China By The Numbers (May 2009)

Transcription

1 abc UBS Investment Research Asian Economic Monitor Global Economics Research Asia Hong Kong China By The Numbers (May 2009) 3 June Tao Wang Economist wang.tao@ubssecurities.com Harrison Hu Associate Economist harrison.hu@ubssecurities.com Our guide to Chinese monthly data what the numbers are, what they mean, and our outlook going forward: Overview and summary UBS activity indicators Business indicators Inflation Money and credit Base money and sterilization Fixed asset investment Industrial production Industrial inventories Industrial profits Consumption and retail Property and construction Trade FDI FX reserves and capital flows Exchange rate Financial markets Data tables This report has been prepared by UBS Securities Co. Limited ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 26.

2 Overview and summary Data from the past couple of months show that: Q1 GDP growth rebounded q/q, helped by the re-stocking in some sectors and stimulus-related investment demand. Exports continued to decline sharply in April, but orders increased slightly. New bank lending decelerated but we think overall bank lending is sufficient to support our estimated 7. GDP growth in With the strong push in fiscal stimulus and bank credit, fixed asset investment (FAI) in infrastructure and other government-related sectors picked up strongly, however private and housing investment remained weak. A rebound in property sales is consistent with our outlook for a recovery in housing investment later in Retail sales appear to be resilient, as consumption may be supported by falling food and commodity prices. Signs of domestic demand-led recovery have become more apparent. Exports continued to fall in April, suggesting persistent weak external demand. While we do expect exports to stabilize in line with global credit conditions and demand in the coming months, we think export-related manufacturing investment will decline this year. Meanwhile, the government stimulus package, accompanied by strong credit growth, has led to increased fixed investment, production (some of it ahead of final orders) and a consistent rebound in PMI. A pick-up in housing and auto sales and construction activity has buoyed the market. Rapid push on fiscal stimulus and bank lending. The funds related to the fiscal stimulus package have been disbursed quickly, but more importantly, credit expansion has far exceeded expectation. The highly expansionary monetary policy, coupled with a strong desire for growth and investment by local governments, helped to push new bank lending to RMB5.2 trillion in the first four months of the year. While market-based economic activity remains weak and investment demand likely dormant, we expect the significant increase in bank lending to translate to rapid fixed investment growth, albeit in government-related sectors and projects. We expect strong FAI growth to push Q2 growth above 1 q/q. The focus on infrastructure investment and other construction has led to an early recovery of metal production, even as final demand may start to recover only in the coming months. While the government has increased social spending on healthcare and transfer payment to the poor, we do not expect consumption growth to become the lead growth engine this year. The upside and the risks of the recovery story. With continued strong bank lending growth and the expected recovery in domestic housing investment, GDP growth may have some upside from our forecast if global demand starts to rebound later this year. Nevertheless, at the micro level, we expect corporate earnings to fall in light of excess capacity and downward pressure on prices. While strong bank lending is necessary for domestic demand growth, we think the lower level of new bank lending in April is sufficient and more sustainable, although it may disappoint the market. CPI inflation is likely to be contained by weakness in commodity and food prices and by a decline in core manufacturing prices, but the excess liquidity in the system increases the risk of resource misallocation and an asset market bubble. A lack of market-based real demand could also lead to a double dipping in growth later on. Outlook in the coming year. We expect the economic recovery in China to continue, supported not by a strong turnaround in the external situation, but by continued government stimulus and bank lending. The recent optimism about the economy may have also been accentuated by the flood of liquidity into the system, which we think is unsustainable. In the coming months, investors should look out for the following: (1) a tapering off in new bank lending, but sufficient liquidity to support an economic recovery and FAI in government-mandated sectors; (2) a rebound in housing construction activity in H209, which would provide comfort for sustained underlying loan growth outside of infrastructure; (3) both exports and imports starting to stabilize in the coming months, with trade surplus likely rising again; (4) China not actively diversifying its FX reserve holding and the RMB kept stable against the USD, but seeing increased trade friction with major trading partners. UBS 2

3 UBS activity indicators What the numbers say: The UBS Expenditure Index picked up in April as the fall in net exports and softening of retail sales growth were more than offset by a rise in fixed investment growth. The Physical Activity Index continued to rebound, led by the pick-up in industrial production and improvement in construction activity. What they mean: China s trade surplus declined in April 2009 as exports dropped more than imports. The rapid push of the substantial economic stimulus, as reflected by surging bank lending, has significantly boosted FAI spending, leading to a rebound in orders and production, and electricity production seems to have bottomed. 12-month outlook: We expect the Physical Activity Index to recover along with sequential economic growth. We think export growth will likely remain negative for a few months, bringing down with it export-related investments. Stimulus policies have already helped to halt the slide in economic activity, and we expect a more visible rebound in the summer when the substantial loan growth of the past few months translates to actual investment, resulting in rising orders and activity. Our overall expenditure index rose as domestic expenditure rebounded on surging fixed investment The Physical Activity Index also rebounded Chart 1: UBS Expenditure Index by source Chart 2: UBS Physical Activity Index Grow th rate (% y/y 3mma) Net exports Fixed investment Consumption Grow th rate (% y/y, 3mma) Physical activity index - - Chart 3: Transport and energy Chart 4: Industry and construction Grow th rate (% y/y, 3mma) Grow th rate (% y/y, 3mma) 4 3 Construction Industry Electricity Transportation due to the rebound in production and construction, while transportation and power production seem to have also bottomed UBS 3

4 Business indicators What the numbers say: Chinese business surveys are often contradictory, but the latest data show signs of an early economic recovery. PMI indicators rose strongly from the lows in December 2008, largely on improving orders and raw material inventory, and the NBS leading index also picked up. The OECD leading index and entrepreneur expectations seem to have bottomed, and consumer confidence has stabilized. What they mean: We generally do not follow business indicators closely, given the wide dispersion of results. The latest rebounds in PMI, OECD and NBS leading index, together with other positive signs including the surge in bank lending and FAI spending, as well as the pick-up in industrial production, can be seen as signs of a rebound in sequential growth momentum led by the stimulus policy. 12-month outlook: We expect the leading economic indicators to maintain their recent strength in the near term, and to rise further once it is clearer that the stimulus policy is bearing fruit. Monthly leading indicators have rebounded or stabilized Chart 1: PMI and Tankan indices Chart 2: Other business climate indices Chart 3: Leading indicators Diffusion index level Index level Index level Diffusion index level Diffusion index level Entrepreneur expectation Business climate 5000 Enterprise index (RHS) NBS PMI CLSA PMI NBS leading index Consumer confidence index OECD leading indicator (RHS) Source: CEIC, Bloomberg, UBS estimates Source: CEIC, OECD, UBS estimates UBS 4

5 Inflation What the numbers say: Headline CPI inflation fell 1. y/y in April, led mainly by a drop in pork and fuel prices. Meanwhile, PPI inflation extended its decline to 6. in April. What they mean: Food and fuel prices have been responsible for CPI fluctuations in the past few years, with core goods and services prices remaining relatively muted. The rise in headline CPI inflation between mid-2007 and mid-2008 was mainly driven by a surge in pork, poultry products, and vegetable prices. The fall in these prices is now the main reason for the decline in the CPI index, while the sell-off in energy and other commodities is driving down the PPI. Core manufacture prices have also softened. 12-month outlook: We expect headline inflation to average 0. y/y in We do not expect CPI inflation to flare up soon as the weakness in food and commodities prices is likely to dominate CPI movement in the coming months. Core manufacturing prices also face downward pressure from declining export demand and expected weaker growth in domestic consumption. Both food price inflation and core dropped Upstream prices and export price indicators collapsed Chart 1: CPI by component Chart 2: Upstream price indices Chart 3: Export prices Inflation rate (% y/y) Inflation rate (% y/y) Hong Kong import price index (% y/y) 2 Overall CPI index Food and fuel "Core" inflation 2 Producer price Raw materials Corporate goods Import price 8% Overall China Chinese consumer goods UBS 5

6 Money and credit What the numbers say: April new lending decelerated to RMB592 billion from RMB1.9 trillion in March. The growth in overall bank lending remained high at 3 y/y, while M2 growth increased slightly, to 2 y/y in April. What they mean: New bank lending reached record highs in the past few months on a seasonally adjusted basis. Almost 3 of the new bank credit was short-term discount bills, which largely reflect the abundance of bank liquidity rather than true lending. The surge in underlying bank lending was mainly because of three factors: the abolishing of the credit quota, the rapid push of fiscal stimulus and matching bank loans, and easier approval of local governments investment projects. The natural tapering off in bank lending does not mean that growth will slow, and we continue to think that there will be enough liquidity to support an economic recovery in month outlook: Increasing bank lending is important in sustaining domestic demand in However, we think the rapid pace of bank lending in Q109 was neither sustainable nor necessary. As we expected, the pace of loan growth has started to taper off, as normal bank lending and stimulus-related lending are front-loaded, and bill financing is shrinking as banks find more opportunities to extend higher-yielding loans. We think runaway loan growth would significantly increase the risk of resource misallocation and an asset price bubble; we estimate new bank lending in 2009 to be RMB7-8 trillion. Both credit and broad money growth surged After surging since November 08, new bank lending remains at a very high level in April Chart 1: Money and credit growth Chart 2: Sequential growth Chart 3: Monthly new lending Grow th rate (% y/y) Broad money M2 Bank lending Grow th rate (% q/q) Broad money M2 Bank lending New monthly flow lending (RMB bn) Index 1100 Nominal new loans (sa, 3mma) New loans/gdp (RHS) UBS 6

7 Base money and sterilization What the numbers say: Base money growth stabilized in March following the earlier rapid growth. FX inflows slowed while the PBC resumed its sterilization operations. What they mean: The PBC has been flooding the market with money supply to ensure adequate liquidity for banks to increase lending. Banks average excess reserve ratio dropped in March after a period of explosive lending growth. 12-month outlook: With liquidity-generating FX inflows persisting (albeit at a slower pace) and monetary policy remaining expansionary, we see base money growth to remain at current pace. However, as liquidity is in no longer in short supply and bank lending is rising sharply, the PBC may want to stabilize the pace of base money growth. Base money growth increased in recent months And commercial bank excess liquidity ratio dropped in March as banks quickly convert excess reserve into loans Chart 1: Base money growth (y/y) Chart 2: Base money growth (q/q) Chart 3: Bank excess reserve position Grow th rate (% y/y 3mma) PBC base money (RR adjusted) Excluding cash Grow th rate (% q/q 3mma, sa, annualized) PBC base money (RR adjusted) Excluding cash - PBC reserves less required reserves (% of deposits) 1 8% Chart 4: Sterilization operations Chart 5: Sterilization by component Grow th rate (% y/y 3mma) 8 Domestic contribution FX reserve contribution 6 Total reserve money grow th (RR adjusted) 4-12-month cumulative sterilization (RMB bn) Other Bonds Reserve requirements -4 Sterilization The PBC has reduced sterilization with reserves requirements UBS 7

8 Fixed asset investment What the numbers say: The growth in urban fixed asset investment accelerated to 3 y/y in April from 3 y/y in March. On a real GDP-consistent basis (i.e., excluding secondary asset transactions), FAI growth also rose significantly. What they mean: FAI strength in recent months has mainly came from government investments and SOEs investing in infrastructure projects, while investment by foreign-funded companies and investments related to exports continued to drop sharply, consistent with falling external demand. Keep in mind there is a large and varying gap between the actual pace of investment activity and the headline monthly growth figures due to the volatile non-capital asset trading transactions such as land purchases, and mergers and acquisitions; the fluctuations in our adjusted investment series better reflect the turns in the broader economy. However, this adjustment has become even more difficult in recent months given the large movements in both input and asset prices. 12-month outlook: The rapid push of fiscal stimulus and substantial loan growth are being reflected in faster growth in fixed asset investment. While we expect investment in the market-based manufacturing sectors that face weak demand (especially those related to exports) to decline, government-influenced investment will continue to rise sharply, pushing growth in overall real fixed capital formation to above 11% y/y in 2009E. Both nominal and adjusted real investment picked up The adjusted real series also correspond more closely to the movements in our Physical Activity index and in financial flows Chart 1: Fixed asset investment growth Chart 2: Real investment vs. physical index Chart 3: Real investment vs. financial flows Grow th rate (% y/y) Grow th rate (% /y/y) Grow th rate (% y/y) Grow th rate (% /y/y) Grow th rate (% y/y) 3 3 Nominal fixed investment (3mma) Real adjusted investment (3mma) 3 2 Physical activity index (RHS) Real adjusted investment (3mma) 3 3 Financing proxy (RHS) Real adjusted investment (3mma) UBS 8

9 Industrial value-added and sales What the numbers say: Growth of both real industrial sales and industrial value-added slowed somewhat in April in y/y terms, but sequential q/q growth momentum continued to rebound. What they mean: The most volatile determinants of industrial production trends are construction spending and exports. In the past couple of months, the decline in electricity consumption has called into question the reliability of industrial value added statistics, but we believe the divergence in the two statistics could, in part, be explained by: (i) a decline or continued weakness in the production of some energy-intensive industries; and (ii) bigger production cuts or more shutdowns of less energy-efficient plants within those industries. In the mean time, the VAI of some light manufacturing such as food processing, medical products, electric machinery, and plastic products grew strongly. 12-month outlook: We expect industrial production to rebound in the course of 2009, reflecting, in part, the government s policy stimulus, the stabilization of exports, and the rebound in housing-related construction spending. Industrial indicators show signs of recovery Chart 1: Industrial sales growth Chart 2: Industrial value-added growth Chart 3: Light vs. heavy industry Grow th rate (% y/y 3mma) Real grow th rate (% y/y 3mma) Real growth rate (% y/y 3mma) 4 3 Nominal industrial sales Real industrial sales 2 Industrial value added 2 Overall value-added Light industry Heavy industry 3 2 UBS 9

10 Industrial inventories What the numbers say: Real industrial inventory stocks, as a share of industrial sales, stopped rising between December 2008 and February 2009, and the pace of new inventory flows fell sharply. However, steel inventory at large and medium mills and iron ore inventory at ports have risen rapidly in recent months. What they mean: In late 2008, as construction spending and materials demand fell, production and import cuts led to aggressive de-stocking in some sectors, and a slowdown in inventory build-up at the macro level even in the face of falling demand. At the macro level, aggregate stocks are still relatively well-behaved. Following the announcement of the stimulus package, production of steel and some other construction material recovered strongly, prior to final demand picking up, which has led to rising finished goods inventory in some sectors. 12-month outlook: We see a possible upturn in light manufacturing industrial stocks in H109 as the economy slows, but production cuts and rebounding demand in the heavy industry sector should help limit the overall stock build-up. The aggregate industrial inventory/sales ratio has stopped rising On a flow basis, the pace of inventory build-up has dropped sharply in recent months Chart 1: Inventory/sales ratio Chart 2: Flow inventory/sales ratio Chart 3: Contribution to flow ratio Inventory/sales ratio index month inventory grow th as a share of monthly sales (%) 3% 1% Contribution to flow inventory/sales ratio (pp) 3% 1% Machinery/Equipment Chemical/Metals Light industry Mining -1% UBS 10

11 Industrial profits What the numbers say: Industrial earnings fell 37% y/y in the first two months of Leading the fall were profits in the mining and metals sectors, dropping more than 6 y/y, while light industry profits also declined. In March, data from 22 (of 31) regions suggests that industrial earnings have stabilized, as we had expected. What they mean: The sharp decline in commodity prices resulted in the fall in profits in resource-related sectors, but falling oil and food prices have been positive for petrochemical and food processing sector margins. Weak export and domestic demand led to the drop in margins of light manufacturing. 12-month outlook: We expect a further squeeze in light industry margins on declining export demand and weak overall sales. Earnings in heavy industrial sectors may have bottomed as demand starts to pick up from stimulusrelated infrastructure construction and later in the year a recovery in housing construction, and as commodity prices stabilize at a lower level than in the previous year. However, overcapacity in some industries, such as steel, will continue to weigh on earnings prospects, in our view, forestalling a meaningful recovery. Industrial earnings fell sharply, but margins stabilized in Jan-Feb 09 Chart 1: Industrial earnings growth Chart 2: Industrial profit margins Earnings grow th (% y/y 3mma) Overall ex Mining Heavy Light Profit margin (%) 7% Overall industry ex Mining (seasonally adjusted) % 1% -6 Chart 3: Heavy industry Chart 4: Light industry Profit margin (%) Profit margin (%) 8% 7% Heavy industry (seasonally adjusted) 7% Light industry (seasonally adjusted) 3% 3% 1% 1% Heavy industry margins rebounded, led by chemical sector UBS 11

12 Industrial profits, continued Chart 5: Mining Chart 6: Food processing Chart 7: Textile Profit margin (%) Profit margin (%) Profit margin (%) 3 3 Mining (seasonally adjusted) 1 1 Food processing (seasonally adjusted) Textile (seasonally adjusted) 2 8% 3% 1% Chart 8: Other light manufacturing Chart 9: Chemical Chart 10: Metals and Materials Profit margin (%) Profit margin (%) Profit margin (%) 8% 7% Other light manufacturing (seasonally adjusted) 8% 7% Chemical (seasonally adjusted) 8% 7% Metals and Materials (seasonally adjusted) 3% 3% 3% 1% 1% 1% Chart 11: Machinery and equipment Chart 12: Electronics Profit margin (%) 9% 8% Machinery and equipment (seasonally adjusted) Prof it margin (%) 7% Electronics (seasonally adjusted) 7% 3% 3% 1% 1% UBS 12

13 Consumption and retail sales What the numbers say: The growth in retail sales fell in April, while real sales growth stayed flat due to falling prices. What they mean: Growth in real urban income and expenditure has rebounded since H208 on rapid disinflation, especially as food prices has fallen. Growth in rural income, on the other hand, has flattened, and rural expenditure growth has started to slow. China s retail sales data does not cover consumption of services, but does include some sales to firms and government agencies. The expenditure survey data is difficult to interpret. 12-month outlook: We expect urban expenditure growth to slow modestly this year but remain resilient as disinflation, the reversal of negative wealth effect, and government stimulus will largely offset the rise in unemployment and slower wage growth. We expect rural income and expenditure growth to be affected more by significant jobs losses among migrant workers. Higher grain procurement prices, increased fiscal spending in rural areas, and recent rural reform should help to cushion the negative impact. Retail sales growth has slowed Urban income growth rebounded while rural income growth stagnated Chart 1: Real retail sales y/y Chart 2: Urban income and expenditure Chart 3: Rural income and expenditure Retail sales grow th (% y/y, 3mma) Real grow th rate (% y/y, sa, 12mma) Real grow th rate (% y/y, sa, 12mma) 2 Nominal Real 2 Urban income Urban expenditure 2 Rural income Rural expenditure UBS 13

14 Property and construction What the numbers say: Our construction activity index continued to rebound in April. Of its components, completion, sales, and floor space under construction, all rose strongly, while new construction and land development continued to drop sharply. What they mean: The rebound in the construction index is a positive sign. While the strong pick-up in sales volume supports our view that fundamental property demand remains strong outside the high-end sector, the surge in property completion may largely reflect the strong housing starts years ago. The weaknesses in new construction and land purchase, which can partially explain the lacklustre demand for construction-related materials, reflect (i) continued weak sentiment and outlook among developers, and (ii) the construction of mass market property and low-end public housing has not yet come in full force. 12-month outlook: We expect mass-market and low-end housing construction to pick up strongly in the coming months, which in Q309 should more than offset the continued decline in high-end property new construction. We think the recent government decision to lower the own-capital requirement for commodity residential construction will help stimulate property investment. Construction activity rebounded, as sales, construction and completion rose Property prices have stabilized Chart 1: Real construction index Chart 2: Construction by component Chart 3: Property and land prices Real construction activity grow th (% y/y) Construction and floorspace indicators (grow th rate, % y/y) New /current Completed/sold Land sales/development -3 Grow th rate (% y/y) 18% 1 Property prices 1 Land prices 1 8% - Chart 4: Construction vs. steel demand Chart 5: Property lending Grow th rate(% y/y) Domestic steel consumption Overall construction index Floorspace started / under construction Grow th rate (% y/y) Growth rate (% y/y) 1 ST Loans to Construction 33% 1 Loans to Real Estate Developers (RHS) 1 28% 23% 8% % 13% 8% The construction index matches domestic steel and materials consumption swings well Loans to developers and construction rose strongly UBS 14

15 Trade What the numbers say: Imports dropped 23% y/y in April while the fall in exports steepened to 22. y/y from 17% y/y in March. Real imports grew in April from the low levels of early 2009, but exports continued its sequential decline. What they mean: The sharp drop in underlying real exports is consistent with continued economic contraction in China s major markets. The stabilization in real imports reflects the strong pick-up in some commodity imports related to domestic infrastructure investment demand, as well as the rise in processing inputs imports due to the tentative recovery in processing exports orders. However, the surge in some imports, such as iron ore, also reflected the price competitiveness of the imports relative to domestically produced products, not just overall demand. 12-month outlook: We expect both exports and imports to stabilize in the coming months as the extreme uncertainties that froze orders earlier on fade. Towards the end of 2009, we expect exports to recover on rebounding consumer demand, even though from a lower level. On imports, we expect volume growth to continue. Nevertheless, we expect the trade surplus to increase this year due to a sizable terms of trade gain. Both exports and imports continued to fall in April Chart 1: Export growth Chart 2: Import growth Chart 3: Sequential trends Export grow th (% y/y, 3mma) Import grow th (% y/y, 3mma) Sequential q/q grow th rate (% annualized, 3mma) Nominal Real Nominal Real Exports (real) Imports (real) Chart 4: Trade balance Chart 5: Change in balance by category Monthly trade balance (US$ bn) Headline Seasonally adjusted -5 Contribution to change in trade balance (US$ bn, sa, 3mma) 20 Primary Chemical 15 Metals Machinery Electronics Light Trade surplus narrowed in April due to the steeper fall in exports Most of the action is heavy industry and primary materials UBS 15

16 Trade, continued Chart 1: Trade balance by sector Chart 2: Trade balance by region Monthly trade balance (US$ bn, sa, 3mma) Primary Chemical 40 Metals Machinery Electronics Light Monthly trade balance (US$ bn, sa, 3mma) Europe North America Japan Other Asia Other -15 Chart 3: Real import growth by sector (i) Chart 4: Real import growth by sector (ii) Commodity imports have risen significantly Real import grow th rate (% y/y 3mma) Agriculture Minerals Fuels Chemicals -4 Real import growth rate (% y/y 3mma) Metals/materials -4 Electronics Machinery/equipment Light manufactures -6 Chart 5: Real export growth by sector (i) Chart 6: Real export growth by sector (ii) Real export grow th rate (% y/y 3mma) Primary resources Chemicals Metals/materials - Real export grow th rate (% y/y 3mma) Electronics - Machinery/equipment Light manufactures -3 UBS 16

17 FDI What the numbers say: FDI inflows stabilized in H108 after surging in 2007, but have fallen since H208. At the same time, direct investment abroad more than doubled in 2008, albeit still smaller than inward FDI. What they mean: FDI inflows have fallen in recent months as the expectation of RMB appreciation have faded and the financial crisis abroad has deepened. FDI flows have not been a significant contributor to the Chinese macroeconomic cycle. The significant growth in outward investment, mainly minerals mining and finance, reflects China s growing interest in overseas raw material resources, as well as Chinese enterprises increasing participation in global competition. 12-month outlook: We expect smaller, but still sizable FDI inflows in 2009, with a continued rise in Chinese investment abroad. FDI has stabilized Chart 1: FDI flows Share of GDP (%) 3% 3% Net inw ard FDI Net outw ard FDI 1% 1% -1% UBS 17

18 FX reserves and capital flows What the numbers say: FX reserve growth slowed significantly in Q408 and rebounded somewhat in Q109. The slower accumulation of FX reserves contrasted with the continued large trade surplus in recent months (except in February). What they mean: The smaller change in Q408 and Q109 FX reserves against the large trade surplus and persistent FDI inflows suggests a net other capital outflow in these months. However, the reversal in trade financing movements, the new FX regulation, and the possible losses in reserves could have clouded the true picture. We think the strictly defined hot money inflows into China had been relatively small, and the cushion from continued trade surplus and large FX reserves is big enough even if net capital flows turn negative. 12-month outlook: Our baseline forecast is for continued accumulation of underlying FX reserves, by as much as US$300 billion in After adjusting for valuation effects, FX reserve accumulation slowed since Q Other capital flows turned negative, but could be clouded by other factors Chart 1: FX reserve accumulation Chart 2: Reserve growth by source Chart 3: Hot capital flows Monthly FX reserve grow th (US$ bn) Headline Valuation and Seasonally Adjusted, 3mma Share of GDP (%, sa 3mma) 2 FX reserve accumulation (Adjusted) "Basic" balance of payments Other capital flows (Adjusted) Implied "other" capital flow s (% of GDP) From Financial system FX data From PBC FX reserve data (Adjusted) UBS 18

19 Exchange rate What the numbers say: Except for falling against the USD for a few days in early December, the RMB has remained stable since July, after appreciating at an annual rate of more than in Q108. Meanwhile, the USD has fluctuated wildly against the majors. What they mean: In recent months, the concerns about slowing export demand and talk of an expanded role of the RMB have dominated the discussions about the exchange rate, with contradictory implications. The RMB has appreciated by more than against the trade basket between July and end-november 2008, but has since seen volatile movements as the USD fluctuated wildly against other major currencies. 12-month outlook: We expect the RMB/USD to remain roughly unchanged in the coming year against a wide range of USD/EUR movements. While the policy priorities of supporting export growth leave no room for further RMB appreciation, China might face strong international criticism and protectionist reaction if it depreciated the currency while still having a large trade surplus in a global recession. Moreover, the RMB does not face any depreciation pressure from economic fundamentals from either the trade account or capital account. Volatile against the basket Remains stagnant against the USD The implied depreciation in the NDF market has moderated Chart 1: RMB against the basket Chart 2: Recent RMB movements Chart 3: NDF RMB expectations RMB exchange rate against US dollar 8.4 Bilateral change (annualized, % y/y) NDF forw ard premium against the dollar month forw ard 12-month forw ard Implied trade-w eighted basket Actual - - One-month One-year Jul-05 Mar-06 Nov-06 Jul-07 Mar-08 Nov-08-2 Jul-05 Mar-06 Nov-06 Jul-07 Mar-08 Nov-08 - Jul-05 Mar-06 Nov-06 Jul-07 Mar-08 Nov-08 UBS 19

20 Financial markets What the numbers say: After falling sharply in Q408, short-term interest rates have remained stable, while longterm bond yields have picked up somewhat. Meanwhile, the domestic A-share market has rebounded strongly, rising by more than 6 from its trough and 4 ytd, outperforming most other markets in the world. What they mean: Investors risk tolerance on equity investment has eased. We believe investors are prepared for poor economic data and earnings results, while any positive news (eg, rising QoQ earnings, higher-than-expected bank loans, a rebound in the PMI, and a property market recovery) are likely to be exaggerated in H109. The rise of long-term bond yields in recent months probably reflects improving growth prospects and market concerns about inflation over the medium to long term. 12-month outlook: We expect much of the recent A-share market gains to be sustained, although a deepening global recession, continued weak headline growth and production numbers, fall in earnings, and the upcoming resumption of IPO activities, might weigh on the equity market for the next few months. Investors are now focusing on both QoQ earnings growth as well as liquidity flows from the banking system. We expect short-term and longterm interest rates to remain low given the extremely expansionary monetary policy. Short rates have come down sharply Will the rebound continue? Chart 1: Money market interest rates Chart 2: Shanghai composite index Percent per annum 8 Shanghai composite Index Average 7-day interbank rate Average long bond yield PBC 1-year rate UBS 20

21 Macroeconomic data tables Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 Physical Activity Index (SARS-adjusted) % y/y Industrial production % y/y Energy usage % y/y Transportation volume % y/y Construction % y/y Agriculture % y/y CPI (1994=100) Index s.a Food Index s.a Goods Index s.a Services Index s.a CPI % y/y Food % y/y Goods % y/y Services % y/y Producer price index (1996=100) Index s.a Raw materials price index (1996=100) Index s.a Corporate goods price index (1994=100) Index s.a UBS import price index (1996=100) Index s.a Producer price index (1996=100) % y/y Raw materials price index (1996=100) % y/y Corporate goods price index (1994=100) % y/y UBS import price index (1996=100) % y/y M0 RMB bn (s.a.) M1 RMB bn (s.a.) M2 RMB bn (s.a.) Loans RMB bn (s.a.) Deposits RMB bn (s.a.) M0 % y/y M1 % y/y M2 % y/y Loans % y/y Deposits % y/y Reserve money RMB bn (s.a.) Reserve money (adjusted) y/y% Banks' excess reserve ratio % Nominal fixed asset investment (monthly) % y/y Real investment (GDP-consistent basis) % y/y Industrial sales RMB bn Real industrial sales % y/y Real industrial value added % y/y Industrial inventories RMB bn Inventory/sales ratio % Industrial profits (ytd) RMB bn Profit margin % (s.a.) Retail sales RMB bn Real retail sales (adjusted) % y/y Urban per capita income RMB (s.a.) Urban per capita expenditure RMB (s.a.) Rural cash income RMB (s.a.) Rural cash expenditure RMB (s.a.) Composite construction index % y/y Property price index % y/y Land price index % y/y Exports USD bn Imports USD bn Trade balance USD bn Real export growth % y/y Real import growth % y/y FDI utilized (ytd) USD bn FDI utilized (monthly) USD bn (s.a.) FX reserves USD bn Monthly FX intervention (adjusted) USD bn (s.a.) Current account (estimate) % GDP FDI % GDP "Other" capital (residual) % GDP RMB 3-month NDF premium (implied) 1.1% % % -1.8% -1.1% RMB 12-month NDF premium (implied) 5.7% 5.3% 3.1% % % -1.9% -0.9% 1. 7-day interbank market rate % per annum Average long bond yield % per annum Shanghai composite index (month average) Index Source: UBS UBS 21

22 Key Economic Indicators and Forecasts Economic Indicators Country China H.K. India 7 Indo. Japan Korea Malay. Nominal GDP (2007, USDbn) Per Capita GDP (2007, USD) 2,560 29, ,916 34,647 21,661 6,849 Per Capita GDP (2007 USD PPP) 5,540 42,010 2,740 3,570 33,548 26,570 13,220 Real GDP Growth: 2008E % 6.1% -0.7% E % E % % 1.8% % (Avg) % % 4.3% 6. CPI (Yearly average): 2008E 5.9% 4.3% 9.1% 9.8% % E % % 1.7% E % 1.1% (Avg) % 2.9% 2. Exports (%): 2008E % 19.9% 25.8% % 2009E % -0.1% E % 23.8% % (Avg) 30.3% % 14.9% Imports (%): 2008E % % E % % 2010E % 25.3% (Avg) 26.8% 12.1% % 13.7% Trade balance (USDbn): 2008E E E (Avg) Current A/C (USDbn):1 2008E E E (Avg) Current A/C % GDP 2008E 9.8% % 0.1% % E % -0.9% % E % % 0.7% (Avg) 6.8% 11.1% % 3.8% 1.7% 14.7% Fiscal Balance % GDP (2007) % -1.3% Sovereign Credit Risk Indicators Country China H.K. India 7 Indo 5 Japan Korea 3 Malay. Total Foreign Debt (07E, USDbn) N/A Foreign Public LT debt (07E,USDbn) Nil Foreign ST Debt (07E, USDbn) N/A Total Foreign Debt/GDP 10.1% N/A % Total Foreign Debt/Exports Goods & Services % 52.1% 102.7% N/A 49.9% 24.7% T. Debt Services/Exports Goods & Services 2.1% % N/A % Foreign Ex. Reserves (USDbn) Reserves/Imports (months) Sovereign Rating Moody/S&P A1/A+ Aa2/AA+ Baa2/BBB- Ba3/BB- Aaa/AA A2/A A3/A- Pakistan Phil. Sing. Taiwan Thai. Vietnam Asia ,019 1,621 36,393 16,819 4, ,273 2,480 3,290 41,140 34,410 7,840 2,600 18, % 0.1% % % % N/A % 3. N/A 5.9% % 7.1% 4.9% % 8.8% % % 6.3% % -1.1% % N/A 3.7% 0.8% 0.3% 1. N/A 2.7% 8.3% % % % -1.9% % % -21.9% N/A -12. N/A % 9. N/A % % 12.8% % 16.7% % % 16.8% % -14.1% % N/A -16.3% N/A % 3.9% 14. N/A % % % N/A N/A N/A N/A N/A N/A % % 6.3% -0.1% -10.3% % % 2. N/A 6. N/A % N/A 5.9% -3.3% 2.7% 22.7% 7.3% % % % Pakistan Phil. 9 Sing. Taiwan Thai. Vietnam Asia % % 25.1% 22.8% 30.7% N/A % 34. N/A 12.9% % % 1. N/A N/A B3/CCC+ B1/BB- Aaa/AAA Aa3/AA- Baa1/BBB+ Ba3/BB Nil 1 Singapore: NODX; 2 Philippines, India = Public Sector Balance; Latest data available; 3 Source of foreign debt: IMF; 4 Indonesia Total Public Sector Debt; 5 Source of foreign debt: Bank Indonesia; 6 Source for all other information: EIU; 7 India GDP and current account balance, Fiscal years beginning April; 8 Total Public Debt as at end 1996; 9 Total Public Debt Figures; 10 All aggregate series calculated using 2005 Nominal GDP fixed weight, Asia (ex. Sri Lanka, Pakistan & Vietnam). Prices in forecast and databank tables are as at 30 th May UBS 22

23 Economic Databank USD Exchange Rate (period end) E 2010E Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Ytd Avg China* Hong Kong India* Indonesia Japan Korea Malaysia Pakistan N/A Philippines Singapore Taiwan Thailand Vietnam N/A N/A *China: Official Rate before 1989, Shanghai Swap Rate , Unified Rate from January 1994; India: Currency unified Mar Money Market Interest Rates E 2010E Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Ytd Avg China Hong Kong India Indonesia Japan Korea Malaysia Pakistan N/A Philippines Singapore Taiwan Thailand Vietnam N/A N/A Singapore, Malaysia, Hong Kong, Philippines : 3m Interbank; Indonesia: 28Days SBI; Thailand: Onshore 3M interbank rate/ 3m implied forward before Jan 96/interbank call before 1988 China: 7 Days Interbank Offered Rate; Taiwan: 31-90D CP; Korea: 91D NCD; India: 91D T-bill, Overnight rate prior to 1993; Vietnam: 3M Deposits rate; Sri Lanka: 3M T Bill; Pakistan: 3M T Bill; Japan: 3M CD 10Y Bond Yield E 2010E Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Ytd Avg China N/A N/A Hong Kong India Indonesia Japan Korea Malaysia Pakistan N/A Philippines Singapore Taiwan Thailand Vietnam N/A N/A SG: before June 98 Prime lending; MY: before 95 Prime lending; TH: before 95 MOR; ID: before Jul 03 Prime Lending; PH: before Oct 96 Prime lending; CN: before April 2002 Capital Construction Loan: 1 Year; HK: before 96 BLR; Taiwan: before 95 Prime Lending rate; IN: Before Jan 2000 Prime lending; Sri Lanka & Pakistan: 10y bond yield ; Korea: 3y Ref corp. bond yield before Oct 98/5Y Treasury Bond Real GDP %YoY E 2010E Q1 Q2 Q3 Q4 Q1 Ytd Avg China % 10.9% % % 6.1% 6.1% Hong Kong 10.3% 0.7% 3.9% 2.3% % % 7.3% 4.1% % -7.8% India**** % % % 7.7% 5.8% 5.8% Indonesia 9.9% % 5.7% 6.3% 6.1% 3.3% 4.7% Japan % 5.3% % 1.9% % % 1.3% % -4.3% -9.7% -9.7% Korea % % % 3.1% % -4.3% Malaysia % 9.8% 8.3% 5.3% 6.3% % % 4.7% 0.1% Pakistan *** % 5.8% N/A N/A N/A N/A N/A Philippines % % % % % Singapore 9.7% % 7.3% 7.8% 1.1% % % -10.1% Taiwan 7.3% % % 0.1% -6.1% 2.3% 6.3% % Thailand 4.8% 4.7% % % % 3.9% % -7.1% Vietnam -2.9% % % N/A % % 3.1% Malaysia: Historical GDP data up to 1996 use 1978 as the base year. Data from 1997 and forecasts use 1987; Thailand: Q498, Q199 are NESDB stats releases ; CPI Inflation %YoY (period average) E 2010E Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Ytd Avg China % 9.9% 17.1% % 4.8% 5.9% % % 7.1% 6.3% 4.9% % Hong Kong % 0.9% % 0.7% % % 6.3% % 1.8% 3.1% % 0.8% India* % % 3.7% % % 7.8% 7.8% 7.7% 8.3% % % % 8.7% Indonesia 18.1% 4.8% % % % % 11.8% 12.1% 11.8% 11.7% 11.1% % 7.3% % Japan 7.8% % -0.1% -0.7% -0.3% % % 1.3% % 2.1% 2.1% 1.7% % -0.3% -0.1% -0.1% Korea 28.7% % 2.8% % 1.7% 2.3% 3.9% 4.1% 4.9% % % 4.8% % 3.7% 4.1% 3.9% % 3. Malaysia 6.7% 0.3% 3.1% % % 2.8% % 7.7% % % 3.7% Pakistan** % 10.8% % N/A 14.1% % % 25.3% 23.9% % 23.3% % 19.1% 17. Philippines % % % 2.8% 9.3% % % % % % % 7.3% % 6. Singapore % % % % 6.7% % % 2.9% 1.9% % 1. Taiwan % 4.1% 3.7% 1.3% 2.3% 1.8% % 0.3% 3.9% 3.9% 3.7% % 4.7% 3.1% % 1.3% % -0.1% % Thailand 19.8% % 5.7% % % % % 3.9% % % -3.3% -1. Vietnam % 8.3% 23.1% 10. N/A % % 27.9% 26.7% % % 11.3% % * India: Fiscal year beginning April; ** Pakistan: Fiscal year beginning July Source for all tables on this page: UBS estimates, Datastream & CEIC UBS 23