railway Network 7,431 km (4,617 mi)

Operating Speed 350 km/h (217 mph)

Test Speed 486 km/h (302 mph)

Network by 2012 13,000 km (8,078 mi)

Network by 2020 16,000 km (9,942 mi)

Source: “Off the Rails?” The Economist, April 2, 2011.



Airports in China

BACKGROUND

43

China’s Airports

• As of early 2011, China had approximately 500 airports, over 440 of which were paved.• In 2010, China ranked 15th in the world in the number of airports.

Beijing Capital International Airport, the 2nd Busiest Airport in the World

• Ranked the 2nd busiest airport in the world as of May 2011, the Beijing Capital Airport served 11 domestic and 55 foreign airline companies.

• As of early 2011, the airport’s current capacity was 78 million passengers per year. In 2009, it accommodated 65.3 million passengers, six years ahead of schedule. By 2012, the airport was projected to accommodate 90 million passengers.

• Beijing Capital International Airport has operated since 1958 and as of May 2011 offered over 5,000 scheduled flights to 88 cities in China and 69 cities abroad.

• The airport has three terminals: Terminal 1, opened in 1958; Terminal 2, in 1999; and Terminal 3, in 2008. • Terminal 1 was originally designed to serve 60 flights daily and 1,500 passengers at peak hours. It was

expanded during the 1995 – 1998 time period. • Terminal 2 can accommodate 26,500,000 passengers annually and 9,210 passengers at peak hours. • Terminal 3 opened in 2008 to accommodate increased demand. It is the 4th largest building by floor space in the

world; it is 17% larger than London’s Heathrow Airport’s five terminals combined. • The Beijing Capital Airport remains one of the world’s most technologically advanced airports, equipped with

state-of-the-art systems, security, and baggage-handling facilities. Source: CIA World Factbook (June 2011); www.chinahighlights.com, Airports Council International: “Final Airport Traffic Results for 2009,” March 2010; “Year to Date Passenger Traffic August

2010”, November 2010; www.travelchinaguide.com.

Rank Country # of Airports1 United States 15,079 2 Brazil 4,072 3 Mexico 1,819 4 Canada 1,404 5 Russia 1,213 6 Argentina 1,141 7 Colombia 990 8 Bolivia 881 9 Paraguay 800 10 Indonesia 684 11 South Africa 578 12 Papua New Guinea 562 13 Germany 549 14 United Kingdom 505 15 China 502

Country Comparison: Airports

Source: CIA World Factbook (June 2011). Data are as of 2010.



2008 Beijing Olympics

Closing Ceremony

Opening Ceremony

In August 2008, China hosted the 29th Olympiad in Beijing. Themed “One World, One Dream,” the 2008 Beijing Olympics dazzled the world with its grand ceremonies and architecturally distinctive sports venues, and delineated China’s ascension as a global economic and political power. In the words of Jacques Rogge, President of the International Olympic Committee, “the world has learned about China, and China has learned about the world, and I believe this is something that will have positive effects for the long term.”Source: “Olympics Close With a Bang and a Double-Decker Bus,” The New York Times, August 24, 2008;

en.beijing2008.cn.

China’s Beijing Olympics and Shanghai ExpoBACKGROUND

44

From May to October 2010, China hosted the Shanghai World Expo. Themed “Better City, Better Life,” the Expo represented the common wish of humankind for better living in future urban environments. The expo featured themed pavilions of the Chinese provinces, countries, corporations, and organizations. Each pavilion celebrated architectural and scientific achievements and cultural progress while expressing the role of innovation and unity in improving living standards worldwide. The Expo documented a world-record attendance of over 73 million visitors, surpassing the former world-record holder, Japan, whose Osaka Expo in 1970 recorded 64 million visitors. Approximately 5.2% of the Expo’s visitors were foreigners. In addition to China’s widely acclaimed pavilion, other elaborate pavilions included those of Britain, France, Germany, the United States, and Saudi Arabia, for several of which, visitors sometimes waited in line for as long as three to eight hours.

Source: “Shanghai Expo Sets Record With 73 Million Visitors,” The New York Times, November 2, 2010, www.archdaily.com; en.expo2010.cn; www.inhabitat.com.

2010 Shanghai Expo

China’s Pavilion, “Oriental Crown” Theme: Chinese Wisdom in Urban Development

Shanghai Expo Sports Arena and Performing Arts Center

Britain’s Pavilion, “Seed Cathedral” Theme: Building on the Past, Shaping Our Future

Saudi Arabia’s Pavilion, “Moon Boat” Theme: Vitality of Life

Year City Year City1896 Athens 1960 Rome 1900 Paris 1964 Tokyo 1904 St. Louis 1968 Mexico City 1908 London 1972 Munich 1912 Stockholm 1976 Montreal 1916 - Canceled (World War I) 1980 Moscow 1920 Antwerp 1984 Los Angeles 1924 Paris 1988 Seoul 1928 Amsterdam 1992 Barcelona 1932 Los Angeles 1996 Atlanta 1936 Berlin 2000 Sydney 1940 - Canceled (World War II) 2004 Athens 1944 - Canceled (World War II) 2008 Beijing 1948 London 2012 London1952 Helsinki 2016 Rio De Janeiro1956 Melbourne

History of the Summer Olympiad

Number of Medals Gold Silver Bronze TotalUSA 36 38 36 110 China 51 21 28 100 Russia 23 21 28 72 Great Britain 19 13 15 47 Germany 16 10 15 41

2008 Beijing Olympics – Medal Standings

http://www.archdaily.com/58293/saudi-arabia-pavilion-for-shanghai-world-expo-2010/saudipavilion2/



Category Badminton Tennis Match Time 1+ Hrs. 3+ Hrs.

Shuttle/Ball In Play 37 min. 18 min.

Rallies 146 299

Shots 1,972 1,004

Shots Per Rally 13.5 3.4

Distance Covered 4 mi. 2 mi.

The earliest form of Badminton originated in China in the 5th century BC and was called “Ti Jian Zi.”

The later forms of Badminton were: (i) “Battledore and Shuttlecock,” played in China, Japan, India, and Greece during the 1st century AD; (ii) “Jeu de Volant,” played throughout Europe; and (iii) “Poona,” played in India during the mid-19th century.

Modern Badminton most resembles India’s “Poona,” and was adopted and modified by Britain during the mid-19th century.

Modern Badminton is known for its intense and fast- paced rallies, and fast-moving shuttlecock, which travels approximately 260 km/h (162 mph).

Badminton in the Summer Olympiads Olympic Medals Table Since Inception

Country ‘92 ‘96 ‘00 ‘04 ‘08 Total

China 5 4 8 5 8 30

Indonesia 5 4 3 3 3 18

South Korea 4 4 2 4 3 17

Denmark 1 1 1 1 4

Malaysia 1 2 1 4

Great Britain 1 1 2

Netherlands 1 1

BACKGROUND

45

Badminton in China

He Hanbin and Yu Yang, Bronze Medalists In Mixed Doubles

Lin Dan, Gold Medalist In Men’s Singles

Defending Women’s Singles Champion Zhang Ning

Brief History of Badminton Chinese Olympians in the 2008 Beijing Olympics

Basic Rules of Badminton

Court Net and Post ShuttlecockRacquet

Equipment of Badminton

• A match consists of the best of three games of 21 points. • A point is scored on every serve. • Players rest for 60 seconds when the leading scorer has

11 points. • In the third game, Players change sides when the leading

scorer has 11 points.

Badminton in China

• Given its rich historical experience with Badminton, China is considered one of, if not the best in the world, at the sport.

• Badminton is one of the most popular sports in China, along with martial arts, basketball, football, and table tennis.

Chen Jin, Bronze Medalist In Men’s Singles

Hendra Setiwan and Markis Kido, Gold Medalists In Men’s Doubles

Du Jing and Yu Yang, Gold Medalists In Women’s Doubles

Source: The Beijing Organizing Committee, http://en.beijing.2008.cn; Badminton World Federation, www.bwfbadminton.org.

Badminton Compared to TennisBadminton is often compared to tennis. The statistics shown here compare the championship games of the 1985 All England and 1985 World Badminton tournaments.



Found in an attic in West London, the important 18th century vase pictured here was sold for US$70 million in November 2010, the final price being US$86 million after adding the 20% buyer’s premium levied by the auction house and Britain’s value-added tax. Standing 16 inches tall, the ovoid-shaped vase from the period ruled by Emperor Qianlong is believed to originate from Jiangxi Province, China’s porcelain capital for 1,000 years.

History of Modern Chinese Paper CurrencyBACKGROUND

46

First Series of Renminbi, Issued in 1948

Fifth Series of Renminbi, Issued in 1999

Second Series of Renminbi, Issued in 1955The second series of the renminbi was introduced on March 1, 1955, bringing an end to the first series of the renminbi. With the introduction of the second series, the Chinese moved the decimal point of its currency four places to the left; as a result, a first series ¥10,000 note became equivalent to a second series ¥1 note.

Fourth Series of Renminbi, Issued in 1987The fourth series of the renminbi was introduced on April 27, 1987. The fourth series of the renminbi circulated alongside the third series and its exchange rate with the third series was 1:1. It included security features such as watermarks, magnetic ink, and fluorescent ink.

The first series of the renminbi was introduced on December 1, 1948, the day the People’s Bank of China was established in Shijiazhuang, Hebei Province. The renminbi was titled “the People’s Currency.”

Source: Show China, www.showchina.org.

Third Series of Renminbi, Issued in 1962The third series of the renminbi was introduced in 1962. Unlike the second series renminbi, the third series did not replace its predecessor, as the second series renminbi continued to be used. The third series used vivid colors, was smaller in size than the second series, and had distinct national themes, an unconventional border design, and embroidered Zhuang text.

The fifth series of the renminbi was introduced on October 1, 1999. Initiated by Prime Minister Zhu Rongi, the introduction of the fifth series of the renminbi aimed to facilitate economic growth, provide better security, and commemorate the 50th anniversary of the People’s Republic of China. As of early 2011, the fifth series of the renminbi was the current currency in circulation throughout China.

Qing Dynasty (c. 1740 AD) Vase Sold for Over US$86 Million

Source: Financial Times, “House Clearance Vase Fetches £43m,” November 12, 2010, www.ft.com; New York Times, “Qing Dynasty Relic Yields Record Price at Auction,” November 12, 2010, www.nytimes.com.



October 1934 – October 1935

The Long MarchBACKGROUND

47

• The Long March was a massive military retreat undertaken by the Red Army of the Communist Party of China, the predecessor of the People’s Liberation Army, to evade the pursuit of the Kuomintang (KMT or Chinese National Party) army. The march resulted in the relocation of the communist revolutionary base from southeastern to northwestern China and in the emergence of Mao Zedong as the undisputed leader of the Communist Party of China.

• The march was not one long march, but a series of marches, as various communist armies in the south escaped to the north and west. The Long March commenced after a series of five attacks by the Chiang Kei-shek-led Kuomintang army, which attempted to obliterate the communist party base. On the fifth attack, Chiang Kai-shek mustered approximately 700,000 troops and established a series of cement blockhouses surrounding the communist party. The Chinese Communist Central Committee broke through a weak section of the Kuomintang Army’s barricade and fled westward, marking the beginning of the Long March in October 1934.

• Fighting Kuomintang forces throughout their year-long journey, the Red Army soldiers and participants traversed approximately 8,000 miles, 18 mountain ranges, and 24 rivers to reach the northwestern province of Shaanxi. Of the 86,000 Red Army soldiers and participants who started the march in October 1934, 8,000 completed the journey in October 1935. Many troops and participants were lost along the way due to fighting, disease, and starvation.

• The Long March established Mao Zedong as the decisive leader of the Chinese Communist Party; it also enabled the embattled communists to recuperate and rebuild in north China; and it also helped the Communist Party of China to develop a positive reputation among the Chinese citizenry and to attract young Chinese citizens during the late 1930s and early 1940s. From their base at Yan’an in Shanxi province, the party grew in strength and eventually defeated the Nationalists in the struggle to control mainland China.

• In 2006, the Chinese government produced a movie, My Long March, relating the personal experiences of a fictional participant in the Long March.

Source: Texas Education Agency; Encyclopedia Britannica, www.britannica.com; “From Revolution to Politics: Chinese Communists on the Long March,” by Benjamin Yang (Westview Press, 1990).

Map of the Long March History of the Long March

Community Party of China Leaders: Mao Zedong and Zhou Enlai

Kuomintang of China Leader: Chiang Kai-shek



BACKGROUND

China’s Political System

48Source: Morgan Stanley Smith Barney Investment Strategy; Congressional Research Archive, “Understanding China’s Political System,” by Michael F. Martin, April 14, 2010; US-

China Business Council; the China Business Review; People’s Daily Online.

People’s Republic of China

The Communist Party of China (CPC) The State Council (Chinese Government)

Other Institutions (Interconnected with the CPC and the State Council)

• Formally established on July 20, 1921 in Shanghai, the Communist Party of China (CPC) began as a Marxist-Leninist party organized into small groups that operated on the principle of “democratic centralism.”

• The contemporary CPC is organized into a hierarchal network of organizations that reaches into many aspects of Chinese society. The CPC has affiliations with universities and schools, think tanks, state-owned enterprises, private corporations, and foreign-owned companies, among other institutions.

• The CPC’s most powerful policy-and decision-making entity is the Political Bureau (Politburo). The Politburo Standing Committee consists of a smaller group of elite party members that wields much of the political power in China.

• The President and Vice President preside over China’s government. As of early 2011, the President and Vice Present were Hu Jintao and Xi Jinping, respectively.

• The General Secretary has historically been the highest position in the CPC; generally, the General Secretary of the CPC is also the President of China.

• The State Council, along with its ministries, bureaus, commissions, and agencies, serves as the administrator and regulator of China’s day-to-day government functions.

• The Premier of the CPC runs the State Council. The Premier is also a member of the Politburo Standing Committee, emphasizing the interconnection between the CPC and the Chinese government. As of early 2011, the Premier was Wen Jiabao.

• China’s government is essentially divided into two parts: a system of ministerial organizations, including the Ministry of Foreign Affairs, and the Ministry of Commerce, among others; and a system of geographic organizations, including provincial, municipal, county, and township and village governments.

• As of early 2011, China had: 34 provincial-level governments(1); over 300 prefecture-level governments; over 3,000 county-level governments; and over 40,000 township-level governments.

• Although China’s constitution does not outline the division of power among the various tiers of government, each tier of government reports to the tier of government above it.

• Established on August 1, 1927, the People’s Liberation Army (PLA) is China’s unified military organization, responsible for all air, land, and naval forces.

• As of early 2011, the PLA was the largest military force in the world, with over two million citizens on active duty.

• The two Central Military Commissions (CMC), a state entity and a party entity, are responsible for military policy and decisions.

• The party CMC is chaired by the CPC General Secretary, symbolizing the prerogative of military leadership.

• The National People’s Congress (NPC) is China’s unicameral legislative body. The NPC meets annually for about two weeks to officially set government policy and select China’s leadership.

• As of early 2011, the NPC had approximately 3,000 members, 70% of whom were in the CPC and 30% of whom were in in other parties including the United Front Democratic Party. As of early 2011, the NPC had a standing committee of about 150 members.

• The CPC approves all selected, not popularly elected, NPC candidates and overseas the election process.

The People’s Liberation Army (PLA) The National People’s Congress (NPC)

China’s Two Vertically integrated Political Institutions are Interconnected

• The Supreme People’s Court is responsible for civil, criminal, and administrative cases, as well as appeals.

• It reports to the NPC and the NPC Standing Committee. • The Chief Justice (also named the President) of the

Supreme People’s Court is appointed by the NPC and can remain in office for no more than two successive terms, each of which is five years.

• Other deputy presidents and judges are appointed by the NPC Standing Committee.

• Another judicial body, the Supreme People’s Procuratorate, supervises the application and enforcement of the law.

The Supreme People’s Court

Note:1. China’s 34 provincial-level governments include: 23 provinces; five autonomous regions; four municipalities; and two special administrative regions.



BACKGROUND

Past and Present Leaders of the Communist Party of China

49

Hua Guofeng (1976 – 1981)

Source: China Online Encyclopedia.

Mao Zedong (1943 – 1976)

Hu Yaobang (1981 – 1987)

Zhao Ziyang (1987 – 1989)

Hu Jintao (2002 – )

Chairmen / General Secretaries of the Communist Party of China

Jiang Zemin (1989 – 2002)

Hua Guofeng (1976 – 1980)

Zhou Enlai (1949 – 1976)

Li Peng (1987 – 1998)

Wen Jiabao (2003 – )

Premiers of the Communist Party of China

Zhu Rongji (1998 – 2003)

Zhao Ziyang (1980 – 1987)



• Mr. Deng was the Paramount Leader of the People’s Republic of China from 1978 to 1992, and he is credited with steering China away from its Lenin-like, Maoist organizational philosophy into a wider world of technological growth and international trade.

• Mr. Deng’s rise as a political figure in China was a long and trying one: he was purged twice by the Communist Party of China (CPC) during the Cultural Revolution for promoting economic policies that differed from those of Chairman Mao Zedong; and he later regained prominence when he was appointed the Paramount Leader of the CPC in 1978 by outmaneuvering Mao’s chosen successor, Hua Guofeng.

• Despite serving as the Paramount Leader, Mr. Deng never held office as the head of state, head of government, or General Secretary of the Communist Party of China (historically the highest position in Communist China).

• Mr. Deng believed: that China needed to separate from its Maoist mold of state control; that China needed to encourage its long-dormant entrepreneurial spirit; and that China needed to open up to capitalism, whatever the political fallout.

– Mr. Deng often said, “it does not matter if a cat is black or white, so long as it catches mice.”

• Under his leadership, China focused on the “Four Modernizations” set forth by Zhou Enlai in 1963; they included: agriculture; industry; national defense; and science and technology.

• In addition to his policy changes in economics, Mr. Deng loosened the controls placed by Mao Zedong on filmmaking, fashion, music, and the visual arts.

BACKGROUND

Deng Xiaoping“The Maoist Who Reinvented Himself, Transformed A Nation, and Changed the World” Time Magazine

50

Deng Xiaoping

1. Agriculture

2. Industry

3. National Defense

4. Science and Technology

The Four Modernizations Pursued Under Mr. Deng’s Leadership

Source: “60 Years of Asian Heroes,” Time Magazine, November 13, 2006.

Source: “60 Years of Asian Heroes,” Time Magazine, November 13, 2006.



Prime Minister Wen Jiabao

• Born in December 1942, President Hu Jintao, an ethnic Han native of Jixi, Anhui Province, joined the CPC in April 1964 and as of early 2011 was the Paramount Leader of the People’s Republic of China.

• Mr. Hu’s political philosophy can be summarized by two phrases: “Harmonious Society;” and “Peaceful Development.” To achieve the former, Mr. Hu established the “Scientific Development Concept,” China’s official socio-economic ideology that aims to solve its economic, environmental, and social problems.

• Mr. Hu also developed China’s Core Value System called, “Eight Honors and Eight Shames.” This moral code is used as a guideline for the Chinese, and slightly differs from the ones established by Mao Zedong and Deng Xiaoping, in that for the first time it focuses on codifying moral standards as opposed to setting social or economic goals.

• One of Mr. Hu’s power-bases has been the Communist Youth League of China.

• Mr. Hu studied engineering at the Water Conservancy Engineering Department of Tsinghua University. He is married to Liu Yongqing and they have two children together.

President Hu Jintao

BACKGROUND

Leaders of the Communist Party of China

51

Source: Photos of Hu Jintao and Wen Jiabao, http://english.peopledaily.com; “Who will be China’s Next Leaders?” by Geoff Dyer, Financial Times, March 5-6, 2011; China Internet Information Center; www.china.org.cn; Hu’s Political Philosophies, by Robert Lawrence Kuhn, March 13, 2010.

1. Love the country; do it no harm.

2. Serve the people; never betray them.

3. Follow science; discard ignorance.

4. Be diligent, not indolent.

5. Be united, help each other; make no gains at others’ expense.

6. Be honest and trustworthy; do not sacrifice ethics for profit.

7. Be disciplined and law abiding, not chaotic and lawless.

8. Live plainly, work hard; do not wallow in luxuries and pleasures.

President Hu Jintao’s “Eight Honors and Eight Shames”

Source: Xinhua News Agency, www.chinaview.cn.

• Born in September 1942, Prime Minister Wen Jiabao, an ethnic Han native of Tianjin, joined the CPC in September 1967 and as of early 2011 was the sixth and current Premier of the State Council of the People’s Republic of China.

• Mr. Wen has been regarded as China’s leading figure behind its economic policy, as a member of the Politburo Standing Committee of the CPC.

• Soft-spoken and known for his strong work ethic, Mr. Wen has advocated for a more balanced approach in developing China’s hinterland regions, and he played a key role in China’s response to the 2007-2009 global financial crisis and its subsequent stimulus programs.

• Mr. Wen accompanied former General Secretary Zhao Ziyang to Tiananmen Square during the 1989 Tiananmen Square Protests, and unlike Mr. Zhao who was punished by house arrest for the rest of his life, Mr. Wen was later promoted to Vice Premier under his mentor, Zhu Rongji.

• Mr. Wen has been very popular of the senior CPC leaders among the public. He has consistently spent time over the New Year holidays in poor, rural areas, referring to himself as “Grandpa Wen.”

• Mr. Wen studied geological surveying and prospecting at the Beijing Institute of Geology. He is married to Zhang Peili, a jewelry expert and investor, and they have a son together.

An Ancient Chinese Proverb

龍游淺水被蝦戲Chinese characters:

English translation:

In shallow waters, shrimps make fools of dragons.

Source: www.special-dictionary.com.



BACKGROUND

China’s Likely Transition of Party Leaders

52

President Hu Jintao’s Likely Transition Timeframe

[Photo]

2011

• Likely to step down as Communist Party Chief late in the year

2012

• Presidential term scheduled to end in March

2013

• Likely to relinquish position as Supreme Military Commander sometime in the 2014-2015 years

2014 2015

Prime Minister Wen Jiabao’s Likely Transition Timeframe

2011

• Likely to leave the Communist Party’s Politburo Standing Committee

2012

• Likely end of Premiership term

2013 2014 2015

[Photo]

Source: Photos of Hu Jintao and Wen Jiabao, http://english.peopledaily.com.

The Chinese Dragon Dance

Originating in the Han dynasty, the Chinese Dragon Dance shown here is performed to celebrate the lunar new year. It is performed by a group of people operating different parts of the dragon costume. The Dragon Dance, however, was not always a celebration of the lunar new year; it originally was a prayer dance asking the Dragon deity for rain and good weather during farming season. The dance has evolved over years and is now an expression of courage, pride, and wisdom.

The dragon itself is symbolic to the Chinese, as they have often called themselves the “Descendants of the Dragon.” In ancient China, the dragon was considered a deity that brought good luck, power, dignity, fertility, wisdom, and auspiciousness. During imperial China, it was the emblem of imperial authority and appeared on imperial robes, porcelain vases, paintings, and flags. Today, it is a symbol of traditional Chinese culture and serves as an integral element of the Chinese New Year celebration.

Source: Photo, www.imf.org, www.chinaculture.org, www.123chinesenewyear.com.



• Born in July 1955, Executive Vice-Premier Li Kequiang, an ethnic Han native of Dingyuan, Anhui Province, joined the CPC in March 1974.

• As Premier Wen Jiabao’s top lieutenant, Mr. Li’s official portfolio has included responsibility for development, price controls, finance, climate change, and macroeconomic management.

• Mr. Xi made his first major appearance internationally at the 2010 World Economic Forum in Davos, Switzerland. At the Forum, Mr. Xi briefed the audience on China’s commitment to sustainable development, green energy, a decrease in the income gap, the modernization of key strategic industries, and peaceful development.

• The son of a low-level official from the poor, rural province of Anhui, he was sent to work for four years as a farmer during the Cultural Revolution. During that time, China’s universities only admitted those with a suitable proletarian class background but in 1977, the competitive entrance exam was restored. A total of 11.6 million people applied. Li was one of 401,000 admitted, making him a member of the famous “Class of 1982.”

• Mr. Li earned an LLB and PhD in Economics from Peking University (colloquially known as Beida University).• Mr. Li is married to Cheng Hong, a professor at the Capital University of Economics and Business in Beijing, and

his father-in-law is a former vice-secretary of the Communist Youth League Central Committee.

BACKGROUND

Next Likely Leaders of the Communist Party of China

53

Executive Vice–Premier Li Kequiang: Likely Successor to Premier Wen Jiabao

• Born in June 1953, Vice President Xi Jinping, son of a former revolutionary leader imprisoned by Mao Zedong, joined the CPC in 1974.

• In October 2010, Vice President Xi Jinping was appointed Vice Chairman of the Central Military Commission (CMC) of the CPC, solidifying Mr. Xi as the likely successor of the current party chief President Hu Jintao.

• Vice President Xi Jinping has been viewed as a moderate who appears to be particularly engaged on key economic and strategic issues involving China and the world.

• At age 15, he was sent to work among peasants in the yellow hills of Shaanxi province. He stayed seven years in the village of Liangjiahe, which eventually named him party secretary.

• As party secretary in Guangdong province during the 1980s, he was instrumental in development of the special economic zone in Shenzhen, the city near Hong Kong that became the symbol of China’s economic take-off.

• A self-confessed fan of American movies, particularly World War II movies, Mr. Xi was named one of the most influential people in the world in the 2009 Time 100 list.

• Mr. Xi Jinping studied Chemical Engineering at Beijing’s prestigious Tsinghua University. • Mr. Xi is a so-called princeling, a descendant of a member of the revolutionary party elite, and his second

marriage is to a celebrity folk singer and army major general, Pen Liyuan. • Mr. Xi was first married to Ke Xiaoming, the daughter of China’s ambassador to the United Kingdom in the late

1970s. They have a daughter enrolled at Harvard University as of early 2011.

Source: Photos of Xi Jinping and Li Keqiang, english.peopledaily.com.cn; “Who will be China’s Next Leaders?” by Geoff Dyer, Financial Times, March 5-6, 2011; Wall Street Journal, “China Grooms a New Leader, Politically Deft, if Little Known,” January 24, 2011; “China Anoints Its Next Leader,” October 17, 2010; “Xi’s Career Gives Few Clues to His Beliefs,” October 19, 2010; “China’s Li Delivers A Polished Future,” Forbes, January 28, 2010.

Vice President Xi Jinping: Likely Successor to President Hun JintaoThe Window of the World (WOW)

Founded in 2004 in Shenzhen, The Window of the World is a 48,000-square-meter replica park that includes 130 reproductions of the world’s most attractive tourist destinations, including the Roman Colosseum, the Leaning Tower of Pisa, the Tower of London, Niagara Falls, the Grand Canyon, the Taj Mahal, and the Sphinx. Each replica is built at a ratio of 1:1, 1:5, or 1:15.

Source: www.travelchinaguide.com.

The Sphinx at WOW

Taj Mahal at WOW

Niagara Falls at WOW



BACKGROUND

Five-Year Plans of the PRC

• The Five-Year Plans of the People’s Republic of China represent a series of economic development initiatives. The Chinese economy has been influenced by the CPC through the plenary session of the Central Committee and national congresses. The party plays a leading role in establishing the foundations and principles of Chinese communism, mapping strategies for economic development, setting growth targets, and launching reforms.

• Planning is a key characteristic of centralized economies, and one plan established for the entire country normally includes detailed economic development guidelines for all its regions. In order to more accurately reflect China’s transition from a Soviet-style planned economy to a socialist market economy, the name of the 11th five-year program was changed to “guideline” from “plan.”

Plan or Guideline

Years Covered Theme Key Features

First 1953-1957 Stalinist Central Plan Industrialization and agricultural producers’ cooperatives

Second 1958-1962 Great Leap Forward Capital construction and heavy Industry expansion

Third 1966-1970 Agricultural Push Agricultural development and basic needs

Fourth 1971-1975 Cultural Revolution Infrastructure construction and agriculture

Fifth 1976-1980 Post-Mao (Reforms and Opening Up) Infrastructure construction, and expansion of the steel, petroleum, and agriculture industries

Sixth 1981-1985 Readjustment and Recovery National defense industry, energy conservation and environmental protection, foreign trade and investment, technological innovation, and cultural life improvement

Seventh 1986-1990 Socialism with Chinese Characteristics Economic reform, openness to the outside world, construction of a socialist ideological civilization, development of science and education, and development of the energy, communications, telecommunications, and raw materials industries

Eighth 1991-1995 Technical Development Expansion of economic development zones, foreign reserves growth, imports and exports growth, and the construction and development of transportation infrastructure, including ports, airports, railways, and highways

Ninth 1996-2000 Reform of State-Owned Enterprises Socialist market economy, modernization, population control, and poverty

Tenth 2001-2005 Strategic Restructuring National economy, social IT, infrastructure, population control, forest area coverage, high school and higher education enrollment, and medical and health services

Eleventh 2006-2010 Rebalancing Alert Development of the services industry, research and development, urbanization, energy conservation, water conservation, pollution control, pensions, and a rural cooperative medical care system

Twelfth 2011-2015 Pro-Consumption Higher wages, a social safety net, domestic consumption, large-scale transactions-intensive industries including wholesale and retail trade, domestic transport and supply-chain logistics, healthcare, and leisure and hospitality

Source: www.china.org.cn; Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Incorporated Research, “China’s 12th Five-Year Plan,” March 21, 2011.

Emblem of the CPC Flag of the CPC

54



BACKGROUND

China’s 12th Five-Year Plan (2011 – 2015)Focus on Social and Economic Development

• In October 2010, China held its Fifth Plenum of the 17th CPC Central Committee. The Committee discussed China’s 12th Five-Year Plan, which was officially released in two annual meetings in March 2011.

• The March 2011 draft focused on social and economic development, emphasizing the transformation of China into a consumer-driven, capital-intensive economy.

• Under the March 2011 draft of the 12th Five-Year Plan, China intended to provide 4 trillion yuan (US$600 billion) to emerging industries, including energy and environmental protection, information technology, biotechnology, advanced manufacturing, alternative energy, new materials, and new-energy automobiles. – China projected that the added value of these industries would reach 8% of GDP by 2015 and 15% by 2020.

• China remained focused on closing the income disparity between rich and poor, between urban and rural populations, and between coastal and interior regions and provinces.

• Other priorities in the 12th Five-Year Plan included: preparing for an aging population; improving medical services; stabilizing property prices; maintaining prosperity and stability in Hong Kong; modernizing rural areas; improving labor rights; boosting domestic demand; reforming the financial system; and opening up further to the outside world.

Source: China Economic Net, http://en.ce.cn/

77.1

52.1

21.54.2

17.5

28.8

27.9

16.9

13.5

28.5

21.0

5.722.1

57.9

3.91.4

0

25

50

75

100

'00 '05 '10E '20ELow Income Middle Income

Upper Middle Income High Income

China’s Household Income Distribution%

Source: Euromonitor, Morgan Stanley & Co. Inc. EM/Asia Equity Strategy Team. Estimates are as of March 2011.

Source: “China Underlines Emerging Industries in 12th Five-Year Plan,” International Business Times, October 18, 2010; China Economic Net, http://en.ce.cn/.

Chinese Proverbs• One step at a time.• A bad word whispered will echo a

hundred miles.• A courageous foe is better than a

cowardly friend.• Whenever the water rises, the boat will

rise too.• A smile will gain you ten more years of

life. • With time and patience, the mulberry

leaf becomes a silk gown. • Beat your drum inside the house to spare

the neighbors. Source: www.worldofquotes.com.

55



BACKGROUND

56

Military Resources in East and Central Asia

Source: “The Military Balance 2011,” by the International Institute for Strategic Studies, March 8, 2011; Stockholm International Peace Research Institute.

Active Personnel Combat-Capable

Fixed-Wing Aircraft SubmarinesSurface Vessels

Above Corvette Size Missiles

China 2,300,000 1,998 71 80Full range of conventional and nuclear missiles, including the new Dong Feng "carrier killer" that can potentially hit a moving carrier 2,000 miles away

India 1,300,000 691 16 47 Conventional and nuclear medium-range missiles, including anti-ship and assorted anti-air missiles

North Korea 1,200,000 620 70 3 Conventional medium-range missiles and possible nuclear warheads

US Pacific Command 325,000 1,900 39 80 Full range of conventional and nuclear missiles

South Korea 655,000 498 23 47 Air and sea defense missiles

Pakistan 617,000 433 8 9 Conventional and nuclear short-range missiles

Vietnam 482,000 219 2 7 Air and sea defense missiles

Taiwan 290,000 509 4 26 Air and sea defense missiles

Japan 248,000 469 18 49 Coastal air and sea defense missiles

Russia 130,000 445 23 17 Full range of conventional and nuclear missiles

Malaysia 109,000 82 2 8 Air and sea defense missiles

Philippines 125,000 34 0 1 Anti-air missiles

Brunei 7,000 0 0 0 Air and sea defense missiles

Military Resources in East and Central Asia



BACKGROUND

57

China and Rare Earth Elements

• As defined by International Union of Pure Applied Chemistry (IUPAC), rare earth elements or rare earth metals represent a collection of seventeen chemical elements in the periodic table. Because of their geochemical properties, rare earth elements are not often found in concentrated and economically exploitable forms. Until 1948, most of the world’s rare earths were sourced from placer sand deposits in India and Brazil. Through the 1950s, South Africa emerged as the world’s primary rare earth source. Through the 1960s until the 1980s, the Mountain Pass rare earth mine in California was the leading producer. As of May 2011, concerns arose over a potential shortage of rare earths. Over the 2010-2020 time period, worldwide demand for rare earth elements was expected to exceed supply by 40,000 tonnes annually unless major new sources were developed.

• As of January 2011, China produced over 95% of the world’s rare earth supply, mostly in Inner Mongolia, with only 48% of the world’s proven reserves. Rare earth metals are essential components of smartphones, electric cars, many computer parts, clean energy applications, and a range of military hardware. Uncertainty over supply disruptions, rules changes, export quotas, export taxes, and in some cases, targeted embargoes has raised concerns for countries and companies facing supply shortages and rising prices, and led to research and development into substitutes and plans to expand rare earths production outside China. China has also exerted important influence over the global supply of other elements, including antimony, bismuth, germanium, indium, magnesium, silicon, tin, tungsten, and vanadium.

Source: IUPAC; www.iupac.org; The New York Times, “After China’s Rare Earth Embargo,” October 29, 2010; “Many Want Rare Earths, But Few Are Mining Them,” February 6, 2011; United States Geological Survey, www.usgs.gov; US Department of Energy, Molycorp Minerals; Riedel Research.

55,000,000 48% of the

world’s total 22,000,000 19%

3,100,000 3% 1,600,000

1%48,000 <0.05% 30,000

<0.05%

China Russia(1) US India Australia Brazil Malaysia Japan(2) Other

0

130,000 96%

2,500(3)

2%0 2,700

2%0 550

<0.5%350

<0.5%0 NA

19,000,000 17% 13,000,000

11%

2010 Production (Tons) % of Total

2008 Consumption (Tons) % of Total

Reserves As of January 2011 (Tons)

Notes:1. Data are for the Commonwealth of Independent States, which include: Azerbaijan, Armenia, Belarus, Georgia, Kazakhstan, Moldova, Russia, Tajikistan, Turkmenistan, Uzbekistan, and

Ukraine.2. The Japan category shown here includes Southeast Asia.3. This total reflects 2009 Data.

74,000 60%

0 18,500 15%

0 0 0 0 23,500 19%

8,000 6%

http://www.google.com/imgres?imgurl=http://www.33ff.com/flags/XL_flags/Australia_flag.gif&imgrefurl=http://www.33ff.com/flags/worldflags/Australia_flag.html&usg=__Q2_PIXfJQLE2k-xhNBT7mHeifdM=&h=240&w=360&sz=12&hl=en&start=11&zoom=1&um=1&itbs=1&tbnid=wc4Xrbs-myn3dM:&tbnh=81&tbnw=121&prev=/images%3Fq%3Daustralian%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=SrJSTeS7C8XdgQex6MGTCA

http://www.google.com/imgres?imgurl=http://www.malaysiaworldexpo.com/img/malaysia_flag2.gif&imgrefurl=http://www.malaysiaworldexpo.com/malaysia.html&usg=__2tF5z2ASeuYdMZ-SVTsc_T8m0r4=&h=216&w=360&sz=5&hl=en&start=4&zoom=1&um=1&itbs=1&tbnid=dFTeIXwWsu1ljM:&tbnh=73&tbnw=121&prev=/images%3Fq%3Dmalaysian%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=67RSTZ3aB4HEgAeT8NmrCA



BACKGROUND

58

The 17 Rare Earth Elements

The 17 Rare Earth Elements Atomic

Number Symbol Name Selected Usages

21 Sc Scandium Light Aluminium-Scandium alloy for aerospace components, and additive in Mercury-vapor lamps 39 Y Yttrium Yttrium-Aluminum garnet (“YAG’) laser, and YBCO high-temperature superconductors 57 La Lanthanum High-refractive index glass, flint, hydrogen storage, battery-electrodes, and camera lenses 58 Ce Cerium Chemical oxidizing agents, polishing powder, and yellow colors in glass and ceramics 59 Pr Praseodymium Rare-earth magnets, lasers, core materials for carbon-arc lighting, and colorants in glasses and enamels 60 Nd Neodymium Rare-earth magnets, lasers, violet colors in glass and ceramics, and ceramic capacitors 61 Pm Promethium Nuclear batteries 62 Sm Samarium Rare-earth magnets, lasers, neutron capture, and masers 63 Eu Europium Red and blue phosphors, lasers, and mercury-vapor lamps 64 Gd Gadolinium Rare-earth magnets, high-refractive index glass or garnets, lasers, x-ray tubes, and computer memories 65 Tb Terbium Green phosphors, lasers, and fluorescent lamps 66 Dy Dysprosium Rare-earth magnets and lasers 67 Ho Holmium Lasers 68 Er Erbium Lasers and Vanadium Steel 69 Tm Thulium Portable X-ray machines 70 Yb Ytterbium Infrared lasers and chemical reducing agents 71 Lu Lutetium PET Scan detectors and high-refractive index glass

Source: IUPAC, www.iupac.org; The New York Times, “After China’s Rare Earth Embargo,” October 29, 2010; United States Geological Survey, www.usgs.gov; www.periodictable.com.

The IUPAC Periodic Table

The 17 Rare Earth Elements

The 17 rare earth elements include: the lanthanoids (elements 57 to 71), Scandium, and Yttrium. Some versions of the Periodic Table often label the lanthanoids and actinoids (elements 90 to 103) as “rare earth metals,” not to be confused with the 17 rare earth elements, which according to IUPAC only include the lanthanoids, Scandium, and Yttrium.

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/057.1/s9s.JPG&imgrefurl=http://periodictable.com/Elements/057/index.html&usg=__HQC_f3bB9J6Txq58jsuhWPvRr_c=&h=356&w=356&sz=30&hl=en&start=3&zoom=1&um=1&itbs=1&tbnid=sHh4MMa7eV12rM:&tbnh=121&tbnw=121&prev=/images%3Fq%3Dlanthanum%26um%3D1%26hl%3Den%26sa%3DN%26tbs%3Disch:1&ei=G8lSTazmAYTVgQfc7rykCA

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/059.1/s9s.JPG&imgrefurl=http://periodictable.com/Elements/059/index.html&usg=__gQmxoYOPnrwLbJ9uNtLTnHc0zns=&h=356&w=356&sz=22&hl=en&start=2&zoom=1&um=1&itbs=1&tbnid=A6NaWVsACegKEM:&tbnh=121&tbnw=121&prev=/images%3Fq%3Dpraseodymium%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=rs1STbKsAsTcgQffrtmbCA

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/062.6/s9s.JPG&imgrefurl=http://periodictable.com/Elements/062/index.html&usg=__cMvLwZidNm9poRjI_Pj8x_ujn5Y=&h=356&w=356&sz=19&hl=en&start=2&zoom=1&um=1&itbs=1&tbnid=SEN1wiU5hMSdfM:&tbnh=121&tbnw=121&prev=/images%3Fq%3Dsamarium%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=OdBSTYOOJcKcgQeYstmPCA

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/064.1/s9s.JPG&imgrefurl=http://periodictable.com/Elements/064/index.html&usg=__dxEa2iycdd-OMxh6aHYe-yNzq4M=&h=356&w=356&sz=15&hl=en&start=3&zoom=1&um=1&itbs=1&tbnid=4w5cZ-6ALAt84M:&tbnh=121&tbnw=121&prev=/images%3Fq%3Dgadolinium%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=TtBSTa7HEcnTgQeP_5iYCA

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/066.2/s9s.JPG&imgrefurl=http://periodictable.com/Elements/066/index.html&usg=__w3_V4ADR3Hh28AMyDsIv52Xc0VM=&h=356&w=356&sz=19&hl=en&start=4&zoom=1&um=1&itbs=1&tbnid=7z7bFr34ue0xPM:&tbnh=121&tbnw=121&prev=/images%3Fq%3Ddysprosium%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=ZtBSTYRJgsmBB7nSgKsI

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/068.5/s9s.JPG&imgrefurl=http://periodictable.com/Elements/068/index.html&usg=__P9NQ7prOL3daPDQ7cSbYiuAAVYc=&h=356&w=356&sz=19&hl=en&start=2&zoom=1&um=1&itbs=1&tbnid=xmaG1M0UW4HXJM:&tbnh=121&tbnw=121&prev=/images%3Fq%3Derbium%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=g9BSTc2YAoecgQeMh9mSCA

http://www.google.com/imgres?imgurl=http://periodictable.com/Samples/069.1/s9s.JPG&imgrefurl=http://periodictable.com/Elements/069/index.html&usg=__crHBRGoe8xFnAqwVT2td2agTXlY=&h=356&w=356&sz=25&hl=en&start=2&zoom=1&um=1&itbs=1&tbnid=9kp-6A44z_RIbM:&tbnh=121&tbnw=121&prev=/images%3Fq%3Dthulium%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=ldBSTYuUIsbdgQeFmbGrCA



Estimates are as of March 20112010 2020E

CountryReactor

UnitsNet Capacity

(MWe)% of

WorldReactor

UnitsNet Capacity

(MWe)% of

World

1 China 12 9,706 3% 96 112,270 20%

2 United States 104 100,367 27% 111 109,183 19%

3 France 58 63,130 17% 60 66,370 12%

4 Japan 54 46,824 12% 59 53,589 9%

5 Russia 31 21,743 6% 43 32,289 6%

6 South Korea 21 18,460 5% 30 29,380 5%

7 Germany 17 20,379 5% 17 20,379 4%

8 India 20 4,388 1% 36 18,092 3%

9 Canada 18 12,652 3% 21 15,237 3%

10 Ukraine 15 13,230 4% 17 15,130 3%

Global Total 442 374,806 606 568,973

Top 10 Producers of Nuclear Energy by 2020

As of June 2011, almost half the nuclear reactors under construction in the world were in China. The Chinese utilize reactor designs from Russia, the US, France, and China itself. A key issue is whether foreign suppliers will be able to keep pace with Chinese demand for critical and scarce components.

BACKGROUND

59

China’s Nuclear Energy Industry

Overview of China’s Nuclear Energy Industry• Prior to Japan’s Sendai Earthquake of March 11, 2011 (measuring 9.0 on the Richter Scale), the Chinese were prepared to spend US$511

billion to build up to 245 reactors, according to Arthur D. Little, a management consulting firm. • The Chinese have been rapidly developing self-sufficiency in reactor design and construction. They plan to use several suppliers, with

the goal of becoming a developer themselves. • As of December 2010, China operated 12 nuclear plants, having built one to two reactors per decade; by early 2011, 27 facilities were

under construction.• As of June 2011, China’s energy planners aimed to have 96 reactors by 2020, and by 2030, enough additional reactors to generate more

power than all 104 reactors in the US, the 2010 leader in nuclear reactor units. • The Chinese have planned for non-fossil fuels to produce 15% of China’s energy by 2020; although the Chinese have invested significant

amounts on wind turbines and solar panels, nuclear power needs to be built up to reach that target. • The Chinese have been building reactors faster and at a lower cost than the rest of the world. State ownership of the industry guarantees

capital and relatively quick approvals of new plants. Low-cost labor and experience in major infrastructure projects, such as power plants and rail and subway systems, also help. As a result, according to Areva, building a Western-designed reactor in China costs about US$4 billion, 40% less than one in Normandy, and can be completed in 46 months, versus 71 months in France.

• Guangdong Nuclear has indicated its intention to sell its reactors abroad by 2013 (China has supplied commercial reactor technology only to Pakistan).

Source: Morgan Stanley Smith Barney Investment Strategy; “China Wants Nuclear Reactors–Fast,” Bloomberg Businessweek, December 2, 2010.

Source: World Nuclear (December 2010).

A Nuclear Reactor Under Construction in the Zhejiang Province in Eastern China.

Tianwan Nuclear Power Station in the Jiangsu Province in Eastern China.

Where China is Building Its Reactors

Source: The Ux Consulting Company; Morgan Stanley & Co. Inc. Research, “Global CleanTech: Tohoku Quake: Implications for Clean Technology,” March 22, 2011.



Notes:1. China data are estimated and include: (i) SAFE Investment Company, US$347.1 Billion; (ii) China Investment Corporation, US$332.4 Billion; (iii) National Social Security Fund, US$146.5

Billion; and (iv) China-Africa Development Fund, US$5.0 Billion. 2. UAE data include: (i) Abu Dhabi Investment Authority, US$627.0 Billion; (ii) International Petroleum Investment Company, US$48.2 Billion; (iii) Investment Corporation of Dubai, US$19.6

Billion; (iv) Mubadala Development Company, US$13.3 Billion; and (v) RAK Investment Authority, US$1.2 Billion. 3. Singapore data include: (i) Government of Singapore Investment Corporation, US$247.5 Billion; and (ii) Temasek Holdings, US$145.3 Billion.

As of March 2011, the 5th Largest Sovereign Wealth Fund in the World

BACKGROUND

60

China Investment Corporation (CIC)

1. Select investments based on economic and financial objectives, and an assessment of the commercial return.

2. Allocate capital and assets within the given risk tolerance of the owner to maximize shareholder value.

3. Seek an inactive, passivist role in investing in companies.

4. Seek long-term, stable, sustainable, and risk-adjusted return.

CIC’s Four Investing Principles

Source: China Investment Corp, www.china-inv.cn.

Overview of the China Investment Corporation• China Investment Corporation (CIC) is an investment institution established as a wholly state-owned company under the Company Law of

the People’s Republic of China. CIC is headquartered in Beijing and was established on September 29, 2007, with the issuance of special bonds worth Rmb 1.55 trillion by the Ministry of Finance. The issued bonds were used to acquire approximately US$200 billion of China’s foreign exchange reserves, forming the foundation of its registered capital.

• CIC’s overseas investment portfolio is mainly composed of equity, fixed income, and alternative investments, in developed and emerging markets. Its alternative investments include hedge funds, private equity, commodities, and real estate, among other asset classes.

• CIC is one of four Chinese sovereign wealth funds, the others being the State Administration of Foreign Exchange (SAFE) Investment Company, the National Council for the Social Security Fund, and the China-Africa Development Fund. As of March 2011, CIC had US$332 billion in assets under management, making it the fifth largest sovereign wealth fund in the world. – SAFE, which is primarily responsible for managing China’s foreign exchange reserves, had US$347 billion in assets as of March 2011,

making it the fourth largest sovereign wealth fund in the world. As of March 2011, the National Social Security Fund and the China-Africa Development fund had US$147 billion and US$5 billion in assets under management, respectively.

– Aggregated together, China’s four sovereign wealth funds were worth US$831 billion as of March 2011.• For information on CIC’s US securities holdings, please go to www.sec.gov. Source: China Investment Corp, www.china-inv.cn, Sovereign Wealth Fund Institute, www.swfinstitute.org.

CIC’s Executive TeamLou Jiwei, Chairman & CEOPrevious Position: Deputy Secretary General of State CouncilEducation: Masters degree in Economics, and a Bachelors degree from Tsinghua University.

Gao Xiqing, President & CIOPrevious Position: Deputy Chairman of the National Council for the Social Security FundEducation: JD degree from Duke University, and a Masters degree from the University of International Business and Economics in Beijing.

Jin Liqun, Chairman of Board of SupervisorsPrevious Position: Vice President of Operations of the Asian Development BankEducation: Masters degree from Beijing Foreign Studies University, and a Hubert Humphrey Fellow in the Economics Graduate Program at Boston University.

Source: China Investment Corp, www.china-inv.cn.

(1)

(3)

(2)

203143 85 73 70 48

292393439

557

709831

0

250

500

750

1,000

Non-Oil Oil

The Largest Sovereign Wealth FundsAs of March 2011

Assets (US$ Billions)

Source: Sovereign Wealth Fund Institute, www.swfinstitute.org. Data are as of March 2011.

China UAE Norway Saudi Arabia

Singa- pore

Hong Kong

Kuwait Russia Qatar Australia Libya Algeria

http://www.google.com/imgres?imgurl=http://www.appliedlanguage.com/flags_of_the_world/medium_flag_of_united_arab_emirates.gif&imgrefurl=http://www.appliedlanguage.com/flags_of_the_world/flag_of_united_arab_emirates.shtml&usg=__2NNrMhx7q8w--E1oHtBSLuK3gt4=&h=151&w=304&sz=4&hl=en&start=15&zoom=1&um=1&itbs=1&tbnid=3tOPXbDnj7hv0M:&tbnh=58&tbnw=116&prev=/images%3Fq%3Dunited%2Barab%2Bemirates%2Bflag%26um%3D1%26hl%3Den%26sa%3DN%26tbs%3Disch:1&ei=KjV-TeCqH4OC0QHJkZz2Aw

http://www.google.com/imgres?imgurl=http://scrapetv.com/News/News%2520Pages/Science/Images/norway-flag.jpg&imgrefurl=http://scrapetv.com/News/News%2520Pages/Science/pages/Water.html&usg=__fSOFit7m67_jf8EJzqgSMPLaD7I=&h=282&w=365&sz=9&hl=en&start=10&zoom=1&um=1&itbs=1&tbnid=8jmcvoTbcwWYWM:&tbnh=93&tbnw=121&prev=/images%3Fq%3Dnorway%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=zTV-Tby6NaGX0QHIyLjXAw

http://www.google.com/imgres?imgurl=https://www.cia.gov/library/publications/the-world-factbook/graphics/flags/large/sn-lgflag.gif&imgrefurl=https://www.cia.gov/library/publications/the-world-factbook/geos/sn.html&usg=__U0c62tfPjLgQtVFuXCjCAttybs4=&h=302&w=453&sz=4&hl=en&start=1&zoom=1&um=1&itbs=1&tbnid=W6sBQxUMzq2ASM:&tbnh=85&tbnw=127&prev=/images%3Fq%3Dsingapore%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=FjZ-TYeGHM-D0QGUncXuAw

http://www.google.com/imgres?imgurl=http://www.topnews.in/files/hong-kong-Flag.gif&imgrefurl=http://www.topnews.in/hong-kong-shares-gain-25-cent-optimism-december-293756&usg=__JJXk36hlbKe_W1LN-fBkB5kCBc8=&h=216&w=324&sz=2&hl=en&start=7&zoom=1&um=1&itbs=1&tbnid=9W_N0XFiOY5xUM:&tbnh=79&tbnw=118&prev=/images%3Fq%3Dhong%2Bkong%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=Gjd-TaOvDIWM0QHlh5CIBA

http://www.google.com/imgres?imgurl=http://www.usflags.com/images/products/qatar.gif&imgrefurl=http://www.usflags.com/products/Qatar-Flag.asp&usg=__JqZ3ye2-PpBWPypp0hK13aBW1M8=&h=180&w=270&sz=3&hl=en&start=19&zoom=1&um=1&itbs=1&tbnid=Qm0Wc66lm5tgIM:&tbnh=75&tbnw=113&prev=/images%3Fq%3Dqatar%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=Szd-TavtOa-E0QHP4qCABA

http://www.google.com/imgres?imgurl=http://www.senojflags.com/images/national-flags/Australia-Flag.gif&imgrefurl=http://www.senojflags.com/Australia-Flags&usg=__Y--KRztUYCjqUQj2WJrm2xD0lsM=&h=288&w=431&sz=6&hl=en&start=9&zoom=1&um=1&itbs=1&tbnid=VZRRL7HPtRkBbM:&tbnh=84&tbnw=126&prev=/images%3Fq%3Daustralia%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=6zd-TeHvBsKF0QH6raiEBA

http://www.google.com/imgres?imgurl=http://www.chevroncars.com/learn/flags/img/Libya-flag.gif&imgrefurl=http://www.chevroncars.com/learn/flags/Libya&usg=__DTZssChoT4Yf0vQDTzdlxlcRZws=&h=225&w=450&sz=1&hl=en&start=12&zoom=1&um=1&itbs=1&tbnid=eoYR-yhaeQ07KM:&tbnh=64&tbnw=127&prev=/images%3Fq%3Dlibya%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=fzh-TZjYG5C40QG_zKmEBA

http://www.google.com/imgres?imgurl=http://www.buyflagshere.com/store/images/buy_algeria_flag.gif&imgrefurl=http://www.buyflagshere.com/store/index.php%3Fmain_page%3Dproduct_info%26cPath%3D2%26products_id%3D183&usg=__O6yx1UoTZ58IM4RM0Iul4tjnp_Q=&h=206&w=300&sz=3&hl=en&start=17&zoom=1&um=1&itbs=1&tbnid=1HknvjuN2SsQYM:&tbnh=80&tbnw=116&prev=/images%3Fq%3Dalgeria%2Bflag%26um%3D1%26hl%3Den%26tbs%3Disch:1&ei=vTh-TbqyMvGQ0QH9pqjQAw



• As of April 2011, China had US$3.0 trillion in foreign exchange reserves, ranking number one with 32% of the world’s total.

• From 1995 through 2010, China’s foreign exchange reserves have grown at a compound annual growth rate (CAGR) of 28%.

• The foreign exchange reserves of China, Hong Kong, and Taiwan have more than quadrupled from 2003 through 2009.

219 257 316 325 357 380 446 557 725975

1,1961,460

1,9572,420

3,003

3,498 3,717

0500

1,0001,5002,0002,5003,0003,5004,000

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11

China Hong Kong Taiwan

Combined Foreign Exchange Reserves of China, Hong Kong, and TaiwanUS$ Billion

74 105 140 145 155 166 212 286 403610

8191,066

1,5281,946

2,3992,847

3,045

0

500

1,000

1,500

2,000

2,500

3,000

3,500

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11

China’s Foreign Exchange ReservesUS$ Billion

BACKGROUND

China’s Foreign Exchange ReservesDecember 1995 ─ April 2011

Source: Bloomberg, LLC.

Source: Bloomberg, LLC. Data are as of April 2011.

Note:1. Data are as of April 2011.

(1)

(1)

61

The Summer Palace, or Yíhé Yuán (Gardens of Nurtured Harmony), is an imperial garden in Beijing mainly composed of Longevity Hill and Kunmig Lake. First built in 1750, the palace covers an area of 2.97 km2, three-quarters of which is covered by water. The palace served as a summer residence and safe haven for emperors during the Qing dynasty. In 1998, UNESCO included the Summer Palace on its World Heritage List, calling the Summer Palace “a masterpiece of Chinese landscape garden design.”

Summer Palace

Source: www.travelchinaguide.com; UNESCO World Heritage Centre.



4.44.9

5.4

4.23.9

3.1 3.02.6

2.93.6

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09

US Direct Investment in ChinaUS$ Billions

15.4 19.3 20.0 16.819.0

10.5 12.1 11.624.2

30.2 34.4 39.3 35.4

17.521.6

(10)0

102030405060708090

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009(20)

0

20

40

60

80

100

Indonesia Korea Malaysia Philippines Thailand Taiwan China

Foreign Direct Investment in China Compared With Six Other Asian NationsUS$ Billions US$ Billions

35.8 40.2 44.2 43.8 38.8 40.7 46.9 52.7 53.560.6 60.3

69.5 74.8

92.4 90.0

0

20

40

60

80

100

120

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Annual Foreign Direct Investment Flows into China, 1995 – 2009US$ Billions

BACKGROUND

Foreign Direct Investment Flows

Source: People’s Republic of China Ministry of Commerce; People’s Republic of China National Bureau of Statistics; China Statistical Yearbook 2009. Data are as of December 31, 2009.

Source: Morgan Stanley & Co. Inc. Research; People’s Republic of China Ministry of Commerce; People’s Republic of China National Bureau of Statistics; China Statistical Yearbook 2009. Data are as of December 31, 2009.

• Annual Foreign Direct Investment in China has more than doubled over the 1999 – 2009 time frame.

• In the post-Millennium era, investment flows into China have exceeded the combined flows into six other Asian emerging market economies.

Source: People’s Republic of China Ministry of Commerce. Data are as of December 31, 2009.

62



BACKGROUND

China’s Trade Activity with the United States

• In 2010, China was the United States’ top trading partner, in part due to its fixed- currency rate pegged to the US dollar for the first half of the year.

• Over the 2001 – 2010 time frame, China’s total trade activity grew at a compound annual growth rate of 15.9%.

Source: US Department of Commerce; US International Trade Commission. Data are as of December 31, 2010.

Source: US International Trade Commission; The US-China Business Council. Data are as of December 31, 2010.

0

4

8

12

16

20

2005 2006 2007 2008 2009 2010

United States China

Annual Passenger Car SalesMillion

Source: Bloomberg, LLC. Data are as of December 31, 2010.

0 20 40 60 80 100

United States

Japan

Germany

United Kingdom

Korea

Taiwan

Mexico

Brazil

Argentina

China

Passenger Cars in Select CountriesPenetration of Passenger CarsUnits per 100 Households (2009)

Source: CEIC, Euromonitor, Morgan Stanley & Co. Inc. Research. Data are as of November 2010.

Source: US International Trade Commission; The US-China Business Council. Data are as of December 31, 2010.

(US$ Billion) or percentage change as indicated

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

US Exports 19.2 22.1 28.4 34.7 41.8 55.2 65.2 71.5 69.6 91.9

% Change YoY 17.8% 15.1% 28.5% 22.2% 20.5% 32.1% 18.1% 9.7% (2.7%) 32.0%

US Imports 102.3 125.2 152.4 196.7 243.5 287.8 321.5 337.8 296.4 364.9

% Change YoY 2.3% 22.4% 21.7% 29.1% 23.8% 18.2% 11.7% 5.1% (12.3%) 23.1%

Total Bilateral Trade 121.5 147.3 180.8 231.4 285.3 343.0 386.7 409.3 366.0 456.8

US Balance (83.1) (103.1) (124.0) (162.0) (201.7) (232.6) (256.3) (266.3) (226.8) (273.0)

China's Trade with the United States, 2001 – 2010

2010 (US$ Billion)Description 2009 2010 % ChangeElectrical Machinery 9.4 11.5 21.9%

Power Generation Equipment 8.4 11.2 33.6%

Oil Seeds and Oleaginous Fruits 9.3 11.0 18.1%

Air and Spacecraft 5.4 5.8 8.0%

Optics and Medical Equipment 4.0 5.2 31.2%

Plastics 4.3 4.8 10.5%

Inorganic and Organic Chemicals 3.4 4.5 34.2%

Vehicles (Excluding Railway) 1.9 4.5 134.4%

Pulp and Paperboard 2.5 3.0 22.0%

Copper 1.8 2.9 62.0%

Top US Exports to China2010 (US$ Billion)Description 2009 2010 % ChangeElectrical Machinery 72.9 90.8 24.5%

Power Generation Equipment 62.4 82.7 32.5%

Apparel 24.4 28.8 18.1%

Toys and Games 23.2 25.0 7.7%

Furniture 16.1 20.0 24.5%

Footwear 13.3 15.9 19.4%

Plastics 8.0 9.6 20.1%

Iron and Steel 8.0 8.4 4.4%

Leather and Travel Goods 6.0 7.5 24.4%

Optics and Medical Equipment 5.6 7.0 25.7%

Top US Imports from China

63



BACKGROUND

China’s Trade Activity with the World

• China’s global trade has increased dramatically in recent years.

• Over the 2001 – 2010 period, China’s total trade activity grew at a compound annual growth rate of 26.2%.

• With imports up an estimated 39% in 2010, China became an important source of growth for its neighbors in Asia and elsewhere.

Source: People’s Republic of China National Bureau of Statistics; Morgan Stanley & Co. Inc. Research. Data are as of December 31, 2010. Estimates are as of May 2011.

Source: China’s Customs Statistics, by the People’s Republic of China General Administration of Customs. Data are as of December 31, 2010.

Source: The World Bank. Data are as of December 31, 2009.

Weighted Avg. of All ProductsYear Tariff (%)1992 32.2 1993 30.3 1994 27.9 1995 NA1996 19.8 1997 15.8 1998 15.6 1999 14.5 2000 14.6 2001 14.1 2002 NA2003 6.5 2004 6.0 2005 4.8 2006 4.3 2007 5.1 2008 4.7 2009 4.2

Tariff Rates in China

(US$ Billion) or percentage change as indicated

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E

Exports 266.1 325.6 438.2 593.3 762.0 968.9 1,217.8 1,430.7 1,201.7 1,577.9 1,814.6

% Change YoY 6.8% 22.4% 34.6% 35.4% 28.4% 27.2% 25.7% 17.5% (16.0%) 31.3% 15.0%

Imports 243.6 295.2 412.8 561.2 660.0 791.5 956.0 1,132.6 1,005.9 1,394.8 1,645.9

% Change YoY 8.2% 21.2% 39.8% 36.0% 17.6% 19.9% 20.8% 18.5% (11.2%) 38.7% 18.0%

Total Trade 509.7 620.8 851.0 1,154.6 1,422.0 1,760.4 2,173.8 2,563.3 2,207.6 2,972.7 3,460.5

Balance 22.6 30.4 25.5 32.1 102.0 177.4 261.8 298.1 195.8 183.1 168.7

China's Trade with the World

Source: China’s Customs Statistics, by the People’s Republic of China General Administration of Customs. Data are as of December 31, 2010.

64

2010 (US$ Billion)Description 2009 2010 % ChangeLeading Imports

Electrical Machinery 244 314 29.0%

Minerals, Fuels, and Oil 124 189 52.1%

Power Generation Equipment 124 172 39.4%

Ores, Slag, and Ash 70 109 54.9%

Optics and Medical Equipment 67 90 34.1%

Leading Exports

Electrical Machinery 301 389 29.1%

Power Generation Equipment 236 310 31.4%

Apparel 100 121 20.5%

Iron and Steel 47 68 44.1%

Furniture 39 52 34.0%

China's Leading Import and Export Products

2010 (US$ Billion)Economy 2009 2010 % ChangeLeading Import Suppliers

Japan 131 177 35.0%

South Korea 103 138 35.0%

Taiwan 86 116 35.0%

United States 70 92 32.0%

Germany 56 74 33.4%

Leading Export Destinations

United States 296 365 23.1%

Hong Kong 166 218 31.3%

Japan 98 121 23.7%

South Korea 54 69 28.1%

Germany 50 68 36.3%

China's Leading Import Suppliers and Export Destinations



Section 2

Issues for Consideration

65Source: The Metropolitan Museum of Art.

Dish with Birds and Flowers on Fan c.1730 – 1750 AD

Chinese Art at the Metropolitan Museum of Art in New York• From December 15, 2010 through May 1, 2011, the Metropolitan Museum of Art exhibited an extravagant display of Chinese Art from

the 18th and 19th centuries (Qing dynasty). The art collection featured a variety of Chinese art including textiles, lacquers, ivories, jades, and porcelains.

• The art of the Qing dynasty has informed Western perceptions of Chinese taste and imagery for centuries, beginning in the late 17th

century with Europeans’ fascination for chinoiserie. • The museum’s February 2011 exhibition, “The Emperor’s Private Paradise: Treasuries from the Forbidden City,” included paintings,

decorative works, architectural elements, and religious works from the elaborate two-acre private retreat constructed in 1771 deep within the Forbidden City in Beijing as the retirement residence of the Qianlong Emperor, who presided over the Qing dynasty during the zenith of its power and wealth.

Ornate Box with Landscape Scenes and Auspicious Emblems,

18th Century

Jade Figurine of A Temple Attendant Late 18th Century

Ivory Tablet with Design for a Carpet Qianlong Period (1736 – 1795 AD)

Snuff Bottle with European Woman and Child, Qianlong Period (1736 – 1795 AD)

Lacquer Vase with Floral Background and Landscapes in Cartouches,

18th Century

Woman’s Silk Theatrical Jacket 19th Century



ISSUES FOR CONSIDERATION

Select Forces Affecting China’s Securities Prices

66

• Among the key forces expected to affect China’s securities prices over the near-to-intermediate term are:– Fundamental Factors– Valuation Factors– Psychological, Technical, and

Liquidity Factors

Fundamental Factors• Global, pan-Asian, and

indigenous Chinese economic and geopolitical conditions

• Technological progress and innovation

• Monetary, fiscal, and currency policies

• The degree of substantive progress in implementing economic, political, and reform goals

Valuation Factors• Price-Earnings Ratios

• Price-to-Sales Ratios

• Price-to-Book Ratios

• Dividend Yields

• Ratios relative to those in other countries and to historical levels in China

Psychological, Technical, and Liquidity Factors• Domestic and foreign investors’ capital flows

• Consumer, business, and investor confidence

• The degree of enlightenment in the authorities’ policies affecting the economy and financial markets

China’s Securities Prices


Belonging to the Chi’ien-lung Emperor of the Qing dynasty, the fine silk weaving shown here illustrates the 500 Buddhist deities known as lohans. This hand scroll can be divided into nine pictorial segments, each reflecting one of the nine Buddhist poems; the topics include the Buddha descending from Western Paradise, and the proclaiming of the Law and the enlightenment of the universe.

The Five Hundred Lohans

Source: www.artsmia.org.




Important Inputs to the Chinese Investment Outlook

67

Important Inputs to the Investment Outlook in China:

1. Investors may consider China as in a positive secular long-term trend that is also subject to short-term cycles.

2. As of April 2011, China had over US$3.0 trillion in foreign exchange reserves, the highest in the world and representing 31.6% of global reserves; “greater China” (including China, Hong Kong, and Taiwan) possessed foreign exchange reserves of over US$3.7 trillion.

3. China’s real GDP has grown and is projected to grow rapidly: 2007, +13.0%; 2008, +9.6%; 2009, +9.1%; 2010E, +10.2%; 2011E, +9.0%; and 2012E, +9.0%.

4. Broad and narrow money supply growth in China was 25%, 26%, 28%, and 20% per annum for 2007, 2008, 2009, and 2010, respectively.

5. China’s economic growth has been largely driven by foreign direct investment, exports, capital inflows by overseas Chinese, and savings rates as high as 52%; domestic private consumption grew at 26.6% in 2008 and 11.4% in 2009.

6. As part of its 12th Five-Year Plan, officially released in March 2011, China laid out plans to provide 4 trillion yuan (US$600 billion) to financially support key emerging industries, including energy conservation and environmental protection, information technology, biology, advanced manufacturing, new energy, new materials, and new-energy automobiles.

7. China has continued as a significant consumer of the world’s basic materials: in 2009, China surpassed India and the European Union in coal imports, and accounted for 47% of the world’s steel consumption. China’s efforts to improve energy conservation has brought about and may lead to a further slowdown in imports of certain materials.

8. China’s fixed asset investment-to-GDP ratio amounted to 46% in 2009.

9. Employment in China rose by 5.9 million jobs in 2007, 4.9 million in 2008, and 5.2 million in 2009.

10 . The industrial sector’s share of Chinese GDP rose from 41% in 1990 to 46% in 2009, accounting for 47% of the cumulative increase in China’s GDP over that same period. By comparison, in India the services sector’s share of GDP increased from 40% in 1990 to 55% in 2009, accounting for 60% of the cumulative increase in Indian GDP growth over that same period.

Source: Morgan Stanley Smith Barney Investment Strategy; Bloomberg, LCC; The Economist Intelligence Unit; “China Underlines Emerging Industries in 12th Five-Year Plan,” International Business Times, October 18, 2010; China Economic Net, http://en.ce.cn/.




Investment Trends

• The Chinese economy has expanded at a rapid pace due primarily to export growth, foreign direct investment, and state-sponsored infrastructure investment.

• The Chinese government has continued its strong commitment to economic reforms.

• Chinese companies increasingly focus on penetrating global markets.

• The Chinese economy has been among the fastest growing major economies in the world. This growth has primarily been driven by three sources:

i. Export activity, which has grown on average at approximately 22% per annum from 2001 through 2010, with exports growing 31% in 2010.

ii . Foreign direct investment (FDI), which totaled over US$600 billion from 2000 through 2009, including US$90 billion in 2009; and

iii . State-sponsored infrastructure spending, which has increased fixed investment dramatically.• The Chinese government has renewed its commitment to reforms, many of which may also promote

significant economic growth. These reforms include:i. The restructuring of State-Owned Enterprises (SOEs) through improved corporate governance and

privatization; ii . The continued restructuring of SOEs’ non-performing loans;iii . The gradual opening of certain industries to foreign investment; andiv. The agreement by the China Securities Regulatory Commission (CSRC) to allow private and foreign

investors in appropriate cases to acquire controlling stakes in domestically-listed companies.• Unlike many other developing countries, China has not been materially affected by low capital intensivity, and

has entered high value-added industries, for three primary reasons:i. China’s savings rate is exceptionally high for both demographic and historical reasons;ii . China can produce many investment goods at its own low cost; andiii . China has embraced globalization on both the supply and demand sides.

• Long-term investment themes include a focus on: (i) household consumption, culture and leisure, and healthcare; (ii) the materials sector, mainly agrichemicals, chemicals, and shipping; and (iii) a continued industrial upgrade, mainly in aerospace and defense, industrials, and machinery.

• Chinese companies have gained market share from their non-Chinese competitors in China and continue to move into the global marketplace. As part of the trend toward increasing globalization and global labor arbitrage, China’s export-led growth has had deflationary implications for certain companies, sectors, and countries.

• To continue growing, China has begun to: (i) focus on increasing domestic demand; (ii) draw somewhat less support from externally-driven demand; and (iii) improve the efficiency of its capital allocation mechanisms.

Source: Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Inc. Research; “Surge in Exports From China Hits Global Industry,” The Wall Street Journal, October 10, 2002; “Real Trading Depends on Big Agenda for Change,” Financial Times, December 12, 2002; US-China Business Council.

Beginning in the first millennium BC, a vast network of trade routes known as the "Silk Road" linked the people and traditions of China with those of Europe. The Silk Road contained three major routes: (i) the northern route ran westward from China to the Black Sea; (ii) the central route, to Persia and the Mediterranean Sea; and (iii) the southern route, to Afghanistan, Iran, and India. Ivory and gold, food such as pomegranates, safflowers, and carrots went east out of Rome; from China and Asia came jade, furs , ceramics, and manufactured objects of bronze, iron, and lacquer. These historic routes served as major conduits for the transport of material goods, and more importantly, of knowledge and information, between East and West. (Please also see pages 11 and 15.)

The Silk Road

Source: www.travelchinaguide.com, encyclopedia.com.

68




Intermediate Term Strengths and Hindrances in China

69

Strengths Hindrances

Source: Morgan Stanley Smith Barney Investment Strategy; Bloomberg, LCC (March 2011); The World Bank (May 2011).

• China’s economic development has been driven by several decades of steadfast commitment to wide-ranging reforms, as China transitions from a state-owned to a market-driven economy.

• China has demonstrated prowess as a world-class and large- scale manufacturer. This reflects a judicious combination of high national saving, improvements in infrastructure, and large inflows of foreign direct investment (FDI).

• China’s competitiveness also draws successfully on its large reserves of inexpensive labor who are willing to learn and work hard.

• China has invested significant sums in large infrastructure projects including roads, highways, port facilities, airports, and telecommunications/internet resources.

• China has ample financial resources: (i) a 52% savings rate, one of the highest of any nation in the world; and (ii) (as of 1Q2011) US$3.0 trillion in foreign exchange reserves.

• Economically progressive and intelligent leadership in China appears desirous of supporting growth. The mentality, pride, purposefulness, and sense of China’s past and future place in history are important motivators of the Chinese population.

• China is one of the world’s leading buyers of raw materials and suppliers of manufactured products, and is becoming an increasingly important investor in and contributor to Asian and global trade and economic development.

• Overseas Chinese, along with Chinese returnees who have a strong desire to see China succeed, are making important contributions to China’s economy and financial markets.

• China needs to continue reducing the wide income and wealth gaps between: rich and poor, urban and rural populations, and coastal and interior regions and provinces.

• China’s banking system and non-performing loans (NPLs) may represent a hindrance to balanced growth in the Chinese economy.

• As in many countries, issues of transparency, censorship, governance, and the rule of law need to be properly addressed.

• In the second half of the first decade of the 21st century, signs of a potential residential property bubble emerged in certain Chinese cities.

• Ecological, environmental, and health challenges remain , including China’s growing needs for food, oil, clean air and clean water; such factors may hold growth below China’s potential.

• China has a relatively undeveloped services sector , representing a source of future jobs creation.

• By eliminating millions of jobs per year due to reforms, China needs to create jobs for displaced workers.




Potential Risks

• Some publicly-traded companies may lack transparency because of their ties to state-owned parent companies. In some cases, this may lead to complicated and somewhat opaque transactions involving the financial statements of such firms.

• The China Securities Regulatory Commission (CSRC) has had relatively limited oversight and can change or amend its rules and regulations at any time.

• China’s banks have at times had sizeable amounts of nonperforming loans (NPLs).• Loose credit can exacerbate the oscillations of cyclical boom-bust episodes.• Chinese economic policies have to balance continued economic reforms with the need to reduce

domestic unemployment.• According to several Chinese economists, China needs to maintain more than 7% annual

GDP growth to keep unemployment rates below 15-20% in rural areas.• The Chinese legal system contains inherent uncertainties that could limit legal protections

available to investors, including difficulties in effecting service of the legal process and enforcing judgments against Chinese companies’ managements.

• Some analysts assert that China’s national economic statistics, including its economic growth rate, are not entirely accurate, as they are compiled from provincial data which may be subject to political revision.

• China’s stock market may not be a representative indicator of the national economy due to variations in economic growth and changes in stock market regulations which may affect investor sentiment.

Source: Morgan Stanley Smith Barney; “Outcasts From China’s Feast,” The Wall Street Journal, November 6, 2002; “China’s Bank-Loan Problems May Dwarf Japan’s,” Barron’s, November 11, 2002; “Beijing Rising,” Financial Times, December 3, 2002; “Asia Minor,” The New Republic, December 16, 2002; “China’s Success Doesn’t Lift Stocks,” The Wall Street Journal, December 27, 2002.

Select Paintings by Qi Baishi (1864-1957)

“Old Man,” circa 1945

“Shrimp,” circa 1950

Source: www.chinapage.com.

70




Bullish Factors Affecting China’s Economy and Markets

71

Fundamental Factors

Source: Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Inc. Research; Bloomberg, LLC; The World Bank; “China’s Economic Blueprint: Take Five,” The Economist, March 12, 2011; “Bamboo Capitalism,” The Economist, March 12, 2011; “Chinese and Germany: Reflected Glory,” Financial Times, January 19, 2011.

• Low labor costs and a large labor force; China is projected to benefit from a low demographic dependency ratio and abundant labor supply through 2020.

• A high savings rate (gross domestic saving in China as a percentage of GDP reached 52% in 2009, one of the highest savings rates of any country in the world). China’s national savings exceeds national investment, as reflected in persistent and sizable current account surpluses. The availability of low-cost capital has been deemed by economists to be an unlikely binding constraint on capital formation until at least 2016.

• Aggregate household indebtedness represented 18% of GDP as of early 2011, compared to 95% of GDP in the United States.

• Continued population movement to urban centers.

• Increasing emphasis on the development of domestic consumer spending and the raising of consumption as a percent of GDP.

• Sources of consumption growth include: (i) rising income; (ii) a lower savings ratio; and (iii) consumption upgrades, suggesting that a “golden age of consumption” may continue to unfold in China.

• Progress in building out and/or modernizing infrastructure, including airports, railways, highways, seaports, and telecommunications and internet resources.

• China is continuing initiatives to implement planned reforms in social security, rural land management, recapitalization of state-owned banks, taxation, and capital markets oversight.

• China is dedicating resources to improving schools, farm aid, rural social services, and healthcare.

• China is focusing on strengthening its banking system, including capital infusions and the earmarking of foreign exchange reserves to fortify banks’ balance sheets.

• Even as China’s GDP growth appears likely to decelerate somewhat through 2020, Morgan Stanley Asia/Pacific Research expects China to generate average gains of 8% per year as overall consumption, the service sector, and income rise relative to GDP. According to World Bank estimates, China’s potential GDP growth is likely to reach 8.4% over the 2011 to 2015 time period, and 7.0% over the 2016 to 2020 time period.

• Consumption is projected to become a key driver of economic growth. By 2020, Morgan Stanley Asia/Pacific Research expects Chinese consumption to reach two-thirds of the US level and account for approximately 12% of global consumption. China’s private consumption appears to be substantially underestimated.

• Important reforms, if carried out, could potentially generate substantial efficiency and productivity gains. Such reforms include improved financial intermediation by developing the indigenous bond market and/or deregulating interest rates, and improving access for private entrepreneurs to sectors currently subject to state monopoly (including health care, education, telecommunications, media, and transportation).

• Morgan Stanley China economists originally forecast 9.0% GDP growth and 4.5% CPI inflation for 2011, with consumption and investment representing equally important contributors to growth. The lagged effect of massive monetary expansion in 2009 to 2010 was expected to continue to provide strong tailwinds for inflation, while the headwinds stemming from weak external demand were seen as weakening. CPI inflation was expected to rise in the first half of 2011, to peak at 5.5% year-over-year by mid year, and to decelerate to 4.0% year-over-year by year-end 2011.

• As part of its “market-based reform” of interest rates, China expects that freer interest rates will better reward household savers, discourage excessive investment, and possibly allow private borrowers to obtain loans from state banks by offering to pay higher rates.

• One estimate by The Economist magazine puts the share of GDP produced by enterprises that are not majority-owned by the state at 70%. According to Zheng Yumin, the CPC secretary for the Commerce Department of Zhejiang province, more than 90% of China’s 43 million companies are private. The heartland for entrepreneurial clusters centers in regions such as Zhejian, but entrepreneurial businesses have spread far and wide across the country.

• In areas that include not only solar panels but also wind energy turbines, telecommunications networks, power transmission, and high-speed trains, as of early 2011 Chinese companies were already on a par with their Western counterparts. In other areas, such as construction machinery, machine tools, automobiles, and electrical engineering, companies were gearing up to compete.




Bullish Factors Affecting China’s Economy and Markets

72

Valuation Forces

Psychological, Technical, and Liquidity Forces

Source: Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Inc. Research; Bloomberg, LLC; FactSet.

• As of May 2011, select valuation measures for the MSCI China Index were:

– 11.0x next-twelve-months Price-to-Earnings; 13.8x trailing Price-to-Earnings

– 2.2x Price-to-Book value

– 2.3% dividend yield

• China continues to increase its participation in world trade, portfolio capital flows, and foreign direct investment.

• Resources continue to be directed toward improving the position of low-income Chinese, including: (i) increasing urban and rural welfare payments; (ii) overhauling grain production; (iii) reducing rural and agricultural taxes; and (iv) improving education.

• China’s increasing physical capital, particularly in machinery and equipment, and gains in human capital and education, represent long-term underpinnings of China’s continued progress and development.

• Many government, monetary, and regulatory organizations have benefited and are continuing to benefit from innovative, energetic, and enlightened leadership.

• China projected Rmb 7 trillion in new bank loans in 2011, representing a generous level of liquidity to fuel growth: at 16% of GDP in 2011, new bank loans were forecast to be well above the 13% “normal” new loans to GDP ratio that prevailed before the financial crisis (2005 to 2007 average).

• Morgan Stanley China Economists forecast that renminbi strengthening would continue in 2011 at an annualized rate of 6.5%, implying strong re-rating potential in market valuation, given the strong correlation between renminbi appreciation expectations and Chinese market valuation.

• China’s economic strength and corporate fundamentals may be the strongest in Asia, yet the country’s stock markets underperformed the region in 2009 and in 2010. Morgan Stanley Asia/Pacific Equity Strategists forecast that in 2011, such mispricing would be unlikely to continue given this fundamental backdrop.

• As of May 2011, the price relationship of dual-listed domestic China A shares versus their Hong-Kong-listed H-share equivalents had moved from a premium to parity or in some cases, to a discount.

Fundamental Factors

• China’s 12th Five-Year Plan is based on three legs to the consumer-led growth stool: boosting employment; raising wages; and shifting the allocation of the resulting increment in labor income away from saving toward spending.

• China’s 12th Five-Year Plan focuses on the development and expansion of seven strategic emerging industries (SEIs): new-generation information technology; high-end equipment manufacturing; advanced materials; alternative-fuel cars; energy conservation and environmental protection; alternative energy; and biotechnology.

• China has modernized its factories, infrastructure, shelter, and offices. It has educated its people. It has also built up an enormous reservoir of domestic saving and foreign exchange reserves. China has also broken the mold on poverty reduction and internal migration from the countryside to new cities.



Fundamental Factors


Bearish Factors Affecting China’s Economy and Markets

73

Source: Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Inc. Research; Bloomberg, LLC; FactSet; “China’s Economic Blueprint: Take Five,” The Economist, March 12, 2011; “Where Are the Profits?,” The Economist, December 12, 2010; “China’s Opaque Ways of Finding New Leaders Are Threat to Reform,” The Economist, March 25, 2011; “Chinese Peasants Feel Bullied Over Land,” by Calum MacLeod, USA Today, March 25, 2011; “Greed and Fear,” CLSA Asia-Pacific Markets, February 24, 2011; “China Reaches Lewis Turning Point as Labor Costs Rise,” by Chris Ansty, Bloomberg Businessweek, June 11, 2010.

• According to Prime Minister Wen Jiabao in his annual speech to China’s National People’s Congress on March 5, 2011, China’s development is neither balanced, coordinated nor sustainable. China relies too heavily on investment and on consuming natural resources and too little on consumer spending. The income generated is unevenly divided between: profits and wages, rich households and poor households, coastal provinces and inland regions, and the cities and the countryside.

• Property, capital expenditures (capex), and lending bubbles have occasionally developed in the Chinese economy and managing the aftermath of bubbles can be a challenging process.• According to forecasts made by the United Nations, the average annual growth rate of the working-age population in China over the 2011 – 2020 time period has been projected to be about 0.13%, a

significant slowdown from the average annual growth rate of 1.24% over the 1991 – 2010 time period. • As China’s population ages, the share of savers aged 34–59 in the population should decline and the share of dis-savers aged 65 and above should rise; these divergent trends should lower the average

household savings ratio. • From 2011 onward, technological and factor productivity gains from structural reform are unlikely to be as strong as over the 1980 – 2010 period. This is because the most obvious distortions in the

economy have already been largely removed, and as economic development reaches a higher level, it becomes increasingly difficult to effect more profound reforms to address deep-seated structural rigidities.

• According to data compiled by OECD Analyst Angus Maddison, Japan and Korea reached the US$7,000 per-capita GDP level in the late 1960s and the late 1980s, respectively. As the Chinese economy reaches the US$7,000 per-capita GDP inflection point similar to that in the Japanese economy around 1969 and in the Korean economy around 1988, China’s overall GDP growth may be expected to decelerate and inflation to accelerate, in similar fashion to what occurred in Japan and Korea.

• China’s average real GDP growth during 1970 –1990 was 8.4%, while the country’s average working-age population and employment growth was 2.58% and 2.55%, respectively, producing a growth rate versus employment gap of 5–6 percentage points.

• China’s real GDP growth rate per annum between 1990 and 2010 was 10.5%, while the country’s average growth in working-age population and employment was 1.3% and 0.98%, respectively, producing a growth rate versus employment gap of 9–10 percentage points.

• If official statistics are reliable, owing in part to the lack of a well-funded social safety net (such as social security, private pensions, Medicaid assistance, and unemployment insurance), the Chinese household sector generated a savings rate amounting to 52% of GDP in 2009, meaning the country had to rely on exports and fixed investment as primary sources of output and employment growth.

• As of May 2011, it was posited that should economies in the developed world surprise on the upside and experience rapid economic growth in 2011, oil and food prices would rise globally, forcing China to tighten monetary policy aggressively. In such a scenario, stock prices could likely come under selling pressure.

• If the Chinese authorities were to rely mainly on administrative controls over monetary aggregates instead of allowing price-based policy instruments such as interest rate hikes and appreciation of the renminbi to control inflation, the risk of a policy-induced boom (in 2010) and bust (2011) cycle would be expected to rise.

• From close to 20% in 2003 to just above 10% in 1H 2010, operating profit margins were declining in China. Exporters’ profit margins were often less than 2%, according to China’s Minister of Commerce. The Chinese government has been phasing out subsidies to industry and relaxing energy price controls. Workers have been demanding higher salaries. Environmental standards have been tightened. Should China allow the interest rates that banks pay depositors to rise, the transfer of wealth from savers to well-positioned corporations would be reduced.

• Growing evidence that credit growth in 2010 was much larger than the formal Rmb 7.95 trillion of loan growth reported by the banking sector may raise a medium-term inflation risk in China if the velocity of money in circulation rises. Thus, M2 rose by 27.5% year-over-year in 2009 and 19.7% year-over-year in 2010, while nominal GDP rose by only 8.6% in 2009 and 16.7% in 2010.

• As migrant farmers’ pay rose 40% in 2010, and all 31 Chinese provinces and regions increased their minimum wages in 2011 and 2011, China appeared to be approaching the so-called Lewis Turning Point, a pivotal period during a developing country’s advance when demand for workers begins to outstrip supply, leading to higher wages, prices, inflation, and interest rates.

• Excess capacity may represent a concern in several areas of the Chinese economy, including automobiles, steel, chemicals, and electronics.• Future leaders in China tend to be chosen by a relatively limited number of people and thus must not offend too many special interests if they hope to succeed; as a result, the political and economic

reforms necessary to keep China stable may be delayed or watered down. • In China, all land is owned by the state. Local authorities rely on land sales for a majority of their revenues. Land appropriation, at times illegal, involuntary, inadequately compensated, and enforced by

violence, may cause serious social unrest.



Fundamental Factors (Continued)

Valuation Forces

Psychological, Technical, and Liquidity Forces


Bearish Factors Affecting China’s Economy and Markets

74Source: Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Inc. Research; Bloomberg, LLC; FactSet; “Rising Wages Will Burst China’s Bubble,” by Peter Tasker,

Financial Times, January 11, 2011; “Greed and Fear,” CLSA Asia-Pacific Markets, February 24, 2011; “Let A Million Flowers Bloom,” The Economist, March 12, 2011.

• As of January 2011, the one-year time deposit rate in China was 3%, whereas the headline CPI inflation was 4.9%. Deposit growth had slowed sharply, albeit from very high levels: the total renminbi deposits growth rate had fallen from 29% year-over-year in June 2009 to 17.3% in January 2011. According to CLSA Asia-Pacific Markets Research, if deposit growth should drop below 12% year- over-year, a level not seen since the monthly data began in 1997, an inflationary pickup in the velocity of money in circulation could occur.

• To continue growing rapidly, China needs to transition from its manufacturing, price-based competitive strengths to indigenous innovation and value-based strengths; among the factors needed for this transition are: (i) creative, entrepreneurial initiatives by companies, individuals, universities, and technical institutes; (ii) moving from highly centralized economic planning to an increasing degree of individual economic choice; (iii) improved management of boom-bust cycles in real estate and other asset categories; (iv) and market-based rather than controlled prices for wages, for interest rates, and for coal, oil, and other natural resources.

• Even though a significant proposition of China’s residential property tends to be purchased with cash (or when a mortgage is taken out, with a downpayment of 25-50% of the price), as of May 2011 property values in numerous Chinese cities were significantly overvalued and faced the possibility of a serious correction.

• China needs to productively employ 150-200 million workers (“another Europe”) within the 2010 – 2030 time period to help foster social stability.• Although shortages persisted as of May 2011 among low-skilled workers in China, more than seven million people were graduating from the country’s universities each year (up from less than one

million per year in 1998), with many of them facing difficulty finding work commensurate with their self-perceived elevated status. • In order to increase household consumption’s share of China’s GDP, several structural reforms may be necessary through: (i) reducing the maximum personal income tax rate from 45% to 25%

(equal to the corporate profit tax rate); (ii) lowering the Value Added Tax (VAT) to 12% from 17%, among the highest in the world; (iii) raising deposit rates to positive levels after inflation; and (iv) working to bring residential property prices down to the early 2011 global average of two months of after-tax salary per square meter.

• A study by Qiao Liu, a professor at the University of Hong Kong, concluded that the average return on equity for companies wholly or partly owned by the state was barely 4%, despite the benefit of inexpensive leverage provided by government-controlled banks.

• In 2009, total assets under management for the national social security fund, local government retirement plans, and private sector pensions totalled just Rmb 2.4 trillion. That amounts to only $470 of lifetime retirement benefits for the average Chinese worker, underscoring the inadequacy of China’s social safety net.

• As of 2009, the Chinese urbanization ratio was 47%, roughly where Japan was in 1964. The floating population of unregistered urban migrants is estimated to be between 50 – 140 million people.

• With certain metropolitan areas’ housing prices in China selling at multiples of urban household incomes, affordability of home ownership has continued to be an issue. • On the cyclically adjusted “Shiller P/E,” which uses a 10-year average of earnings, the China equity market has in recent times been almost as expensive as the US stock market was in 1929.

• Among the macro-level issues that have the potential to create uncertainty in China over the intermediate term are: (i) projected reform of China’s taxation system; (ii) the external value of the renminbi; and (iii) in the developed world, meaningfully slower consumption growth and/or protectionist measures affecting some of the main categories of Chinese exports.

• Poverty, inequality, and urban labor displacement may present significant hindrances to social and economic progress.• China’s economy faces challenges in transitioning toward domestic consumption in order to rely less on exports and foreign direct investment.• Under Communist Party rule, China may continue to encounter political tradeoffs and potential pitfalls as it continues to evolve from a centrally planned economy to a more market-oriented

economy.• Regional developmental gaps; air, water, and soil pollution; rural-urban income disparities; and the structure and efficacy of China’s public health system may add to social pressures.




China’s Economy in Context

75

Note:1. GDP and average disposable income are stated in 2005 US dollars.

4,451

14,980

4,829

12,987

3,458

1,127 1,020 866355

5,601

1,783 1,349 1,111505

0

6,000

12,000

18,000

China India Brazil Russia Indonesia U.S. Japan

The Five BRICI Markets in the Boxed Area Below Represent Almost 15 Percent of the World’s GDP and 45 Percent of Its Population (1)

Real GDP, 2009 and 2015E, for Select Countries(In Billions of US Dollars)

Source: The Economist Intelligence Unit; “The Internet’s New Billion,” The Boston Consulting Group, September 2010.

2009 Population (MM) 1,335 1,166 194 141 240 307

2009 Real Per Capita Average Disposable Income ($)

1,134 810 3,881 3,970 563 32,592

2009 2015E

Source: Ashmore; World Economic Outlook, by the International Monetary Fund, October 2010.

4,451

14,980

4,829

12,987

3,458

1,127 1,020 866355

5,601

1,783 1,349 1,111505

0

6,000

12,000

18,000


307

32,592

307

32,592

4,451

14,980

4,829

12,987

3,458

1,127 1,020 866355

5,601

1,783 1,349 1,111505

0

6,000

12,000

18,000


307

32,592

% of World GDP at Market Prices 2005 2010 2015E1 China 5.0 9.3 12.2 2 Brazil 2.0 3.3 3.4 3 Russia 1.7 2.4 3.1 4 India 1.8 2.3 2.9 5 Mexico 1.9 1.6 1.6 6 Korea 1.9 1.6 1.7 7 Turkey 1.1 1.2 1.3 8 Indonesia 0.6 1.1 1.4 9 Poland 0.7 0.7 0.7

10 Saudi Arabia 0.7 0.7 0.8 11 Taiwan 0.8 0.7 0.8 12 South Africa 0.5 0.6 0.6 13 Argentina 0.4 0.6 0.5 14 Iran 0.4 0.5 0.5 15 Thailand 0.4 0.5 0.5 16 Venezuela 0.3 0.5 0.4 17 Colombia 0.3 0.5 0.5 18 UAE 0.3 0.4 0.4 19 Hong Kong SAR 0.4 0.4 0.4 20 Malaysia 0.3 0.4 0.4 21 Singapore 0.3 0.4 0.3 22 Egypt 0.2 0.4 0.4 23 Nigeria 0.2 0.3 0.4 24 Israel 0.3 0.3 0.3 25 Chile 0.3 0.3 0.4 26 Czech Republic 0.3 0.3 0.4 27 Philippines 0.2 0.3 0.3 28 Pakistan 0.2 0.3 0.3 29 Algeria 0.2 0.3 0.3 30 Romania 0.2 0.3 0.3 31 Peru 0.2 0.2 0.3 32 Ukraine 0.2 0.2 0.2 33 Hungary 0.2 0.2 0.2 34 Kazakhstan 0.1 0.2 0.3 35 Qatar 0.1 0.2 0.3 36 Kuwait 0.2 0.2 0.2 37 Bangladesh 0.1 0.2 0.2 38 Vietnam 0.1 0.2 0.2 39 Morocco 0.1 0.1 0.2 40 Slovak Republic 0.1 0.1 0.1

Total 25.3 34.1 39.6

Emerging Markets 27.9 37.4 43.3 EU15 28.5 24.0 21.1 US 27.8 23.6 22.0 Japan 10.0 8.7 8.0

Top 40 Largest Emerging Markets in 2010



2010–2020EActual

2000–2009Base Case

Assuming Current Trends Continue

Expected Growth Deceleration & Structural Adjustment

Probability (%) 70 20 10

Macro

GDP growth (%) 10.3 8.0 9.5 6.5

CPI Inflation (%) 1.9 3.5 2.5 4.0

Production

Agriculture 17 15 15 15

Manufacturing 40 35 40 33

Services 43 50 45 52

Expenditure

Consumption 49 54 47 58

Investment 48 43 50 41

Income

Labor 40 45 40 52

Profits 31 30 35 20

Three Morgan Stanley Research Scenarios for the Chinese Economy Through 2020


Three Scenarios for the Chinese Economy Through 2020

Source: Morgan Stanley & Co. Inc. Research, “The China Files: Chinese Economy through 2020,” November 8, 2010.

The Base Case Scenario• The Base Case scenario projects that the Chinese economy can maintain an

average of 8% growth per annum through 2020. Average CPI inflation through 2020 is projected at 3.5%, mainly reflecting an increasingly normalized labor market.

• Under the Base Case, China’s nominal GDP would triple from its 2009 size, reaching Rmb 103 trillion. Assuming an average 3% appreciation of the renminbi against the US dollar per annum, Chinese nominal GDP in US dollar terms would quadruple from its 2009 size, reaching US$20 trillion by 2020.

The Current Trends Continue Scenario• In the Current Trends Continue scenario, the Chinese economy would

basically continue as in the recent past, with no material change compared to the previous decade, featuring strong growth, modest inflation, and no meaningful transformation of the economic structure.

• The Current Trends Continue scenario might occur if: (i) the global economy were to stage a strong recovery back to pre-crisis levels and sustain its pace of expansion thereafter; or (ii) China’s economy remained so competitive that China’s export growth remained as strong as pre-crisis levels, without causing a backlash of trade protectionism measures.

The Growth Deceleration and Adjustments Scenario• In the Growth Deceleration and Adjustment scenario, the Chinese economy

might undergo drastic growth deceleration and structural adjustment.• Such a scenario might materialize due to very proactive policy intervention

to correct the structure of the economy or by external shocks such as a major decline in external demand and/or sustained surges in globally traded commodities prices due to supply shocks.

76



Morgan Stanley China Economists expect that urbanization will remain China’s principal growth driver over the 2010–2020 period. This view also holds that the rapid urbanization of the 2000–2010 time period will likely continue or even accelerate between 2010 and 2020, lifting China’s urbanization ratio to the level of developed countries, from the 47% in 2010 to 63% in the long term.

As part of its initiative to support urbanization in midsize and small cities, particularly in the inland provinces, the Chinese government has decided to speed up the reform of the household registration system. This reform seeks to equalize rural and urban citizens’ entitlements to pension, education, and other social benefits, so that migrant workers from rural areas can more easily relocate to urban areas.

0

10

20

30

40

50

60

70

1949 1979 2009 2039E 2069E

Demographics


The China Landscape: Megatrends

Source: Morgan Stanley & Co. Inc. Research, “The China Files: US Corporates and China’s Megatransition,” September 20, 2010; “Off the Rails,” The Economist, April 2, 2011.

People born after 1980, the “Chinese baby boomers,” are projected to represent more than 50% of China’s population by 2015.This demographic shift may have three investment implications: (i) Chinese baby boomers tend to be globally aware and optimistic about their economic future; (ii) Chinese baby boomers tend to be more financially secure than were past generations; and (iii) Chinese baby boomers are likely to double the country’s birth rate.

1 2 3Urbanization Infrastructure

0

200

400

600

800

1,000

1,200

1980

1985

1990

1995

2000

2005

2010

E20

15E

2020

E

Population born pre-1980 Population born post-1980

China’s Post–1980 Baby Boomers

Source: CEIC, Morgan Stanley & Co. Inc. Research, E = Morgan Stanley & Co. Inc. estimates as of September 2010.

Population in Millions

China has made significant strides in developing its infrastructure, with considerable scope for more economic expansion and rebalancing. The country plans further investment in its national high-speed rail and highway grids, ultra- high-voltage power transmission networks, nuclear power plants, gas distribution grids, and sewage and solid waste treatment facilities. China intends to lengthen its total rail network from 86,000 kilometers to 120,000 by 2015, and at least 60% of this system will be electrified, up from 40%. By 2015, China’s high-speed passenger rail system should reach 16,000 kilometers in length from 2010’s total of 8,400 kilometers, making it one of the most extensive high-speed rail networks in the world. By 2016, China’s total roadway capacity, now at 70% of US capacity, will likely surpass that of the US.

Source: Time Magazine, www.time.com.

China’s High-Speed Passenger Rail System

China’s Rate of Urbanization

Source: CEIC, Morgan Stanley & Co. Inc. Research, E = Morgan Stanley & Co. Inc. estimates as of September 2010.

US in 1840

Artificially Suppressed

US in 1900 US in 1960

Share of Urban Population (%)

77




The China Landscape: Megatrends

4 5 6Completion of Public Services Network

Consumer Finance Industrial Upgrades

China’s high rate of personal savings stems from individuals’ concerns about retirement without a comprehensive, government-sponsored social security system in place. Morgan Stanley China Economists believe that an aggressive reform and funding of the country’s pension, healthcare, and education systems will help unleash domestic demand, and that planned reforms of China’s entitlement programs will push consumer growth rates beyond levels previously seen.

Source: Morgan Stanley & Co. Inc. Research, “The China Files: US Corporates and China’s Megatransition,” September 20, 2010.

Consumer finance in China lags that of developed economies such as the US and Europe: total credit in China represents about 10% of consumers’ total expenditure, compared with around 50% in more developed economies. Thus, as consumer credit becomes more accessible in China, consumer spending is expected to increase. A thriving internet environment makes online shopping possible and also drives consumer credit. Since China has the highest number of internet users in the world, 390 million, as of September 2010 Morgan Stanley Economists expected substantial upside for online settlement and credit cards as e-commerce continues to develop in China. As of 2010, about 20% of Chinese internet users shopped online, far below the rate in developed countries, which is about 60%. Should online shopping penetration rise to 50%, there could be as many as 120 million additional credit card users in China (in 2010, there were about 150 million cardholders). Morgan Stanley China Economists estimate that China’s consumer credit spending as a percentage of total consumption will reach the world average of 40% by 2020, boosting consumers’ purchasing power by a dramatic 30%. This is before taking into account the reduction in personal savings rates and the improved wage growth expected to take place across China.

In the early 1990s, when China started to rise as a global producer, only 3% of its working population had college degrees. This lack of educated laborers forced Chinese companies to adopt a low-quality, mass-production approach to their business models. Such conditions have been changing rapidly.As of 2010, approximately 10% of China’s workforce had earned a college degree and Chinese companies were changing their business models to employ this better-educated work force. China’s approach to production has been changing as a younger, college-educated population continues to enter the workforce. Morgan Stanley Research estimates that by 2020, some 35% of China’s workforce will be college educated. This level will match that of the US in 2010. A strong correlation exists between education and the value added of the manufacturing and service sectors of an economy.

18.7

8.2

3.92.4

0.70.30.20

5

10

15

20

25

2002 2003 2004 2005 2006 2007 2008

Online Shopping Transactions in China$ in Billions

Source: “Chinese Consumer Report 2010,” by Roland Berger, July 2010.

CAGR: +115%

78



At macro levels, the Morgan Stanley Research China strategy team expects that by 2020:• China’s GDP share in the world economy will grow to 14% from 8% in 2010. • China’s domestic Fixed Asset Investment (FAI) will keep growing at an 11.0% CAGR, to more than

double 2010 levels. • China’s private consumption will grow at a 12.6% CAGR, to more than triple 2010 levels. • China will have made its currency, the renminbi, freely convertible and its capital account open. • China will become one of the largest outbound investors, in financial direct investment and in world

capital markets. At micro levels, the Morgan Stanley Research China strategy team expects that by 2020:• China baby boomers, those born after 1980, will represent 45% of the workforce and will be the dominant

consumers. • China will have deepened its urbanization ratio to 63%, having added 300 million people to its urban

population, an increase of 50% from 2010. • China’s labor cost-to-GDP ratio will increase to 30%, with wages more than quadrupling.• Of Chinese workers, 35% will have college degrees. • China will have developed a comprehensive consumer finance industry, driven by advances in e-

commerce and credit reporting. The credit consumption ratio could rise to 40% from 10% in 2010. • China will have in place a nationwide, world-class infrastructure, from ports to airports, highways to high-

speed rail lines, and power grids to gas distribution networks.


The China Landscape: Megatransition

The Megatransition: China by 2020Obstacles to GrowthAs the second decade of the 21st century continues to unfold, China is in the process of effecting a megatransition, from the world’s factory to an economic powerhouse on the global stage. The megatrends identified here, while facing some constraints, represent the push-and-pull factors to help China achieve such a megatransition.

Source: Morgan Stanley & Co. Inc. Research, “The China Files: US Corporates and China’s Megatransition,” September 20, 2010.

As China heads toward a megatransition, the country will undoubtedly face obstacles to its ongoing growth. It must therefore adjust its growth model to address these obstacles if it hopes to continue on a trajectory of expansion. Two main obstacles to ongoing growth are environmental issues and resource constraints.

Environmental IssuesChina, the world’s top carbon emitter, accounts for approximately 24% of global carbon emissions, and its emissions liability is growing faster than that of any other nation. Further industrialization, growing urbanization, and rising disposable income will drive up energy consumption in 2010 – 2020, and the rate of carbon emissions will multiply unless China makes a concerted effort to alter its current growth model.

Resource ConstraintsAs of 2010, China consumed a significant share of the global supply of commodities and energy. Given China’s high rate of growth, this rate of consumption cannot continue over the long term. China competes for coal, tin, lead, zinc, aluminum, crude oil, and many additional resources with other growing economies in a global market vastly different from the one that it entered as a rapidly developing economy in 1993. Since then, other countries have begun to achieve significant growth – Brazil, Russia, and India, for example – and demonstrate considerable demand for many of the same resources as China.

79



• As of April 2011, economists characterized China as entering a middle-income transition. Such a transition occurs when per capita income (on a nominal US dollar basis) reaches US$4,000-5,000 (approximately where China was in 2010) and ends when income levels reach US$10,000-12,000. The high economic growth rates that brought China to the threshold of this transition were often achieved through labor-intensive exports, which tend to gradually lose competitiveness in the global economy as surplus labor disappears and wages rise. Low-end manufacturing (e.g., textiles) may eventually migrate to lower-cost countries in earlier stages of economic development (e.g., Vietnam or India), leading to changes in China’s growth model and economic structure. Exports may change as well, as the value added per person rises for China to remain competitive.

• Japan, South Korea, Taiwan, and Singapore managed to pass through the middle-income transition rather quickly. Brazil stalled at one point during its transition. As of early 2011, Thailand, Indonesia, and Malaysia have been less successful in making the transition.

• A source of anxiety for central planners is that they must relinquish control over large swathes of the economy and allow market forces operate to a greater degree in order for the middle-income transition to succeed.

• Following this advice would mean less government planning, less targeting, and less clarity. Moreover, after the government lets go of resource allocation and other matters best left to market forces, it should concentrate on infrastructure, human capital, education, social services, and health care.

• By one estimate, China’s state-owned sector shrank from 77.6% in 1978, the year of Deng Xiaoping’s first economic reforms, to 29.5% in 2007. Significant governmental controls on the economy remained in place as of early 2011, including: (i) price controls on grain and gasoline; (ii) use controls on coal and other energy resources; (iii) industry consolidation; (iv) wage setting in the state-owned sector; and (v) ultimate control of a high percentage of listed companies.

• China’s consumption patterns continued to evolve as of early 2011, with the emergence of status-conscious shoppers, notable online buying, widespread advertising, new businesses such as beauty parlors, and increased car ownership rates (which more than doubled from 2005 through 2010). As part of its 12th Five-Year Plan, China planned to employ several means to put more income into the hands of mainstream consumers, including:

– (i) Raising Wages;

– (ii) Tapping State-Owned Entities (SOEs);

– (iii) Raising Interest Rates;


China: The Middle-Income Transition

Source: “A Middle-Class Dragon: As China Enters a Period of Middle-Income Transition, The Stakes Could not be Higher,” CFA Magazine, March-April 2011.

– (iv) Reducing Income Taxes;

– (v) Expanding Consumer Credit;

– (vi) Building Affordable Housing;

– (vii) Increasing Social Spending;

– (viii) Developing the Services Sector; and

– (ix) Introducing Modern Retail Methods.

China: The Middle-Income Transition

80



In Why The West Rules – For Now, Ian Morris explains the rise-and-fall cycles in world history and suggests that “shift[s] of wealth and power [are] inexorable.” Morris contends that the East and the West are not “value judgments,” but merely “geographic labels” and argues that the patterns of world history along with present-day dynamics implicate that “the next 40 years will be the most important [years] in world history.”

Morris shows how different empires, including the Roman Empire and the Song dynasty of China, climbed up the development ladder by periods of “axial thought,” only to fall, upon hitting a “hard ceiling,” usually inflicted by what he calls the Five Horsemen of the Apocalypse: climate change, migration, famine, epidemic, and state failure.

What really concerns Morris, however, is not whether the East may outcompete the West, but whether the competition itself may be disrupted by a new set of forces: nuclear proliferation, population growth, and global epidemics. “We are approaching the greatest discontinuity in history,” explains Morris.

Morris suggests that we must decide between “the Singularity,” salvation through the expansion of our collective technological abilities, and “Nightfall,” an apocalypse from the old Five Horsemen aided by the new set of forces. For the Singularity to win, “everything has to go right,” and “for Nightfall to win only one thing needs to go wrong,” argues Morris.

Because distinctions of geography are becoming increasingly irrelevant, Morris believes that the dogma “East is East and West is West” is a catastrophic view of current civilization and that the several decades ahead are more important than we realize.


China Nationally and Regionally Emulates Other Asian Nations


Time

Japan

South Korea, Taiwan,

Singapore, Hong Kong

Philippines, Indonesia, Thailand, Malaysia

ChinaVietnam,

India

Com

para

tive

Adv

anta

ge

Time

Special Economic

Zones

Pearl River Delta /

Yangtze River Delta

Eastern Provinces

Central Provinces

Western Provinces

• “Asia’s Economic Miracle” can be illustrated by the “Flying Geese Paradigm.” This theory postulates that Asian nations will sequentially catch up with more advanced economies through a regional rotation where the production of commoditized goods moves continuously from the more- to the less-advanced countries. The lead nation in this pattern is Japan, followed by the newly industrializing economies (South Korea, Taiwan, Singapore, and Hong Kong). After these groups come the Philippines, Indonesia, Thailand, and Malaysia. Finally, come the more recently developing major nations in Asia, including China, Vietnam, and India.

• It may be argued that, given the sheer size of the Chinese economy and population, and the country’s vast regional disparities, China’s internal development may also in fact follow the “Flying Geese Paradigm,” in this case with the lead region being the Special Economic Zones, followed by the Pearl River Delta and the Yangtze River Delta. After these regions come the other Eastern provinces, with the Central and Western provinces following behind.

Com

para

tive

Adv

anta

ge

Different Economies in Asia Different Regions in China

From Why The West Rules – For Now:The Patterns of History, and What They Reveal About the Future. By Ian Morris (Farrar, Straus & Giroux, 2010).

Source: “The Final Conflict,” The New York Times Book Reviews, December 12, 2010.

81




Chinese Affluent ConsumersFrom a Study Conducted by MasterCard and HSBC on Affluent Chinese Consumers

Source: Big Prizes in Small Places: China’s Rapidly Multiplying Pockets of Growth, The Boston Consulting Group, November 2010.

• In late 2006, MasterCard and HSBC conducted a study of affluent Chinese consumers, defined as those whose annual household income is between US$6,000 and US$25,000 per year. In five focus groups in Shanghai, Guangzhou, and Beijing; over 780 surveys were conducted.

• Among their findings, they concluded in their 2007 report that affluent Chinese consumers:– (i) value self-respect and fun and enjoyment in

life; – (ii) view time constraint/convenience as a top

factor affecting buying decisions;– (iii) view a senior job position as the top

perception of social status; and– (iv) view property and domestic stocks as the

top assets in which to store wealth.

16 15 15 14 13

43

30 30 29

2017

0

10

20

30

40

50

Senior JobPosition

Private Club Membership

Property Ownership

High Level of Education

Private Car Frequent Overseas

Travel

Overseas Bank Account

Rare Collectibles

Overseas Education

Branded Products

Overseas Assets

Perceptions of Factors that Contribute to Social StatusPercentage of those Polled in the 780-sample survey by HSBC

Source: “Understanding the Affluent Consumers of China,” MasterCard and HSBC, Second Quarter 2007.

Source: MasterCard and HSBC, “Understanding the Affluent Consumers of China,” Second Quarter 2007.



1 Self-respect

2 Fun and enjoyment in life

3 Being well respected

4 Sense of accomplishment

5 Financial security

6 Social security

7 Good relations with others

8 Self-fulfillment

9 Sense of belonging

10 Having excitement

Top Ten Values

1 Property 7 Bonds

2 Domestic stocks 8 Foreign stocks

3 Fixed deposits in RMB 9 Collectibles

4 Insurance with investment 10 Bank investment products

5 Investment funds 11 Gold

6 Fixed foreign currency bonds 12 Financial company investment products

Priorities in Investing

1 Time constraint/convenience

2 Being green

3 Brand

4 Luxury

Top Factors Affecting Buying Decisions

Notes:1. Large Cities include Chinese cities with a population of more than one million, as defined by The Boston Consulting Group.2. Small cities include Chinese cities with a population between 250,000 and one million, as defined by The Boston Consulting Group.

(1)

(2)

Population (Millions) 2010 2020E

Large Cities 65 127

Smaller Cities 83 288

Total 148 415

(With Annual Household Income of Rmb 60,000 ~ US$9,050)

Middle-Class and Affluent Consumers

82



30%

35%

40%

45%

50%

55%

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10E 11E

Gross Domestic Saving As a % of GDP

%


China’s Gross Domestic Saving as a Percentage of GDP

Source: The World Bank; Morgan Stanley & Co. Inc. Research. Data are as of December 31, 2010. Estimates are as of May 2011.

Gross Domestic Product (GDP) is a measure of a country’s or region’s total output of goods and services for final use occurring within its domestic territory, regardless of the allocation to domestic and foreign claims.

Gross Domestic Product

Source: The World Bank.

• Healthcare: increased healthcare spending as a share of GDP.

• Financial Services: Increased spending on financial services, particularly for retirement saving purposes.

• Real Estate and Infrastructure Development: Rapid urbanization and rising household wealth should drive strong demand for private housing, and associated urban infrastructure.

• The Aging Consumer: A declining share of children and youth in the population versus a rising elderly share will shift the mix of consumer spending.

• The Independent Female: Increasing education and job opportunities should lead to growing demand for female- focused brands and products.

Asia’s Shifting Demographic Profile: Possible Investment Themes

Source: Morgan Stanley & Co. Inc. Research, “Investment Perspectives: US and the Americas,” December 3, 2008.

83



38.059.0 69.0

158.0

38.030.023.016.06.03.00

50

100

150

200

Housing Services Overall FinancialServices

PowerUsage

TradableGoods

Telecom DairyProducts

Auto Sales Beer

China’s official statistics may substantially understate the true magnitude of consumption within the country, due to the following factors: (i) Chinese official data for personal consumption expenditures substantially underestimate the consumption of services, especially housing and health care; (ii) comparing the consumption of non-services tradable goods between the US and China, the gap between the US and China is much smaller than suggested by overall consumption data, as shown below;

and (iii) a like-for-like comparison of specific types of goods and services consumed by households in China and in the US indicates that the magnitude of China’s personal consumption relative to that in the US may be much greater than is generally perceived, as shown below.


China’s Consumption May Be Understated

Personal Consumption in 2008

Comparison of Personal Consumption: Ratio of China Compared to the US%


%

1.6 1.2

3.2

10.0

0

3

6

9

12

Total Overall Consumption Non-Services Tradable Goods

US China

40 50 60 70 80 90

UK

US

Brazil

France

Canada

Poland

Japan

Mexico

Germany

World

Russia

Australia

Taiwan

Argentina

Czech

S. Korea

India

Thailand

Indonesia

Malaysia

China

China’s Under-ConsumptionConsumption as a Percentage of 2009 GDP

Source: Euromonitor; CEIC; Morgan Stanley & Co. Inc. Research. Data are as of 2009.

84




Three Pillars Underpin Rising Chinese Consumption through 2020


Consumption Drivers

Pillar I: Rising Income

Econ

omic

Gro

wth

Dev

elop

men

t of

Serv

ice

Indu

stry

Wag

e In

crea

se

Pillar II: Lower Savings Ratio

Gov

ernm

ent

Expe

nditu

re

Inco

me

Re-

dist

ribut

ion

Agi

ng P

opul

atio

n

Pillar III: Consumption Upgrade

Leve

l of E

cono

mic

Dev

elop

men

t

Urb

aniz

atio

n

The third pillar of consumption growth is a consumption upgrade, a fundamental and rapid change in the type of consumption. Consumers’ preferences tend to reflect the level of economic development of the state; in other words, consumers’ taste for goods and services adjusts with their standard of l iv ing; economic development and urbanization are thus expected to drive consumption trends in China through 2020.

915

52

0

20

40

60

China US France

“Going Shopping with my Family is One of the Best Ways to Spend Time with Them.” (2008 Data)Percentage of those who Strongly agreed or agreed

Source: McKinsey & Company, “2010 Annual Chinese Consumer Study,” August 2010, How the World Shops (2008).

• In August 2010, McKinsey & Company published its annual study of Chinese consumers. Among its findings were:

8916

45

0

20

40

60

China US UK Japan

“Well-known brands are of better quality.” (2008 Data)Percentage of those who strongly agreed or agreed

The first pillar of consumption growth is rising income. Household income growth is the primary source of consumption growth, and is dependent on three factors: (i) overall economic growth; (ii) labor concentration in the economy; and (iii) total earnings of the labor force. Morgan Stanley Research believes these three factors will help accelerate household income growth over the next decade.

The second pillar of consumption growth is a lower savings ratio. The key drivers of a declining savings ratio are: (i) government expenditures on public goods (rail passenger transport, social housing) and services (education, healthcare) to reduce households’ precautionary saving; (ii) income re-distribution to reduce the overall savings ratio as the savings ratio of low income households exceeds that of higher income households; and (iii) an aging population as the savings ratio tends to decline with an aging population.

85



0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

'70 '80 '90 '00 '10E '20E '30E '40E '50E

Key Trends in China• A disparity exists between GDP

growth and employment growth.• The growth rate of the working-age

population has been slowing.– The total dependency ratio (1)

was expected to bottom in 2010.• Wages are likely to increase as

China shifts away from a labor- driven economy to a capital-driven one.

Note:1. The dependency ratio represents the number of dependents, i.e., children and the elderly, compared to the working-age population.

2468

1012141618

1970 1980 1990 2000 20100.00.51.01.52.02.53.03.54.0

GDP Growth Employment Growth


Labor Supply and Workforce Trends in China

86

GDP Growth Is Outpacing Employment Growth…

%, 3-Yr Moving Avg. %, 3-Yr Moving Avg. rhs

Source: CEIC; Bloomberg, LLC; Morgan Stanley & Co. Inc. Research. Data are as of December 2010.

(10.0)

(5.0)

0.0

5.0

10.0

15.0

20.0

'80 '90 '00 '10 '20E '30E '40E '50E

Population Growth Working-age Population Growth

…and the Working-age Population Growth is Slowing…% Growth, 5-Yr Period

(0.5)

0.0

0.5

1.0

1.5

2.0

2.5

'10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E

Working-age Population Labor Supply (Urban & Rural)

…Leading to an Declining Labor Supply…% Growth, YoY

…and, Therefore, Increased WagesBillions of Rmb % of GDP

0

3,000

6,000

9,000

12,000

15,000

18,000

21,000

'05 '07 '09 '11E '13E '15E '17E '19E0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Total Wages Total Labor Cost

Total Dependency Ratio (1)

Source: “UN World Population Prospects: 2010 Revision,” by the United Nations Population Division, May 3, 2011. Source: CEIC; Morgan Stanley & Co. Inc. Research. Data and estimates are as of

November 2010.

Projected to bottom in 2010

Source: “UN World Population Prospects: 2010 Revision,” by the United Nations Population Division, May 3, 2011.

Source: CEIC; Morgan Stanley & Co. Inc. Research; “UN World Population Prospects: 2010 Revision,” by the United Nations Population Division, May 3, 2011.




Demographic Trends in China

Source: “China’s Mainland Population Grows to 1.3397 Billion in 2010: Census Data,” Xinhua News Agency, April 28, 2011; “China’s One-Child Policy Faces New Fire,” The Wall Street Journal, April 29, 2011; “New Census Finds China’s Population Growth Has Slowed,” The New York Times, April 28, 2011.

The Sixth National Population Census

China’s One-Child Policy

• On April 28, 2011, the National Bureau of Statistics (NBS) released the results of the Sixth National Population Census. The census reported that China’s population in 2010 was 1.34 billion, up from 1.27 billion in 2000. The average annual growth rate during the 2000-2010 time period was 0.57%, down from 1.07% during the 1990-2000 time period.

• Among the findings of the Census were:– Urban population in 2010 surged by more than 45%, leaving urban and rural China nearly equal in population. More than 261 million citizens, nearly one in five, were

living in places other than where China’s household registration process (the Hukou System – please see page 39) indicated that they did.– The illiteracy ratio was 4.08% in 2010, down from 6.72% in 2000. University graduates in 2010 represented 8.9% of citizens, versus approximately 3.6% of citizens in

2000.– People over 60 accounted for 13.3% of China’s population, compared to 10.3% in 2000. People under 14 accounted for 16.6% of China’s population in 2010, down

from 23% in 2000.– China in 2010 had approximately 120 males for every 100 females. Population experts have forecast that by 2020, 24 million Chinese single young men might have

little prospect of marrying or having their own children.

• China’s one-child policy has been enforced by the National Population and Family Planning Commission, which employed a half-million full-time staffers and six million part-timers as of early 2011. It has collected millions of dollars a year in fines from people who violate family-planning rules.

• Under the one-child policy as of early 2011, many (but not all) couples who had more than one child could face fines of several months’ salary and could lose their jobs if they worked for the state. The policy exempted several groups, including ethnic minorities, rural couples whose first child is a girl, and couples in which both partners are only children. The commission was believed to be considering limited pilot plans to relax the policy as of early 2011.

• Prior to the adoption of the one-child policy in 1980, China’s fertility rate, the average number of children born to each woman, was experiencing a decline. In 1979, the fertility rate was 2.7, down from 5.5 in 1970, due to a policy encouraging people to marry later, wait longer between children, and have fewer children.

• In 2000, a group of 24 leading demographers, economists, and former Family Planning officials joined forces to advocate for the end of the one-child policy. By early 2011, the advocacy group had encouraged China to terminate the policy because China’s fertility rate was approximately 1.5 to 1.6 (by their calculation), as compared to the “replacement rate” of 2.1 children for every woman, which is generally required to keep a population stable. The advocacy group cautioned that China’s labor force might start to shrink by 2016.

• The National Population and Family Planning Commission held a different view. In a report released in 2004, the commission noted that China’s fertility rate had been 1.8 from 1991 through 2003 and should remain at 1.8 through 2033. The commission credited the one-child policy with preventing 400 million births, based on the assumption that, without it, the fertility rate would have stayed where it was in 1970. The commission also predicted that China’s overall population would peak at 1.5 billion in 2033.

• As of May 2011, the US Census Bureau and several Chinese demographers predicted that China’s population would peak at around 1.4 billion in 2026.

87




Demographic Trends in China

(80) (60) (40) (20) 0 20 40 60 80

0–4

10–14

20–24

30–34

40–44

50–54

60–64

70–74

80–84

90–94

100+

China’s Population PyramidMillions of Persons

Source: “UN World Population Prospects: 2010 Revision,” by the United Nations Population Division, May 3, 2011.

1970 2010 2020E

Female Male

(80) (60) (40) (20) 0 20 40 60 80

0–4

10–14

20–24

30–34

40–44

50–54

60–64

70–74

80–84

90–94

100+

(80) (60) (40) (20) 0 20 40 60 80

0–4

10–14

20–24

30–34

40–44

50–54

60–64

70–74

80–84

90–94

100+

On May 3, 2011, the United Nations Population Division released the “World Population Prospects, the 2010 Revision,” a report that forecasts global demographics through 2100. As illustrated above, the UN Population Division forecasted that China’s aging population as a share of the total population would grow in the years ahead, due in part to the effects of the one-child policy. The division estimated that China’s fertility rate from 2005 through 2010 was 1.56, lower than that reported by China’s National Population and Family Planning Commission. The division also estimated that China’s fertility would trough out at 1.51 between 2015 and 2020. Demographers, economists, and policy experts noted that such demographic trends could represent headwinds to economic growth through 2020 and potentially beyond.


80 60 40 20 0 20 40 60 80 80 60 40 20 0 20 40 60 80 80 60 40 20 0 20 40 60 80

88



Increasing Urbanization Rates in ChinaISSUES FOR CONSIDERATION

89

47.048.0

49.150.1

53.2

58.5

45.744.9

44.042.9

41.740.5

30

35

40

45

50

55

60

65

2003 2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2015E 2020E% of the Population Living in Urban Centers

Increasing Urbanization Rates in China

%

Source: National Bureau of Statistics, Ernst & Young Estimates, Morgan Stanley & Co. Inc. Research. Data and estimates are as of November 2010.

China’s Urbanization Rate in Context

% (2009)

Source: CEIC, Morgan Stanley & Co. Inc. Research. Data are as of 2009.

The urbanization rate is the percentage of a country’s total population living in urban areas. The rate reflects migration patterns and the degree to which a country or region is developing or modernizing.

Urbanization Rate

Source: The Encyclopedia of Earth, United Nations.

Japan in 1964 US in 1900

China in 2009

Note:1. The estimated years assume that the urbanization rate will increase by approximately 1.0% each year. If the urbanization rate were to increase by approximately 1.5% each year, China’s

urbanization rate would reach 63.0% by 2020, according to Morgan Stanley & Co. Inc. Research.

(1) (1) (1) (1) (1)

94

92

90

85

82

80

78

78

74

73

67

65

64

62

53

47

37

34

30

28

15

0 20 40 60 80 100

Singapore

Argentina

UK

Brazil

South Korea

US

France

Mexico

Germany

Russia

Japan

Philippines

Malaysia

Poland

Indonesia

China

Pakistan

Thailand

India

Vietnam

Sri Lanka



22.6 21.9

33.5

39.837.4

44.845.0

40.7

44.4

0.0

10.0

20.0

30.0

40.0

50.0

60.0

China’s Consumption/Production of Materials as a % of World Aggregates: 2005, 2010E, and 2015E

%


China’s Demand for Industrial Commodities

Source: Morgan Stanley & Co. Inc. Research, “Global Metals Playbook: 2Q11: Growth Continues Amid Heightened Volatility,” April 8, 2011.

“The wise have likened jade to virtue. For them, its polish and brilliancy represent the whole of purity; its perfect compactness and extreme hardness represent the sureness of intelligence; its angles, which do not cut, although they seem sharp, represent justice; the pure and prolonged sound which it gives forth when one strikes it represents music. Its color represents loyalty; its interior flaws, always showing themselves through the transparency, call to mind sincerity; its iridescent brightness represents heaven; its admirable substance, born of mountain and of water, represents the earth. Used alone without ornamentation it represents chastity. The price which all the world attaches to it represents the truth.”

The earliest findings of jade in Chinese culture date back some 4,000 to 6,000 years. For millennia in China, jade has been viewed as a symbol of virtue, power, sincerity, and as an emblem of status. In ancient times, only the aristocratic class owned jade wares and many ancient Chinese believed jade had supernatural powers that could confer immortality.

Jade in Chinese Culture

Jade Mandarin Duck (Qing dynasty, 221-206 BC)

─ Confucius (circa 550-480 BC)

• China’s iron ore imports more than quadrupled from 2003 to 2009, as China overtook Japan and the European Union to become the world’s largest importer of iron ore.

• In 2009, China produced 568 million metric tons of crude steel, 46% of the world’s production.

2005 2010E 2015E 2005 2010E 2015E 2005 2010E 2015E

Aluminum Copper SteelSource: http://chineseculture.about.com.

90



• On April 15, 2011, Morgan Stanley Research published a 57-page report, “China Internet/Media: e-Commerce: Harvesting in Digital China.”

• China online retailers have been rapidly capturing market share from fragmented offline rivals. China’s largest 20 retailers are estimated to represent less than 10% of total retail sales, versus 40-50% in the United States.

• China’s e-commerce leaders tend to offer relatively cheaper goods (often at 30-40% discounts to offline products), convenience, and broader selections.

• Critical success factors for future Chinese e-commerce leaders include: (i) scale; (ii) operating efficiency; (iii) capital efficiency; and (iv) cost leadership.

• The report notes that e-commerce has become the fastest growing advertising category in China. Such robust demand should favor advertising leaders.

• Page nine of the report contains a list of 15 Morgan Stanley Research reports published between April 2008 and January 2011 about China’s internet and media industry.


Business-to-Consumer (B2C) e-Commerce and Growing Internet Usage in China

91

Internet Users in the Five BRICI Countries Should More Than Double to 1.2 Billion by 2015 (1)

Number of Internet Users, 2009–2015E, for Select CountriesMillions

Note:1. An Internet user is defined as someone aged two years or older who went online in the past 30 days; penetration represents the number of Internet users divided by the population.

Source: Ministry of Industry and Information Technology; iResearch; Internet World Stats; Economist Intelligence Unit; “The Internet’s New Billion,” The Boston Consulting Group, September 2010.

28 7 33 31 12 70 74

47 19 74 55 37 73 81

2006 2009 2015E

2009 Penetration (%)

2015E Penetration (%)

Business-to-Consumer (B2C) e-Commerce

21188

22393

238101137

49 36 26 20

384

81 68 44 31

650

237155

76 94

0

250

500

750


Source: Morgan Stanley & Co. Inc. Research, “China Internet/Media: e-Commerce: Harvesting in Digital China,” April 15, 2011.

“Along the River During the Qingming Festival,” by Zhang Zeduan

(1085 – 1145)

“China’s Mona Lisa”

Source: “Along the River During the Qingming Festival,” The New York Times, July 4, 2007.

“Night-Shining White,” by Han Gan (c. 705 – c. 785)

Source: The Metropolitan Museum of Art.




China and India: A Critical Global Relationship

92

• Primarily in the Arunachal Pradesh region of the Himalayas, China asserts claims to 90,000 square kilometers (55,923 square miles), over which India also claims ownership. In 2006, China’s ambassador to India declared that the entire state of Arunachal Pradesh is in Chinese territory.

• As neighboring nations with immense populations, multi-thousand year-old cultures, and competing claims over disputed territory, China and India have extensive trade ties, with US$60 billion in bilateral trade in 2010, up from only US$270 million in 1990.

• China and India fought a border war in 1962 and have not resolved their territorial disputes in Tibet and Kashmir, even though diplomatic ties were reestablished in 1976.

• India shelters thousands of Tibetan refugees, and the 14th Dali Lama has lived in Dharamsala, located in northern India, from 1959 onward. • China has at times had close military ties with Pakistan.• Over a period of years, China and India have conducted a series of at times cordial but inconclusive border negotiations, which were in their 13th round as

of August 2009. • A significantly contentious issue between China and India has been control of water resources, and inter-basin and inter-river water transfer projects; the

Tibetan plateau is the origin of several major rivers in Asia, including the Yangtze, Yellow, Indus, Mekong, Brahmaputra (known in China as the Yalong Tsangpo, or the Yaluzangbu), and other rivers, all of which provide water to China, India, Bangladesh, Bhutan, Cambodia, Laos, Myanmar, Nepal, Pakistan, Thailand, and Vietnam.

• For the Yalong Tsangpo (Brahmaputra), China has proposed, not without contention, dispute, and controversy:– (i) Constructing a canal to divert part of the river northward to supply water into arid regions, which account for 50% of the country’s total landmass but

which have less than 10% of the country’s water resources; and– (ii) Building a 40,000 Megawatt hydroelectric dam on the so-called “Great Bend” of the river. If built, the dam would be the largest hydroelectric dam in

the world, with over twice the capacity of the Three Gorges Dam, which is the located in Hubei Province of China and was the largest dam in the world as of May 2011.

Source: Morgan Stanley Smith Barney Investment Strategy

History and Current Relations



Source: Morgan Stanley Investment Strategy; Morgan Stanley & Co. Inc. Research, “India and China: New Tigers of Asia, Part III,” August 13, 2010; International Monetary Fund.


China and India: Expanding Strengths

93

• From the 1980 to 2010 time period, real GDP growth in China averaged 10.0% annually, as compared with 6.2% in India.

• As of May 2011 according to the International Monetary Fund, China’s economy was the second largest in the world, approximately four times larger than India’s economy.

• From 2010 through 2020, China’s consumption was expected to rise, while India’s consumption was expected to fall. According to Morgan Stanley Research, India lagged China in per-capita consumption of key items by a range of three to 13 years, depending on the product.

• According to United Nations World Population data, China’s urbanization rate is expected to reach 53% by 2020, up from 45% in 2010. By contrast, India’s urbanization rate is expected to reach 34% by 2020, approximately where China was in 2000.

• China has superior infrastructure, including the world’s fastest and longest high- speed rail network as of May 2011. India lacks many of the infrastructural elements needed to foster economic growth and urbanization. China’s economic growth over the 1985 to 2010 time period indicates that India would need to increase its infrastructure spending to 10% of GDP, up from the 2010 level of 7.5%, in order to achieve a 10% sustainable GDP growth rate.

• By 2020, China’s high class, classified as those earning over US$10,000 in annual household income, is forecasted to account for 58% of China’s population, as compared with India’s high class, forecasted to account for 46% of India’s population.

• In 2009, China’s total capital expenditures were more than fives times India’s capital expenditures. China’s investment-to-GDP ratio was 1.4 times that of India.

China’s Relative Strengths / India’s Relative Weaknesses

• As of early 2011, the Morgan Stanley India strategy team was projecting that India would be the fastest growing economy from 2010 through 2030.

• From 2010 to 2020, India was expected to contribute 136 million people to the global labor pool, accounting for approximately 26% of the increase in global working-age population. In comparison, China was expected to contribute 23 million people over the same period, down from 118 million during the 2000 to 2010 time period. The US, Japan, and Europe were forecasted to contribute 11 million, 8 million, and 21 million, respectively, from 2010 to 2020.

• According to United Nations Population Estimates, India would be the only large country with favorable demographics after 2010. Japan, Europe, and the US (in that order) would have a significant rise in their aging population. Although China benefited from a growing working-age population from 1980 to 2010, its aging population was expected to grow from 2010 to 2050. By contrast, India’s working- age population was expected to grow steadily from 2010 through 2040.

• Assuming supportive policy measures, the Morgan Stanley India strategy team believed that India would emerge as the global leader in producing secondary- and tertiary-educated talent from 2010 to 2020.

• As of late 2010, India’s government appeared to be initiating extensive government and economic reforms to improve the social well-being of its citizenry and to foster economic growth, with plans to: (i) reduce government subsidies; (ii) implement a Goods and Services Tax (GST) system, a tax initiative aimed at reforming the existing tax laws, moving from the existing tax system that taxes goods based on production to a new tax system that taxes goods based on consumption; (iii) improve the direct tax system to encourage long-term savings; (iv) consolidate the deficit of the public sector; (v) reduce the government’s ownership in state-owned entities; (vi) accelerate spending on infrastructure; and (viii) allow foreign direct investment in retail marketing and distribution.

India’s Relative Strengths / China’s Relative Weaknesses



Source: “Now Beijing Feels that Time is On its Side, “ by Gideon Rachman, Financial Times, January 18, 2011; “The New Era of US-China Rivalry,” by Aaron Friedberg, The Wall Street Journal, January 18, 2011; “China’s Best Way Forward,” by Yu Yongding; and “East and West Are in it Together,” by Martin Wolf, Financial Times, January 19, 2011.


China as a Superpower

94

• Managing the geopolitical agenda (South China Sea; East China Sea; military resources; relations with North Korea and Taiwan)

• Exercising growing power and responsibility

• Respecting differences in culture, history, and political systems

• Achieving rapid, widely shared, and environmentally sustainable growth

• Sustaining prosperity and managing shared challenges

• Strengthening the legitimacy and effectiveness of global governance

• Managing economic opportunities including: trade; currency adjustment; the structure and functioning of the international monetary system; climate change and the global commons; and conflicts over access to natural resources

• Managing mutual suspicions; managing constraints on freedom of action; managing acceptance and non-acceptance of certain aspects of other nations’ behavior; and avoiding “a drift into escalating reciprocal demonization”

Source: “In China’s Orbit,” by Niall Ferguson, The Wall Street Journal, November 18, 2010.

Chinese J-20 Stealth Fighter Jet Chinese Aircraft CarrierAgenda Items for China



The Shenzhen Stock Exchange (SZSE)

• Founded: 1990• Companies Listed: 1,174

– Chinese: 1,174– Non-Chinese: 0

• Stock Market Capitalization: US$1.3 Trillion• Rankings by Market Capitalization:

– 12th largest in the world – 7th largest in the Asia Pacific region

Shenzhen Stock Exchange

The Shanghai Stock Exchange (SSE)

• Founding Date: 1990• Total Companies Listed: 890

– Chinese: 890– Non-Chinese: 0


– 6th largest in the world – 3rd largest in the Asia Pacific region

Shanghai Stock Exchange

Section 3

Investing Background

95

China’s Three Stock Exchanges: the Shanghai Stock Exchange; the Shenzhen Stock Exchange; and the Hong Kong Stock Exchange.

1 2 3

Source: World Federation of Exchange Members, Hong Kong Stock Exchange, Shanghai Stock Exchange, Shenzhen Stock Exchange, www.asialynx.com.

Hong Kong Stock Exchange (HKEx)

• Founded: 1891• Total Companies Listed: 1,397

– Chinese: 1,381– Non-Chinese: 16


– 5th largest in the world – 2nd largest in the Asia Pacific region

Hong Kong Stock Exchange



202

9,982

508 642260

1,477

2,499

182 326 480

5,745

1,198

390

2,789

2,024

163 NA NA

2,412

1,430 1,3491,004

629283222

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

1980 1990 2000 2010E 2015E

China Brazil Russia India Mexico

INVESTING BACKGROUND

China’s GDP Relative to Four Other Large Emerging Market Economies2009 (US$)


Gross Domestic ProductUS$ Billion (2009 US$)

Source: Financial Times, “A Strategy to Straddle the Planet,”January 28, 2011. Notes:

1. Data are for the twelve months through August 2010. 2. Data are for calendar year 1998.

China’s Share of Various Countries’ Foreign Trade

(1)

(2)

(2)

(Total Imports From, Plus Exports To, Each Nation)

Country 1992 2010South Korea 4.0 % 22.8 %Taiwan 0.5 22.1Australia 3.7 20.6Japan 5.0 20.4Malaysia 2.2 16.3United States 3.5 14.3Brazil 0.9 14.0South Africa 1.8 13.1Saudi Arabia 0.9 12.8Indonesia 3.5 12.7Thailand 2.2 12.0India 0.4 10.5Argentina 1.1 9.7Egypt 1.6 9.0Russia 3.8 8.9Canada 1.5 7.0Nigeria 0.5 6.9Netherlands 0.5 6.5Turkey 0.7 6.4United Kingdom 0.6 6.2Germany 1.3 6.1Mexico 0.1 5.7Italy 1.2 4.8Spain 0.1 4.2France 1.0 3.8Sweden 1.1 3.8Poland 0.7 3.4Switzerland 0.8 3.3Belgium 0.3 2.9

China is the No.1 Trading Partner of:% Share of Countries’ Trade (Imports and Exports) in 2000 and 2009

0

5

10

15

20

25

2000 2009

Rank Among Trading Partners

3 → 1 3 → 1 6 → 1 10 → 1 10 → 12 → 1

JapanSouth Korea Australia Russia

South Africa India

Source: International Monetary Fund Direction of Trade data via Karim Foda of the Brookings Institute. Annual data are as of 2009.

96




China GDP Per Capita Relative to Four Other Large Emerging Market Economies

21,337

7,281

10,673

18,106

251796

15,807

7,737

14,266

4,927

14,429

11,289

2,376

12,449

7,518

4,914

3,291

1,518870

4160

2,500

5,000

7,500

10,000

12,500

15,000

17,500

20,000

22,500

1980 1990 2000 2010E 2015E

Russia MexicoBrazilChina India

GDP Per Capita Adjusted to the Purchasing Power of 2009 (US$)


GDP Per Capita of Select Emerging Market EconomiesGDP Per Capita Adjusted to the Purchasing Power of 2009 (US$)US$

As of early 2011, Taiwan’s Ministry of Economic Affairs proposed allowing the Chinese to invest up to 10% in Taiwanese technology companies, and up to 50% in new technology-sector joint ventures.

If implemented, the new rule would give Chinese investors access to some of Taiwan’s most globally competitive companies. As of early 2011, Taiwanese manufacturers made nine out of every ten notebook computers in the world. As of early 2011, Taiwan Semiconductor Manufacturing Company was the world’s largest contract chipmaker and Hon Hai, also known as Foxconn, was the world’s largest electronics manufacturing services provider.

The proposed rule showed that the Taiwanese had become comfortable with establishing closer economic relations with mainland China. Prior to the announcement of the proposed rule, the Taiwanese had been somewhat cautious about Chinese involvement in Taiwan’s technology sector, which the Taiwanese regarded as a national champion.

Chinese investment in Taiwan was prohibited until 2009, despite Taiwan’s long history of investing in China. In 2009, the Chinese were allowed to invest in only 99 sectors, accounting for US$137 million of foreign investments in Taiwan, as compared with over US$200 billion of Taiwanese investment in mainland China.

“Taiwan Eases Rules for Chinese Investors”

By Robin Kwong of The Financial Times

Source: “Taiwan Eases Rules for Chinese Investors,” Financial Times, February 28, 2011.

97



.0

2.0

4.0

6.0

8.0

10.0

50.0

Pakist

anInd

iaViet

nam

Philipp

ines

Indon

esia

Wester

nMoro

cco

Swazila

ndCen

tral

Turkmen

istan

China

Thaila

ndPeru

Colombia

South

Africa

Costa

RicaEas

tern

Malays

iaBraz

ilRus

siaKore

a UKJa

pan US

0.3 0.3 0.3 0.2 0.3 0.3 0.3 0.4 0.3 0.3 0.3 0.4 0.5 0.5 0.6 0.7 0.8 0.8 0.9 0.9 1.0 1.1 1.3 1.51.7

2.1

2.7

3.33.7

0.0

1.0

2.0

3.0

4.0

5.0

'81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 00 '01 '02 '03 '04 '05 '06 '07 '08 '09

China Nominal GDP Per Capita, 1981 – 2009US$ 000s


China GDP Per Capita

Source: CEIC, Morgan Stanley & Co. Inc. Research. Data are as of 2009.

1. Competition

2. Scientific Revolution

3. Rule of Law and Representative Government

4. Modern Medicine

5. Consumer Demand

6. Work Ethic, Savings, and Capital Accumulation

Six Key Components of Economic Takeoff in the West

1. Consume More

2. Import More

3. Invest Abroad More

4. Innovate More

The “Four Mores” Elements of Continued Growth in China

Source: China Economic Information Network, Bloomberg. Data are as of 2009.

China’s GDP Per Capita and Regional Disparities within a Global Context

2009 Nominal GDP Per Capita (US$ 000s)

Source: Civilization: The West and the Rest, by Niall Ferguson (Allen Lane, 2011).

Source: Civilization: The West and the Rest, by Niall Ferguson (Allen Lane, 2011).

98




Countries Matching the GDP of Chinese Provinces

260250244

232225220

206201

180175

148142136135133129127

117110

7372

6030262619

8

665596

574379

333287

0 160 320 480 640 800

GuangdongJiangsu

ShandongZhejiang

HenanHebei

LiaoningShanghai

SichuanHunanHubei

Hong KongFujian

BeijingInner Mongolia

AnhuiShaanxi

HeilongjiangJiangxi

GuangxiTianjinShanxi

JilinChongqing

YunnanXinjiangGuizhou

GansuHainanMacau

NingxiaQinghai

Tibet

US$200 Billion ≤ GDP < US$400 Billion

GDP > US$400 Billion

Source: The Economist, Economist.com/chinacompare; Economist Intelligence Unit; CEIC; World Trade Organization. Data are as of 2010.

GDP < US$50 Billion



Gross Domestic Product (GDP)2010 (in US$ Billion)

Libya (Xinjiang

(Uyghur Autonomous Region))

Malta (Tibet Autonomous Region)

Bolivia (Qinghai)

Croatia (Gansu)

Malaysia (Sichuan)

Vietnam (Yunnan) Kuwait

(Guangxi)

Libya (Guizhou)

Qatar (Chongqing)

Algeria (Shaanxi)

Ethiopia (Ningxia)

Czech Republic (Inner Mongolia

(Mongol Autonomous Region))

Ukraine (Heilongjiang)

Qatar (Jilin)

United Arab Emirates (Liaoning)

Hungary (Tianjin)

Philippines (Beijing)

Colombia (Hebei)

Hungary (Shanxi)

Thailand (Henan)

Nigeria (Hubei)

Singapore (Hunan)

Kazakhstan (Jiangxi)

Indonesia (Guangdong)

Egypt (Hong Kong)Panama (Macau)

Kenya (Hainan)

Ireland (Fujian)

Austria (Zhejiang)

Pakistan (Anhui)

Finland (Shanghai)

Switzerland (Jiangsu)

Switzerland (Shandong)

From The Economist

99




Countries Matching the Population of Chinese ProvincesFrom The Economist

6459

5753

4846

4343

38373737

3529

2726

2422

1917

129

766

31

989493

8178

71

0 20 40 60 80 100

GuangdongShandong

HenanSichuanJiangsu

HebeiHunanAnhuiHubei

ZhejiangGuangxiYunnan

LiaoningJiangxi

GuizhouHeilongjiang

FujianShaanxiShanxi

ChongqingJilin

GansuInner Mongolia

XinjiangShanghai

BeijingTianjinHainan

Hong KongNingxiaQinghai

TibetMacau

Population2010 (In Million)

Population < 20 Million

20 Million ≤ Population < 40 Million



Population > 80 Million

Armenia (Tibet Autonomous Region)

Denmark (Qinghai)

Ghana (Gansu)

Germany (Sichuan)

Spain (Yunnan) South Africa

(Guangxi)

Argentina (Guizhou)

Venezuela (Chongqing)

Canada (Shaanxi)

Jordan (Ningxia)

Poland (Heilongjiang)

Saudi Arabia (Jilin)

Sudan (Liaoning)

Zimbabwe (Tianjin)

Chile (Beijing)

Congo (Hebei)

Uganda (Shanxi)

Vietnam (Shandong)

Ethiopia (Henan)

Iran (Jiangsu)

Britain (Anhui)Italy

(Hubei)

France (Hunan)

Kenya (Jiangxi)

Myanmar (Zhejiang)

Cameroon (Shanghai)

Algeria (Fujian)

Philippines (Guangdong)

Papua New Guinea (Hong Kong)

Solomon Islands (Macau)

Burundi (Hainan)

Yemen (Inner Mongolia


Romania (Xinjiang



100




Countries Matching the Exports of Chinese ProvincesFrom The Economist

333129

191211998886654444432211100

362208

148136

8351

0 80 160 240 320 400

GuangdongJiangsu

ZhejiangShanghai

ShandongFujian

LiaoningTianjinBeijingHebei

SichuanXinjiang

HubeiHenanAnhui

JiangxiHong Kong Heilongjiang

HunanGuangxi

ShanxiChongqing

ShaanxiInner Mongolia

YunnanJilin

HainanGuizhouNingxiaMacauGansu

TibetQinghai

Exports2009, (In US$ Billion)

(1)

Note:1. Hong Kong excludes re-exports.

Exports < US$5 Billion

US$5 Billion ≤ Exports < US$10 Billion



Exports > US$200 Billion

Belize (Tibet Autonomous Region)

Rwanda (Qinghai)

Nepal (Gansu)

Benin (Ningxia)

Bahrain (Sichuan)

Namibia (Yunnan)

North Korea (Guizhou)

Gabon (Guangxi)

Mongolia (Hainan)

Panama (Macau)

Sri Lanka (Hong Kong)

South Korea (Guangdong)

Nigeria (Fujian)

Thailand (Zhejiang)

Congo (Hunan)

Latvia (Jiangxi)

Lebanon (Chongqing)

Trinidad and Tobago (Hubei)

Serbia (Anhui)

Taiwan (Jiangsu)

Austria (Shanghai)

Hungary (Shandong)

Costa Rica (Henan)

Bosnia and Herzegovina

(Shaanxi)

Iceland (Shanxi)

Greece (Hebei)

Colombia (Tianjin)

Oman (Beijing)

Libya (Liaoning)

Jordan (Heilongjiang)

Botswana (Jilin)

El Salvador (Inner Mongolia



Uzbekistan (Xinjiang


101




China and Greater Asia Economic ForecastAs of May 2011

Notes:1. Asia Pacific includes: China, Hong Kong, India, Indonesia, Korea, Malaysia,

the Philippines, Singapore, Taiwan, Thailand, and Australia.2. Represents the composite consumer price index.3. Represents the one-year working capital rate.4. Represents the Hong Kong mortgage rate.

Source: CEIC, Morgan Stanley & Co. Inc. Research.

At the burial site of the first Chinese emperor Qin Shihuangdi (circa 260-210 BC) stands an army of approximately 8,000 terracotta warriors. The Emperor ordered this massive clay army to be produced for his protection in the afterlife. Prior to Emperor Qin’s rule, it was tradition in China for slaves and soldiers to be buried alive in their master’s tomb for service and protection in the afterlife. During Qin’s reign, the burying of humans was abolished. To substitute for human soldiers, Qin summoned the creation of this terracotta army. Emperor Qin’s tomb of terracotta soldiers was discovered in 1974 and attracts more than two million visitors a year.

Emperor Qin’s Terracotta Army of Xian

5. Data represent the Taiwan First Commercial Bank Prime Lending Rate before 2003, and the Base Lending Rate since 2003.

6. Represents the three-month time deposit rate.7. Represents the 90-day money market middle rate.

Source: Encyclopedia Britannica, www.britannica.com, www.globalmountainsummit.org, www.chinaculture.org.

Calendar Years ending Dec. 312006 2007 2008 2009 2010 2011E 2012E

Real GDP Growth (%)Asia Ex-Japan 10.0 % 10.8 % 7.2 % 6.2 % 9.3 % 7.7 % 7.9 %AXJ (Ex-China and India) 5.6 6.0 2.8 0.0 7.1 4.7 4.7Asia Pacific(1) 9.6 10.5 7.0 6.0 9.0 7.5 7.8China 12.7 14.2 9.6 9.2 10.3 9.0 9.0Hong Kong 7.0 6.4 2.1 (2.7) 7.0 6.0 4.0Taiwan 5.4 6.0 0.7 (1.9) 10.5 3.8 4.2CPI Inflation (%, Period Average)Asia Ex-Japan 3.4 % 4.6 % 6.4 % 2.4 % 5.1 % 5.1 % 3.8 %Asia Pacific(1) 3.8 4.3 6.2 2.6 4.9 4.8 3.8China 1.5 4.8 5.9 (0.7) 3.3 4.6 4.0Hong Kong(2) 2.0 2.0 4.3 0.5 2.4 3.8 4.4Taiwan 0.6 1.8 3.5 (0.9) 1.0 2.0 1.6Current Account (% of GDP)Asia Ex-Japan 6.1 % 7.2 % 6.0 % 4.8 % 4.1 % 2.8 % 2.6 %China 9.1 10.1 9.1 5.2 5.2 3.0 2.8Hong Kong 12.1 12.4 13.7 8.6 6.6 6.0 5.6Taiwan 7.0 8.4 6.3 11.4 9.4 8.6 8.8Interest Rates (Prime Lending Rate, %, Period End)China(3) 6.1 % 7.5 % 5.3 % 5.3 % 5.8 % 6.6 % 6.8 %Hong Kong (4) 5.3 4.1 3.5 2.3 2.0 2.3 3.8Taiwan(5) 4.0 4.4 4.5 2.5 2.6 3.1 3.5Interest Rates (3-Month Interbank Rate, %, Period End)China(6) 1.8 % 3.3 % 1.7 % 1.7 % 2.3 % 3.0 % 3.3 %Hong Kong 3.9 3.5 1.0 0.1 0.3 0.4 2.4Taiwan(7) 1.8 2.2 1.1 0.6 0.7 1.2 1.5USD Exchange Rate (Period End)China 7.81 7.31 6.83 6.83 6.60 6.20 5.82Hong Kong 7.78 7.80 7.75 7.75 7.75 7.78 7.75Taiwan 32.60 32.40 32.90 33.00 30.10 28.60 27.00

China, and Greater Asia Economic Forecast

102



Estimates of future performance are based on assumptions that may not be realized. The indexes are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is no guarantee of future results. International investing entails greater risk, as well as greater potential rewards compared to US investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economics.


Asia Pacific Market ValuationsAs of December 31, 2010

Select Chinese InventionsPaper ─ Chinese legend indicates that the new invention of paper was presented to the Emperor in the year 105 AD. Archeological evidence, however, shows that paper was used in China two hundred years before that time. Either way, the Chinese were significantly ahead of the rest of the world. The craft of papermaking utilized an abundance of bamboo fiber to produce a fine quality paper.

Gunpowder ─ Chinese scientists discovered that an explosive mixture could be produced by combining sulfur, charcoal, and saltpeter (potassium nitrate). This invention provided the Chinese military with an advantage over its adversaries. New weapons were rapidly developed, including rockets and other projectiles that could be launched from a bamboo tube.

Compass ─ By the third century AD, Chinese scientists had learned to make magnets by heating pieces of ore to high temperatures and then cooling the pieces in a North/South position. The magnet was then placed on a piece of reed and floated in a bowl of water marked with directional bearings. These first navigational compasses were widely used on Chinese ships by the 11th century AD.

Source: The Franklin Institute, Philadelphia, PA.

Source: FactSet, I/B/E/S, MSCI, Morgan Stanley & Co. Inc. Research.

103

As of December 31, 2010Mkt Cap Total Return (US$) 2005 – 2010 P/E EPS Growth Dividend

US$Bn 2005 2006 2007 2008 2009 2010 CAGR 2010 2011E 2012E 2010 2011E 2012E P/B ROE Yield

MSCI Asia Pacific Ex Japan 6,206 23.3% 16.5% 14.3% -41.8% 37.6% 17.0% 4.4% 15.0 12.3 11.6 47.1% 14.3% 13.4% 1.6 10.3% 2.4%

Countries

Australia 973 16.0% 30.9% 28.3% -50.7% 76.4% 14.5% 6.9% 12.3 10.5 10.2 19.0% 12.6% 7.4% 2.1 8.3% 4.1%

China 676 19.8% 82.9% 66.2% -50.8% 62.3% 4.6% 11.8% 13.5 11.7 10.1 30.1% 15.4% 16.3% 2.3 6.3% 2.2%

Hong Kong 316 8.4% 30.4% 41.2% -51.2% 60.2% 23.2% 6.7% 13.1 12.0 10.7 28.0% 8.6% 12.5% 1.8 12.5% 2.4%

India 313 37.6% 51.0% 73.1% -64.6% 102.8% 20.9% 12.1% 13.5 11.0 9.3 22.2% 22.5% 19.0% 3.6 6.3% 0.9%

Indonesia 90 15.1% 73.8% 54.2% -56.5% 126.2% 33.9% 15.1% 3.2 2.6 2.2 18.7% 22.6% 16.8% 4.4 4.3% 2.2%

Korea 540 57.0% 12.6% 31.9% -55.3% 71.3% 26.7% 8.5% 8.0 7.1 6.3 50.1% 12.5% 12.7% 1.6 7.7% 1.1%

Malaysia 111 2.3% 37.1% 46.1% -41.2% 52.1% 37.0% 9.6% 14.0 12.0 10.7 29.6% 16.9% 11.8% 2.4 7.5% 2.3%

New Zealand 11 1.7% 16.6% 8.9% -53.8% 50.4% 8.3% -0.3% 17.4 13.5 12.7 4.9% 20.8% 12.9% 1.6 10.6% 5.2%

Philippines 20 22.6% 58.2% 40.4% -52.6% 65.6% 33.9% 11.1% 8.1 7.4 6.5 31.4% 9.5% 14.2% 2.9 6.1% 2.4%

Singapore 190 14.4% 46.7% 28.4% -47.4% 74.0% 22.1% 9.2% 37.4 34.2 31.1 23.4% 9.6% 9.8% 1.9 8.5% 2.8%

Taiwan 449 6.4% 20.0% 8.4% -46.5% 79.2% 21.8% 4.9% 14.5 13.1 11.6 91.4% 10.6% 13.2% 2.1 7.5% 3.2%

Thailand 66 8.7% 11.1% 46.0% -48.5% 76.6% 55.7% 9.6% 12.2 10.1 8.7 19.9% 21.0% 15.9% 2.4 6.3% 2.5%

Asia Pacific Market Data Sheet




Emerging Market Relative Valuation: Equities and CurrenciesAs of January 2011

Source: The Bank Credit Analyst, “Outlook 2011: A Pivotal Year Ahead,” January 2011 – Volume 62, No.7.

Taiwan

Russia

Hungary

Poland

Turkey

Thailand

The Czech Republic

Malaysia

ChinaKorea

Philippines

Brazil

Mexico

India

South AfricaColombia

Indonesia

Chile

0

4

8

12

16

20

0 4 8 12 16 20

Emerging Market Relative Valuation: Equities and Currencies

Relatively Low Valuations

Relatively High Valuations

Notes:1. Currency valuation are calculated as an average of: (i) Purchasing power parity (nominal GDP divided by GDP at PPP); and (ii) Real effective exchange

rate deviation from its 10-year moving average.2. Equity valuation are based on: (i) An average of trailing and forward price/earnings ratios; (ii) Price/book value ratios; and (iii) Dividend yields.

• In January 2011, The Bank Credit Analyst (BCA) conducted an analysis of Emerging Market (EM) Valuation. BCA ranked EM countries based on the valuation levels of their equities and currencies.

• As of January 2011, they concluded that EM countries with high valuations included Brazil, Chile, Colombia, Indonesia, and South Africa; EM countries with low valuations included Hungary, Malaysia, Poland, Russia, Taiwan, Thailand, and Turkey.

Low Valuation Equity Valuation Ranking (2) High Valuation

Low

Val

uatio

nC

urre

ncy

Valu

atio

n R

anki

ng (1

)H

igh

Valu

atio

n

A Tulou, or “earthen building,” is a traditional communal residence in the Fujian province of southern China, usually of a circular configuration surrounding a central shrine. These structures were occupied by clan groups. Some were constructed of cut granite or had substantial walls of fired brick. Most large- scale tulou seen today were built of a composite of earth, sand, and limestone known as sanhetu. In 2008, the famous Fujian Tulou was designated a UNESCO World Heritage site.

Tulou

Source: World Heritage Convention.

104



13.3

2.5 2.56.6

10.6

22.7

41.545.6

8.4

50.6

104.4

0

25

50

75

100

125

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Chinese IPO Priced Equity Offerings

US$ Billions


Chinese Initial Public Offering ActivityAnnual Initial Public Offering (IPO) Volume, 2000 – 2010

Source: Dealogic. Data are as of December 2010.

Note:1. The equity offerings include all Chinese companies listed on stock exchanges globally.

Number of Transactions: 27 29 28 36 61 81 91 139 51 185 471Denotes Chinese Stock Exchange

• By market capitalization, China’s stock exchanges accounted for 12% of the world’s total stock exchange market.

Source: World Federation of Exchange Members. Data are as of December 2010.

By Stock Market Capitalization As of December 31, 2010

RankCompany NameMarket Cap.

(US$ Tn)% of

World

1 NYSE Euronext 16.3 29.7%

2 NASDAQ 3.9 7.1%

3 Tokyo SE Group 3.8 7.0%

4 London SE Group 3.6 6.6%

5 Shanghai SE 2.7 4.9%

6 Hong Kong Exchanges 2.7 4.9%

7 TSX Group (Canada) 2.2 4.0%

8 Bombay SE 1.6 3.0%

9 BOVESPA (Brazil) 1.5 2.8%

10 Australian SE 1.5 2.7%

11 Deutsche Börse 1.4 2.6%

12 Shenzhen SE 1.3 2.4%

13 SIX Swiss Exchange 1.2 2.2%

14 BME Spanish Exchanges 1.2 2.1%

15 Korea Exchange 1.1 2.0%

16 NASDAQ OMX Nordic Exchange 1.0 1.9%

17 MICEX (Russia) 0.9 1.7%

18 Johannesburg SE 0.9 1.7%

19 Taiwan SE Corp. 0.8 1.5%

20 Singapore Exchange 0.6 1.2%

Total 54.9

Stock Exchanges Around the World

105




Largest Chinese IPOs in 2010

Source: Dealogic; Bloomberg, LLC; Shanghai Expo; www.expo2010.china.hu. Data are as of December 2010.

Shanghai Emblem Hong Kong Emblem

Pricing Date Issuer IndustryDeal Size ($US MM)

Offer Price (US$)

Shares Offered (MM) Bookrunners Exchange

1 6-Jul-10 Agricultural Bank of China Ltd Financial Institutions 22,466 0.41 54,794 China Galaxy Securities, China International Capital, CITIC Securities, Guotai Junan Securities

Hong Kong,Shanghai

2 12-Aug-10 China Everbright Bank Co. Ltd Financial Institutions 3,220 0.46 7,000 China International Capital, JP Morgan Shanghai

3 11-Feb-10 Huatai Securities Co. Ltd Financial Institutions 2,299 2.93 785 Haitong Securities Shanghai

4 11-Nov-10 China Rongsheng Heavy Industries Group Holdings Ltd Transportation 1,803 1.03 1,750 Bank of China, CCB International Capital,

Deutsche Bank, JPMorgan, Morgan Stanley Hong Kong

5 3-Feb-10 China First Heavy Industries Machinery 1,660 0.83 2,000 Bank of China Ltd Shanghai

6 21-Jan-10 China XD Electric Co. Ltd Computers & Electronics 1,516 1.16 1,307 China International Capital Shanghai

7 9-Dec-10 Chongqing Rural Commercial Bank Co. Ltd Financial Institutions 1,486 0.68 2,186 Morgan Stanley, Nomura Hong Kong

8 16-Sep-10 Ningbo Port Co. Ltd Transportation 1,100 0.55 2,000 Bank of China Shanghai

9 23-Apr-10 Shenzhen Hepalink Pharmaceutical Co. Ltd Healthcare 869 21.68 40 China JianYin Investment Securities Shenzhen

10 21-May-10 Sichuan Kelun Pharmaceutical Co. Ltd Healthcare 733 12.21 60 Sinolink Shenzhen

11 30-Dec-10 China Hainan Rubber Industry Group Co. Ltd Chemicals 707 0.90 786 CITIC Securities Shanghai

12 13-Dec-10 China Datang Corp Renewable Power Co. Ltd Utility & Energy 643 0.30 2,143 China Everbright Sec.(HK), Cinda Int'l Capital, Credit Suisse, JP Morgan, Macquarie Group, UBS Hong Kong

13 22-Oct-10 China South Publishing & Media Group Co. Ltd Media 637 1.60 398 Bank of China Shanghai

14 6-Aug-10 Jihua Group Corp Ltd Aerospace & Defense 602 0.52 1,157 UBS Shanghai

15 13-Oct-10 Springland International Holdings Ltd Retail 546 0.76 719 DBS, Morgan Stanley Hong Kong

Largest Chinese Initial Public Offerings in 2010 (1)

106

The securities mentioned are provided for informational purposes only and should not be deemed as a recommendation to buy or sell. Returns do not include payment of any charges or fees an investor would pay to purchase the securities. Such costs would lower performance.



48.4

14.7

31.5 34.1 31.1

56.2

66.7

115.1

187.1

138.2

187.2

0

50

100

150

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Chinese M&A TransactionsIncludes Domestic and International Transactions Involving Chinese Companies, As Acquirors or TargetsUS$ Billions


Chinese M&A ActivityAnnual M&A Volume, 2000 – 2010

Source: Thomson Reuters. Data are as of December 2010.

Number of Transactions: 571 608 1,086 1,695 2,350 1,951 2,179 2,911 3,306 3,040 3,455

Chinese Cross-Border Acquisition Activity

• Motivated by a desire to attain global scale, acquire raw materials, obtain technical innovation, and secure access to foreign markets, Chinese corporations accounted for approximately 10% of the value of cross-border acquisitions in 2010.

• As China’s enterprises invest abroad, its interests should continue to align with global interests, increasing the country’s enthusiasm for and embrace of international cooperation.

• As of late 2010, China (including Macau and Hong Kong) owned approximately 6% of the world’s stock of Foreign Direct Investment.

• As of early 2011, stock exchange- listed Chinese firms, many of which are state-controlled, represented approximately 13% of total global equity capitalization.

107




Largest Chinese M&A Transactions in 2010

Source: Thomson Reuters. Data are as of December 2010.

Chinese Acquirors Accounted for All of the Top 15 Chinese M&A Transactions in 2010, Seven of Which Were Cross-Border

DateAnnounced Target Name

Nationality of Target Target Industry Target Business Description Acquiror Name

Nationality of Acquiror

Deal Size ($US MM)

1 10-Dec-10 Occidental Argentina Expl Argentina Energy Provides power generation services world wide Sinopec Group China 2,450

2 29-Nov-10 Henan Luohe Shuanghui Ind. (Assets) China Food & Beverage A congolomerate of various food & beverages companies Henan Shuanghui Invest & Dvlp. China 5,052

3 29-Nov-10 Henan Shuanghui Invest & Dvlp China Food & Beverage Produces meat and engages in wholesaling Rotary Vortex Ltd Hong Kong 2,474

4 22-Nov-10 Draka Holding NV Netherlands Metals/Mining/Coal Manufactures wire and cable products Tianjin Xinmao Science & Tech China 1,757

5 4-Nov-10 Shanghai Bailian Group Co. Ltd China Retail Owns and operates shopping centers Shanghai Friendship Group China 2,536

6 1-Oct-10 Repsol YPF Brasil SA Brazil Energy Engages in oil and gas exploration Sinopec Group China 7,111

7 27-Sep-10 Album Resources Pte Ltd Australia Metals/Mining/Coal Engages in the mining of minerals and metals Minmetals Resources Ltd China 2,818

8 1-Sep-10 Shenzhen Dvlp. Bank Co. Ltd China Banking Provides local and foreign currency deposits and loan services Ping An Ins (Grp) Co. of China China 4,313

9 9-Jun-10 Hangang Hanbao Iron & Steel Co. China Metals/Mining/Coal Manufactures steel sheets used in automobiles and pipe steels

used in the oil industry Hebei Iron & Steel Co. Ltd China 2,345

10 21-May-10 Peregrino Project (Statoil ASA) Brazil Energy Owns oil reserves in the Campos Basin area Sinochem Group China 3,070

11 12-Apr-10 Syncrude Canada Ltd Canada Energy Engages in oil and gas exploration in Canada Sinopec International China 4,650

12 14-Mar-10 Bridas Corp. Argentina Energy Engages in oil and gas exploration in South America, Central Asia, and Middle East CNOOC Ltd China 3,100

13 5-Mar-10 Shanghai Pudong Dvlp. Bk China Banking Provides banking and financial services including deposits, loans, settlements, and government bond trading China Mobile Grp Guangdong Co. China 5,831

14 3-Feb-10 Yima Coal Ind Grp Co Ltd (Assets) China Metals/Mining/Coal Owns coal mining assets in China Nanjing Xinwang Tech Co. Ltd China 1,996

15 22-Jan-10 Denway Motors Ltd Hong Kong Automotive Manufactures motor vehicles, and automotive equipment and parts China Lounge Investments Ltd Hong Kong 3,048

Largest Chinese M&A Transactions in 2010

108The securities mentioned are provided for informational purposes only and should not be deemed as a recommendation to buy or sell. Returns do not include payment of any charges or fees an investor would pay to purchase the securities. Such costs would lower performance.




Notable Resource-Related Transactions by China, 2005 – 2010

Source: Heritage Foundation; “China’s Sure Bet,” Barron’s, November 8, 2010.

Source: Forbes; International Business Times, “Top 10 Richest People in China 2011,” March 10, 2011.

Source: Forbes; The Economist, “Dusk for the Patriarchs,” February 5, 2011.

As of March 2011Net Worth

Name Business US$ Bn1 Robin Li Internet 9.4

2 Liang Wengen Construction 8.0

3 Zong Qinghou Food & Beverage 5.9

4 Li Li Pharmaceuticals 5.7

5 He Xiangjian Appliances 5.5

6 Wu Yajun Property 5.5

7 Hui Ka Yan Property 5.1

8 Zhang Jindong Electronics 5.0

9 Ma Huateng Internet 5.0

10 Wang Jianlin Property 4.6

China's Wealthiest Individuals

As of February 2011Net Worth

Name Business US$ Bn1 Li Ka-shing Property 24.0

2 Kwong Siu-hing Property 20.0

3 Robert Kuok Hotels 9.0

4 Cheng Yu-tung Jewellery and Property 9.0

5 Stanley Ho Casinos and Hotels 3.1

6 Lui Chee-woo Casinos and Hotels 3.0

7 David Li Banking 1.9

8 Gordon Wu Property 0.9

Hong Kong's Wealthiest Individuals

109

Date InvestorDeal Size (US$ Bn) Description

Aug. 2005 China National Petroleum 4.2 State-owned oil giant, parent of PetroChina, buys Calgary-based PetroKazakhstan

Sept. 2006 China National Machinery 3.0 State-owned consortium to develop iron ore in Gabon Republic

Nov. 2007 China Metallurgic Group 2.9 State-owned metal producer to develop Afghanistan's largest copper mine

Feb. 2008 Aluminum Corp. of China 12.8 With Alcoa, buys 12% of Australia's mining giant Rio Tinto

June 2009 Sinopec 7.2 Petrochemical giant buys Switzerland's Addax Petroleum, a play on West Africa and Iraq

Aug. 2009 Yanzhou Coal 3.0 China's fourth-largest coal producer buys Australian miner Felix Resources

Dec. 2009 Shunde Rixin 1.9 Private, Guangdong-based conglomerate buys 70% of exploration rights to Chilean iron ore deposits

March 2010 CNOOC 3.1 State-owned offshore oil giant buys a 50% stake in a unit of Bridas Energy

May 2010 Sinochem 3.1 State's largest chemical trader buys 40% of Brazil's Peregrino field

Notable Resource-Related Transactions by China, 2005 – 2010



Domestic Investors

Overseas-registered Mainland Companies

Issu

esM

arke

tIn

vest

ors

0

500

1,000

1,500

2,000

95 00 05 08Tradable SharesNontradable, State-Owned Shares

US$ Billions

Overview of China-Related Equities

• Chinese companies can issue A, B, and H shares, and ADRs. While the different types of shares in the same company may trade on different exchanges, and in some cases in different currencies, their entitlement to dividends is essentially the same.

• The differences in valuation are largely a result of differing profiles of buyers and sellers and liquidity on the various exchanges.

Source: Morgan Stanley & Co. Inc. Research; Morgan Stanley Smith Barney Investment Strategy; Blackrock.

While China’s stock market has been expanding, many companies remain state-controlled.

Tradable vs, Non-tradable Shares

Source: Bloomberg, LLC. Data are as of 2008.

Behind China’s Boom

Overview of China-Related Equities

Domestic Companies

A-Shares (CNY)

B Shares(USD/HKD)

H Shares (HKD)

China– Related Stocks

ADRs

Foreign Investors

Singapore, US, London…

• Qualified Domestic Institutional Investors (QDII) may invest in H Shares, Red Chips, P Chips, China-Related Stocks, and ADRs.

• Qualified Foreign Institutional Investors (QFII), introduced in 2003, may invest in China A Shares.

63%

37%62%

38%66%34%

31%69%


Shanghai and Shenzhen Stock Exchanges

Hong Kong Stock Exchange

P Chips (HKD)

Red Chips (HKD)

110




-0.2

2.3

6.9

12.8

11.0

16.9

-11.4

11.0

20.6

31.4

-1.0

2.5

-20 -10 0 10 20 30 40

Shanghai A-Shares Index

Shenzhen A-Shares Index

Shanghai B-Shares Index

Shenzhen B-Shares Index

Hang Seng Enterprise Index

Hang Seng China Aff.Company Index

MSCI China P Chip Index

MSCI China

S&P China BMI Index

S&P 500

Dow Jones

NASDAQ

Historical Performance of China Shares2010 Price Performance in US Dollar Terms


2010 Performance% Price Return in US$ Terms

Shanghai B-Shares Stock Price Index

NASDAQ Composite Index

2008-2010 CAGR

26.2%

65.6%

26.6%

74.1%

12.4%

18.0%

33.3%

14.9%

27.5%

Tiananmen Square, in the center of Beijing, is said to be the largest square in the world. It measures 880 meters (2,887 feet) from north to south, and 500 meters (1,640 feet) from east to west, has a total area of 440,000 square meters (4.7 million square feet) and can hold one million people. Over several hundred years, in front of Tiananmen, many public meetings and demonstrations have been held. Tens of thousands of people visit daily. Source: www.about.com.

Tiananmen Square

Shanghai A-Shares Stock Price Index

Shenzhen B-Shares Stock Price Index

Hang Seng China Enterprises Index (H Shares)

Hang Seng China Affiliated Company Index (Red Chips)

MSCI China Index

Standard & Poor’s China BMI Index

Standard & Poor’s 500 Index

Dow Jones Industrial Average

29.7%

Shenzhen A-Shares Stock Price Index 55.1%


MSCI China P Chip Index (P Chips) 51.9%

111



As of May 2011, individual investors were the leading holder of Chinese A-shares, despite the rapid growth in institutional investors.

Individuals64%

Mutual Funds23%

Other Institutions13%

Share of Investor Base by Free-float Market Capitalization

China’s Domestic Fund Management Industry and Chinese Individual Investors

China’s Growing Domestic Asset Management Industry Individual Investors’ Share of the China’s A-Shares Market

Source: CEIC, Morgan Stanley & Co. Inc. Research, Morgan Stanley Smith Barney Investment Strategy. Data are as of May 2011.

• Although institutional investors, mainly mutual funds, had flourished from 2002 to 2009, individual investors remained the majority holder of A-shares as of May 2011.

• As of May 2011, the Morgan Stanley Research China strategy team estimated that 65% of institutional funds had come from retail investors.

• From early 2001 to early 2011, retail investors tended to be momentum investors. From November 2005 through September 2007, the Shanghai SE Composite index rose 405%; during that same time period, the number of new individual investment accounts grew at times at over 2,500% year-over-year. From 2007 through October 2008, the Shanghai SE Composite index fell 68%; during that same time period, the number of new individual investment accounts shrank considerably as many investors withdrew funds from the stock market. From 2008 to early 2011, the number of new individual investment accounts grew in line with the performance of the Shanghai SE Composite index.

Expansion of Fund Products

Source: Wind, Morgan Stanley & Co. Inc. Research. Data are as of May 2011.

0

100

200

300

400

'97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '110

200

400

600

800

AuM of Mutual Funds, Equity Portion Shanghai Composite Index

Source: Wind, Morgan Stanley & Co. Inc. Research. Data are as of May 2011.

Aggregate Assets under Management (AuM) of Mutual FundsAuM of Mutual Funds (US$ Billions) Shanghai Composite Index (US Dollars)

0200400600800

1,000

'98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '110.00.30.60.91.21.5

Number of Funds NAV per Fund

Number of Funds NAV per Fund (US$ Billions)


• From 1997 through 2010, China’s domestic asset management industry had grown at a 41% CAGR in assets under management. As of May 2011, Chinese fund managers owned 23% of the A-shares market and represented the core of institutional ownership of the A-share market. As of May 2011, over 750 Chinese domestic mutual funds were in operations, with a collective net asset value (NAV) per fund of US$0.5 billion. As of May 2011, fund managers were allowed to sell short, invest in index futures, and employ margin.

(1)

(1)

112



China’s A-Shares Market

1.6

1.5

1.5

1.4

0.6

16.3

3.9

3.8

3.6

3.3

2.2

0 2 4 6 25

NYSE Euronext

NASDAQ

Tokyo SE Group

London SE Group

A Shares (Shanghai & Shenzhen)

TSX Group (Canada)

Bombay SE

BOVESPA (Brazil)

Australian SE

Deutsche Börse

H-Shares (Hong Kong)

China’s A-Shares Market: the Fifth Largest in the World

Market Capitalization as of December 31, 2010 (US$ Trillion)

Source: Bloomberg, LLC; World Federation of Exchanges. Data are as of December 31, 2010.

Overview of the A Shares Market


• China’s A shares market was created in 1990, but remained a nascent market until the reform of non-tradable shares in 2005. Prior to 2005, mainland Chinese companies had two share classes: tradable shares listed on the Shanghai and Shenzhen stock exchanges; and non- tradable, non-listed shares with the same ownership rights and claims as tradable shares. In 2005, the China Securities Regulatory Commission (CSRC) launched a program to convert non-tradable shares into tradable shares by 2006, using bonus shares, cash, options, and capital-raising incentives to help facilitate the conversion process.

• In 2009, the CSRC launched the Growth Enterprise Market (GEM) board, a NASDAQ-style initiative to develop the equity market for start-ups and growing businesses. As a result of the creation of the GEM board, the Shenzhen stock exchange launched the ChiNext market, a sub-exchange for domestic start-ups, with the intent of attracting more companies.

• The CSRC’s initiatives produced results: from 2005 to 2010, the A shares market grew rapidly, with a CAGR of 53.4%. As of December 2010, the A shares market was China’s largest and primary stock market and represented the world’s fifth largest stock market, with US$3.3 trillion in market capitalization, or 55.4% of China’s 2010E GDP.

• As of early 2011, the CSRC was in the process of launching the International Board, a sub-exchange of the Shanghai stock exchange that would allow foreign companies and offshore Chinese companies that are technically based overseas to sell renminbi-denominated bonds and shares publicly in mainland China.

Source: The Asset Magazine, “GEM Board a New Test for China Market,” October 2009; Beltratti, Andrea and Bernardo Bortolotti, “The Non-tradable Share Reform in the Chinese Stock Market,” Fondazione Eni Enrico Mattei, November 2006; Business China, “China Considering International Board,” November 29, 2010; China Daily, “ChiNext: to boom or to doom?” November 13, 2009; Economic Observer, “China’s International Board a Step Closer,” September 23, 2010.

0

500

1,000

1,500

2,000

2,500

5,000

2002 2003 2004 2005 2006 2007 2008 2009 2010

A Shares H Shares Red-Chip Shares B Shares

China’s A Shares Market Relative to Other Chinese Shares MarketsMarket Capitalization on December 31st of Every Year (US$ Billion)

31.2%A Shares Market as a Percentage of China GDP

30.6% 22.7% 17.2% 40.7% 122.0% 38.4% 65.6% 55.4%


113



• Qualified Foreign Institutional Investors (QFII) are a group of investors allowed to invest in China’s domestic A-shares stock market.

• These QFII are subject to regulations by the Chinese government.• Since the inception of the QFII program in 2003, the number of OFII grew from zero to over a 100 as of April

2011.

16,57017,720

20,690

1,700

3,425

5,645

9,0459,995

13,443

0

5,000

10,000

15,000

20,000

25,000

2003 2004 2005 2006 2007 2008 2009 2010 20110

10

20

30

40

50

60

70

80

90

100

110

120

QFII Approved Investment Funds Number of QFII

Qualified Foreign Institutional Investors in ChinaQFII Approved Investment Funds (US$ Millions) Number of QFII

Qualified Foreign Institutional Investors (QFII)

Source: Factiva, Morgan Stanley & Co. Inc. Research. Data are as of April 2011.

Source: CEIC, Morgan Stanley & Co. Inc. Research.

Note:1. Data for 2011 are as of April 29, 2011.

(1)


114

Name Quota ($MM)UBS Ltd. 800

Citigroup Global Markets 550

Credit Suisse 500

Fortis Bank 500

Nikko Asset Management 450

Morgan Stanley International 450

HSBC 400

Deutsche Bank AG 400

Nomua Securities 350

ING Bank NV 350

Goldman Sachs & Co. 300

Merrill Lynch International 300

INVESCO 250

Select List of QFII



Oracle Bone Script is the oldest known form of Chinese written language. According to archeological research, it dates back as far as 4,800 years ago. The oracle bones, made of cattle scapulae or turtle plastrons, were used in divination ceremonies during the Shang dynasty (1776 – 1122 BC). The Shang dynasty flourished in China for over six centuries before being supplanted by the Zhou dynasty. The oracle bones were heated to produce cracks from which “yes” or “no” answers could be derived.In the history of human civilization, written Chinese is unique: a script whose fundamental structural principles have not changed for more than forty-five centuries. Written Chinese evolved from a pictographic script (with each character representing a thing or idea) to a logographic one (with each character representing a spoken syllable). Chinese is the only ancient logographic system that was never abandoned or converted to alphabet form.

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Shanghai SE Composite

Shanghai SE Composite Index (A and B Shares)Chinese Renminbi


Performance of the Shanghai SE Composite Index (A & B Shares)1994 Through 2010

1994

-16%

1995

-1%

1996

+71%

1997

+24%

1998

-6%

1999

+20%

2000

+35%

2001

-20%

2002

-9%

2003

0%

Source: FactSet. Data are as of December 31, 2010.

% Price Change Per Year:

2004

-20%

2005

-3%

2006

+113%

2007

+89%

2008

-58%

2009

+65%

2010

-6%

Oracle Bone Script

Source: “Letter From China – Oracle Bones,” The New Yorker, February 16, 2004, www.chinapage.com.

115




0

3,000

6,000

9,000

12,000

15,000

18,000

21,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Hang Seng China H-Shares Index

Hang Seng China Enterprises Index (H Shares)

Hong Kong Dollars


Performance of the Hang Seng China Enterprises Index (H Shares)1994 Through 2010

1994

-36%

1995

-31%

1996

+34%

1997

-26%

1998

-45%

1999

+14%

2000

-18%

2001

+8%

2002

+13%

2003

+152%



In 1999, Chinese archeologists unearthed what is believed to be the oldest known playable musical instrument, a seven-holed flute fashioned 9,000 years ago from the hollow wing bone of a large bird. It is the best preserved of six intact flutes found at Jiahu, an archeological site in the Yellow River valley in China’s Henan Province. Also at Jiahu, more than 40 house foundations have been discovered, as have 370 cellars and 9 pottery kilns. Jiahu has become an important site for understanding the early underpinnings of Chinese society, when humans left the caves of the Stone Age and began practicing agriculture and establishing permanent settlements.

The Archeological Site at Jiahu

Source: The New York Times, September 28, 1999.

2004

-6%

2005

+12%

2006

+94%

2007

+56%

2008

-51%

2009

+62%

2010

-1%

116




75

100

125

150

175

200

225

2007 2007 2009 2010

Hang Seng China A/H Premium Index

Hang Seng China A/H Premium Index

Index Level (Base = 100)


Hang Seng China A/H Premium Index2006 Through 2010


Created by HSI Services Ltd. in 2006, the Hang Seng China A/H Premium index tracks the price premium (or discount) of A-shares to H-shares. The higher the index, the higher premium of A-shares over H-shares, and vice-versa. The index is based to 100 and is denominated in US dollars.

Definition of the Hang Seng China A/H Premium Index


2007

+48.4%

2008

+43.7%Annual Average Premium of A-Shares to H-Shares:

2009

+31.1%

2010

+5.1%

The Chinese People’s Political Consultative Conference (CPPCC) is a political advisory body of the People’s Republic of China. The organization consists of delegates from a range of political parties and organizations, as well as independent members, in China.

Chinese People’s Political Consultative Conference

Source: www.china.org.

117




0

25

50

75

100

125

150

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

MSCI China Index – Price Performance (Excluding Dividends)

Index Level (Expressed in US Dollars)


Performance of the MSCI China Index1993 Through 2010

Source: FactSet.



The Bank of China Tower houses the headquarters for the Bank of China in Hong Kong. It was designed by Ieoh Ming (I.M.) Pei. Born in China in 1917, Pei has lived many years in the US, and earned a Masters in Architecture from Harvard University in 1944. In 1983, Mr. Pei was awarded the Pritzker Architecture Prize.

Bank of China Tower

1993

+34%

1994

-47%

1995

-23%

1996

+35%

1997

-26%

1998

-44%

1999

+10%

2000

-32%

2001

-26%

2002

-16%

2003

+81%

2004

-1%

2005

+16%

2006

+78%

2007

+63%

2008

-52%

2009

+59%

2010

+2%

Source: www.pcf-p.com.

(As of Dec. 31, 2010) IndexSector Weight %Financials 37.4 Energy 18.1 Telecom Services 11.3 Industrials 8.4 Materials 6.2 Consumer Discretionary 5.5 Information Technology 5.4 Consumer Staples 5.2 Utilities 1.8 Health Care 0.8 Total 100.0

MSCI China Constituents

118






Constituents of the MSCI China IndexPerformance Data in US Dollars as of December 31, 2010

YE2010 Value of US$1.00 Price Return (US$) (%)Company Name if Purchased on 1/1/05 Index weight 2005 2006 2007 2008 2009 2010

1 China Mobile Ltd 2.93 8.84% 39.6 82.5 104.7 (43.2) (6.4) 5.7 2 Industrial & Commercial Bank of China Ltd NA 6.69% NA NA 15.6 (26.7) 57.8 (8.6) 3 China Construction Bank Corp. NA 6.38% NA 82.8 34.5 (35.3) 56.9 7.4 4 CNOOC Ltd 4.42 6.27% 26.1 40.3 79.2 (45.1) 68.4 50.8 5 Bank of China Ltd NA 4.89% NA NA (11.7) (43.6) 98.0 1.5 6 China Life Insurance Co. Ltd (A Shares) 6.11 4.49% 32.1 286.4 51.6 (41.3) 62.8 (17.4) 7 PetroChina Co. Ltd 2.45 4.08% 53.4 73.0 25.8 (50.9) 37.2 8.7 8 Tencent Holdings Ltd 36.32 3.23% 78.9 232.7 112.6 (14.8) 236.8 (0.0) 9 Ping An Insurance (Group) Co. of China Ltd 6.58 2.83% 8.6 200.1 93.9 (54.9) 81.2 27.5

10 China Petroleum & Chemical Corp. 2.32 2.26% 20.6 86.4 63.2 (59.9) 47.3 7.4 11 China Shenhua Energy Co. Ltd NA 2.11% NA 118.3 148.3 (64.6) 131.6 (14.4) 12 China Merchants Bank Co. Ltd 'H' NA 1.46% NA NA 92.8 (54.6) 84.1 2.2 13 Agricultural Bank of China Ltd NA 1.25% NA NA NA NA NA NA14 China Unicom (Hong Kong) Ltd 1.81 1.25% 2.7 80.4 56.6 (47.7) 10.5 7.9 15 China Overseas Land & Investment Ltd 7.57 1.12% 73.6 213.0 54.0 (32.0) 52.1 (12.5) 16 China Telecom Corp. Ltd 1.43 1.07% 0.2 49.0 45.2 (53.1) 12.1 25.3 17 Belle International Holdings Ltd NA 1.05% NA NA NA (71.0) 166.3 44.7 18 Bank of Communications Co. Ltd NA 0.99% NA 167.0 15.0 (48.3) 61.1 (8.6) 19 Hengan International Group Co. Ltd 13.15 0.94% 73.0 118.4 81.1 (28.4) 131.2 16.1 20 Yanzhou Coal Mining Co. Ltd 3.42 0.88% (28.1) 25.8 145.5 (63.0) 201.4 38.1 21 China Coal Energy Co. Ltd NA 0.81% NA NA 383.9 (74.7) 130.7 (15.0) 22 Want Want China Holdings Ltd NA 0.77% NA NA NA NA 69.4 24.9 23 China Resources Enterprise Ltd 2.62 0.73% 14.3 60.9 49.5 (59.4) 109.6 12.1 24 Dongfeng Motor Group Co. Ltd NA 0.69% NA 92.7 45.5 (54.3) 347.0 19.6 25 Jiangxi Copper Co. Ltd 5.77 0.67% (16.7) 114.6 141.3 (70.1) 223.1 38.8 26 China Yurun Food Group Ltd NA 0.64% NA 65.3 80.6 (29.4) 152.3 10.8 27 China Merchants Holdings (International) Co. Ltd 2.10 0.64% 15.3 88.7 51.6 (68.9) 68.5 21.3 28 Tingyi (Cayman Islands) Holding Corp. 11.84 0.63% 128.2 98.1 65.4 (28.3) 113.7 3.4 29 Inner Mongolia Yitai Coal Co. Ltd 33.11 0.63% 19.8 68.4 1,009.3 (74.5) 250.9 65.0 30 China CITIC Bank Corp. Ltd NA 0.59% NA NA NA (45.5) 150.1 (24.2) 31 Anhui Conch Cement Co. Ltd 8.63 0.57% 13.3 170.4 161.3 (47.1) 39.9 45.7 32 Kunlun Energy Co. Ltd 9.88 0.57% 40.5 150.7 15.7 (51.4) 328.0 16.6 33 GOME Electrical Appliances Holding Ltd 1.76 0.56% (25.3) 15.8 223.8 (77.2) 179.6 (1.0) 34 Zijin Mining Group Co. Ltd 10.23 0.55% 94.8 216.1 177.8 (60.9) 57.8 (3.1) 35 China Resources Land Ltd 10.76 0.54% 144.9 187.8 84.7 (44.6) 85.6 (19.7)

Source: FactSet, MSCI.

119






36 China Communications Construction Co. Ltd NA 0.54% NA NA 165.2 (53.0) (22.3) (8.7) 37 Aluminum Corp. of China Ltd 1.54 0.53% 28.6 21.7 123.0 (74.5) 109.5 (17.3) 38 Kingboard Chemical Holdings Ltd 2.83 0.53% 28.0 45.0 51.5 (69.9) 121.5 50.8 39 PICC Property and Casualty Company Ltd 4.17 0.52% (17.4) 78.8 179.0 (62.3) 67.4 60.5 40 China Pacific Insurance (Group) Co. Ltd NA 0.50% NA NA NA NA NA 4.3 41 China Minsheng Banking Corp. Ltd NA 0.50% NA NA NA NA NA (8.7) 42 China Oilfield Services Ltd 7.09 0.49% 31.9 72.3 228.8 (64.7) 48.7 80.6 43 China National Building Material Co. Ltd NA 0.49% NA NA 494.7 (68.8) 72.4 10.7 44 Beijing Enterprises Holdings Ltd 4.17 0.47% 13.7 26.5 122.3 (14.2) 77.9 (14.5) 45 Lenovo Group Ltd 2.14 0.46% 54.1 (11.9) 121.3 (69.7) 130.2 2.2 46 Guangzhou Automobile Group Co. Ltd 1.83 0.45% (7.0) 22.0 58.6 (51.6) 104.9 2.6 47 China Mengniu Dairy Co. Ltd 3.38 0.44% 8.5 208.9 39.5 (64.5) 175.2 (26.0) 48 China Resources Power Holdings Co. Ltd 3.39 0.44% 3.8 167.5 129.0 (44.4) 5.5 (9.0) 49 China Railway Group Ltd NA 0.43% NA NA NA (49.7) 12.4 (7.4) 50 CITIC Pacific Ltd 0.91 0.42% (2.7) 24.8 61.8 (80.6) 149.3 (3.6) 51 Cosco Pacific Ltd 0.84 0.42% (11.6) 28.2 13.6 (61.7) 25.5 36.0 52 China COSCO Holdings Co. Ltd NA 0.40% NA 47.6 387.5 (74.8) 77.1 (13.9) 53 BYD Co. Ltd 7.53 0.40% (41.8) 148.6 72.7 (5.9) 438.7 (40.5) 54 GCL-Poly Energy Holdings Ltd NA 0.38% NA NA NA (83.6) 280.1 23.0 55 Evergrande Real Estate Group Ltd NA 0.38% NA NA NA NA NA (12.1) 56 Huabao International Holdings Ltd 11.98 0.38% 14.6 250.6 84.4 (34.5) 64.7 49.9 57 CSR Corp. Ltd NA 0.37% NA NA NA NA 35.3 78.8 58 Weichai Power Co. Ltd 7.10 0.37% (39.1) 108.9 106.8 (58.7) 329.2 52.2 59 Air China Ltd 2.91 0.37% (17.3) 69.6 175.3 (79.2) 152.8 43.5 60 Shimao Property Holdings Ltd NA 0.36% NA NA 36.1 (72.8) 173.5 (20.4) 61 China Taiping Insurance Holdings Co. Ltd 7.47 0.35% 3.4 196.1 117.8 (44.0) 110.5 (5.0) 62 Shanghai Industrial Holdings Ltd 2.02 0.35% (2.5) 2.2 104.8 (47.6) 123.9 (15.5) 63 Nine Dragons Paper Holdings Ltd NA 0.34% NA NA 46.8 (88.7) 465.3 (12.4) 64 Alibaba.com Ltd NA 0.33% NA NA NA (79.7) 222.4 (22.8) 65 China Railway Construction Corp. Ltd NA 0.33% NA NA NA NA (13.8) (6.2) 66 ENN Energy Holdings Ltd 5.24 0.33% 38.5 42.7 75.5 (46.9) 144.7 16.2 67 Chaoda Modern Agriculture (Holdings) Ltd 2.14 0.32% 12.5 54.9 42.3 (26.6) 67.6 (29.9) 68 Shandong Weigao Group Medical Polymer Co. Ltd 51.27 0.31% 98.2 385.6 116.8 (34.3) 120.1 69.8 69 Sinopharm Group Co. Ltd NA 0.30% NA NA NA NA NA (1.9) 70 Agile Property Holdings Ltd NA 0.30% NA 94.1 94.0 (71.4) 182.0 0.1

120








71 Sino-Ocean Land Holdings Ltd NA 0.30% NA NA NA (63.5) 105.0 (29.3) 72 Fushan International Energy Group Ltd 13.66 0.30% 121.1 11.3 422.6 (61.2) 288.5 (29.5) 73 ZTE Corp. (H Shares) 3.35 0.29% 4.0 36.7 17.0 (31.9) 207.2 (3.7) 74 Parkson Retail Group Ltd NA 0.29% NA 174.2 143.4 (52.9) 55.4 (12.6) 75 China Everbright Ltd 4.45 0.29% (20.1) 188.0 171.3 (61.3) 101.6 (8.8) 76 Poly (Hong Kong) Investments Ltd 4.91 0.29% (21.7) 29.7 340.3 (73.4) 430.9 (22.0) 77 Shanghai Electric Group Co. Ltd NA 0.28% NA 23.0 101.3 (52.1) 14.3 42.5 78 China Agri-Industries Holdings Ltd NA 0.27% NA NA NA (25.8) 164.8 (13.7) 79 China High Speed Transmission Equipment Group Co. Ltd NA 0.27% NA NA NA (54.6) 102.0 (36.7) 80 Longfor Properties Co. Ltd NA 0.27% NA NA NA NA NA 23.3 81 Zhuzhou CSR Times Electric Co. Ltd NA 0.27% NA NA 6.6 (45.3) 154.3 91.7 82 Zhaojin Mining Industry Co. Ltd NA 0.26% NA NA 109.2 (62.9) 158.2 104.6 83 China Longyuan Power Group Corp. Ltd NA 0.26% NA NA NA NA NA (29.4) 84 China Shipping Development Co. Ltd 1.50 0.26% (17.2) 108.1 72.7 (62.4) 51.4 (11.4) 85 Brilliance China Automotive Holdings Ltd 3.90 0.25% (24.2) 14.4 31.5 (76.6) 440.5 170.1 86 Dongfang Electric Corp. Ltd 16.21 0.25% 66.7 162.5 215.5 (70.3) 114.3 84.6 87 Golden Eagle Retail Group Ltd NA 0.25% NA NA 17.5 (32.8) 191.0 20.7 88 Angang Steel Co. Ltd 3.34 0.25% 6.0 172.2 107.0 (59.1) 97.4 (30.7) 89 China International Marine Containers (Group) Co. Ltd 3.32 0.24% (12.4) 185.7 6.4 (70.8) 132.3 84.0 90 Huaneng Power International Inc. 0.71 0.24% (11.9) 35.9 17.8 (31.4) (21.6) (6.6) 91 Geely Automobile Holdings Ltd 9.31 0.24% (10.7) 136.2 14.0 (28.0) 577.4 (20.6) 92 Country Garden Holdings Co. Ltd NA 0.24% NA NA NA (78.8) 52.0 2.9 93 Tsingtao Brewery Co. Ltd 5.18 0.23% 4.7 59.5 99.2 (37.9) 165.6 (5.6) 94 Soho China Ltd NA 0.23% NA NA NA (58.4) 26.1 37.3 95 China Vanke Co. Ltd 7.82 0.23% 69.1 199.5 102.9 (52.5) 62.6 (1.6) 96 China Rongsheng Heavy Industries Group Holdings Ltd NA 0.22% NA NA NA NA NA NA97 China Shipping Container Lines Co. Ltd 1.71 0.22% (13.4) (22.5) 237.9 (74.4) 139.2 22.5 98 China Resources Cement Holdings Ltd 0.45 0.22% (28.0) NA NA NA NA 52.9 99 Li Ning Co. Ltd 4.23 0.21% 41.4 125.9 132.5 (58.1) 143.7 (44.3)

100 Zhejiang Expressway Co. Ltd 1.43 0.21% (10.1) 23.8 108.9 (63.3) 57.9 6.3 101 Anta Sports Products Ltd NA 0.20% NA NA NA (67.2) 226.2 6.8 102 Guangzhou R&F Properties Co. Ltd NA 0.20% NA 148.1 65.0 (69.1) 60.2 (19.0) 103 Shui On Land Ltd NA 0.20% NA NA 33.7 (72.9) 106.4 (18.9) 104 Renhe Commercial Holdings Co. Ltd NA 0.20% NA NA NA NA 49.1 (22.9) 105 Jiangsu Expressway Co. Ltd 2.60 0.20% 28.1 11.4 73.4 (32.5) 21.3 28.3

121








106 Wumart Stores Inc. 6.13 0.20% 19.5 84.1 (3.9) (12.6) 113.1 55.6 107 Hengdeli Holdings Ltd NA 0.19% NA 219.0 36.2 (72.4) 267.3 57.1 108 Semiconductor Manufacturing International Corp. 0.33 0.19% (37.7) (4.1) (19.0) (60.1) 53.8 11.7 109 Guangdong Investment Ltd 1.54 0.19% 11.8 20.7 26.5 (29.7) 45.6 (11.9) 110 China Dongxiang Group Co. Ltd NA 0.18% NA NA NA (67.4) 219.0 (44.1) 111 SINOPEC Shanghai Petrochemical Co. Ltd 1.39 0.18% 2.8 28.7 24.9 (58.4) 54.2 30.9 112 Lee & Man Paper Manufacturing Ltd 3.71 0.18% 35.8 121.4 78.9 (88.8) 461.4 9.8 113 China BlueChemical Ltd NA 0.18% NA NA 59.6 (36.5) 49.3 17.0 114 China Shanshui Cement Group Co. Ltd NA 0.18% NA NA NA NA 214.3 (2.2) 115 BBMG Corp. NA 0.18% NA NA NA NA NA 23.8 116 Fosun International Ltd NA 0.17% NA NA NA (65.0) 113.3 5.1 117 Great Wall Motor Co. Ltd 6.71 0.17% (28.5) 193.6 49.0 (75.8) 258.3 147.3 118 China Gas Holdings Ltd 3.46 0.17% 50.4 5.1 118.1 (66.2) 271.7 (20.2) 119 China Southern Airlines Co. Ltd 2.32 0.17% (27.5) 41.6 224.5 (81.1) 87.5 96.2 120 Yuexiu Property Co. Ltd 2.77 0.17% 2.8 172.9 4.3 (67.0) 193.2 (2.0) 121 Datang International Power Generation Co. Ltd 0.93 0.16% (2.3) 41.7 71.4 (40.7) (18.3) (18.7) 122 Franshion Properties (China) Ltd NA 0.16% NA NA NA (49.6) 30.4 (14.8) 123 Sinofert Holdings Ltd 0.87 0.16% (68.6) 123.6 124.8 (48.2) 15.7 (7.6) 124 Metallurgical Corp. of China Ltd NA 0.16% NA NA NA NA NA (25.5) 125 China Communications Services Corp. Ltd NA 0.16% NA NA 74.1 (36.9) (21.4) 20.9 126 China Shineway Pharmaceutical Group Ltd 5.16 0.16% (9.6) 15.0 25.2 (22.4) 233.3 53.0 127 Lonking Holdings Ltd NA 0.16% NA 503.4 33.8 (67.6) 171.4 57.3 128 Beijing Capital International Airport Co. Ltd 1.26 0.15% 7.8 71.0 116.8 (70.4) 32.1 (19.5) 129 KWG Property Holding Ltd NA 0.15% NA NA NA (79.9) 160.3 (1.4) 130 Bosideng International Holdings Ltd NA 0.14% NA NA NA (68.9) 138.2 77.7 131 Maanshan Iron & Steel Co. Ltd 1.38 0.14% (19.8) 77.4 20.8 (46.3) 105.7 (27.3) 132 Skyworth Digital Holdings Ltd 1.69 0.13% 0.2 (71.8) 52.9 (62.9) 1,733.6 (42.4) 133 China Zhongwang Holdings Ltd NA 0.13% NA NA NA NA NA (30.8) 134 China National Materials Co. Ltd NA 0.13% NA NA NA (50.8) 24.0 8.4 135 Hidili Industry International Development Ltd NA 0.13% NA NA NA (79.5) 300.2 (32.9) 136 Shanghai Lujiazui Finance & Trade Zone Dev. Co. Ltd 3.89 0.11% 1.0 157.3 119.1 (61.7) 115.1 (17.1) 137 Greentown China Holdings Ltd NA 0.11% NA NA (16.1) (73.2) 275.1 (29.5) 138 Sinotruk (Hong Kong) Ltd NA 0.11% NA NA NA (56.7) 73.7 (11.9) 139 Hopson Development Holdings Ltd 2.96 0.10% 237.1 130.9 (2.3) (73.9) 99.9 (25.5) 140 China Travel International Investment Hong Kong Ltd 0.70 0.09% (25.4) 36.1 101.8 (70.4) 53.6 (24.8)

122





0

100

200

300

400

500

600

700

800

900

1,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Year-end Balance of Outstanding Chinese Treasury BondsDeal (Face) ValueUS$ Billions

Number of Bonds Outstanding: 3 6


China’s Treasury Bond Market1993 Through 2010

Source: Dealogic. Data are as of December 31, 2010.

• China’s Treasury Bond market was in its nascent stages pre-2004.

• As of 2010, China’s Treasury Bond market had grown twelvefold since 2004 in terms of dollar value, and sevenfold in terms of number of bonds outstanding.

• Sources of information on Chinese Treasury Bonds include: – www.bloomberg.com– www.financeasia.com

7 10 11 12 12 12 13 14 14 31 48 66 94 121 174 225

Coursing over a distance of 6,380 kilometers (3,964 miles), the mighty Yangtze river is the longest river in China and the third longest in the world after the Amazon in South America and the Nile in Africa. In China, the Yangtze is referred to as the Chang Jiang, meaning “long river.” China’s second longest waterway, the Yellow River, extends 5,464 kilometers (3,350 miles).

The Yangtze River

Source: www.travelchinaguide.com, www.chinaculture.org, www.china-tour.cn.

123




China’s Corporate Bond Market1993 Through 2010

0

100

200

300

400

500

600

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Year-end Balance of Outstanding Chinese Corporate BondsDeal (Face) ValueUS$ Billions

Source: Dealogic. Data are as of December 31, 2010.

Number of Bonds Outstanding: 39 48 44 46 53 42 39 36 33 42 57 82 124 183 291 426 829 1,388

In February 2010, Chinese authorities allowed foreign entities to issue bonds in RMB to offshore investors, primarily through the Hong Kong market. Chinese entities have been able to issue offshore bonds since 2008. Since then, a number of global enterprises have tapped into the market. International banks HSBC and Standard Chartered were the first to issue offshore bonds in June 2009, via their on-shore Chinese subsidiaries.

In 2010, the first international companies entered the market. McDonald’s (ticker: MCD) was the first global company to issue an offshore renminbi-denominated bond, with a RMB 200 million (US$29 million) three-year bond priced at 3%. Caterpillar (CAT) sold a RMB 1 billion (US$51 million) two-year issue in November, priced at 2%.

In early 2011, the World Bank issued offshore renminbi-denominated bonds for RMB 500 million (US$75 million), as two-year notes yielding 0.95%. The World Bank bond was sold in lots of RMB 500,000 per note, putting them out of reach of many retail investors.

International investors have expressed interest in the bonds’ RMB currency denomination, which was expected to appreciate between 4% and 5% versus the US dollar in 2011.

Offshore Renminbi-Denominated Bonds

Source: “Renminbi Goes Offshore,” Barron’s, January 10, 2011.

Renminbi (Yuan)–Denominated Chinese Share Trading in Hong Kong: Following an agreement on July 19, 2010 to relax certain restriction on Chinese currency transfers in Hong Kong and thereby allow more yuan- denominated investment instruments to be traded there, in early 2011, Chinese officials announced plans to allow the listing of yuan-denominated shares of Chinese firms on the Hong Kong stock exchange.

Panda Bonds are renminbi-denominated fixed income securities issued since 2005 by non-Chinese borrowers to raise capital within China. As of early 2011, two foreign entities had each raised a total of RMB 2 billion through the issuance of Panda Bonds: (i) the International Finance Corporation, with a 10-year, 3.40% annual coupon bond and a seven-year, 3.20% coupon bond; and (ii) the Asian Development Bank, with a 10-year, 3.34% annual coupon bond and a 10-year, 4.20% coupon bond.

124




Short-Term Interest Rates in ChinaMay 1996 through May 2011

The Chinese Garden

Tracing back more than 2,500 years, Chinese landscape design has been a traditional element of Chinese art and expression. Emperors built simple gardens to blend nature with the arts, creating an environment to achieve spiritual harmony with nature.

Chinese gardens consist of traditional Chinese architectural design, lush but simple plant life, and elements of Chinese art and poetry. Chinese Gardens serve as a personal retreat, a safe haven where one can flee from the distractions of everyday life to harmonize with and revel in the beauty and splendor of nature.

The Chinese consider gardens a serious art form and as with painting, sculpture, and poetry, aim to attain in their design properties of balance, harmony, proportion, and variety ─ considered essential components of life.

Source: www.mobot.org.

0.01.02.03.04.05.06.07.08.09.0

'96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11

China’s One-Year Deposit Rate%

Source: People’s Bank of China; Bloomberg, LLC. Data are as of May 31, 2011.

China’s One-Year Lending Rate

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

'96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11

%

Source: People’s Bank of China, Bloomberg, LLC. Data are as of May 31, 2011.

6.31%

3.25%

125



Section 4

Understanding China’s Investment Potential

126

Source: www.china.org.cn, www.wikipedia.com, www.travelchinaguide.com.

Liuhe Pagoda Built in 1165 AD during the

Song dynasty

Songyue Pagoda Built in 523 AD

China’s Oldest Stone Pagoda

Xumi Pagoda Built in 636 AD during the Tang dynasty

Chinese Pagodas

Chinese pagodas represent an integral element of traditional Chinese architecture. The Pagoda evolved from the Indian stupa characterized by a dome-shaped steeple.

Originally built to preserve Buddhist relics, Chinese pagodas were used by the ruling class to exemplify their power and wealth and were believed to house immortal spirits. In the Modern Era, pagodas are admired and celebrated for their unique and indispensable place in traditional Chinese architecture and Chinese history.

Small Wild Goose Pagoda, Xian Built in 707 AD during the Tang dynasty

Big Wild Goose Pagoda, Xian Built in 652 AD during the Tang dynasty



R&D Funding

Government 29% 69%

Industry 65% 21%

Academic/Nonprofit 6% 10%

R&D Execution

Government 10% 23%

Industry 71% 67%

Academic/Nonprofit 19% 10%

2009 R&D

Investors should devote thought and attention to:• Developing comprehension of China’s demographic, environmental, savings, investment,

political, innovation, productivity, and technological trends• Evaluating the development and potential of China’s energy, natural resources, agricultural,

communications, transportation and internet infrastructure• Examining China’s credit and capital markets and capital allocation strategies• Identifying catalysts and hindrances to growth• Exploring the status and role of China’s financial systemAmong the issues that investors should consider in formulating investment strategies relating to Chinaare:

– Domestic Politics (Page 128)– The Economy (Pages 129 and 130)– The Chinese Renminbi (Pages 131 and 132)– Credit and Capital Markets (Page 133)– Geopolitics (Page 134)– China’s Maritime Positioning (Page 135)– The Property Market (Page 136 and 137)– Inflation and Deflation (Pages 138 and 139)– Energy (Page 140)– Security (Page 141)– The Relationship Between the US and China (Page 142)– Other Issues (Pages 143, 144, 145, and 146)

UNDERSTANDING CHINA’S INVESTMENT POTENTIAL

Select Steps Toward Understanding China’s Investment Potential

127

Research & Development in China Compared to the US

In China and in the US, corporate entities perform most research and development (R&D). The difference is that in China, the majority of those entities are owned by the state; in 2009, the government funded 69% of the R&D efforts in the country. By contrast, the US government accounted for only 29% of America’s R&D expenditures that year.

Source: “China vs. the World: Whose Technology Is It?” Harvard Business Review, December 2010; “Global R&D Forecast,” Battelle Institute, December 22, 2009, China Economic Quarterly, 3Q2006; OECD R&D Statistics, 2009.

US China




Domestic Political Issues for Consideration in China Include:• The role, effectiveness, flexibility, and degree of independence of:

– The Head of State (President)– The Central Administrative System (including the State Council, the Premier, Vice Premiers,

Ministers, and other officials)– The National People’s Congress– The Communist Party– The Military– The Civil Service– The Judiciary– The Central Bank– The Media;

• Maturation of civic polity, dissent, opposition views, and the political system (Please see page 48);• Stipulations and guarantees of the Constitutional System;• The degree of state intervention in and control over various economic sectors;• Structuring and strengthening a social safety net;• Investing in housing, healthcare, and education;• Expanding the middle class;• Uses of the Sovereign Wealth Funds and Foreign Exchange Reserves; and• Populating, administering, and fostering the growth of underdeveloped provinces, autonomous

regions, and municipalities.


Domestic Politics

128

China Giant Dragon Stamps, 1878

China’s Growing R&D

Over the past decade, China has increased its R&D expenditures by about 21% per year. During the same period, US R&D spending grew by less than 4% per year. If these growth rates continue, China’s R&D spending will catch up with that of the US by 2020. Factor in the belief that the renminbi is undervalued by 40%, and China’s R&D spending could match that of the US by 2016.

Source: “China vs. the World: Whose Technology Is It?” Harvard Business Review, December 2010; National Science Foundation; Ministry of Science and Technology of the People’s Republic of China.

0

50

100

150

200

250

300

350

400

450

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10US China

R&D SpendingUS$ Billions

Source: www.chinesephilately.com.




China Economy Snapshot

• GDP (2010E): US$5.7 Trillion• GDP Per Capita – Purchasing Power

Parity (2010E): US$7,400• Inflation YOY CPI (May 2011): +5.4%• Unemployment Rate (Dec. 2010): 4.1%• Labor Force (2010E): 780 million• Labor Force by Sector (2008):

agriculture 39.5%; industry 27.2%; services 33.3%

• Industries: mining and ore processing; machine building; armaments; textiles and apparel; petroleum; cement; chemicals; fertilizers; consumer products; food processing; transportation equipment; telecommunications equipment; commercial space launch vehicles; and satellites.

• Agriculture: rice; wheat; potatoes; corn; peanuts; tea; millet; barley; apples; cotton; oilseed; pork; and fish.

• Public Debt (2010E): 17.5% of GDP


The Economy

129

Historical Backdrop

• Since World War II and particularly since 1978, the impressive growth of the manufacturing, mining, and service sectors has transformed China from a largely rural economy into an advanced, industrial, urbanized nation.

• In 2001 after 15 years of negotiations, China joined the World Trade Organization (WTO). The key turning point came in November 1999, when the US and China signed a trade treaty. China is also a member of the Asia Pacific Economic Cooperation (APEC) and the Group of Twenty Finance Ministers and Central Bank Governors (G-20).

• In 2008 and early 2009, growth slowed sharply as a result of the global economic downturn, a contraction in world trade, highly stressed international financial market conditions, and a dramatic decline in world commodity prices.

• As of May 2011, China’s economy in 2010 was estimated to be composed of 9.6% agriculture, 46.8% industrial goods, and 43.6% services.

Source: CIA World Factbook (June 2011); Bloomberg, LLC.

3.0

6.0

9.0

12.0

15.0

18.0

'80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

China’s Real GDP Growth Rate, 1980–2010Year-over-Year Change %


Source: BBC News, “China Joins the WTO – at last,” December 11, 2001, CIA World Factbook (May 2011).



Economic Issues for Consideration by China’s Policymakers Include:

• Ensuring the quality, emphasis, and efficacy of economic policy;

• Restructuring and diversifying the economy away from an emphasis on exports and inward foreign investment toward appropriate development of domestic consumption of goods and services;

• Productively using China’s significant infrastructure investments, including roads, ports, airports, telecommunications, and the internet, for commercial advantage;

• Stimulating technological innovation and creativity;

• Managing portfolio and direct investment flows into and out of China;

• Transforming the Chinese export economy into a high value-added products and services economy; and

• Creating national-champion companies to grow, acquire, and compete within global markets.


The Economy

130

Source: CEIC, Morgan Stanley & Co. Inc. Research, Bloomberg, LLC. Data are as of April 30, 2011.

Developed by the National Bureau of Statistics and Goldman Sachs, the China Business Cycle Signal is a leading economic indicator that aims to monitor the pace of China’s economy relative to macroeconomic performance and trends. The indicator is based on: the Hang Seng Mainland Free-float Index; industrial product sales; M2 money supply, new fixed-asset investment; the logistics index; contract value of foreign direct investment; the consumer expectations index; and yield spreads versus Chinese government bonds.

40

60

80

100

120

140

160

'91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11

China’s Business CycleBusiness Cycle Signal (Leading Indicator)

Indexed to a 100

Definition of the China Business Cycle Signal Indicator

Overheating

Increasing

Stable

Decreasing

Overcooling


Source: CEIC, Morgan Stanley & Co. Inc. Research. Estimates are as of June 2011.

% Y-o-Y Growth 2008 2009 2010E 2011E

GDP 9.6 9.1 10.2 9.0

Consumption 8.6 8.4 9.8 10.0

Gross Capital Formation 11.0 20.5 12.0 10.0

Mining 15.4 7.7 7.3 6.0

Manufacturing 14.8 16.7 13.1 15.0

Real Estate 8.3 13.2 21.0 16.0

Infrastructure 8.6 30.5 7.3 2.7

Other 11.6 26.5 5.0 3.6

Net Exports (Cont, ppt) 0.8 -3.7 -0.2 -0.6

Trade Balance ($Bn) 297 198 191 179

% of GDP 6.5 3.9 3.2 2.4

CPI (%) 5.9 -0.7 3.2 4.5

Forecasts of Key Macroeconomic Indicators






The Chinese Renminbi

131

Historical Backdrop and Forecasts

• From 1981 to 1993, the Chinese renminbi experienced six currency devaluations versus the US dollar. These valuations ranged from 9.6 percent to 44.9 percent, and the official exchange rate moved from 1.59 renminbi per US dollar to 5.82 renminbi per US dollar.

• On January 1, 1994, China devalued the official rate to prevailing swap rate of 8.7 renminbi per US dollar, the seventh devaluation of the renminbi. At the end of 1998, China’s foreign exchange reserves reached $US145 billion; concurrently, China pegged its official exchange rate at 8.28 renminbi per US dollar and the exchange rate remained essentially fixed through mid-2005.

• On July 21, 2005, China ended its fixed-rate currency regime, allowing the renminbi to strengthen through mid- 2008.

• On July 21, 2008, China pegged its exchange rate at 6.83 renminbi per US dollar, and its exchange rate remained fixed through mid-2010.

• Monetary authorities in China have been asked by other developing countries to allow the renminbi to appreciate.

• On June 19, 2010, China ended its fixed-rate currency policy in effect from July 21, 2008; from June 19, 2010 to December 31, 2010, the renminbi appreciated 3.3%.

• A strengthening renminbi is considered one monetary tool to help contain Chinese domestic inflation.

• As of June 2011, Morgan Stanley Research was forecasting a period-end renminbi per US dollar rate of 6.20 in 2011 and of 5.82 in 2012.

Source: Morgan Stanley Smith Barney Investment Strategy. Hong Kong Center for Economic Research; “China Ends Fixed-Rate Currency” Washington Post, July 22, 2005; Bloomberg; Morgan Stanley & Co. Inc. Research. Data are as of December 31, 2010. Estimates are as of June 2011.

0

1

2

3

4

5

6

7

8

9

10

'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '06 '08 '10 '12

Chinese Renminbi per US Dollar Exchange Rate

Chinese Renminbi per US Dollar Exchange Rate

CNY/USD

1

2

3

4

6

7

1

2

5

3

Denotes a devaluation of the renminbi

Denotes a revaluation of the renminbi

The National Day of the People’s Republic of China is celebrated as a public holiday every year on October 1st throughout mainland China, Hong Kong, and Macau, with a variety of government-organized festivities, including fireworks and concerts. When the anniversary is a multiple of five (e.g., the 50th, 55th, or 60th), large scale official celebrations may be held, including an inspection of military resources on Tiananmen Square.

October 1st, The National Day of the People’s Republic of China

“China’s July 4th”

Source: www.chinatravel.com, www.chinahighlights.com.

E

Morgan Stanley Research forecasts





The Chinese Renminbi

132

Transforming the Renminbi into a Global Currency

• As of early 2011, the Bank of China Ltd. began allowing customers to trade the renminbi, also known as the yuan, in the United States, thereby expanding the nascent offshore market for the currency, which began in Hong Kong in 2010. The Bank of China, 70%-owned by the Chinese government, permitted companies and individuals to buy and sell the Chinese currency through accounts with its US branches.

• The decision represented another move by China to allow the renminbi, whose value had been tightly controlled by the government, to become an international currency that can be used for trade and investment.

• Until the middle of 2010, the buying and selling of the renminbi had largely been confined to mainland China by the country’s strict capital controls. In July 2010, China opened the currency to trading in Hong Kong.

• The preparations for convertibility reflect Chinese strength, as China, the world’s second-largest national economy, has recognized that as a significant global power it must have a global currency.

• In December 2010, Chinese regulators increased the number of exporters that could use yuan to settle international transactions from a few hundred to nearly 70,000.

• A number of currency strategists and economists have predicted that by 2015 or thereafter, 20% to 30% of China’s US$2.3 trillion in annual imports could be conducted in yuan rather than dollars. As of January 2011, less than 1% was denominated in yuan.

Source: “New Move to Make Yuan a Global Currency,” The Wall Street Journal, January 12, 2011.

Trans-Siberian Railway

The Trans-Siberian Railway is a network of railways connecting European Russia with Russia’s Far East provinces, Mongolia, and China. The main route, the Trans-Siberian, runs from Moscow to Vladivostok via southern Siberia and was built between 1891 and 1916. At 9,288 kilometers (5,772 miles) and spanning 8 time zones, it is the longest single continuous service in the world, and it takes approximately seven days to complete its journey.

Source: www.lonelyplanet.com.




Credit and Capital Markets

133

Credit and Capital Markets Issues for Consideration Include:

• Developing reliable and liquid markets for bank credit, mortgage finance, public and private equity, venture capital, money market instruments, and fixed income securities;

• Managing the internal and external value of the Chinese renminbi;

• Structuring appropriate conditions affecting capital flows;

• Channeling the contribution of foreign financial services and asset management firms;

• Broadening the institutional and individual investor base;

• Achieving a level playing field for investors, issuers, and intermediaries; and

• Strengthening and internationally advancing regulatory, legal, and accounting safeguards and standards.

Source: “Beijing – The Palace Museum,” WantChinaTimes, September 29, 2010, www.travelchinaguide.com.

The Palace Museum in Beijing

Chinese Proverbs• If you always give, you will always have. • Better a diamond with a flaw than a pebble without.• A thorn defends the rose, harming only those who

would steal the blossom. • A single conversation with a wise man is better than

ten years of study.

• If there is a wave, there must be a wind. • Keep your chin up. • No wisdom like silence. • Patience is a plaster for all sores. • The mind is the emperor of the body.

Source: www.worldofquotes.com.

The Palace Museum, also known as the Forbidden City, was the imperial residence and center of the kingdom during the reign of 14 emperors in the Ming dynasty and 10 in the Qing dynasty until 1912, the year that last emperor of the Qing dynasty and of China was overthrown.

Located in Beijing, the Palace Museum covers over 720,000m2 (7.2 million square feet), with over 9,000 rooms and a layout following strict feudal code. It is divided into two main sections, the Front Palace and the Inner Palace. In the center of the Front Palace stand the Hall of Supreme Harmony, the Hall of Complete Harmony, and the Hall of Preserving Harmony. The Inner Palace includes the Palace of Heavenly Purity, the Hall of Prosperity, the Hall of Earthly Peace, and the Imperial Garden.

More than an imperial palace, The Palace Museum is a treasure house of Chinese art, holding over 1.5 million Chinese relics, including paintings, calligraphy, porcelain, gold and silver wares, ancient books, imperial seals, and instruments.





Geopolitics

134

Geopolitical Issues for Consideration Include:

• China’s relations with:

– India, Japan, Mongolia, and Korea

– Other Neighboring Countries in Asia

– The United States

– The European Union

– Middle Eastern Countries

– The United Nations;

• China’s stance toward disputed territories and maritime zones;

• The integration of China’s economy, natural resources, population, financial system, weltanschauung, and military capabilities into global frameworks;

• China’s role in preventing the spread of nuclear, chemical, and biological weapons; and

• China’s role in shaping and addressing global climatological, environmental, and ecological issues.

During the period 713 – 756AD, the Tang dynasty reached its zenith. This era is also considered to be China's golden age of poetry, producing one of China’s greatest poets, Li Bai (701 – 762 AD).

The Golden Age of Poetry in China

Blue mountains to the north of the walls, White river winding about them; Here we must make separation and go out through a thousand miles of still grass. Mind like a floating wide cloud, Sunset like the parting of old acquaintances who bow over their clasped hands at a distance; Our horses neigh to each other as we are departing.

“Farewell to a Friend,” by Li Bai

Medallion Robe, Qing dynastySource: www.artsmia.org.


Source: www.chinapage.com.



China’s Maritime PositioningIn 2006 China Central Television showed a documentary series, Daguo Jueqi (The Rise of Great Powers). It included interviews with historians and international leaders and was considered accurate enough to be purchased by the History Channel and broadcast in the US. The twelve 50-minute episodes explained how the Portuguese, Spanish, Dutch, French, British, German, Japanese, Russian, and American empires rose, prospered, and fell.

The series also examines the maritime achievements of the major powers in their rise to global dominance. Whatever the population, size or territory of the originating country, its strategy was always to open to the outside world, to control the principal sea lanes and deep-water bases, and to master technology, naval action, and influence.

The documentary broke with decades of Chinese Communist Party historical ideology and revealed China's post-Millennium pragmatism as that of a rising power intent on avoiding its past political philosophy that left it in a long period of weakness during the 19th century.

China's intentions appear to address two major issues: (i) China’s territorial claims on Taiwan and the extent of Chinese territorial waters in its exclusive economic zone (EEZ); and (ii) with China having become the world's second largest oil importer, the protection of its four energy corridors: (i) the Straits of Malacca; (ii) the Sundra and Gaspan Straits; (iii) passages through Filipino waters; and (iv) via rail/pipeline/potential canal networks involving Myanmar and Thailand.

China has been in disputes with Japan over the Diaoyu Islands (Senkaku in Japanese) near Okinawa. Tokyo insists that its EEZ extends 450 km to the west of the archipelago, which Beijing contests by claiming the entire continental plateau that extends its own territory into the East China Sea. This area is estimated to contain a potential 200 billion cubic meters of natural gas. China is also in disputes with Taiwan, Vietnam, the Philippines, Malaysia, Brunei, and Indonesia over the Spratly Islands (Nansha in Chinese) and the Pratas Archipelago (Dongsha), and with Vietnam and Taiwan over the Paracel Islands (Xisha in Chinese).

Beijing has been building a string of permanent Chinese bases along the shores of the Indian Ocean and the maritime routes to Malacca including: Marao in the Maldives; Coco Island in Myanmar; Hambatota in Sri Lanka; Woody Island 300 miles east of the Paracel Archipelago; Chittagong in Bangladesh; and Gwadar in the Baluchistan region of Pakistan; with consideration given to the construction of coastal bases in Africa, several of whose countries have opened to Chinese investment.

The naval bases, river ports, sea walls, and protected submarine bases (including the new Sanya nuclear base on Hainan Island) have been expanded and modernized, as befits a nation whose foreign trade depends 90% on sea routes. In 2006 China’s sea-related industries accounted for 10% of GDP and seven of the world’s 20 leading ports were Chinese.

China's fifth national defense white paper in 2006 transferred priority from the army, which traditionally held pride of place, to the navy and air force.

The situation in the South China Sea is not a declared arms race, but a variable geometry opposition between the Indian, US, Australian, and Japanese fleets, and the Chinese and Pakistani fleets.

China’s history of naval action and influence and maritime positioning and technology dates back to the Ming dynasty. During the Ming dynasty, China commanded one of the world’s most advanced naval fleets and commissioned Admiral Zheng He to explore the seas of Southeast Asia. By the 15th and 16th centuries, China had mastered astronomic observation-based navigation and the compass, built multi-mast ships with pivotable rigging, and invented the anchor, the printing of marine navigation charts, the capstan, and the adjustable centre-board. Their junks had watertight compartments and stern-mounted rudders.

Military Profile in AsiaSooner than previously expected, China has been significantly altering the balance of military power in the Pacific and challenging the other nations’ ability to project military power in Asia, through the Dongfeng 21D land-based anti-ship ballistic missile, designed to target aircraft carrier groups with the help of satellites, unmanned aerial vehicles, and over-the-horizon radar.


China’s Maritime Positioning

135Source: Excerpted and adapted from “China’s Naval Ambitions,” by Olivier Zajec, Le Monde Diplomatique, September 2008; “China Flash of Maritime Muscle May Mean Power Push

in Asia Seas,” Bloomberg, March 23, 2009.




China’s Property Market

136

Current Landscape• As of early 2011, concerns persisted over the state of China’s property market, in which property prices had risen 86% from

January 2006 through March 2011. Although some economists believed that China’s property prices had started to show signs of stabilizing, its sharp 53% rise from January 2009 through March 2011 inspired caution that a potential bubble- bursting scenario was on the horizon.

• As a preferred way for individuals to store wealth and carrying minimal or no property taxes; with high savings rates, ample bank liquidity, and low national indebtedness; and in view with local governments’ dependence on revenues from land redevelopment, housing prices in China have at times have reached excessive valuation levels and exorbitant multiples of average annual earnings (for example, in Beijing in 2010, 18 times, compared to a 2006 US nationwide peak of 6.4 times).

• In addition to high property prices and high valuation levels, data as of early 2011 highlighted a vacancy issue: approximately 64 million apartments and houses had remained empty during the last six months of 2010, according to Chinese media reports.– On the assumption that each apartment could serve as a home to a typical Chinese family of three (two parents and one

child), the vacant properties could accommodate 200 million people, representing more than 15% of the country’s early- 2011 1.3 billion population. If correct, the empty dwelling units would have been sufficient to house over half of the US population at the time.

(5)05

101520253035

Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10

Residential Land Price Property Price

Land and Property PricesBased on 70 Major Cities in China% Year-over-Year (Monthly Data)

Source: CEIC; Morgan Stanley & Co. Inc. Research; BIS; Bloomberg, LLC. Data are as of December 31, 2010.

2468

101214161820

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 10

Beijing ShanghaiGuangzho Shenzhen

Property Valuation at Very High LevelsProperty Price/Annual Incomex

Source: Morgan Stanley & Co. Inc. Research, “China Property: Transaction Tracker,” May 12, 2011. Data are as of December 31, 2010.

18.0x16.4x13.9x

National Ave: 7.3x

9.8x

4,000

5,000

6,000

7,000

8,000

9,000

10,000

'06 '07 '08 '09 '10

National Property PricesRmb per Square Meter

Source: Morgan Stanley & Co. Inc. Research, “China Property: Transaction Tracker,” May 12, 2011. Data are as of March 2011.

President Hu Jintao on Social HousingIn a seminar in Zhongnanhai on November 30, 2010, President Hu Jintao called for “accelerating social housing construction and reinforcing adjustments in the property market.” His speech highlighted the government’s determination to meet the housing needs of the low-income population.The Ministry of Housing and Urban-Rural Development had set a construction target for 2011 of 10 million units, 70% more than the 5.8 million units in 2010. Investments in social housing construction could therefore potentially total more than Rmb 1,000 billion, or 20% of real estate investments. Source: Morgan Stanley & Co. Inc. Research, “From Goldilocks to

Reflation,” December 2010.

+53%

Source: Morgan Stanley Smith Barney; Morgan Stanley & Co. Inc. Research; SBS, “China’s Ghost Cities,” March 20, 2011.





China’s Property Market

137

• In 2010, investment in residential real estate accounted directly for 12% of China’s GDP, up from 10% in 2009 and a record.

• By contrast, the peak of spending on US residential investment in 2005 was equal to just 6% of GDP.

• A larger role for real estate in the Chinese economy means the consequences of a bust could be more serious than in the US. A crackdown on speculation saw growth in real-estate investment fall from 31% a year at the end of 2007 to 3% at the beginning of 2009. The hit to construction spending, as much as the fall in exports, crunched China’s GDP growth to a decade low of 6.5%. Data from Soufun Holdings, which runs China’s leading property website, indicated that average prices in first-tier cities such as Beijing and Shanghai were rising considerably faster than disposable incomes.

• Plans to build 10 million new budget residences in 2011 were expected to somewhat cushion China’s economy from a sharp slowdown in private-sector construction.

• In the US, mortgage debt reached 103% of GDP in 2007. As of March 2011, in China, long-term loans to households, a proxy for mortgage borrowing, was 16% of GDP. Including all loans to real-estate developers and a share of loans to local government investment vehicles (some of which were invested in property), the total would have been 50% of GDP.

Source: National Bureau of Statistics; Soufun Holdings; WSJ Reporting. Data are as of March 2011.

Source: “China: Subsidized, Not Subprime,” by Tom Orlik, The Wall Street Journal, March 26-27, 2011.

80

100

120

140

160

180

200

220

2006 2007 2008 2009 2010Tier I Cities (Soufun Holdings)Urban Per Capita Disposable IncomeNational Change (NBS)

China’s Property and Income IndicesIndex Level

Chinese Property Market: Subsidized, not Subprime10 Leading Indicators of Speculative Bubbles

Source: “China’s Red Flags,” by Edward Chancellor, GMO White Paper, March 2010.

1. Great investment debacles generally start out with a compelling growth story.

2. A blind faith in the competence of the authorities is another typical feature of a classic mania.

3. A general increase in investment is another leading indicator of financial distress.

4. Great booms are invariably accompanied by a surge in corruption.

5. Strong growth in the money supply is another robust leading indicator of financial fragility.

6. Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts.

7. Crises generally follow a period of rampant credit growth.

8. Moral hazard is another common feature of great speculative mania, with a prevailing belief that the authorities will not let bad things happen to the financial system.

9. During period of prosperity, financial structures become precarious.

10. Questionable loans are generally secured against collateral, most commonly real estate, with a combination of strong credit growth and rapidly rising property prices.



The Chinese character for “Wealth”


Inflation and Deflation

138

The Landscape• From January 2001 to December 2010, China’s CPI and PPI indices experienced significant episodes of inflation

and deflation, characterized by steep inclines and declines in price levels. • From April 2006 to April 2008, China’s CPI rose 12%; following that sharp rise in CPI levels, the CPI index fell

2% from April 2008 to October 2009. During these two periods from early 2006 to late 2009, China’s PPI also experienced volatile inflationary and deflationary price movements.

• As of March 2011, Morgan Stanley Research China Economists believed that inflationary pressures would remain relatively muted in China as they forecast the CPI to increase 4.5% year-over-year in 2011. Uncertainty surrounded the extent to which China’s potential strengthening of the renminbi might subdue inflationary pressures.

• In the absence of sufficiently assertive policy measures by the central government and the People’s Bank of China to address inflation expectations, cost of living increases, elevated money velocity, and bank lending, the authorities might have been expected to face: speculative purchases of property; mass hoarding of consumption goods (including grain, vegetables, and fuel); significant capital outflows; and possibly, some degree of social unrest.

Source: Morgan Stanley & Co. Inc. Research. Data are as of December 31, 2010.

(5)

0

5

10

15

20

25

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10

CPI Food CPI Non-Food CPI

Consumer Price Index (CPI)% Change Year-Over-Year (Monthly Data)


(15)

(10)

(5)

0

5

10

15

20

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10

PPI Producer Goods PPI Consumer Goods PPI

Producer Price Index (PPI)% Change Year-Over-Year (Monthly Data)


1 Industry2 Producer Goods

ExcavationRaw MaterialsManufacturing

3 Consumer GoodsFoodClothingDaily-Use ArticlesDurable Goods

Composition of China's PPI Index

Source: www.chineseculture.about.com.

Source: Morgan Stanley Smith Barney Investment Strategy; Morgan Stanley & Co. Inc. Research, “China Economics: China Inflation Tracker,” March 29, 2011.





Inflation and Deflation

139

Morgan Stanley Research Estimates for China’s Headline CPIAs of March 2011

Renting and Private Housing8.9%

Water, Electricity, and Fuel6.0%

Building and Decoration Materials4.0%

Estimated Residence Weights (18.9%)2011

Tobacco and Beverages4.0%

Clothing8.5%

Household Facility and Services5.8%

Residence18.9%

Medicine, Medicare, and Articles9.0%

Food30.3%

Transportaion and Communication9.3%

Recreation, Education, Culture Articles, and Services14.2%

Estimated CPI Weights2011

The Consumer Pricing Index• Although CPI weights have generally been kept confidential in China, the National Bureau of Statistics (NBS) has been known

to revise them every five years. The window of revision opened again in 2011 after the previous reweighting in 2006.• In January 2011, the NBS released data regarding CPI weights. The food weighting in the CPI was cut by 2.21 percentage

points to allow more reflection of certain non-food components in the CPI. Changes in weightings of the non-food components included: residence, +4.22 percentage points; tobacco and beverages, -0.55 percentage points; clothing, +0.36 percentage points; household facility and services, +0.36 percentage points; medicine, medicare, and articles, -0.36 percentage points; transportation and communication, +0.05 percentage points; and recreation, education, culture articles, and services, +0.25 percentage points.

• As of March 2011, Morgan Stanley Research estimated that the food weighting in the CPI could have been downsized to 30.3% after the re-weighting, and consequently, the non-food CPI could have risen to 69.7%.

• As of early 2011, the NBS had classified “property purchase” as an investment as opposed to a consumed good; as a result, property prices were not reflected in “residence,” nor in headline CPI. In 2009, the NBS reported that the residence portion of the CPI accounted for 14.7% of the headline CPI. As of March 2011, Morgan Stanley Research estimated that the residence portion accounted for 18.9% of the headline CPI. Morgan Stanley Research’s detailed breakdown of the residence portion consisted of: renting and private housing, 8.9%; water, electricity, and fuel, 6.0%; and building and decoration materials, 4.0%.

CPI Re-Weighting in 2011 Percentage Point Change vs. 2006 Weighting

Food 2.21

Non-food 2.21

Tobacco and Beverages 0.51

Clothing 0.49

Household Facility and Services 0.36

Medicine, Medicare, and Articles 0.36

Transportation and Communication 0.05 Recreation, Education, Culture Articles, and Services 0.25

Residence 4.22

Source: Morgan Stanley & Co. Inc. Research, “China Economics: China Inflation Tracker,” March 29, 2011.

Source: National Bureau of Statistics; CEIC; Morgan Stanley & Co. Inc. Research. Estimates are as of March 29, 2011.



ResourceGlobal

Ranking% of World

ReservesCoal 3 13.3

Natural Gas 14 1.5

Oil 14 1.1

Based on 2010 Data

Energy TypeGlobal

Ranking% Consumption

of WorldCoal 1 48.2

Oil 1 20.3

Hydroelectric 1 21.0

Wind 1 22.4

Natural Gas 4 3.4

Nuclear 9 2.7

Solar 9 2.2

Geothermal 18 0.2

Carbon Dioxide Emissions 1 25.1

China's Energy Consumption

(Twelve Months Ending November 2010)

CountryTonnes

(Millions)Barrels

(Millions)1 Saudi Arabia 45.3 332

2 Angola 40.8 299

3 Iran 21.1 155

4 Russia 15.2 111

5 Oman 15.2 111

6 Sudan 12.8 94

7 Iraq 10.6 78

8 Kazakhstan 10.0 73

9 Kuwait 9.7 71

10 Brazil 7.9 58

The Ten Largest Oil Exporters to China


Energy

Energy Issues for Consideration Include:• China’s elasticity of oil, gas, and coal supply;• China’s usage of hydro, solar, wind, nuclear, and biomass energy sources;• The structure, efficiency, and strategic positioning of China’s state-owned energy enterprises.• China’s onshore and offshore oil-and-gas exploration activity and overall energy import infrastructure;• New exploration and drilling activity in China and nearby territories;• Price differentials for energy products sold in domestic compared to non-domestic markets; and• Pathways of China’s external investment in the energy sector, and the forms and degree of allowable

foreign investment in the energy sector.

140

China’s Natural ResourcesChina’s reserves of natural resources include coal, iron ore, petroleum, natural gas, mercury, tin, tungsten, antimony, manganese, molybdenum, vanadium, magnetite, aluminum, lead, zinc, rare earth elements, and uranium.

Source: Morgan Stanley & Co. Inc. Research, “Global CleanTech,” March 22, 2011.

Source: Haven Analytics; US Census Bureau, Foreign Trade Division. Data are as of November 2010.

Source: CIA Factbook, BP Global, BP Statistical Review of World Energy, June 2011.

22.4 9.4 16.1

63.497.6

127.4

7.055.0 45.611.8

3.6 4.1 10.3

17.6

5.0132.4

41.2

68.0 65.873.7

115.2

0

25

50

75

100

125

150

Nuclear CCGT Coal OnshoreWind

OffshoreWind

Solar PV

Capital Costs Fuel Costs Operation Costs

China Energy EconomicsData are as of March 2011Total Generation Costs (US$/MWh)

Note:1. CCGT stands for “combined cycle gas turbine,” a power generation method that uses

natural gas to produce electricity.

(1)


Source: CIA Factbook, BP Global, BP Statistical Review of World Energy, June 2011.




Security

Security Issues for Consideration Include:

• Achieving harmonization of laws and equitable law enforcement;

• Enforcing anti-corruption initiatives;

• Policing, counterterrorism activity, and cooperation with global antiterrorism agencies;

• The position of the Chinese military and police forces in public opinion; and

• Responsiveness to citizens’ concerns and dissent.

141

Excerpt from Chi’ing China Dream of The Red ChamberFour thousand six hundred and twenty-three years ago the heavens were out of repair. So the Goddess of Works set to work and prepared 36,501 blocks of precious jade, each 240 feet square by 120 feet in depth. Of these, however, she only used 36,500, and cast aside the single remaining block upon one of the celestial peaks. This stone, under the process of preparation, had become as it were spiritualized. It could expand or contract. It could move. It was conscious of the existence of an eternal world, and it was hurt at not having been called upon to accomplish its divine mission.

One day a Buddhist and a Taoist priest, who happened to be passing that way, sat down for a while to rest, and noticed the disconsolate stone which lay there, no bigger than the pendant of a lady's fan.

"Indeed, my friend, you are not wanting in spirituality," said the Buddhist priest to the stone, as he picked it up and laughingly held it forth upon the palm of his hand. "But we cannot be certain that you will ever prove to be of any real use; and, moreover, you lack an inscription, without which your destiny must necessarily remain unfulfilled."

The Abacus

Dating back to 2700 – 2300 BC, the abacus is a primitive calculator that was created by the Sumerians, a civilization of southern Mesopotamia, present-day Iraq. Throughout history, the abacus has been used by the Egyptians, Greeks, Persians, Romans, Chinese, Indians, Taiwanese, and Japanese, among others.

In 300 BC, Chinese mathematicians developed a counting system based on the number 10, and they used the abacus to expedite calculations. An abacus is rectangular in shape, and it has beads suspended on a rod, with a beam running from one end of the frame to the other. To use the abacus, the beads on the rods are moved towards and away from the beam.

In 1984, Taiwanese artist Qian Haosun handcrafted this wooden-framed abacus, using metal rods and porcelain beads decorated with dragons. It now resides in the British Museum in London.

Source: The British Museum, www.britishmuseum.org.

Made by Qian Haosun, 1984


Source: Cao Xueqin, The Dream of the Red Chamber. Translated by Henry Giles, http://www.wsu.edu/~dee/CHING/DREAM.htm.




142

Inventive Creative Trusting Charitable

Repressive Authoritarian Ambitious Unfair Regimented Copycat

1 2

China’s Favorable Views of US US’s Unfavorable Views of ChinaArrogant Nationalistic Imperialistic Cold-hearted Corrupt Duplicitous

Dedicated Driven Hard-working Disciplined Pragmatic

China’s Favorable Views of US US’s Favorable Views of ChinaHistorically Aware Purposeful Goal-oriented Motivated Persevering

Entrepreneurial Idealistic Freedom-loving Hard-working Open

Inventive Creative Trusting Charitable

Entrepreneurial Idealistic Freedom-loving Hard-working Open

Potential Outcome

Resentment MistrustDisappointment

Potential Outcome

Harmony, Sharing, Cooperation, Mutual Trust, Symbiosis, Growth, Prosperity, and Global Affirmation

Suboptimal Outcome Best Outcome

3 4

China’s Unfavorable Views of US US’s Unfavorable Views of China China’s Unfavorable Views of US US’s Favorable Views of ChinaXenophobic Obstructionist Arrogant Hedonistic Selfish Profligate

Repressive Authoritarian Ambitious Unfair Regimented Copycat

Arrogant Nationalistic Imperialistic Cold-hearted Corrupt Duplicitous

Hypocritical Meddling Naïve Wasteful Undisciplined Imperialistic Short-Termist

Dedicated Driven Hard-working Disciplined Pragmatic

Historically Aware Purposeful Goal-oriented Motivated Persevering

Xenophobic Obstructionist Arrogant Hedonistic Selfish Profligate

Hypocritical Meddling Naïve Wasteful Undisciplined Imperialistic Short-Termist

Potential Outcome

Testing, Protectionism, Friction, Mutual Recrimination, Conflict, and Global Disruption

Potential Outcome

Resentment Mistrust Disappointment

Worst Outcome Suboptimal Outcome

The Relationship Between the US and ChinaFour Potential Scenarios and Outcomes

Source: Morgan Stanley Smith Barney Investment Strategy (June 2011).




Other IssuesClassified by Subject Matter

143

• Central Bank Independence: Improved pricing of bank credit, more market-determined interest rates, and firmer control over inflationary forces might result from devolving more power and independence to China’s central bank, the People’s Bank of China, which as of May 2011 was one of 27 ministries and agencies under the direction of the State Council and the National Development and Reform Commission (formerly the highly powerful State Planning Commission).

• Financial Market Liberalization: As China continues to open its markets, loosen controls on the renminbi, and gradually transform the nation into a more consumer-focused economy, the country’s financial importance has been growing to global commercial and investment banks, hedge funds, and private equity firms: (i) initial public offerings of Chinese companies reached US$104 billion in 2010 (US$124 billion including Hong Kong companies); (ii) equity trading volume on Chinese and Hong Kong stock exchanges rivaled aggregate US markets’ equity trading turnover; and (iii) Chinese companies completed 3,455 mergers and acquisitions worth US$190 billion, or 9% of global transactions in 2010.

• Monetary Supply and Bank Lending Growth: M-2 rose 19.7% annualized in December 2010, considered quite high for an economy growing at a 10% rate; in fact, M-2 in China had risen from US$1.5 trillion in 2000 to US$11 trillion as of December 2010, larger than the US M-2 of US$9 trillion; in addition, as of May 2011, bank lending in China was larger than in the US, even though its economy was smaller.

• Fostering Innovation: In a document published by the State Intellectual Property Office of China called “National Patent Development Strategy (2011–2020),” China has identified innovation as a key to higher living standards and long-term growth and has set an ambitious goal of two million annual patent filings by 2015, up from 600,000 in 2009 (of which 300,000 were “utility-model patents,” which usually cover products’ engineering features and are less ambitious than the 300,000 invention patents–in the American patent system, there are no utility patents and in 2009 in the US, patent filings totaled approximately 500,000).

• Increased Foreign Investment Flexibility for Chinese Companies: With an effective date of January 1, 2011, China’s State Administration for Foreign Exchange (SAFE) ruled that Chinese companies were allowed to retain and invest export income outside of China; as a result: (i) the growth rate of China’s foreign exchange reserves appeared likely to diminish significantly; (ii) the likelihood of unduly restrictive Chinese monetary policy was expected to lessen; (iii) the rate of speculation in and appreciation of property prices in China appeared likely to slow; (iv) Chinese companies were deemed likely to increase their acquisitions and direct investment activity in the US and other countries, with special emphasis in sectors where China lacked sufficient domestic resources (including oil, uranium, iron ore, nickel, platinum, copper, titanium, chrome, lithium, manganese, and potash, among other areas).

• Increased Overseas Economic Presence: On February 14, 2011, assisted by a US$2.5 billion loan from the state-owned Export-Import Bank of China, the China State Construction Engineering Corporation (the country’s largest construction firm by revenue) broke ground on Baha Mar Resorts Ltd., a US$3.4 billion hotel, casino, and resort project slated to employ as many as 8,000 Chinese construction workers in Nassau, the Bahamas. This plan is part of the company’s initiative to showcase outside China its complex project management capabilities.


Economic Reform/ Technological Innovation Socioeconomics Central Government/

Foreign RelationsCommodities/

Natural ResourcesFinancial System/ Monetary Policy



• Intellectual Property: As China continues to more assertively address issues associated with compulsory disclosure, licensing and/or transfer of foreign technologies, and to vigilantly assure the protection of foreign innovation and intellectual property, including software, copyrights, patents, trademarks, trade secrets, and technical knowhow, in certain businesses including desktop computers, solar panels, wind turbines, high-speed trains, nuclear reactors, and biotechnology, Chinese companies have at times been perceived by foreign firms as acquiring advanced technology through strict local content requirements, preferential contracts favoring state-owned companies, and other means, and then using such knowledge, in addition to low-cost local labor, low-interest loans from state-owned banks and inexpensive government-supplied land, to pursue dominant Chinese global market positions for such products.

• Transformation of Economic Priorities: Following an October 2010 four-day plenum meeting held in Beijing attended by all standing members of the Politburo, the 17th Central Committee of the Communist Party of China issued a communiqué focused on structural issues, reforms, and economic rebalancing in the nation’s 12th Five-Year Plan (2011–2015), for the first time prioritizing domestic consumption ahead of investments and exports.

• Augmenting the Social Safety Net: As part of initiatives to continue funding the social security system, to broaden public confidence in government pension schemes, to foster a shift from very high savings rates to increased household consumption, and to extend the lockup period of the transferred equities by another three years, in June 2009, China transferred to the National Social Security Fund 8.4 billion shares in 131 companies listed on stock exchanges since 2005.

• Empowering Rural Economic Growth: As of May 2011, urban wage levels in China’s inland provinces averaged 50–60% of urban wage levels in the coastal provinces, whereas inland per square meter property prices averaged 25–33% of coastal levels; in other words, migrant workers from the inland provinces could potentially double their wages by moving to a coastal province, with coastal property prices triple to quadruple inland property price levels; among the institutional reforms potentially capable of stimulating rural economic growth are: (i) granting full trading rights of land to rural residents; (ii) improving village governance and election procedures; (iii) eliminating the hukou restrictions (please see page 39) on rural migrants’ access to full urban residency and public services; (iv) providing automobile and home appliance subsidies; (v) improving local healthcare resources; and (vi) increasing financial support for small and mid-sized businesses in rural areas.

• Public Reaction to Pollution: Especially in rural areas where environmental regulation and enforcement has at times been lax and where local officials, under pressure to generate economic growth, have encouraged the development of sometimes unlicensed factories, pollution problems including lead poisoning and toxic gas leaks have led to grass-roots dissatisfaction, public protests, and occasional civil unrest.

• Securing Employment for University Graduates: From 800,000 university graduates annually in 1998 to more than 6 million per year in 2010, China’s large supply of higher-degree recipients trained in accounting, finance, computer programming, and other white-collar occupations has faced significant difficulty in securing challenging and rewarding work. Such difficulty represents a potential source of social instability.


Other Issues

144Source: Morgan Stanley Smith Barney Investment Strategy.

Classified by Subject Matter







Other Issues


• Unleashing the Potential of Megacities: To reap the benefits of integration, efficiency, productivity, shared infrastructure, and sustainability, in January 2011, China announced plans to merge nine Pearl River Delta cities (Guangzhou, 12 million; Shenzhen, nine million; Dongquan, seven million; and six smaller cities with 14 million inhabitants) into a 41,000 square kilometer (14,000 square miles, roughly 25 times the surface area of London) metropolis with more than 42 million people accounting for approximately 10% of the country’s Gross Domestic Product.

• Wage-Price Pressures: According to the International Labour Organisation and Morgan Stanley Economist Stephen Roach, partially reflecting annual productivity growth estimated at 10-15% annually from 1990 through 2010, Chinese workers received real wage increases averaging 12.6% a year from 2000 through 2009 (compared with 1.5% in Indonesia and 0% in Thailand); as of May 2011, Chinese workers were paid approximately US$400 per month, less than workers in Taiwan and Malaysia, but three times more than workers in Indonesia and five times more than workers in Vietnam; by continuing to raise minimum wages, Chinese officials have sought to avert labor unrest while setting in motion concerns about persistent and rising inflation.

• China and Africa: In part due to China’s large foreign currency reserves, in part due to having avoided several developed western nations’ colonial heritage in Africa, and in part due to greater acceptance by China of the current political status quo in many African countries, in the post-2000 era, China has increased its direct investment, infrastructure development projects, and political influence on the African continent. To China, Africa offers not only import sources of significant natural resources, but also important markets for Chinese consumer, industrial, and technological exports.

• China and Central Asia: Central Asia (consisting of Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan) has been increasingly viewed by Chinese officials as a critical frontier for the nation’s energy security, trade expansion, ethnic stability, and military defense.

• China and North Korea: As North Korea’s principal supplier of food and fuel, China could use its leverage to rein in Pyongyang’s nuclear ambitions and exports of nuclear technology, in spite of two Chinese concerns if the Kim dynasty collapsed and the two Koreas (North and South) were reunified as one nation: (i) a large influx of North Korean refugees into China; and (ii) the resulting presence of American military resources close to the China-Korea border.

• China and Southeast Asia: Following China’s 2010 free-trade agreement with the Association of South-East Asian Nations (ASEAN), China in late 2010 and early 2011 signed agreements to modernize and/or build new rail lines in Laos and Thailand, while extending its rail network from Kunming (capital of the Yunnan province) to the China-Laos border and conducting feasibility studies for rail upgrades in Myanmar, Vietnam, and Cambodia.

• China and Taiwan: Between the March 22, 2008 election of Ma Ying-jeou as Taiwan’s president and early 2011, 15 cross-strait agreements were signed, including the 2010 Economic Cooperation Framework Agreement; China plus Hong Kong accounted for 40% of Taiwan’s exports and a 2010 Taiwanese bilateral trade surplus of US$70 billion; Taiwanese businesses had US$90 billion invested in China, where 800,000 Taiwanese lived as of early 2011; following the July 2008 inauguration of direct flights between Taiwan and China, more than 1.6 million Chinese tourists visited Taiwan in 2010.








Other Issues



• Cyberwarfare: To varying degrees, the US, the UK, China, Russia, Israel and other world powers have considered established codes of conduct: (i) placing the onus for investigating aggressive acts on the countries where those attacks originated; (ii) banning behavior opposed by all countries (such as the disabling of networks and data theft); and (iii) clarifying what kinds of cyberactivity might trigger an armed cyber response to cyberwarfare, which aims to disrupt military and civilian networks.

• Diffusion of Power: Unlike the eras of unquestioned centralized authority and consistent policies pursued under Mao Zedong, Jiang Zemin, or Deng Xiaoping, a number of rival power centers, including the military, ministries, and large state-owned corporate interests may have increased the difficulty of resolving bilateral disputes and pursuing China’s broad foreign policy goals.

• Commodity Intensity: The International Monetary Fund has estimated that driven primarily by a less-rapid pace of investment growth, China’s potential growth rate would slow to approximately 7% per annum between 2016 and 2020, compared to an average annual growth of 9.6% for the 15-year period from 1995 through 2009; as China placed increased emphasis on energy efficiency, the country’s service sector was projected to expand relative to manufacturing and heavy industry and consequently, China’s demand for commodities was thought possibly likely to be significantly lower than consensus projections.

• The Critical Importance of Water: As of early 2011, China had 20% of the world’s population, supported by 7% of the world’s fresh water supply (approximately the same as Canada, with China having 40 times Canada’s population); the per-capita volume of water consumption in China was 25% of the global average, projected to decline to 20%; one-third the length of China’s rivers, three-quarters of its principal lakes, and one-quarter of the country’s coastal waters were rated as “highly polluted;” in the Yellow River region and in much of the arid North China plain (including the provinces of Heilongjian, Jilin, Liaoning, Hebei, Shanxi, Beijing, and Tianjin – Northern China possesses only 18% of the country’s water, with 62% of its agricultural land) surface water supply has declined in the post-2000 era and due to exploitation, underground water levels fell as much as three feet annually over the 1975-2000 time period, necessitating the drilling of deep wells to reach water and highlighting the importance of agriculture and water infrastructure improvements, including reservoirs, embankments, pivot and drip irrigation systems, aqueducts, wastewater treatment plants, transfer tunnels, dams, pumping and recycling stations, and desalination facilities.

• Increased Demand for Gold: With a limited number of instruments for investing in cash; when low interest rates produce low or negative real returns on bank deposits; and when real estate investment/speculation is curtailed by the Authorities; Chinese retail demand tends to rise for physical gold (in the form of jewelry, bullion, bars, and coin), gold mining shares, and other gold-linked investment vehicles; according to the World Gold Council, Chinese demand for gold for investment purposes rose 169% from 25.6 metric tons (823,040 troy ounces) in 2007 to 68.9 metric tons (2,215,135 troy ounces) in 2008.

• Strategic Oil Reserves: As a buffer against sudden disruptions of oil supplies, in late 2008 and early 2009, China began building its strategic oil reserves toward a goal of 500 million barrels (equal to 60 days’ supply at 2009 demand levels); as of March 2011, the US’s strategic oil reserve held 727 million barrels.






Source: chinavisita.com.

Section 5

Overview of the Investment Landscape

Emperor's 12-Symbol Robe, Qing dynasty (1644 – 1912)

The 12 Symbols of Chinese Authority

Official costume in imperial China was highly regulated, and the decorative motifs of court costumes were specific to rank. Among the emblems employed for the emperor's ceremonial robes were the twelve imperial symbols: sun, moon, constellation, mountain, pair of dragons, pair of pheasants, libation cups, water weed, millet, fire, ax, and the symmetrical "fu" symbol. A bright yellow was reserved for the emperor, but for some ceremonies, the requisite color was blue. The garment worn for actual rituals was the more formal court robe ("chao pao"), whereas the dragon robe ("qi fu") was used for the periods of fasting that preceded the ceremony. Source: The Metropolitan Museum of Art.

The history of Chinese literature begins with the Shijing or Book of Songs, an anthology of 305 lyrics of various types, compiled circa 300 BC. Most of the songs probably were composed and sung between 1000 and 700 BC. Some historians have suggested, however, that certain lyrics from the Book of Songs may represent much earlier work, dating from the Shang dynasty (1766 – 1122 BC). According to the tunes they were sung by, the poems were divided into three categories, namely, Feng (Ballads), Ya (Festal Odes), and Song (Sacrificial Songs). Feng consists of 160 poems, Ya consists of 105 poems, and Song consists of 40 poems.

The Shijing or Book of Songs

Guan! Guan! Cry the fish hawks on sandbars in the river: a mild-mannered good girl, fine match for the gentleman.

A ragged fringe is the floating-heart, left and right we trail it: that mild-mannered good girl, awake, asleep, I search for her.

I search but cannot find her, awake, asleep, thinking of her, endlessly, endlessly, turning, tossing from side to side.

A ragged fringe is the floating-heart, left and right we pick it: the mild-mannered good girl, harp and lute make friends with her.

A ragged fringe is the floating-heart, left and right we sort it: the mild-mannered good girl, bell and drum delight her.

“Guan! Guan! Cry the Fish Hawks”

Poem from the Shijing, c.300 BC

Source: chinavisita.com; The Penguin Book of Chinese Verse, by Robert Kotewell and Norman Smith (Penguin, 1962).

147



Type Exchange Listing Further Details Description Potential Issues Closed-End and Open-End China/Taiwan Mutual Funds

New York p. 149 Mutual funds that invest primarily in the equities of companies whose principal business is based in China or the Greater China region, including Hong Kong and Taiwan

Investors cannot actively manage the holdings in the underlying mutual funds

Private Equity/Venture Capital Funds

Not applicable p. 150 Private equity and venture capital funds investing in China Some degree of illiquidity and lack of transparency

A Shares Shanghai, Shenzhen p. 151 A Shares are issued by Chinese companies and commenced trading in 1990

The A Shares stock market is China’s largest stock market, and the fifth largest stock market in the world

Limited to domestic investors and qualified foreign institutional investors

B Shares Shanghai, Shenzhen p. 152 B Shares are issued by Chinese companies and commenced trading in 1991

Traded in foreign currencies (US and Hong Kong dollars)

Generally smaller, less liquid market Small-sized companies Relatively narrow investor base

H Shares Hong Kong p. 153 H Shares are issued by Chinese companies and commenced trading in 1993

Generally intended to help restructure State-Owned Enterprises (SOEs) through debt reduction and higher levels of equity capital

Companies with traditional management styles Relatively limited information access and disclosure

Red Chips Hong Kong p. 154 Red Chip shares are issued by Chinese companies that are incorporated in Hong Kong and are owned directly or indirectly by the Chinese government

Relatively small-sized companies Degree of core business focus

P Chips Hong Kong p. 155 P Chip shares are issued by overseas-registered Chinese companies that are run by Chinese nationals and have no affiliations with the Chinese government

Relatively small market Relatively limited information access and disclosure

Other China-Related Indices

Shanghai, Shenzhen, Hong Kong, United States

pp. 156-157 Indices that track various Chinese shares or US-listed companies with exposure to China that are available to domestic or foreign investors

Degree of core business focus Relatively limited information access and disclosure

ADRs

United States, London p. 158 American Depository Receipts based on H shares or other non-U.S. Chinese-related companies

Used by foreign companies to increase liquidity and raise their investor profile

Limited number of China-based ADRs May have limited liquidity

Convertible Bonds (Primarily Traded Over-the-Counter)

Shanghai, Shenzhen, Hong Kong, and Singapore

p. 159 A corporate bond issued by a Chinese-related company convertible into shares at a predetermined price

Limited number of China-based convertible bonds

US, European, and Asian Corporations

United States, London, Paris, Tokyo, and Taiwan, among others

p. 160 US, European, and Asian corporations with exposure to China, through subsidiaries, partnerships, ventures, or sales channels in China

Government regulations and degree of exposure to China

Economic conditions in domicile country or region may affect the realized exposure to China

OVERVIEW OF THE INVESTMENT LANDSCAPE

Examples of Vehicles for Portfolio Investment in China

Source: Morgan Stanley Smith Barney Investment Strategy, Morgan Stanley & Co. Inc. Research.

148




Overview of Closed-End Funds with Exposure to Greater China

• Closed-end funds with exposure to the greater China region may trade at a premium or at a discount to their Net Asset Value (NAV).

• Investors may also consider a range of open-end funds with exposure to the Greater China region and should consult funds’ prospectuses for details.

• Investors may consider diversified emerging markets or Asia-Pacific funds as additional possibilities to obtain exposure to China.

• Sources of further information about closed-end funds include:

– www.cefconnect.com

– www.bloomberg.com

– www.finance.yahoo.com

149

Source: The Overseas Compatriot Affairs Commission of Taiwan.

(Born Inside or Outside of China)

Top 20 Countries2005 Overseas

Chinese Population

1 Indonesia 7,566,200

2 Thailand 7,053,240

3 Malaysia 6,187,400

4 United States 3,376,031

5 Singapore 2,684,900

6 Canada 1,612,173

7 Peru 1,300,000

8 Vietnam 1,263,570

9 Philippines 1,146,250

10 Myanmar 1,101,314

11 Russia 998,000

12 Australia 614,694

13 Japan 519,561

14 Cambodia 343,855

15 United Kingdom 296,623

16 France 230,515

17 India 189,470

18 Laos 185,765

19 Brazil 151,649

20 Netherlands 144,928

Top 20 Countries 36,966,138

Overseas Chinese



0

5

10

15

20

'98 '00 '02 '04 '06 '08 '10

Chinese PE Annual FundraisingUS$ Billions

(1)

• As of late 2010, there were 167 registered foreign managers of private equity funds in China and 265 domestic ones, up from almost none in 2000, according to Asia Private Equity Research.

• In August 2010, Chinese officials lifted a restriction on registered insurance companies placing money with private equity firms; they were allowed to invest up to 5% of their assets.

• A typical Chinese private-equity investment is a non-controlling stake of 15– 40% in an operating company, with the money intended as growth capital.

• From 2005 through late 2010, private equity firms raised more than US$57 billion for investment in China, but as of late 2010, much of that was thought not to have been deployed, according to Preqin, a research firm.


Overview of Private Equity/Venture Capital in ChinaFrom Nascent Beginnings to Burgeoning Present Times

Source: The Economist, “Barbarians In Love,” November 27, 2010.

Private Equity Venture Capital

Source: Center for Asia Private Equity Research

Chinese PE Internal Rates of Return

Source: Center for Asia Private Equity Research

Note:1. Chinese PE Annual Fundraising data are as of late 2010.

Source: Zero2IPO Group.

• Similar to private equity, venture capital in China was a verdant, nascent industry pre-2004, but has since blossomed into a robust and growing industry.

• Chinese and non-Chinese VC firms have been investing capital into growing businesses.

• A significant portion of the funds raised in the 2009 and 2010 years by Chinese and non-Chinese VC firms were denominated in Chinese renminbi.

1.7 1.8 2.0

3.8

1.31.41.0

1.4

0.6

3.0

2.3

0.00.51.01.52.02.53.03.54.04.5

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

Venture Capital Fundraising in ChinaUS$ Billions

2008 2009 2010

Number of New Funds:

24 42 21 29 16 19 26 33 31 30 33

By the Year the Deal was Struck

Year % Year %1998 -5.9 2003 21.31999 -8.3 2004 32.62000 16.1 2005 31.32001 8.2 2006 25.92002 8.6 2007 5.2

• Sources of further information about Chinese and non-Chinese private equity firms with exposure to China include:– www.pedaily.cn/en/– www.asiape.com– www.preqing.com

• Sources of further information about Chinese and non-Chinese venture capital firms with exposure to China include:– www.pedaily.cn/en/– www.asiape.com– www.preqing.com

150





Overview of Chinese A Shares

Source: MSCI; FactSet.

Select Famous Chinese Actors

Michelle Yeoh (1962 – )Born in Ipoh, Malaysia, Michelle Yeoh is a successful Chinese actress. She has acted in Hong Kong and Hong Kong, receiving critical acclaim. Her notable roles include Crouching Tiger, Hidden Dragon in 2000, and Memoirs of a Geisha in 2005.

Bruce Lee (1940 – 1973)Born in San Francisco, California, Bruce Lee was a Chinese-American actor and martial artist. He founded the martial art style, Jeet Kune Do. His famous roles include the Way of the Dragon in 1972, and Enter the Dragon in 1973.

Source: http://chinese-school.netfirms.com, Photos, wikipedia.com,http://idomartialarts.com.

Chow Yun-Fat (1955 – )Born in Hong Kong, China, Chow Yun-Fat is a renowned Chinese actor. He has acted in Hong Kong and Hollywood, receiving numerous awards for best actor and best supporting actor. His most notable roles include Crouching Tiger, Hidden Dragon in 2000, and A Better Tomorrow in 1986.

• A Shares are issued by Chinese companies and listed on the Shanghai and Shenzhen stock exchanges. A shares are restricted to Chinese investors and qualified institutional foreign investors (Please see page 110).

• The Shanghai Stock Exchange A-Share Stock Price Index is a capitalization-weighted index that includes all A-shares listed on the Shanghai Stock Exchange. The index is denominated in yuan and had 876 constituents as of May 2011. The index was inaugurated on February 21, 1992, with a base value of 100 on December 19, 1990.

• The Shenzhen Stock Exchange A-Share Stock Price Index is a capitalization-weighted index that includes all A-shares listed on the Shenzhen Stock Exchange. The index is denominated in yuan and had 1,205 constituents as of May 2011. The index was inaugurated on October 4, 1991, with a base value of 100 on April 3, 1991.

• Sources of further information about A-shares indices include:– www.sse.com– www.szse.com

Industrials24%

Materials18%

Consumer Discretionary13%

Financials13%

Health Care8%

Consumer Staples8%

Information Technology7%

Energy5%

Other4%

MSCI China A Index – Sector BreakdownAs of May 2011Index Weight (%)

Source: MSCI; FactSet.

MSCI China A Index

• The MSCI China A Index is a capitalization-weighted index that seeks to represent the A-shares listed on the Shanghai and Shenzhen stock exchanges. The index provides Chinese investors with a benchmark of the A- shares stock market. As of May 2011, the index had a market capitalization of US$948 billion, with 599 constituents.

• For further information, please go to www.msci.com.

Overview of Chinese A Shares

Source: Bloomberg, LLC; Shanghai Stock Exchange; Shenzhen Stock Exchange; Asian Equity Research Institute; www.chinadaily.com.


151




Overview of Chinese B Shares

• B Shares are issued by Chinese companies and listed on the Shanghai and Shenzhen stock exchanges. B shares are available to Chinese investors and foreign investors (Please see page 110).

• The Shanghai Stock Exchange B-Share Stock Price Index is a capitalization-weighted index that includes all B-shares listed on the Shanghai Stock Exchange. The index is denominated in US dollars and had 53 constituents as of May 2011. The index was inaugurated on February 19, 2001, with a base value of 100 on February 21, 1992.

• The Shenzhen Stock Exchange B-Share Stock Price Index is a capitalization-weighted index that includes all B-shares listed on the Shenzhen Stock Exchange. The index is denominated in Hong Kong dollars and had 53 constituents as of May 2011. The index was inaugurated on October 6, 1992, with a base value of 100 on February 28, 1992. The index has been open to investors since February 19, 2001.

• Sources of further information about B-shares indices include:– www.sse.com– www.szse.com

Financials50%

Energy25%

Industrials25%

MSCI China B Index – Sector BreakdownAs of May 2011Index Weight (%)

MSCI China B Index

• The MSCI China B Index is a capitalization-weighted index that seeks to represent the B-shares listed on the Shanghai and Shenzhen stock exchanges. As of May 2011, the index had a market capitalization of US$8 billion, with four constituents.


Overview of Chinese B Shares

Source: Bloomberg, LLC; Shanghai Stock Exchange; Shenzhen Stock Exchange, Asian Equity Research Institute; www.chinadaily.com.

In Chinese culture, Yin and Yang represent the two opposite principles in nature. The yin- yang doctrine teaches that everything in the universe is the product of the yin and yang principles. Yin, literally meaning “female, night, lunar” in Mandarin, is characterized by darkness, passivity, and coldness. Yang, literally meaning “male, daylight, solar” in Mandarin, is characterized by light, activity, and heat. Together, the yin and yang bring forth changes in the universe through the five material agents: water, wood, fire, earth, and metal. The interaction of the yin and yang principles produces the five elements and enables change to take place within the world.

Yin and Yang

Source: www.168fengshui.com; www.etymonline.com.


152

Source: MSCI; FactSet. Source: MSCI; FactSet.





Overview of Chinese H Shares

• H shares are issued by Chinese companies that are incorporated in mainland China and listed on the Hong Kong Stock Exchange. H shares represent early-phase efforts by the Chinese government to reform and restructure state-owned enterprises (SOEs) through privatization. H shares are available for investment to foreign investors and qualified domestic institutional investors (Please see page 110).

• Companies incorporated in mainland China can also issue A shares on the Shanghai and Shenzhen stock exchanges. These A shares are restricted to Chinese investors and qualified foreign institutional investors (Please also see pages 110 and 151).

• The Hang Seng China Enterprises Index is a freefloat capitalization-weighted index that includes all H-shares listed on the Hong Kong Stock Exchange. The index is denominated in Hong Kong dollars and had 40 constituents as of May 2011. The current Hang Seng China Enterprises Index replaced its predecessor on October 3, 2001, with a base value of 100 on January 3, 2000.– www.hsi.com– www.bloomberg.com

Industrials30%

Financials21%

Materials18%

Energy10%


Utilities5%

Health Care3%

Other7%

MSCI China H Index – Sector BreakdownAs of May 2011Index Weight (%)

MSCI China H Index

• The MSCI China H Index is a capitalization-weighted index that seeks to represent the H-shares listed on the Hong Kong Stock Exchange. As of May 2011, the index had a market capitalization of US$390 billion, with 63 constituents.


Overview of Chinese H Shares

Source: Bloomberg, LLC; Hong Kong Stock Exchange; Asian Equity Research Institute. The Temple of Heaven was the place where the emperors of the Ming dynasty (1368 – 1644 AD) and the Qing dynasty (1644 – 1912 AD) worshipped heaven, venerated their ancestors, and prayed for good harvests. The emperors visited the temple twice a year: on the 15th day of the first lunar month, to pray for a good harvest; and during the Winter Solstice, to give thanks for a good harvest.

The Temple of Heaven

Source: www.beijing-sightseeing.com.

153






Overview of Chinese Red Chip Shares

• Red Chip shares are issued by overseas-registered Chinese companies listed on the Hong Kong Stock Exchange that have at least 30% of their shareholdings held by state-owned organizations or provincial/municipal governments in China. Red Chips are available to foreign investors and qualified domestic institutional investors (Please see page 110).

• The primary difference between Red Chips and H shares is that Red Chips represent Chinese companies incorporated overseas, whereas H shares represent Chinese companies incorporated in mainland China (Please see page 110).

• The Hang Seng China-Affiliated Corporations (Red Chip) Index is a capitalization-weighted index that includes Red Chips listed on the Hong Kong Stock Exchange. The index is denominated in Hong Kong dollars and had 25 constituents as of May 2011. The index replaced its predecessor in 2000, with a base value of 2000 on January 3, 2000.

• Sources for further information about Red Chips include:– www.hsi.com– www.bloomberg.com

Financials29%

Industrials22%Materials

7%

Energy7%


Utilities7%

Health Care7%


Consumer Staples7%

MSCI China Red Chip Index – Sector BreakdownAs of May 2011Index Weight (%)

MSCI China Red Chip Index

• The MSCI China Red Chip Index is a capitalization- weighted index that seeks to represent the Red Chips listed on the Hong Kong Stock Exchange. As of May 2011, the index had a market capitalization of US$171 billion, with 28 constituents.


Overview of Chinese Red Chip Shares

Located in Shandong Province, Tai Shan is not merely the mountain home of the gods; it is considered a deity itself and has been venerated by the Chinese as their most sacred peak since at least the third millennium BC. Over 7,000 steps lead to the summit, and the slopes are filled with numerous temples. The emperors of ancient China regarded Tai Shan as the actual son of the Emperor of Heaven, from whom they received their own authority to rule the people. At least 72 legendary emperors are said to have visited Tai Shan. Chinese legend says that those who climb the mountain will live until they are 100 years old.

Source: sacredsites.com.

Sacred Tai Shan Mountain

Source: Bloomberg, LLC; Hong Kong Stock Exchange; Asian Equity Research Institute.

154






Overview of Chinese P Chip Shares

• P Chip (Private Chip) shares are issued by overseas-registered Chinese companies listed on the Hong Kong Stock Exchange that are privately run by Chinese nationals. As of early 2011, the P Chip market was relatively small, but it had been growing in light of the Chinese governments’ efforts to reform the restructure and expand the size of its capital markets. P Chips are available to foreign investors and qualified domestic institutional investors (Please see page 110).

• The primary difference between P Chips and Red Chips is that P Chips represent Chinese companies that have no affiliations with the Chinese government, whereas Red Chips represent Chinese companies that are at least 30% owned by the Chinese government.

• Due the relatively small size of the market, as of early 2011 the Hong Kong Stock Exchange had not constructed an index to represent P Chips.

Financials24%


Materials17%

Consumer Staples13%


Industrials7%

Utilities4%

Health Care2%

MSCI China P Index – Sector BreakdownAs of May 2011

MSCI China P Index

Overview of Chinese P Chip Shares

• The MSCI China P Chip Index is a capitalization- weighted index that seeks to represent the P Chips listed on the Hong Kong Stock Exchange. As of May 2011, the index had a market capitalization of US$128 billion, with 46 constituents.


Source: Bloomberg, LLC; Hong Kong Stock Exchange; Morgan Stanley & Co. Inc. Research; Asian Equity Research Institute.

155

Source: “At China’s Grand New Museum, History Toes the Party Line,” The New York Times, April 4, 2011.

Covering two million square feet, the National Museum of China in Tiananmen Square is the world’s largest museum under one roof and represents a leading showcase of Chinese history and culture. In the past, the site on Tiananmen Square housed two institutions: the Museum of Chinese History; and the Museum of the Chinese Revolution. In 2003, the two were combined and renamed the National Museum of China. The museum underwent seven major revisions and as of early 2011 featured a grand entrance hall, 850 feet long and 100 feet high, connecting the two earlier museums. The centerpieces of the museum house two permanent exhibitions on Chinese history, one focusing on ancient China and the other focusing on the modern era.

Outside the National Museum of China

Inside the National Museum of China

National Museum of China

Index Weight (%)





Banks40%

Telecommunications17%

Oil & Gas16%

Basic Resources13%

Insurance11%

Other4%


Select China-Related Equity Indices

FTSE China 25 Index• The FTSE China 25 Index includes the 25 largest and most

liquid Chinese companies (Red Chips or H Shares) listed and traded on the Hong Kong Stock Exchange. The index provides foreign investors with a benchmark of the offshore Chinese stock markets and it can be used as a basis for index-linked investment vehicles.

Source: FTSE Group. Data are as of March 31, 2011.

0

10,000

20,000

30,000

40,000

'01 '02 '03 '04 '05 '06 '07 '08 '09 '10

Price Performance Since Inception through 2010$US Dollars


• The FTSE Group manages a family of China- related indices, including: – FTSE China 25 Index– FTSE China A50 Index– FTSE China A All-Share Index– FTSE China A 200 Index– FTSE China A 200 Sector Indices– FTSE China A 200 Style Indices– FTSE China A Blue-Chip Value 100 Index– FTSE China A 400 Index– FTSE China A 600 Index– FTSE China A Small Cap Index– FTSE China A Provincial Indices– FTSE China A High Yield 150 Index– FTSE China A Insurance Investment Index– FTSE China Index– FTSE Hong Kong Index– FTSE China H Share Index– FTSE China B All-Share Index– FTSE China B 35 Index– FTSE China Bond Index– FTSE China A 200 Composite Index

• For further information:– http://www.ftse.com/Indices/FTSE_China_I

ndex_Series/index.jsp

Source: FTSE Group, Bloomberg, LLC.

FTSE China A50 Index

Price Performance Since Inception through 2010$US Dollars


• The FTSE China A50 Index includes the largest 50 A Shares Chinese companies by total market capitalization that are listed and traded on the Shanghai and Shenzhen stock exchanges. The index provides domestic investors and qualified foreign institutional investors with a benchmark of the A shares market and it can be used as a basis for index-linked investment vehicles.

Source: FTSE Group, Bloomberg, LLC.

0

1,000

2,000

3,000

4,000

'04 '05 '06 '07 '08 '09 '10

Sector BreakdownAs of March 31, 2011Index Weight (%)

Banks36%

Insurance12%Basic Resources

11%

Financial Services8%

Industrial Goods7%

Construction5%

Food & Beverage5%

Real Estate3%

Other13%

Source: FTSE Group. Data are as of March 31, 2011.

Sector BreakdownAs of March 31, 2011Index Weight (%)

156




• The Standard & Poor’s China BMI Index includes companies that are publicly traded and domiciled in China, but legally available to foreign investors. The index included 555 companies as of May 2011 and provided foreign investors with an investable universe of publicly traded Chinese companies.

• Standard & Poor’s also maintains two other broad market indices with exposure to China: the Standard & Poor’s Greater China Ex-Taiwan Listed BMI Index; and the Standard & Poor’s China Ex A-B Shares BMI Index. As of May 2011, the indices had 612 and 380 constituents, respectively.

0

200

400

600

800

'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

• The Halter USX China Index includes companies listed on US exchanges that generate most of their revenues from the People’s Republic of China. The index provides a benchmark for companies with exposure to China.

• The Halter USC China Index was created by the Halter Financial Group in response to economic trends taking place in China, as well as developments in US capital markets.

• For a company to be included in the index, it must have an average market capitalization of more than US$50 million for the preceding 40 days, must trade on the NYSE, Nasdaq, or NYSE Arca exchanges, and must derive the majority of its business from China. As of May 2011, the index included 224 US-listed companies with exposure to China.


Select China-Related Equity Indices

Halter USX China Index

0

2,500

5,000

7,500

10,000

'02 '03 '04 '05 '06 '07 '08 '09 '10

Price Performance Since Inception through 2010US$ Dollars

Source: Bloomberg, LLC; www.usxchinaindex.com.

Standard & Poor’s China BMI Index

Source: Bloomberg, LCC. Data are as of December 31, 2010.

Price Performance Since Inception through 2010US$ Dollars



Source: The Economist; Image courtesy of Sotheby’s.

On April 7, 2011, Sotheby’s sold several lots of imperial Chinese porcelain from the Meiyintang collection in Hong Kong. Meiyintang, literally meaning “hall among rosebeds” in Mandarin, has been considered one of the greatest collections of Chinese art privately owned in the West.Stephen Zuellig, a 93-year-old Swiss businessman, assembled the 2,000-piece collection. He and his late brother, Gilbert, began collecting Chinese porcelain in the early 1950s. The brothers sought to collect Chinese porcelain from the Neolithic period to the Qing dynasty. Three fundamental criteria guided their collecting: the rarity of the work; the quality of its decoration; and the condition of the piece. The lots sold represented a microcosm of the entire 2,000-piece collection, ranging from the Yuan dynasty to the Qing dynasty. The most treasured porcelains included the cobalt-blue and copper-red early Ming wares, the monochrome Ming and Qing pieces, and the Qing enamel-engraved porcelain.

Meiyintang Chinese Porcelain

Source: “Meiyintang Marvels,” The Economist, March 19, 2011.

157





Overview of China ADRs

(1)• China ADRs represent American Depository Receipts based on H shares, Red Chips, P Chips, or other non-US China-related companies.

• Several Chinese companies were listed on the New York and the NASDAQ stock exchanges, and 15 Chinese companies were listed on the London Stock Exchange as of early 2011.

• Sources of further information about China ADRs include:



– www.factset.com

– www.adrbnymellon.com

1. Eradicate extreme poverty and hunger.

2. Achieve universal primary education.

3. Promote gender equality and empower women.

4. Reduce child mortality.

5. Improve maternal health.

6. Combat HIV/AIDS, malaria, and other diseases.

7. Ensure environmental sustainability.

8. Develop a global partnership for development.

United Nations Millennium Development Goals

Source: The United Nations, September 2010.

158

Founded in 1980 in New York City’s Chinatown, the Museum of Chinese in America seeks to preserve and present the history, heritage, culture, and diverse experiences of people of Chinese descent in the United States. The museum began as a community-based organization launched by historian John Kuo Wei Tchen and community resident and activist Charles Lai, with the mission of developing a better understanding of Chinese American history. In 2005, the museum was among 400 New York City arts and social service institutions to receive a part of a $20 million grant from the Carnegie Corporation made possible through a donation by New York City mayor Michael Bloomberg. In 2009, the museum relocated to 215 Centre Street and was redesigned by architect Maya Lin.

The Museum of Chinese in America (MOCA)

Source: Museum of Chinese in America; The New York Times, “Reopened Museum Tells Chinese-American Stories,” September 21, 2009; “City Groups Get Bloomberg Gift of $20 Million,” July 6, 2005; “Maya Lin’s Big Dig,” New York Magazine, August 23, 2009.




Overview of China Convertible Bonds

Dating back to the Yuan, Ming, and Qing dynasties, hutongs are narrow streets or alleys mainly located in Beijing, China, near the Forbidden City. Hutongs are formed by lines of siheyuan, traditional courtyard residences. Many neighborhoods were formed by joining one siheyuan to another to form a hutong, and then joining one hutong to another. The word hutong is also used to refer to such neighborhoods. Partly due to the modernization of Beijing, hutongs are fast disappearing, but represent a traditional aspect of Chinese cultural history.

Hutongs

Source: Discover China Tours.

• China convertible bonds are issued by China-related companies and trade either over- the-counter or on a stock exchange.

• In terms of monetary amount outstanding, over 55% of the Chinese convertible bond market is represented by financial issuers.

• Sources of further information about China convertible bonds include:


– www.convertbond.com


159

The Eight Immortals represent a group of legendary xian (immortals, transcendents, saints) in Chinese mythology. Each immortal’s power can be transferred to a power tool that can give life or destroy evil.

They are revered by the Taoists and are a popular element in the secular Chinese culture. They are said to live on a group of five islands in the Bohai Sea.

The immortals (in no special order) are:

(i) Immortal Woman He (He Xiangu);

(ii) Royal Uncle Cao (Cao Guojui);

(iii) Iron-Crutch Li (Tieguai Li);

(iv) Lan Caihe;

Considered signs of prosperity and longevity, the Eight Immortals appear in many forms of Chinese art, including silk paintings, wall murals, sculptures, and wood block prints.

The Eight Immortals

(v) Lü Dongbin (the leader);

(vi) Philosopher Han Xiang (Han Xiang Zi);

(vii) Elder Zhang Guo (Zhang Guo Lao); and

(viii) Hang Zhongli (Zhongli Quan).

Source: www.chinaculture.org.

The Eight Immortals Crossing the Sea




US, European, and Asian Corporations in China

The Morgan Stanley Research China strategy team believes that China is poised for a “megatransition” between 2010 and 2020, from being a leading producer of globally distributed goods, to the world’s largest market for consumer and industrial products. For multinationals, competitive landscapes in specific industries are therefore likely to become more complex, reflecting powerful secular trends that are driving the megatransition: demographics; urbanization; infrastructure; the development of a social security network; consumer financing; and education.

Source: Morgan Stanley & Co. Inc. Research: “The China Files: US Corporates and China’s Megatransition,” September 20, 2010; “The China Files: European Corporates and China’s Megatransition,” October 29, 2010; and “The China Files: Asian Corporates and China’s Megatransition,” November 8, 2010.

According to the Morgan Stanley Research China strategy team, winning strategies of multinationals in China should feature two elements: (i) a shift to franchise- building (establishing brands and distribution/service networks) over revenue generation (maximizing short-term sales); and (ii) a preference for integration (making China a second home market) rather than localization (treating China as another foreign market).

The Morgan Stanley Research China strategy team, together with industry analysts from the US and China for 16 industries, systematically reviewed the landscape of 16 US industries, evaluating companies’ current position, growth strategy, and competitive headwinds. For further information, please refer to the Morgan Stanley Research report, “The China Files: US Corporates and China’s Megatransition,” published on September 20, 2010.

The Morgan Stanley Research China strategy team, together with industry analysts from Europe and China, systematically reviewed the landscape of 18 European industries, evaluating companies’ current position, growth strategy, and competitive headwinds. For further information, please refer to the Morgan Stanley Research report, “The China Files: European Corporates and China’s Megatransition,” published on October 29, 2010.

The Morgan Stanley Research China strategy team, together with industry analysts from China and the Asia Pacific region, systematically reviewed the landscape of 14 industries, evaluating companies’ current position, growth strategy, and competitive headwinds. For further information, please refer to the Morgan Stanley Research report, “The China Files: Asian Corporates and China’s Megatransition,” published on November 8, 2010.

US, European, and Asian Companies’ Opportunity Map in China Morgan Stanley Research Favorites

US Companies

European Companies

Asian Companies

Consumer Boom

HouseholdConsumption

Culture andLeisure

Financial

Materials and UtilitiesChemicals

Water Treatment

Apparel

Luxury Goods

Food and Beverage

Retail

Household Products

Express Courier

Auto and Auto Parts

Advertising

Exhibitions

Leisure and Hotels

Asset Management

HealthcareMedtech

Pharmaceuticals

Industrial UpgradeAerospace/Defense

Machinery

By the Morgan Stanley Research China Strategy Team

160



Section 6

Additional Sources and Disclosures

Ancient Chinese Scroll Paintings

“Spring Outing,” by Zhan Ziqian of the Sui dynasty (581 – 618 AD).

Painted by Zhan Ziqian in the sixth century, “Spring Outing” is the earliest known scroll painting. Zhan Ziqian served in th e government of three historic periods: Northern Qi (550 – 577 AD); Northern Zhou (557 – 581 AD); and the Sui dynasty (581 – 618 AD). He is perhaps best known for his landscape paintings, but he also executed fine Buddhist and Taoist paintings, human figures, and historic legends.

Painted in the tenth century by Gu Hongzhong of the Tang dynasty (618 – 907 AD), “Night Revels of Han Xizai” is considered one of the most important Chinese scroll paintings. The scroll painting depicts Han Xizai, a minister of Li Yu, in five distinct scenes, in which he: (i) listens to the pipa; (ii) watches dancers; (iii) rests; (iv) plays a string instrument; and (v) bids farewell to his guests. As with most Chinese scroll paintings, “Night revels of Han Xizai” views from right to left. The original painting no longer exists, but it is survived by the twelfth-century, Song- dynasty (960 – 1279 AD) remake shown below. The painting now resides in the Palace Museum in Beijing.

Twelfth-Century Remake of “Night Revels of Han Xizai,” by Gu Hongzhong of the Five Dynasties and Ten Kingdoms Period (907 – 960 AD).

Source: “A Visual Sourcebook of Chinese Civilization,” University of Washington, http://depts.washington.edu/chinaciv/; www.cultural-china.com.

Scene v Scene iv Scene iScene iiScene iii

161



Select Websites• CIA World Factbook: http://www.cia.org• The World Bank: http://www.worldbank.org/cn• International Monetary Fund: https://www.imf.org• World Atlas of China: http://www.worldatlas.com• China Market: www.chinamarket.com.cn/E• China Online: The Information Network for China.

www.chinaonline.com• National Geographic: http://nationalgeographic.com/• Asia Society: http://asiasociety.org

Books• Apter, David E. and Tony Saich. Revolutionary Discourse in Mao’s Republic. Harvard University Press, 1998.• Baum, Richard. China Watcher: Confessions of a Peking Tom. University of Washington Press, 2010. • Bickers, Robert. The Scramble for China: Foreign Devils in the Qing Empire 1832–1914. Allen Lane, 2011.• Bremmer, Ian. The End of the Free Market: Who Wins the War Between States and Corporations. Portfolio, 2010. • Brezezinski, Zbigniew. The Grand Chessboard. Basic Books, 1998.• Chang, Iris. The Chinese in America: A Narrative History. Penguin, 2004. • Chang, Jung. Wild Swans: Three Daughters in China. Ancor, 1992. • Chow, Gregory C. Understanding China’s Economy. River Edge: World Scientific Publishing Company, 1994.• Chua, Amy. Battle Hymn of the Tiger Mother. Penguin Press, 2010. • Dikötter, Frank. Mao’s Great Famine: The History of China's Most Devastating Catastrophe, 1958–1962. Walker, 2011.• Ebrey, Patricia B. The Cambridge Illustrated History of China. Cambridge University Press, 1999.• Fairbank, John K., and Edwin O. Reischauer. China: Tradition and Transformation. Boston: Houghton Mifflin, 1979.• Fairbank, John K., and Merle Goldman. China: A New History. Cambridge: Harvard University Press, 1998.• Fallows, James. Postcards from Tomorrow Square: Reports from China. Vintage, 2008.• Ford, Christopher A. The Mind of Empire: China’s History and Modern Foreign Relations. University Press of Kentucky, 2010.• Friedberg, Aaron L. A Contest for Supremacy: China, America, and the Struggle for Mastery in Asia. W.W. Norton & Company, 2011. • Garner, Jonathan. The Rise of the Chinese Consumer: Theory and Evidence. Wiley, 2005.• Hessler, Peter. Country Driving: A Journey Through China from Farm to Factory. Harper, 2010. • Huang, Yasheng. Capitalism with Chinese Characters: Entrepreneurship and the State. Cambridge University Press, 2008.• Jacques, Martin. When China Rules the World: The End of the Western World and the Birth of a New Global Order. Penguin, 2009. • Kissinger, Henry A. On China. The Penguin Press, 2011. • Kuhn, Robert L. How China’s Leaders Think: The Inside Story of China’s Reform and What This Means for the Future. Wiley, 2009. • Kuhn, Robert L. The Man Who Changed China: The Life and Legacy of Jiang Zemin. Wiley, 2009.• Lampton, David M. The Three Forces of Chinese Power: Might, Money, and Minds. University of California Press, 2008.

ADDITIONAL SOURCES AND DISCLOSURES

For More Information

A Mandarin edition of The Art of Asset Allocation, published in March 2005.

• UC Berkley Center for Chinese Studies: http://ieas.berkley.edu/ccs/• China Travel Guide: www.travelchinaguide.com• China’s Largest E-Commerce Site: www.alibaba.com• China’s Three Largest Nasdaq-listed Internet Portals: www.sina.com,

www.sohu.com, www.chinese.ft.com• China Securities Regulatory Commission: www.csrc.gov.cn• China Today: www.chinatoday.com• China Trade World: www.chinatradeworld.com• Woodrow Wilson International Center for Scholars: Kissinger Institute

on China and the United States: www.wilsoncenter.org

A Mandarin edition of The Little Book That Saves Your Assets, published in November 2009.

Publications by David M. Darst, Chief Investment Strategist of Morgan Stanley Smith Barney.

162



Books• Ling, Li. Tibet’s Waters Will Save China. The Chinese Ministry of Water Resources, 2005.• Liu, Warren. KFC in China: Secret Recipe for Success. Wiley, 2008. • Liu, Xiumei. Understanding The Chinese Consumer. VDM Verlag, 2008.• Mahbubani, Kishore. The New Asian Hemisphere: The Irresistible Shift of Global Power to the East. PublicAffairs, 2008.• Mann, James. The China Fantasy: Why Capitalism Will Not Bring Democracy to China. Penguin, 2008. • McGregor, James. One Billion Customers: Lessons From the Front Lines of Doing Business in China. Free Press, 2005. • Mingfu, Liu. The China Dream: The Great Power Thinking and Strategic Positioning of China in the Post-American Age. Beijing: Zhongguo Youyi Chuban Gongsi, 2010. • Nathan, Andrew J, and Bruce Gilley. China’s New Rulers: The Secret Files. New York Review of Books, 2003.• Pan, Philip P. Out of Mao’s Shadow: The Struggle for the Soul of a New China. Simon & Schuster, 2009. • Pehrson, Christopher. String of Pearls: Meeting the Challenge of China’s Rising Power Across the Asian Littoral. Strategic Studies Institute of the US Army War College (SSI), 2006.• Pei, Minxin. China’s Trapped Transition: The Limits of Developmental Autocracy. Harvard University Press, 2006. • Roach, Stephen. This China is Different: A Collection of Essays on China’s Growing Stature in the World Economy. Morgan Stanley Research, March 2002. • Shambaugh, David. China’s Communist Party: Atrophy and Adaption. Woodrow Wilson Center Press/University of California Press, 2008.• Spence, Jonathan. Search for Modern China. New York: Norton, 1990. • Studwell, Joe. The China Dream: The Elusive Quest for the Last Greatest Untapped Market on Earth. Grove Press, 2003. • Terrill, Ross. The New Chinese Empire: Beijing’s Political Dilemma and What It Means for the United States. Basic Books, 2003. • Tse, Edward. The China Strategy: Harnessing the Power of the World’s Fastest-Growing Economy. Basic Books, 2010. • Walder, Andrew G. Fractured Rebellion: The Beijing Red Guard Movement. Harvard University Press, 2010.• Walter, Carl E. and Fraser J.T. Howie. Red Capitalism: The Fragile Foundation of China’s Extraordinary Rise. Wiley, 2011.• Wasserstrom, Jeffrey C. China in the 21st Century: What Everyone Needs to Know. Oxford University Press, 2010.• Whyte, Martin K. Myth of the Social Volcano: Perceptions of Inequality and Distributive Injustice in Contemporary China. Stanford University Press, 2010.• Whyte, Martin K. Two Societies: Rural-Urban Inequality in Contemporary China. Harvard University Press, 2010.

Morgan Stanley Research Publications• Ahya, Chetan, and Tanvee Gupta, “India and China: New Tigers of Asia, Part III,” Morgan Stanley Research, August 13, 2010. • Ahya, Chetan, and Andy Xie, et al., “India and China: New Tigers of Asia, Part II,” Morgan Stanley Research, June 2006.• Ahya, Chetan, and Andy Xie, et al., “India and China: New Tigers of Asia,” Morgan Stanley Research, July 2004.• Gupta, Sunil, Sophie Lu, and Bing Jiang, “China Clean Energy: What a Winner Looks Like,” Morgan Stanley Research, June 30, 2009. • Lou, Jerry, and Allen Gui, et al., “China High-Speed Rail: On the Economic Fast Track,” Morgan Stanley Research, May 15, 2011. • Lou, Jerry, and Allen Gui, “The China Files: US Corporates and China’s Megatransition,” Morgan Stanley Research, September 20, 2010. • Lou, Jerry, and Allen Gui, “China Portfolio Strategy: Tightening Over-discounted; Bottom-fishing Consumers,” Morgan Stanley Research, February 27, 2011. • Lou, Jerry, and Allen Gui, and Ronan Carr, “The China Files: European Corporates and China’s Megatransition,” Morgan Stanley Research, October 29, 2010. • Lou, Jerry, and Allen Gui, and Jonathan Garner, “The China Files: Asian Corporates and China’s Megatransition,” Morgan Stanley Research, November 8, 2010. • Lou, Jerry, Qing Wang, and Allen Gui, “China Trend-Spotting Weekly: Latest Industry and Macro Developments,” Morgan Stanley Research, weekly publication. • Wang, Qing, Steven Zhang, and Ernest Ho, “The China Files: Chinese Economy through 2020,” Morgan Stanley Research, November 8, 2010.• Wang, Qing, Denise Yam, Sharon Lam, Steven Zhang, Ernest Ho, and Jason Liu, “Greater China Economics: Issues in Focus,” Morgan Stanley Research, April 13, 2011.



163



Periodicals• Chua, Amy, “Why Chinese Mothers Are Superior,” Wall Street Journal, January 8-9, 2011.• Chua, Amy, “Our Readers Roar: What Makes A Good Parent,” Wall Street Journal, January 15-16, 2011.• Chua, Amy, “The Tiger Mother Talks Back,” Wall Street Journal, January 15-16, 2011. • The Economist, “China and India: Contest of the Century,” August 19, 2010.• The Economist, “Friend or Foe? A Special Report on China’s Place in the World,” December 4, 2010.• Ferguson, Niall. “In China’s Orbit,” Wall Street Journal, November 18, 2010. • Financial Times, “Africa-China Trade,” June 14, 2010. • Gwin, Peter. “Shaolin Kung Fu,” National Geographic, March 2011.• Harrer, Heinrich. “My Life in Forbidden Lhasa,” National Geographic, May 2008.• Hessler, Peter. “China’s Instant Cities,” National Geographic, June 2007.• Hessler, Peter. “Restless Spirits,” National Geographic, January 2010.• Hoagland, Edward. “China’s Mystic Waters,” National Geographic, March 2009. • Jenkins, Mark. “Searching for Sahangri-La,” National Geographic, May 2009.• Jenkins, Mark. “The Forgotten Road: Tea Horse Road,” National Geographic, May 2010.• Larmer, Brook. “Caves of Faith: Chinese Caves,” National Geographic, June 2010.• Mazzatena, O. Louis, “Rising to Life: Treasures of Ancient China,” National Geographic, November 2001.• Teague, Matthew, “The Other Tibet: Uygurs,” National Geographic, December 2009.• Waldman, Ayelet, “In Defense of the Guilty, Ambivalent, Preoccupied Western Mom,” Wall Street Journal, January 15-16, 2011. • Warren, Lynne, “Panda, Inc.,” National Geographic, July 2006.• Wong, Edward, “Plan for China’s Water Crisis Spurs Concern,” The New York Times, June 1, 2011. • Worrall, Simon, “Made in China,” National Geographic, June 2009.

Publications• The Boston Consulting Group, “The Internet’s New Billion,” September 2010. • The Boston Consulting Group, “Winning in Emerging-Market Cities,” September 2010. • Roland Berger, “Chinese Consumer Report 2010,” July 2010. • Rosen, Daniel H., and Thilo Hanemann, “An American Open Door? Maximizing the Benefits of Chinese Foreign Direct Investment,” Asia Society, May 2011. • MasterCard and HSBC, “Understanding the Affluent Consumers of China,” Second Quarter 2007.• McKinsey Consumer & Shopper Insights, “2010 Annual Chinese Consumer Study,” McKinsey & Company, August 2010.

Television Broadcasts• “In Search of China,” PBS Broadcast in 2000.• “The Tank Man,” PBS Broadcast in 2006. http://www.pbs.org/wgbh/pages/frontline/tankman/



164




Index Glossary

165

Index Disclosure and Index Definitions

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results.

Consumer Price Index: The Consumer Price Index is one of the most widely recognized price measure for tracking the price of a market basket of goods and services purchased by individuals. The weights of the components are based on consumer spending patterns.

Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks traded on the New York Stock Exchange and the NASDAQ. The index is the oldest and single most watched index in the world. It was inaugurated in 1896.

FTSE China 25 Index: The FTSE China 25 Index includes the 25 largest and most liquid Chinese companies (Red Chips or H Shares) listed and traded on the Hong Kong Stock Exchange.

FTSE China A50 Index: The FTSE China A Index includes the largest 50 A Shares Chinese companies by total market capitalization that are listed and traded on the Shanghai and Shenzhen stock exchanges.

Hang Seng China AH Premium Index: The Hang Seng China AH Premium Index tracks the price premium (or discount) of A-shares to H-shares. The higher the index, the higher the premium of A- shares over H-shares, and vice-versa.

Hang Seng China-Affiliated Corporations (Red Chip) Index: The Hang Seng China-Affiliated Corporations (Red Chip) Index is a capitalization index comprised of stocked listed on the Hock Kong Stock Exchange. The companies have at least 30% of their shareholdings held by state-owned organizations or provincial/municipal governments in China. The index was inaugurated in 2000.

Hang Seng China Enterprises (H Shares) Index: The Hang Seng China Enterprises Index is a free-float capitalization-weighted index of H-Shares listed on the Hong Kong Stock Exchange and included in the Hang Seng Mainland Composite Index. The index was inaugurated in 2001.

Halter USX China Index: The Halter USX China Index includes companies listed on US exchanges that generate most of their revenues from the People’s Republic of China.

The NASDAQ Composite Index: The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market, and Capital Market. The index contains over 3,000 securities and was inaugurated in 1971.

Producer Price Index: The Producer Price Index prices received by producers at the first commercial sale. The report measures prices for goods at three stages of production: finished, intermediate, and crude. The index for finished goods generally receives the most attention. Change in this index is the first aggregate inflation measure available for the month.

MSCI Asia Pacific Ex Japan: The MSCI Asia Pacific Ex Japan Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of Asia, excluding Japan. As of December 31, 2010, the MSCI AC Asia ex Japan Index consists of the following 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.

MSCI Australia: The MSCI Australia Index is a capitalization-weighted index that monitors the performance of stocks from the country of Australia.

MSCI China : The MSCI China Index is a capitalization-weighted index designed to represent Chinese B-shares, Hong Kong H-Shares, Red Chip, and P Chip companies that are available to non-Chinese investors. The MSCI China Index is calculated in Hong Kong Dollars.

MSCI China A Index: The MSCI China A Index is a capitalization-weighted index that seeks to represent the A-shares listed on the Shanghai and Shenzhen stock exchanges.

MSCI China B Index: The MSCI China B Index is a capitalization-weighted index that seeks to represent the B-shares listed on the Shanghai and Shenzhen stock exchanges.

MSCI China H Index: The MSCI China H Index is a capitalization-weighted index that seeks to represent the H-shares listed on the Hong Kong Stock Exchange.




Index Glossary

166

Index Disclosure and Index Definitions

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results.

MSCI China P Chip Index: The MSCI China Red Chip Index is a capitalization-weighted index that seeks to represent the P Chips listed on the Hong Kong Stock Exchange.

MSCI China Red Chip Index: The MSCI China Red Chip Index is a capitalization-weighted index that seeks to represent the Red Chips listed on the Hong Kong Stock Exchange.

MSCI Hong Kong: The MSCI Hong Kong Index is a capitalization-weighted index that monitors the performance of stocks from the country of Hong Kong.

MSCI India: The MSCI India Index is a capitalization-weighted index that monitors the performance of stocks from the country of India.

MSCI Indonesia: The MSCI Indonesia Index is a capitalization-weighted index that monitors the performance of stocks from the country of Indonesia.

MSCI Korea: The MSCI Korea Index is a capitalization-weighted index that monitors the performance of stocks from the country of Korea.

MSCI Malaysia: The MSCI Malaysia Index is a capitalization-weighted index that monitors the performance of stocks from the country of Malaysia.

MSCI New Zealand: The MSCI New Zealand Index is a capitalization-weighted index that monitors the performance of stocks from the country of New Zealand.

MSCI Philippines: The MSCI Philippines Index is a capitalization-weighted index that monitors the performance of stocks from the country of Philippines.

MSCI Singapore: The MSCI Singapore Index is a capitalization-weighted index that monitors the performance of stocks from the country of Singapore.

MSCI Taiwan: The MSCI Taiwan Index is a capitalization-weighted index that monitors the performance of stocks from the country of Taiwan.

MSCI Thailand: The MSCI Thailand Index is a capitalization-weighted index that monitors the performance of stocks from the country of Thailand.

Shanghai A-Share Stock Price Index: The Shanghai A-Share Stock Price Index is a capitalization-weighted index that tracks the daily performance of all A-shares listed on the Shanghai Stock Exchange. A-shares are restricted to local investors and qualified institutional foreign investors. The index was inaugurated in 1990.

Shanghai B-Share Stock Price Index: The Shanghai B-Share Stock Price Index is a capitalization-weighted index that tracks the daily performance of all B-shares listed on the Shanghai Stock Exchange. B-shares are restricted to local investors and qualified institutional foreign investors. The index was inaugurated in 1990.

Shanghai Stock Exchange (SE) Composite Index: The Shanghai SE Composite Index is a capitalization-weighted index that tracks the daily performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The index was inaugurated in 1990.

Shenzhen A-Share Stock Price Index: The Shenzhen A-Share Stock Price Index is a capitalization-weighted index that tracks the daily performance of all A-shares listed on the Shenzhen Stock Exchange. A-shares are restricted to local investors and qualified institutional foreign investors. The index was inaugurated in 1991.

Shenzhen B-Share Stock Price Index: The Shenzhen B-Share Stock Price Index is a capitalization-weighted index that tracks the daily performance of all B-shares listed on the Shenzhen Stock Exchange. A-shares are restricted to local investors and qualified institutional foreign investors. The index was inaugurated in 1992.

Standard & Poor’s 500 Index: The Standard & Poor’s 500 Index has been widely regarded as the best single gauge of the large cap US equities market since the index was first published in 1957. The index has over US$ 4.8 trillion benchmarked, with index assets comprising approximately US$ 1.1 trillion of this total. The index includes 500 leading companies in leading industries of the US economy, capturing 75% coverage of US equities.

Standard & Poor’s China BMI Index: The Standard & Poor’s China BMI Index is a capitalization-weighted index that defines and measures investable universe of publicly traded companies domiciled in China, but legally available to foreign investors.




Disclosures

Disclosures

The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. Morgan Stanley Smith Barney is involved in many businesses that may relate to companies, securities or instruments mentioned in this material.

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Morgan Stanley Smith Barney has no obligation to provide updated information on the securities/instruments mentioned herein.

The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Smith Barney recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. Estimates of future performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Smith Barney does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein.

This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Smith Barney is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material.

Morgan Stanley Smith Barney and its affiliates do not render advice on tax and tax accounting matters to clients. This material was not intended or written to be used, and it cannot be used or relied upon by any recipient, for any purpose, including the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Each client should consult his/her personal tax and/or legal advisor to learn about any potential tax or other implications that may result from acting on a particular recommendation.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.

Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited diversification and sensitivity to economic factors such as interest rate changes and market recessions.

167




Disclosures

Disclosures

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Physical precious metals are non-regulated products. Precious metals are speculative investments, which may experience short-term and long term price volatility. The value of precious metals investments may fluctuate and may appreciate or decline, depending on market conditions. If sold in a declining market, the price you receive may be less than your original investment. Unlike bonds and stocks, precious metals do not make interest or dividend payments. Therefore, precious metals may not be suitable for investors who require current income. Precious metals are commodities that should be safely stored, which may impose additional costs on the investor. The Securities Investor Protection Corporation (“SIPC”) provides certain protection for customers’ cash and securities in the event of a brokerage firm’s bankruptcy, other financial difficulties, or if customers’ assets are missing. SIPC insurance does not apply to precious metals or other commodities.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.

Principal is returned on a monthly basis over the life of the security. Principal prepayment can significantly affect the monthly income stream and the maturity of any type of MBS, including standard MBS, CMOs and Lottery Bonds. Yields and average lives are estimated based on prepayment assumptions and are subject to change based on actual prepayment of the mortgages in the underlying pools. The level of predictability of an MBS/CMO’s average life, and its market price, depends on the type of MBS/CMO class purchased and interest rate movements. In general, as interest rates fall, prepayment speeds are likely to increase, thus shortening the MBS/CMO’s average life and likely causing its market price to rise. Conversely, as interest rates rise, prepayment speeds are likely to decrease, thus lengthening average life and likely causing the MBS/CMO’s market price to fall. Some MBS/CMOs may have “original issue discount” (OID). OID occurs if the MBS/CMO’s original issue price is below its stated redemption price at maturity, and results in “imputed interest” that must be reported annually for tax purposes, resulting in a tax liability even though interest was not received. Investors are urged to consult their tax advisors for more information.

Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures funds, funds of hedge funds, private equity, and managed futures funds, are speculative and entail significant risks that can include losses due to leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less regulation and higher fees than mutual funds and risks associated with the operations, personnel and processes of the advisor.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, sale, exercise of rights or performance of obligations under any securities/instruments transaction.


This material is disseminated in Australia to “retail clients” within the meaning of the Australian Corporations Act by Morgan Stanley Smith Barney Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).

Morgan Stanley Smith Barney is not incorporated under the People's Republic of China ("PRC") law and the research in relation to this report is conducted outside the PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevant approvals, licenses, verifications and or registrations from PRC's relevant governmental authorities.

Morgan Stanley Private Wealth Management Ltd, which is authorized and regulated by the Financial Services Authority, approves for the purpose of section 21 of the Financial Services and Markets Act 2000, content for distribution in the United Kingdom.

Morgan Stanley Smith Barney is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.

Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data.

Morgan Stanley Smith Barney material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney.

© 2011 Morgan Stanley Smith Barney LLC. Member SIPC.

168

Portfolio Investment Opportunities in Chinafc.standardandpoors.com › ... ›...

Documents

Transcript of Portfolio Investment Opportunities in Chinafc.standardandpoors.com › ... ›...