THE RISE OF CHINA Presented to Financial Executives International Orange County Chapter May 9, 2007

TOPICS INTRODUCTION POLITICAL SITUATION ECONOMIC CONDITION FINANCIAL ENVIRONMENT CONCLUSION

INTRODUCTION “It now appears that global stock market corrections are made in China.” Stephen Roach of Morgan Stanley

GLOBAL ECONOMY Revolutionize the relative prices of labor, capital, goods and assets Oil price high, yet no inflation Manufactured low-priced goods Lid on wages Excess liquidity – low interest rates – high asset prices Bond yields low

POLITICAL LEADERS 1949: Chinese Communist Party 1 st generation: Mao Zedong 2 nd generation: Deng Xiaoping ( ) 3 rd generation: Jiang Zemin 4 th generation: Hu Jintao (March 2003)

DENG XIAOPING Policy of “Socialism with Chinese Characteristics” Economic openness and foreign trade Iron grip on politics 1989: Tiananmen Incident

JIANG ZEMIN Prime Minister: Zhu Rongzhi Role of capitalism 1992: FDI exploded July 1997: Hong Kong turnover 2001: WTO membership Open to more foreign investment and trade Increase the pace of privatization – only a third is under state controlled Global economic force - Double its share of global manufacturing output

HU JINTAO Nov 2002: Hu Jintao was named Prime Minister: Wen Jiabao Steps toward financial transparency 2008: Olympic games 2010: Shanghai World Trade

REFORMS “Three Representatives” - farmers, workers, and businessmen to be represented in the CCP Freedom of information rule – require government to make any unclassified info public w/in 15 days Expected to pass a controversial law enshrining private property rights Reduce inequality

DEMOGRAPHY Jan 2005: Population 1.3 billion One Child Policy Gender: 100 males to 70 females Middle-class – 25m, just 2% of the population, not big enough to impact globally China’s middle class would soon outnumber US population 1970: 80% rural, 50% illiterate Present: 40% urbanized, 90% literate

MACROECONOMIC DATA (2006 estimate) Inflation rate – 1.5% Unemployment rate – 4.2% Labor force – million Agriculture – 45% Industry – 24% Services – 31% GDP growth – 10.5% Agriculture – 12.46% Industry – 47.28% Services – 40.26%

NATIONAL OUTPUT World’s 4 th largest economy (nominal GDP = $2.68 trillion) Expects GDP to top America by nd in Purchasing Power Parity terms = $10 trillion In just 4 years, China is likely to become #1 GDP per capita (nominal) = $2034 (Rank 105 th) GDP per capita (PPP) = $7593 (Rank 80 th ) Wealthiest cities: around $7000 in 2006 US: (double per capita GDP) China: ,

ECONOMIC CLOUT Currency and trade imbalances – source of political irritations Dec 2006 : First semi-annual “Strategic Economic Dialogue” High-level delegation US-China mutual interdependence

TRADE China’s current account surplus - around 8% of GDP 2006: US trade deficit in goods reached $836 billion Countries/regions that account for most of the deficit: China ($233 billion) European Union ($117 billion) Japan ($88 billion) 70% of exports from China to the US are being done by US MNCs Exports to China grew by 31.7% to $55.2 billion, making it the No. 4 destination for U.S. exports

TRADING PARTNERS (2005) Exports = $974 billion f.o.b. (2006) US – 21.4% Hong Kong – 16.3% Japan – 11% South Korea – 4.6% Germany – 4.3% Imports = $777.9 billion f.o.b. (2006) Japan – 15.2% South Korea – 11.6% Taiwan – 11.2% U.S. – 7.4% Germany – 4.6%

FX RESERVES China's massive hoard is the result of large current-account surplus significant inward foreign direct investment huge inflows of speculative capital over the past couple of years Explosion in reserves creates excess liquidity risks fuelling higher inflation asset-price bubbles imprudent bank lending

LOWER YUAN By keeping the Yuan down China is feeding a trade surplus that is creating a growing political backlash in America and Europe G7 urged Beijing to let the Yuan rise to help ease serious "imbalances" in global finance

DOLLAR OR EURO About 70% of its FX is invested in dollars, mainly Treasury securities Propped up the dollar and reduced American bond yields Need to diversify reserves out of dollars Increase in reserves into euros and emerging Asian currencies Shifting money into euros would push down the dollar

MANAGED FLOAT A big shift out of dollars could push up bond yields and hence mortgage rates Help U.S. manufacturers by raising their competitors‘ costs Pegged to the dollar into ‘managed float’ Yuan rising at an annual rate of almost 7% against dollar since September 2006 On November 13th the yuan hit a new high of to the dollar

MARKET Population – 1.3 billion Rapid urbanization Rising standard of living Increasing demand for consumer goods Think Yao, not Mao MNC – imperative to have China strategy

MANUFACTURING Cheap labor Average factory worker makes $207 a month Manufacture simple to sophisticated goods Wal-Martization Service outsourcing hub Intel plans to open a $2.5 billion factory in Dalian by 2010

FINANCIAL MARKET Weakest link State-owned banks Loans are made on the basis of non-market considerations Banking sector – still murky Limits foreign ownership to 25% High saving rate explains why deposits have grown faster than loans

STOCK MARKET 2007: Open its financial sector to foreign competition and investment Require companies listed in Shanghai and Shenzhen stock markets to adopt norms similar to the International Financial Reporting Standards Need foreign expertise and technology to meet international financing reporting standards

BANKING SERVICES Foreign financial houses spent about $23b to offer a wide range of banking services – credit cards, mortgages, personal finance More than $1.8 trillion in personal savings -- and a savings rate of close to 50% -- could become the financial market of the 21st century

OTHER ISSUES Corruption Lack of transparency Intellectual Property Rights Underdeveloped legal infrastructure China premium (20-30% lower) valuation of risk

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