Transcript Assessing the Impact of Sars: Moderate but meaningful

And then there
was none…
Jim Walker
Chief Economist
September 2005
China’s first capitalist cycle

China will have a severe cyclical downturn in the next two
years

The current upswing, dating from early 2002, is
Schumpeterian in nature
 Business creation is destroying profits

As is natural in the late-cycle, costs are also rising

China’s cost structure is amplifying the problems
©2005 CLSA Asia-Pacific Markets (“CLSA”).
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Page 2
What is a Schumpeterian cycle?

Entrepreneurial swarming

Cause? Private property rights, WTO membership –
changes to the institutional framework, not inventions or
innovations

Creative destruction

Skilled and managerial labour intensive
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
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Page 3
China’s labour shortage

Skilled and managerial workers are in increasingly short
supply

Wage inflation and job turnover are both high

The Taiwanese talent pool is almost dry

Time will solve the problem but not within this cycle
 Productivity growth threatened

General inflation will result
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
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Page 4
Another Austrian element

Banks cause cyclical fluctuations in market economies

China’s banks have been a cycle-damping influence
previously

This cycle will be more normal

Expect a secondary credit contraction after the downturn
begins
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 5
When will it happen?
China’s overheating checklist
Variable
Danger signal when:
Current status:
YoY growth rate significantly exceeds 10year average
M1 below 10-year average; M2 below 10year average
No
Rapid credit expansion relative to trend
Deviation from trend on our BCR chart is
greater than +1 standard deviation
although real overheating present at only
+2 or +3 sds
On trend
No
Adjusted resource gap (the current account
of the balance of payments plus net foreign
direct investment inflows)
Deficit exceeds 3% of GDP
Surplus of 5% of GDP estimated for 2004.
CLSA estimate of 3.9% surplus in 2005
No
Accelerating general inflation
CPI in excess of 5%
CPI is 2.7% YoY in March. Core inflation
rising from last year though
No
Rising asset prices with pressure building
on most risky
Rotation from property and bonds to
equities. Double-digit rises in property
prices
General property inflation now in doubledigits. Domestic share market the worst
performer in Asia in 2004
Yes, but largely contained in
the property market. Gambling
outlets growing though
Rising costs, particularly labour
Wages rise faster than sales growth or
nominal GDP. Raw material input costs
rising fast
Official income statistics understating
increases
Yes
Profits in general fall from previous period
(seasonally adjusted). Surprising on the
downside
1Q05 'A' share corporate earnings growth
in single digits
Yes
Rising inexplicably in general
Double digit rises but below nominal GDP
growth. Not explosive yet
No
Macro
Fast monetary growth relative to history
Micro
Corporate earnings
Accounts receivable
Overheating signal
May 2005:
Source: CLSA Asia Pacific Markets
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 6
China growth – profitless and jobless
 We are lowering our forecast growth range for 2006 to 5-7%

Cost pressures on Chinese companies are unrelenting. The
worst of the oil price increases have yet to be felt because of
controlled product prices

Money supply is plentiful but money demand is faltering

Import growth profile is not about an inventory cycle. Domestic
demand growth in 2Q05 around 8% compared with 18% in
2Q04
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
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Page 7
Strains in the system are showing
‘A’ share PROFITS UNDER PRESSURE
Net profit growth (YoY)
No. of sectors showing negative
YoY profit growth (out of 22)
1Q04
44.2
2Q04
46.2
3Q04
32.6
4Q04
14.7
1Q05
6.6
2Q05
0.9
3
8
9
14
11
15
Source: CLSA Asia Pacific Markets
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 8
Costs are squeezing margins
Input Prices Index
Output Prices Index
50.0 = no change on previous month, S.Adj.
50.0 = no change on previous month, S.Adj.
75
Increasing rate of inflation
75
70
70
65
65
60
60
55
55
50
50
45
Increasing rate of inflation
45
Increasing rate of deflation
40
Increasing rate of deflation
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 9
Sep-05
Aug-05
Jul-05
Jun-05
May-05
Apr-05
Mar-05
Feb-05
Jan-05
Dec-04
Nov-04
Oct-04
Sep-04
Aug-04
Jul-04
Jun-04
May-04
Apr-04
Sep-05
Aug-05
Jul-05
Jun-05
May-05
Apr-05
Mar-05
Feb-05
Jan-05
Dec-04
Nov-04
Oct-04
Sep-04
Aug-04
Jul-04
Jun-04
May-04
Apr-04
40
Jobless growth?
Employment Index
50.0 = no change on previous month, S.Adj.
55
Increasing rate of growth
50
Increasing rate of contraction
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 10
Sep-05
Aug-05
Jul-05
Jun-05
May-05
Apr-05
Mar-05
Feb-05
Jan-05
Dec-04
Nov-04
Oct-04
Sep-04
Aug-04
Jul-04
Jun-04
May-04
Apr-04
45
Manufacturing sector expansion
Purchasing Managers' Index
50.0 = no change on previous month, S.Adj.
60
Improving business conditions
55
50
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 11
Sep-05
Aug-05
Jul-05
Jun-05
May-05
Apr-05
Mar-05
Jan-05
Dec-04
Nov-04
Oct-04
Sep-04
Aug-04
Jul-04
Jun-04
May-04
Apr-04
45
Feb-05
Deteriorating business conditions
Above target M2 but no reaction
China M2 growth and bank lending
26
35
23
30
25
20
20
17
15
14
M2 growth %YoY
Source: CEIC
M2 growth %QoQ sa 3mma
Bank Lending growth %YoY
Jul-05
Apr-05
Jan-05
Oct-04
Bank Lending growth %QoQ sa 3mma
Source: CEIC
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Jan-02
Jul-05
Jan-05
Jul-04
Jan-04
Jul-03
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
0
Jan-00
8
Jul-99
5
Jan-99
11
Apr-02
10
Page 12
Import growth shows demand slowing
China import growth
80
(%YoY)
60
40
20
0
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 13
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
Jan-99
Jan-98
Jan-97
Jan-96
Jan-95
Jan-94
Jan-93
-20
Mitigating forces
China's growth cycle is here
b
B
A = 1998
B = 2015
a = 2001
b = 2006/7
c = 2008/9
c
a
A
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
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Page 14
Profile of the downturn

Real GDP growth in the range 4-5% in 2007, maybe earlier

Deflation likely as credit contracts and asset markets fall
 Global inflation pressures defused – commodity prices will fall
temporarily

Banking sector recapitalisation will become a matter of
urgency. Foreign investors will be welcomed
©2005 CLSA Asia-Pacific Markets (“CLSA”).
IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which may be obtained
on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Page 15