ANCHOR REPORT

China economy
GLOBAL ECONOMICS AND STRATEGY November 2011

China risks
Research analysts

November 2011

We attach a one-in-three probability to China experiencing a hard economic landing commencing before the end of 2014. We define “hard landing” as an abrupt slowdown in real GDP growth to an average of 5% y-o-y or less over four consecutive quarters. We discuss six key reasons why the risk of a China hard landing happening in the next three years appears to have increased. We launch Nomura’s China Stress Index (CSI), which uses 18 indicators to summarize the macro risks in a single measure. Our global strategy teams conduct a “what if” exercise, discussing trading recommendations and stock ideas for this non-trivial risk scenario.

Economist Rob Subbaraman rob.subbaraman@nomura.com +852 2536 7435

Strategist Kevin Gaynor kevin.gaynor@nomura.com +44 (0) 20 710 27800

Any portion of this report that has been prepared by a trading desk analyst is not a product of the Fixed Income Research Department and is not covered by the Research Analyst certification provided in Appendix A-1. For additional information concerning the role of Trading Desk Analysts, please see the important conflicts disclosures beginning at page 101 of this report.

Nomura | Asia Special Report

November 2011

Foreword........................................................................................................... 3 Executive summary ......................................................................................... 4 Introduction – Six reasons to worry .............................................................. 5 Defining a hard economic landing ................................................................. 8 Defining a “hard landing” ................................................................................ 8 Triggers and timing ........................................................................................ 8 Policy responses ............................................................................................ 8 Perceived likelihood ..................................................................................... 10 Nomura’s China Stress Index (CSI) ............................................................. 11 1. Overinvestment and excessive credit ..................................................... 13 Box 1: Fuzzy numbers .............................................................................. 14 Box 2: China‟s challenging GDP arithmetic .............................................. 17 Box 3: Lessons from Japan on the return and cost of capital .................. 19 2. Rudimentary monetary architecture ........................................................ 22 Box 4: Shadow banking in the US and China compared ......................... 26 3. The privileged state-owned enterprises .................................................. 28 Box 5: Investment is high, but savings are even higher ........................... 30 Box 6: The Akerlof market for lemons problem applied to China ............. 31 4. Unintended consequences of financial liberalization ............................ 33 Box 7: A chronology of China‟s capital account liberalization .................. 34 Box 8: Risks associated with financial liberalization: lessons from Japan38 5. The Lewis turning point ............................................................................ 39 6. The setting in of growing pains ............................................................... 43 Demographic challenges .............................................................................. 43 Box 9: China‟s hukou household registration system .............................. 46 Rising inequality and an aspiring middle class ............................................ 46 Resource and environmental strains ........................................................... 51 Pricing a China hard landing – Strategy perspectives .............................. 56 Global macro perspectives ........................................................................... 59 Global equity perspective ............................................................................. 64 Asia-ex Japan FX perspective ..................................................................... 67 Implications for Asia regional equities…………………………………………69 China equities – the risk…………………………………………………….......73 Chinese credits – already reflecting the risks of a China hard landing ........ 91 References...................................................................................................... 94 Appendix: The Construction of Nomura‟s China Stress Index ....................... 97

2

Nomura | Asia Special Report

November 2011

Foreword
We are pleased to present Nomura‟s Anchor report on China, in which our economists, strategists, equity and political analysts assess the medium-term risk of a hard landing – a critical issue for today‟s global economy. At Nomura, we pride ourselves in producing research of the highest standard. Historically, we have had a strong presence across Asia, and in recent years we have increased our footprint in Europe and the United States to become Asia‟s leading global investment bank. Our roots in Asia allow us to see firsthand the breakneck speed at which the region‟s economies are emerging – and contributing over half of global GDP growth. China leads the world in the growth stakes, but the risks in our view have risen and should no longer be ignored. Our base case is that China's economy will average growth of about 8.5% in 2012-14, but we judge that the risks of a temporary interruption that pushes growth far below potential are rising. We define a so-called “hard landing” as an abrupt slowdown in real GDP growth to average 5% or less for at least one year. This report discusses six key factors that lead us to attach a one-in-three likelihood that China‟s economy commences a hard landing before the end of 2014. How would this non-trivial risk of a hard landing in China impact global financial markets? Our global and Asian equity, FX, rates and credit strategy teams assess the macro implications and present trading recommendations and specific stock ideas to this risk scenario. How can investors calibrate the risk of this hard landing scenario? In this report we launch Nomura‟s China Stress Index (CSI) which we will update quarterly. The exact probability of a hard landing is necessarily a matter for investor judgment, but the CSI will give investors an important indication of risk. Nomura‟s Anchor series of reports underscore our dedication to produce thematic, long-term studies, involving cross-region and cross-division collaboration among our global markets research teams. We welcome your feedback as we continue our tradition of collaborative work to deliver unique investment insight and ideas to our clients.

Hideyuki Takahashi Head of Global Research

Paul Norris Head of Global Markets Research

3

David Vincent and Kenneth Persing for editing. our China Stress Index. but this is not without risks. Chien-hua Chen and Qilong Zhang. Overinvestment and excessive credit. quick and effective a policy stimulus would be.Nomura | Asia Special Report November 2011 Executive summary1  This study takes China‟s still enormous economic development potential as a given and focuses on the risks and challenges that lie ahead – for the economy‟s meteoric rise has been associated with a build-up of fundamental imbalances. Michael Kurtz. Unintended consequences of financial liberalization. The Lewis turning point. but the question is how large. such as falling credit standards as banks overly compete with one another. and Jay Chandrasekharan for coordinating the equity analysts. Internationalization of the renminbi is adding pressure for China to accelerate financial liberalization. centered on controlling the exchange rate is not very effective in managing an economy that is rapidly becoming more open and sophisticated. The setting in of growing pains from worsening demographics and increasing strains on natural resources and the environment. We are also indebted to Zhiwei Zhang. Ian Scott. yet they are capital intensive. China's economy is now so big and complex that many of its structural problems are becoming more interrelated. Simon Flint. Alastair Newton. Please refer to the summary pages 56-58 for strategy perspectives. Empirical literature shows that investment booms are more likely to trigger a crisis if they are associated with credit booms. but specific mention should be made of Zhiwei Zhang. associated with a dwindling supply of surplus labour from the countryside. We are grateful to Candy Cheung and Wendy Chen for data analysis. Chi Sun. The key will be whether the risk of a hard landing rises or falls in the future. Enter Nomura's new proprietary tool. making it more challenging to implement structural reforms and address high income inequality. inefficient and crowd out smaller private enterprises. we judge that it would be less than in 2008. China's investment is almost half of GDP. Pradeep Mohinani. or 1. we discuss six compelling reasons why the risk of a hard landing has increased. which uses 18 indicators to summarize the macro risks in a single measure. many of its critical reforms are becoming unavoidably connected. The privileged state-owned enterprises receive preferential government subsidies and bank financing.8x if the shadow banking sector is included. We are well aware that picking the exact timing of a hard landing is devilishly difficult. A rudimentary monetary architecture.             1 The authors of particular parts are accredited in their respective sections. We attach a one-in-three likelihood that a hard landing commences before the end of 2014.5% in 2012-14. making it more difficult to continue undertaking individual reforms gradually and in isolation.5x GDP. trading recommendations and stock ideas should the non-trivial risk of a China hard landing impact global financial markets. China ticks both of these boxes. is likely upon China. which could trigger a serious outbreak of inflation. while domestic credit is nearly 1. We define a hard economic landing in China as an abrupt slowdown in real GDP growth to an average of 5% y-o-y or less over four consecutive quarters. On all three counts. While our base case is that China's economy will average growth of about 8. Paul Sheard and Paul Norris for providing helpful comments on early drafts. and has resulted in a cost of capital that is too low and a financial sector that is repressed. 4 . These growing pains will almost certainly cause the economy's growth potential to slow over this decade. Also. The government would no doubt do all in its power to respond.

5. President Hu Jinato.400 in 2010 is similar to that of Japan in 1975. 2: Nominal GDP per capita: China vs Japan USD 45.000 35. Boao Forum for Asia.000 25.Nomura | Asia Special Report November 2011 Introduction – Six reasons to worry China has made remarkable achievements in development. We define a so-called economic “hard landing” as an abrupt slowdown in real GDP growth to an average of 5% y-o-y or less over four consecutive quarters. high income inequality.000 40. 4. suggesting that China's current real average standard of living is more on par with Japan's before the 1960s. Overinvestment and excessive credit Rudimentary monetary architecture The privileged state-owned enterprises (SOEs) Unintended consequences of financial liberalization The Lewis turning point The setting in of growing pains Six factors lead us to attach a one-in-three likelihood that a China hard landing commences before the end of 2014 2 3 To compare the sizes of economies we convert nominal GDP into USD at market exchange rates. Hainan. but it remains the largest developing country in the world. 1. as China‟s leaders readily admit. GDP per capita in constant prices is a more appropriate yardstick to compare real purchasing power. However.5% in 2012-14.000 20. and there are the growing challenges of worsening demographics. This study takes China‟s still enormous economic development potential as a given and focuses on the macro risks and challenges that lie ahead.000 5. Yet China is still a poor country: its nominal GDP per capita of USD4.000 30. 6. suggesting that there is still lots of room to urbanize. resource shortages and environmental degradation.and investment-led growth model is reaching its limits. 15 April 2011.000 China Japan 0 -10 -20 15.423) in 2010. the once seemingly endless supply of cheap rural labour migrating to the cities is diminishing. macro and industrial policies need a major overhaul. In 2010 it surpassed Japan to become the 2 world‟s second-largest economy (Figure 1). Population. resources and the environment have put great pressure on our economic and social development.000 0 -30 1950 1960 1970 1980 1990 2000 2010 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: CEIC and Nomura Global Economics. 3. China's economy still has lots of room to develop. 5 . industrialize and 3 move up the value-added ladder (Figure 2). World Bank data show that in 1960. Japan's real GDP per capita (USD7. 1: China’s long-run real GDP growth % y-o-y 30 20 10 Fig. but fundamental problems have built up Fig. Our base case is that China's economy will average growth of about 8.000 10. 2. China‟s economy has averaged 10% real growth since it launched its reforms and began to open up in 1978. but we judge that the risks of a temporary interruption that pushes growth far below potential are rising. the economy‟s meteoric rise has been associated with a build-up of fundamental problems: the export.241) was still higher than China's real GDP per capita (USD2. but such data on a consistent basis are only available back to 1960. coordination or sustainability in our development. Six factors lead us to attach a one-inthree likelihood that a China hard landing commences before the end of 2014. Source: CEIC and Nomura Global Economics. China. and there is lack of adequate balance.

5x GDP. Rather than any one of these factors alone. at the earliest. The conventional wisdom seems to be that. environmental degradation and credit rationing to private small to medium-sized enterprises (SMEs). while the financial repression has given rise to a flourishing shadow banking sector. increasing strains on natural resources and the environment. centering on controlling the exchange rate. or 1. the tipping point is when GDP per capita (on a purchasing power parity basis) is USD16. internationalizing the renminbi and moving to a more flexible exchange rate 4 The empirical literature on the causes of financial crises offers some pertinent lessons to China China‟s economy has become so big and complex that many of its structural problems are becoming more interrelated Increasing strains on natural resources. The second reason relates to China's stage of economic development – the economy has become so big and complex that many of its structural problems are becoming more interrelated. can become politically more divisive as power and economic privilege needs to be wrested from local governments. structural problems festering below the surface can bubble up to the surface. However. are causing growing pains to set in that will almost certainly cause the economy's potential growth to slow over the course of this decade and inflation to be structurally higher. Third. which leads to wasteful investment of scarce resources. historically the government has implemented reforms incrementally. or that it would never happen. and demographics are causing growing pains to set in It is becoming more difficult to undertake individual reforms gradually and in isolation For example. real GDP growth shifts down by at least 2 percentage points – and calculate that.740 – which China is unlikely to reach until 2015.031 of its subscribers were asked about the chances of China‟s economy slowing below 5% growth: 12% of respondents believed it will happen within the next year. For example. we find some compelling reasons why the risk of it happening in the next three years should no longer be ignored. 1.740. in part because the most robust leading indicator of financial crises – the debt-to-GDP ratio – is flattered. However.Nomura | Asia Special Report November 2011 While there may be many tell-tale warning signs that a hard landing is coming. They analyse a sample of 41 fast-growing economies over the period 1957 to 2007 and find that on average these economies slow significantly when GDP per capita on a purchasing power parity basis hits 5 USD16. together with demographic changes rapidly turning unfavorable. China has reached a stage of development at which many of its critical reforms are unavoidably connected. 5 Specifically. The first is that an extended period of high GDP growth can mask the build-up of underlying financial problems. making it more difficult to undertake individual reforms gradually and in isolation. a rising old-age dependency ratio and an undervalued exchange rate are important features that typically increase the chances of a sharp slowdown – and China has all of these. In an environment of slowing trend growth and higher structural inflation. Fourth. the SOEs and the banks. The analysis of Eichengreen. higher and more volatile inflation. and implementing reforms can be more challenging. should there be one.8x if the shadow banking sector is included. they also show that a low consumption-to-GDP ratio. While we are well aware that picking the exact timing of a hard landing is devilishly difficult. For example. 47% within the next 2-5 years and the remainder thought longer than 5 years. The empirical literature on the causes of financial crises offers some pertinent lessons to China. Lesson number two is that investment booms are more likely to trigger a crisis if they are associated with credit booms. a hard landing. because of political incentives. the environment. China ticks both of these boxes: investment (public and private) comprises nearly half of GDP and domestic credit is almost 1. removing the generous government subsidies to SOEs. on average. For instance. 6 . according to a Bloomberg global survey on 29 September 2011. the trickiest part is getting the timing right. the authors identify 43 cases where rapidly growing economies slow significantly – that is. Park and Shin (2011) adds some support to this view. has resulted in a cost of capital that is too low and a financial sector that is severely repressed. we believe it is the combination of various imbalances and interactions among them that increases the likelihood of a major setback. a rudimentary monetary architecture. The too-low cost of capital has fueled overinvestment. would not occur until after the transition to China‟s fifth generation of leaders in 4 early 2013. Another example is the generous government and bank support given to the less efficient and capital-intensive state-owned enterprise (SOE) sector.

financial deregulation can pressure banks to engage in overly aggressive competition. lowering overall credit standards.Nomura | Asia Special Report November 2011 regime are adding pressure on China to press ahead with capital account liberalization and interest rate deregulation. One proposed reform is to relax the rigid hukou household registration system. it is hard to envisage substantial change before the next generation of leaders takes the helm in March 2013. We see the pressure building to make more broad-based wholesale reforms. rural surplus labour which is starting to accelerate wage growth. Politically. But without adequate safeguards. but given growing inter-linkages of various reforms. Another example is China‟s shrinking supply of young. such as environmental degradation and social tensions. giving city migrants the same rights as locals so as to encourage greater labour mobility and faster urbanization. big changes will carry greater risks. 7 . But without other reforms this could exacerbate other problems.

but there are many potential triggers Policy responses In response to the global financial crisis China implemented a RMB4trn (13% of 2008 GDP) fiscal stimulus. given: 1) the ratios of investment to GDP and credit to GDP are so high.9% y-o-y for four quarters in a row. Our definition is an abrupt slowdown in real GDP growth to an average of 5% y-o-y or less over four consecutive quarters Triggers and timing Although the advanced economies falling back into recession would hurt China‟s exports.1% in 1989 and 3. The more likely cause would be a major pullback in investment from its current very high share of almost half of GDP. were it to occur. or 1. Whatever the trigger. timing and description of a hard economic landing.Nomura | Asia Special Report November 2011 Defining a hard economic landing The term “China hard landing” is too often a throw-away line that means different things to different people. and 4) simply “investment” fatigue setting in. China‟s real GDP growth could average 4. 2) support from exports is likely to be less than before. we would not rule out it happening earlier. a major pullback in investment would be likely to cause a steep rise in non-performing loans (NPLs) given that China‟s domestic credit-to-GDP ratio is also at an extraordinarily high 1. for external shocks to directly cause a hard landing. However. and since then the lowest average growth on a four-quarter rolling basis was 7. The last time China experienced a hard economic landing by this definition was when real GDP growth slowed from 11. because of political incentives. and 4) policy responses are likely less effective than before. In economists‟ parlance we would regard this as a deep recession. such as social unrest or a deadly pandemic. Defining a “hard landing” We define a hard economic landing in China as an abrupt slowdown in real GDP growth to an average of 5% y-o-y or less over four consecutive quarters. put the steady appreciation of the CNY/USD exchange rate. Note that under our definition. On our estimate of China‟s potential GDP growth being around 8%.8% in 1990. It terms of timing. 3) unforeseen shocks. From Q4 1999. In addition – and with a large dose of humility – we present our views on the likelihood. Through losses of wealth. a hard landing would not be allowed to happen until after the leadership transition in March 2013. over four consecutive quarters. cut the bank 8 . our hard landing definition means GDP growth being at least 3 percentage points (pp) below potential. investments in property (24% of total) and infrastructure (28% of total) appear the most vulnerable components.5% y-o-y in Q4 2001. averaging below 5%. Within gross capital formation. China started publishing quarterly real GDP data.2% in 1991. for instance the People‟s Bank of China (PBC) underestimating inflation and having to play catch-up via aggressive tightening. but one that we do not rule out) before rebounding to over 5% y-o-y in subsequent quarters – but for the four quarters. 3) the economy has become so large and complex that many of the structural problems are becoming more interrelated.5x. confidence and jobs there would likely be large indirect knock-on effects to household consumption. Examples of potential triggers of an investment-led downturn include: 1) a correction in what appears to be an overheated property market. there is an argument that. The most likely cause would be a major pullback in investment. before rebounding to 9. 2) policy mistakes. in our view. on average. which we would regard as equivalent to a contraction in real GDP in the US.3% y-o-y in 1988 to 4. We provide a precise definition of what we regard as a hard economic landing in China. that has been in train since July 2005. on hold.8x once the shadow banking sector is taken into account. the economy is too domestic driven. or it could plunge to negative year-on-year growth in one quarter (a low probability event.

and cut the benchmark 1yr lending rate by 216bp. The growth of newly started fixed-asset investment projects was 23. the economy was overheating. we would expect another stimulus package and. We have no doubt that the government would again do all in its power to respond to signs of a hard landing. On monetary policy. So when the global financial crisis hit. with CPI inflation currently much higher (6. China: The case for structurally higher inflation. including future losses related to NPLs and unfunded pension liabilities which. On all three counts. but the question is how large. and there is now much less pent-up demand. we would expect aggressive cuts in the bank RRR and CNY/USD appreciation to once again be halted (if there were to be large net capital outflows rather than allowing CNY/USD depreciation. However. we would expect the PBC to drawdown its USD3. wasteful investment. we would expect a fiscal stimulus package to again be dominated by public investment. it has less room than it did before. and the pent-up demand caused the growth rate to rebound to over 80% y-o-y in Jan-Oct 2009. because any increase in household income can be saved rather than spent. if all were to be recognized in 2011. we see a higher hurdle than in 2008 for the PBC to cut the benchmark 1yr lending rate aggressively. Second. quick and effective a policy stimulus would be.1% y-o-y in Jan-Aug 2011. but again believe it would be less effective than that seen in 2008-09. p. but the build-up of local government debt in recent years has lifted general government debt (central plus local) to around 50% of GDP. the speed of implementation would likely be slower than in 2008-09. increasing fears of an even bigger hard landing further out – the private response could be to pull back investment even more. Before the global financial crisis.47). 21 September 2011). fiscal stimulus aimed at consumption tends to be less effective than public investment. the highest since the government began publishing the data in 2005. wasteful investment 6 The growth of newly started fixed-asset investment projects was 28. we judge that it would be less than in 2008. to avoid a fall in total investment public investment must grow by twice as much as any decline in private investment growth.1% y-o-y in September 2011) than the 2.9% y-o-y in Jan-July 2008. while China certainly has room for fiscal stimulus. The government “doubling up” with another public-led investment boom could heighten concerns over misallocated. On the other hand. This is no longer 6 the case. Moreover. 9 .Nomura | Asia Special Report November 2011 reserve requirement ratio (RRR) by 250bp. China had many large off-the-shelf investment projects ready to go and so could boost investment quickly.2trn of FX reserves to keep CNY/USD stable).5% in 4Q 2008. core CPI inflation.7% y-o-y in 2007.4% y-o-y in Q3 2011. As such. First. given that government-influenced investment comprises about one-third of total investment. On top of this are the government‟s contingent future liabilities. to avoid the economy becoming more unbalanced. and that this cheap cost of capital contributed to overinvestment. One reason is because of greater inflation pressures today. but the NDRC‟s rejection of new projects caused the growth rate to plunge to -2. Central government debt is still low at around 20% of GDP. Another reason is what we believe is growing recognition among China‟s policymakers that interest rates were set fundamentally too low in the past. Therefore. which excludes food and energy items. has also risen steadily over the past two years to 2. China still has room for fiscal stimulus. we would expect to see greater official resistance to rate cuts than in the past. suggesting that a structural inflation problem is emerging (see Asia Special Report. there would likely be more focus on consumption-boosting measures. Third. the NDRC reversed course after the global financial crisis hit. forcing the National Development Reform Commission (NDRC) to turn down a large number of new investment projects by SOEs and local governments. would lift the general government debt to 85% of GDP. On fiscal policy. but less than in 2008 We see a higher hurdle than in 2008 for the PBC to cut the benchmark 1yr lending rate aggressively The speed of implementation would likely be slower than in 2008-09 Another public-led investment boom could heighten concerns over misallocated. according to the IMF (2011a. for three reasons.

outcome.5% in 2012-14. our overall assessment is that the chance of a hard economic landing has increased in recent years. whereas the financial market tends to take a weightedaverage probability of different possible outcomes. or most likely.e. this year there has been a significant sell-off in China‟s equity and credit markets. We attach a one-in-three probability of real GDP growth falling to an average of 5% y-o-y or less over four consecutive quarters sometime between now and the end of 2014. In other words.0*0. would have severe repercussions for the global economy and financial markets. the latest 10 October survey of 18 market economists by Consensus Economics Inc. shows that the consensus forecast of China‟s real GDP growth is 8.4% in 2013. The way we would reconcile this gap is that economists forecast the modal. it gives a weighted-average GDP growth forecast of at most 7.5*0.Nomura | Asia Special Report November 2011 Perceived likelihood Drawing together the strands of the analysis we have done on the six main macro risks in China. Interestingly. like-for-like. our forecasts are probably not that dissimilar to what the market is pricing in – the key will be whether the risk of a hard landing rises or falls going forward.0% in 2012. We are aware of the non-trivial tail risk of a much worse outcome which.66)+(5.33)}. For example. which brings us to Nomura‟s new proprietary tool – our China Stress Index (CSI).3% in 2012-14.5% in 2012 and 8. while the IMF‟s latest forecast (released in September) is 9.. yet most China economists have not significantly downgraded their GDP forecasts. We attach a one-in-three probability to our definition of a hard landing commencing sometime between now and the end of 2014 10 . While our baseline modal (i. as we explain in the final chapter. If we apply our baseline and hard-landing probabilities to the market method {(8. most likely outcome) forecast – to which we attach the residual two-third probability – is for China‟s real GDP to grow by an average of 8.

For more technical details on the methodology in constructing the CSI. structural inflation risks associated with the Lewis turning point.Nomura | Asia Special Report November 2011 Nomura‟s China Stress Index (CSI) To more closely monitor the risks of a hard landing in China‟s economy. For the indicators that are available only on an annual or quarterly basis.and mal-investment. and 2) how fast the risk has changed compared to history. • Availability: A challenge not only in China. We could have used panel data on GDP from other countries showing hard economic landing experiences internationally. To construct the CSI. We try to capture. the CSI rose to its highest level since it was first compiled. we have constructed a macro China Stress Index. mainly because of a decline in the flow of new shadow banking funding (Figure 3). particularly in the property market. among others. In Q2 2011. We chose indicators that are sourced from official statistics and that have a time series of over a decade. and the increasing challenges arising from high income inequality and environmental degradation. monthly series were interpolated from the longer-frequency data. more noticeably since the global financial crisis The CSI is made up of 18 indicators that quantify the macro risks in China into one summary measure 11 . but they are grounded in our analysis in the following chapter and international experience of the common causes of emerging market crises. but in our view China‟s economy is too special for this exercise to give credible results. domestic credit/GDP and new shadow banking funding/ new total social financing). but in Q3 it eased slightly. So what the CSI tells us is: 1) the direction of overall macro risk. The CSI is made up of 18 indicators that quantify the macro risks in China into one summary measure. and more noticeably since the global financial crisis. We selected the 18 indicators by using two main criteria: • Importance: Each indicator signals an important risk factor that we believe is not fully captured by other indicators in the CSI. The CSI indicates that risks in China‟s macro economy have been on a broad uptrend. The weights. to some extent. the 18 indicators are first standardized and then weighted. are subjective. The CSI is indexed to 100 in January 2000. but in all developing economies is the paucity of the data. the obvious one being real GDP. so that the CSI has a reasonably long history for statistical inference (the CSI begins in January 2000). excessive credit and the problems created by the rudimentary monetary architecture. Yet in the past 20 years China‟s GDP growth has not fallen below 5% and before then the causes of hard landings in GDP were influenced heavily by social and political unrest. To do so would require a reference variable measuring past episodes of hard economic landings in China. One limitation of the CSI is that it does not give a probability of a hard economic landing. or CSI for short. The CSI indicates that risks in China‟s economy have been on a broad uptrend. please see the Appendix: The construction of Nomura‟s China Stress Index. while two have 8% weights (property loans/total loans and residential property price index/long-run trend) and three have 10% weights (gross capital formation/GDP. Most variables have weights of 35%. the risks associated with over.

The results of the CSI. 1 12 . 3: Nomura’s China Stress Index Jan 2000=100 102. residential property prices.2 Gross capital formation/GDP Property loans/total loans Domestic credit/GDP Note: Unit is percentage point.0 100. National Bureau of Statistics and Nomura Global Economics. see Appendix: The construction of Nomura‟s China Stress Index.5 101. Fig.0 101. For details of CSI construction.5 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Note: The last data point is September 2011. For details of construction. gross capital formation. Source: PBC. property loans and domestic credit have been the main recent drivers (Figure 4). should always be open to interpretation. National Bureau of Statistics and Nomura Global Economics. see the Appendix: The construction of Nomura‟s China Stress Index A closer look at the components reveals that rapid increases in residential housing starts relative to sales. 4: The five biggest drivers of the CSI over Jan 2007-Sep 2011 (contribution to the increase in the CSI index over this period) 0 Residential housing starts less sales Residential property price deviation from long-run linear trend 0.5 100.05 0. gross capital formation. property loans and domestic credit have been the main recent drivers Fig. Housing starts relative to sales.Nomura | Asia Special Report November 2011 Fig. property prices. which we will update on a quarterly basis. Source: PBC.15 0. We are under no illusions that the CSI has its limitations and needs to be treated with caution. and used as a tool among many others for analysis of China macro risks.0 99.1 0.

2% in 1941. before surging to 47.8%) and infrastructure (27.3% in 2000 to a relatively high 43.Nomura | Asia Special Report November 2011 1. In international and historic terms. a normal course of economic development as poor countries start with a small capital stock ensuring a high return on capital and hence a high rate of investment. on the other hand. 5: Investment and consumption shares of nominal GDP % GDP Fig. we estimate that more than half of China‟s total gross capital formation was related to property (23. four Asian countries that have experienced rapid economic take-offs. 6: Property investment share of nominal GDP % of GDP 15 70 60 50 Investment Household consumption 12 9 40 30 20 10 1954 6 3 Sep-97 Sep-99 Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 1962 1970 1978 1986 1994 2002 2010 Source: CEIC and Nomura Global Economics. to 13% of GDP in Q3 2011 (Figure 6). Former leader Deng Xiaoping endorsed this trend during his famous South China tour in 1992.9% in 2008. China is now an outlier: no other large economy has had such a high investment-to-GDP ratio for so long 13 . Singapore and Thailand. Korea. 2011 will be the ninth consecutive year that China‟s investment ratio has been over 40%. property investment has continued to surge.6% in 2010 (Figure 5). setting China firmly on the path of export. aggregating the investment data for China‟s 31 provinces suggests that the official national investment-to-GDP ratio could be 7pp too low (see Box 1: Fuzzy numbers). Overinvestment and excessive credit Since the early 1960s the share of total investment (public and private gross capital formation) in China‟s GDP has trended upwards.7%). China‟s share of investment in GDP rose from 35. The highest investment ratio in the US since 1929 was 26.5% in 2009 and to 48. by espousing the benefits of an open economy. The share of investment in China‟s GDP has risen to almost half Fig.and investment-led growth. By the end of 2010. This year. their highest investment ratios typically lasted seven to eight years – and none ever reached the levels seen in China (Figure 7). Surveying Japan. Source: China's NBS and Nomura Global Economics. Undoubtedly there are questions marks over the quality of Chinese data – some claim that China‟s official investment ratio is overstated because the services sector and hence consumption are likely underestimated. China is now an outlier: no other large economy has had such a high investment-to-GDP ratio for so long.

2 Box 1: Fuzzy numbers The quality of China‟s statistics is improving.Nomura | Asia Special Report November 2011 Fig. 7: Asian investment-to-GDP ratios – during economic take-off periods % of GDP 50 45 40 35 30 25 20 China. 1989 -98 t t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9 t+10 Note: t=numbers of years from the starting year. in fact it was a key goal of the 11th Five-Year Plan (2006-10) unveiled in early 14 . a full 7pp higher than the national investment-GDP ratio (see Figure 8). but then again it is also possible that the starting position is a higher investment-to-GDP ratio than officially reported. 1966 -75 Korea. when 2004 nominal GDP was revised up by 16. eg.3% for the past nine years. 8: An alternative measure of the investment-to-GDP ratio % GDP 60 50 40 30 20 10 0 1954 Sum of provinces National 1962 1970 1978 1986 1994 2002 2010 Source: CEIC and Nomura Global Economics. The biggest revision was in 2005 after the first national economic census. CEIC and Nomura Global Economics. The high priority on internal rebalancing of the economy – that is.8% in one fell swoop. the IMF noted that a “full assessment of these various risks is. we arrive at an investment-to-GDP ratio of 55.0-4. Source: China Statistical Yearbook. IMF (2011a. p. Fig. There have also been several sizable upward revisions to China‟s GDP. Some of the glaring examples include the official urban unemployment rate hovering within such a tight range of 4. For China. Fig. weakness in the infrastructure and constraints on the FSAP team‟s access to confidential data”. Following the completion of its first Financial Stability Assessment Program (FSAP) of China in July 2011. and the investment-to-GDP ratio revised down. and how in 2010 real GDP growth in 29 of the 31 provinces was above the national GDP growth of 10. 1978 -88 Thailand.3%. Fig.7%. but large gaps remain. but the fundamental reason why the investment ratio has been so high for so long has more to do with serious factor cost distortions. however. with the share of services in GDP revised up from 31. 3 The recent jump in China's investment ratio to almost half of GDP was driven by a conscious policy response to the global financial crisis. the starting year is 2002. The data are in nominal terms and investment is the sum of public and private gross capital formation. It is possible that the services sector and consumption will be revised up again. 1988 -98 Singapore. hampered by serious data gaps. lowering the investment ratio and raising the consumption ratio – is not a new initiative.7% in 2010.9% to 40. mainly due to under-reporting of the size of the services sector and hence consumption. GDP data are available by province and aggregating the gross capital formation and the GDP data for the 31 provinces.11). 2002 -11e Japan.

notably large SOEs and local governments (see chapter: The privileged state-owned enterprises). Of all the main components in GDP. SOEs and local governments took heed. ramping up investment in property and infrastructure. This large gap gave producers a big incentive to invest. the capital stock-to-output ratio and the depreciation rate of capital.Nomura | Asia Special Report November 2011 2006. which is partly because Chinese households have a high motive for precautionary saving. and cost of. Fearing major knock-on effects to the domestic economy from firms cutting jobs and capex. China's real estate developers. indicating the large wedge between the return on.5% in the 1990s and 14. and cost of.6% in the 2000s.4% in the 1990s and 5. causing China‟s export performance to swing from 23% y-o-y growth in Q3 2008 to a 24% y-o-y contraction in Q2 2009. Yet 7 At almost half of GDP. China Statistical Yearbook. The bank lending rate has historically been artificially controlled far below the return on capital needed to support an industry-led. and back in 2006 the 7 ratio was “only” 42%. However. The fundamental reason for the high investment-to-GDP ratio is the large difference between the return on. The big question is not if. compared with the benchmark 1yr bank lending rate of 9. 15 . the authorities gave the go-ahead to a credit-financed investment boom. or will the process involve one or more episodes that are abrupt and beyond the control of policymakers. but when. education and pensions. Even five years ago. Qualitatively. The cost of capital is estimated using the 1yr bank lending rate. capital % 30 25 20 15 Difference (percentage points) Return on capital Cost of capital 10 5 0 Note: The aggregate return on capital is measured using approximated data on the share of capital in total income. capital of over 10pp over the past three decades (Figure 9). while urbanization has boosted incomes of rural migrant workers. Aziz (2006) found that China‟s low cost of capital was quantitatively an important factor in explaining why the investment-to-GDP ratio was high.8% in the 2000s. Source: CEIC. and cost of. capital Fig. which averaged 18. 9: The difference between the return on. export-orientated growth model. but also the share of wages in national income is low relative to profits. the more fundamental reason for China's persistently high investment-to-GDP ratio is the large difference between the return on. To more formally estimate China's return on capital. the global financial crisis of 2008 was a huge unexpected shock. A simple approximation of the return on capital is nominal GDP growth. SOEs historically provided generous social welfare benefits to their workers. so the downsizing of SOEs in the late 1990s meant that workers needed to save more of their income to pay for their own healthcare. policy-controlled way. the results are similar to that of using nominal GDP growth. Also. causing major disruptions to the economy and markets? International experience shows that rebalancing is never easy. However. putting rebalancing efforts in China firmly on the back burner. and cost of. capital. the stringent hukou household registration system has provided them with scant social welfare benefits in the cities where they live. China‟s investment and consumption ratios re-balance – and will it happen in a gradual. as it usually means redistributing income and power from vested interests that have benefited from the old model – in China. investment is typically the largest swing factor and in most Asian countries it usually contracts at least one year each decade. and Nomura Global Economics. Development and Research Center under the State Council. increasing their precautionary savings. China‟s investment is now so large that were it to stop growing it would cut real GDP growth in half The flipside of China's high investment-to-GDP ratio is a low consumption-to-GDP ratio. The very low or negative real interest rate on bank saving deposits has also forced households to save more than they otherwise might have. we follow a similar methodology to the Bank of Japan (2011) and Bai et al (2006).

n. n. Source: CEIC and Nomura Global Economics. n. At almost half of GDP. n. 1960s 1967:-25% 1960-62:-95% 1967-68: -27% 1960-62:-109% 1966-68: -38% 1970s 1976:-7% 1972:-3% 1976: -9% 1972: -2% 1980s 1990s 2000s 1981: -2% 1989: -5% 1985: -5% 1982-83: -7% 1990: -1% 1998-99: -32% 1996: -3% 1996: -1% 1991: -16% 1998-99: -62% 1998-99: -16% 1992-94: -10% 1997-98: -32% 1992: -1% 1998-99: -47% 2008: -1% 2005: -1% 2001: -5% 2008: -6% 2000-01: -6% 2002: -4% 2008-09: -23% 2001-03: -13% 2009: -13% 2008-09: -17% 2005: -2% 2003: -2% 2001: -9% 2009: -9% 2006: -15% 2004: -2% 2009: -19% 2001-03: -57% 2007-09: -30% 2001: -24% 1997-98: -73% 2009: -25% 2006: -4% India Indonesia Japan Korea Malaysia Real Real Real Real Real n. it would cut real GDP growth in half (see Box 2: China‟s challenging GDP arithmetic). Fig. let alone turn negative.a.a.a. n.a.a.a. 1957-59: -8% 1952: -26% n. 10: Identifying the years when real gross capital formation contracted China Nominal Real* Hong Kong Real 1940s n. China‟s investment is now so large that were it to stop growing. n. 1975: -4% 1972: -10% n. n. official data on real gross capital formation are not available and so Nomura‟s proxy is nominal gross capital formation deflated by the fixed-asset investment deflator back to 1990 and before that. 1967-68: -9% 1961: -2% n. deflated by the GDP deflator. The timing of rebalancing is also now less favourable for China. Philippines Real 1956: -1% 1952: -3% 1949-50: -30% n. n.a.Nomura | Asia Special Report November 2011 China's investment has not fallen since 1990 in volume terms and not since 1976 in value terms (Figure 10).a.a. Note: The shaded areas are decades when real gross capital formation falls.a. 16 .a. 1979: -10% 1974: -10% 1974-75: -12% 1981: -4% 1988: -5% 1983: -3% 1980: -1% 1980: -17% 1985-87: -32% n. 1955: -15% n.a. For China. n.a.a.a.a. 1962: -1% 1960: -11% 1964: -3% 1970: -4% 1984-85: -69% 1980: -4% 1988: -3% 1985-86: -18% 1985: -8% 1982: -5% 1985-86: -8% 1982: -7% 1998-99: -29% 1991: -17% 1998: -24% Singapore Taiwan Thailand Real Real Real 1977: -4% 1975: -5% 1975: -7% n.a. n. n.a.a.a. n. 1950s 1955: -2% 1955:-2% n.a.a. n. as besides investment and consumption. the third engine of growth – exports – is unlikely to be firing on a full cylinder given the crisis-scarred economies of the US and Europe.a.

Meanwhile. such as social unrest or a deadly pandemic. 25 September 2009). carefully calibrating a rebalancing of GDP growth toward consumption is no easy feat.1%. To turn consumption into an engine of growth. then real household consumption would need to grow consistently by 10% pa over 2010-20. the urgent need for the government to 8 As Japan's experience shows.4pp and. 17 . and the cost of. and this likely understates the effective cost of capital as banks are charging a record 61. we expect it to resume hiking in 2012. To illustrate.2% of their new loans above the benchmark lending rate.7%. which according to data from the International Union of Railways extends to 6. or simply because “investment” fatigue sets in. While the central bank has paused its rate hiking cycle.5pp to GDP growth of 9. stoked public anger and a media frenzy that the breakneck development of high-speed rail had cut corners – indeed.Nomura | Asia Special Report November 2011 Box 2: China’s challenging GDP arithmetic8 With investment making up almost half of GDP. 9 A good micro example is China building – in just three years – the world‟s longest and fastest high-speed rail network. if real investment were to grow by only 5% it would contribute 2. which tends to be less productive than private investment. because of a simultaneous fall in the return on capital and a rise in the cost of capital. It needs to transfer a massive amount of income from the still heavily state-subsidized corporate sector to households (see chapter: The privileged state-owned enterprises) and end financial repression. The collision of two new high-speed trains outside the city of Wenzhou on 23 July. This seems a particular risk in China given: 1) the banking sector does not have much experience in gauging credit risk. Another reason to expect the return on capital to soon start to fall is the strong international evidence that investment booms are often associated with a misallocation of capital. capital does not last forever The phrase “China‟s challenging GDP arithmetic” was coined by Paul Sheard.31% in October 2010 to 6. in the shadow banking sector borrowing costs can be several times higher.3% in 2011.339km of high-speed rail under construction by 2012 – more under construction over this period than that of the rest of the world put together – is now unlikely to be achieved. To raise the household consumption-to-GDP ratio from 34% in 2010 to 40% by 2020. consumption growth must outpace GDP growth. and the cost of. However. A third reason is that China's heavy investment can also run into diminishing returns from a social perspective. and assuming real GDP grows 8% pa this decade. China needs higher interest rates to contain what we see as structural inflation problems caused by accelerating labour costs (see chapter: The Lewis turning point). possibly quite sharply. The benchmark 1yr bank lending rate has risen from 5. China‟s large gap could soon start to narrow. contributing 5. China's cost of capital has been increasing and we expect it to rise further. especially in emerging markets. As Japan's experience shows. operator and regulator of the network. Yet we estimate that real household consumption has grown at a double-digit rate in only three of the past 14 years and over the past decade has averaged about 9% growth. it would make no contribution to GDP and so GDP growth would more than halve to 3. 3x larger than in 2006 and 7x larger than in 2001.5trn in 2011.3% growth. whereas real GDP has averaged 10. China needs to do more than simply beef up social welfare spending to reduce precautionary household savings. which can take many years to 9 break even. The return on capital could start falling simply because the enormity of investment is causing the capital stock to accumulate at such a rate that capital is rapidly becoming less scarce. the large positive gap between the return on. the large positive gap between the return on. assuming (conservatively) unchanged contributions from net exports and consumption. Beijing has suspended approvals of new high-speed lines and its original ambitious program of having a further 4.2%. Total nominal investment (i.300km. 2) a massive shadow banking sector has emerged. for the share of household consumption in GDP to rise. As a result. China‟s Railways Ministry is the manufacturer. which is difficult to measure. back in 2009 (see the Global Letter. To illustrate China‟s challenging GDP arithmetic consider the numbers. gross capital formation) is set to total some USD3. an achievement that had produced considerable national pride.56%. and in big infrastructure projects. Nomura‟s global chief economist. unforeseen shocks. If real investment growth were to slow to 0%.e. GDP growth would be just 6. which killed 40 and injured 191. which has given rise to negative real deposit rates (see chapter: Rudimentary monetary architecture). as capital intensive industries pollute the environment and create fewer job opportunities. let alone regulate. “China‟s challenging GDP arithmetic” in the Global Economic Weekly Monitor. and 3) the fact that much of the investment in recent years has been government-led. the central bank hiking aggressively having fallen behind the curve in fighting inflation. China‟s economy is vulnerable to an investment slump for whatever reason: a banking crisis. capital does not last forever (see Box 3: Lessons from Japan on the return and cost of capital). However. We expect real investment to grow by 11.

Nomura | Asia Special Report November 2011 unwind generous subsidies to SOEs and to stop underpricing factor inputs such as land. for example falling behind the curve in fighting inflation and needing to catch up via aggressive rate hikes. leading to a sharp rise in the cost of capital at a time when the return on capital could be 10 falling. 8 September 2010). water and energy. 18 . As interest rates increase. A key risk is policy errors. firms scale back investment for which the expected return is insufficient to cover the higher financing costs. Herd and Chalaux (2010) found empirically that capital spending is negatively influenced by higher interest rates. Using micro data on listed Chinese firms over 2002-07. from administrative measures to more market-price-based instruments (see chapter: Rudimentary monetary architecture). The coming surge in food prices. 10 Firms should adjust their capital stock so that its marginal productivity equals its user cost. Higher interest rates would also be a natural result of accelerating the evolution of China's monetary policy framework. Conway. and a likely continued multi-year surge in food prices (see our Special Report.

According to a recent study by researchers Fukumoto and Muto (2011) at the Bank of Japan. averaging 9. the so-called Lewis turning point (Minami. leading to increased worker bargaining power and a surge in real wages.7% respectively in 1970 (Figure 11). Japan had a small capital stock and so the return on capital was higher than 20%. 11: Japan's investment and consumption shares of GDP % of nominal GDP 70 60 50 40 30 20 10 Gross fixed capital formation Consumption Source: Bank of Japan (2011). In the 1950s. 1973). All these factors contributed to a decline in the return on capital in the late 1960s and early 1970s. reaching 35.Nomura | Asia Special Report November 2011 Box 3: Lessons from Japan on the return and cost of capital Similar to China in the last two decades. 12: Japan’s difference between the return and cost of capital % 35 30 Difference (percentage points) Return on capital Bank lending rate 25 20 15 10 5 0 Source: Bank of Japan (2011). Japan‟s economy became increasingly unbalanced. More pertinent to China. All this led to monetary policy tightening and a rise in bank lending rates and the cost of capital. the main trigger of rebalancing was a decline in the return on capital and a rise in the cost of capital. However. Meanwhile. but also the flow of surplus rural labour moving to the cities started to diminish in the 1960s. 1999). Domestic rebalancing in Japan began after 1970. So in the early 1970s. Borio What accentuates the macro risks of China's investment boom is the credit boom associated with it 19 .7% and. but the rapid accumulation of capital drove down the marginal productivity of capital. An undeveloped financial sector led to some misallocation during the investment boom. like China today. Fig. the IMF (2004) estimates that about 75% of the credit booms were associated with a banking crisis. the bank lending rate was highly regulated in the 1950-60s and was kept very low to support an industry-led growth model. in the early 1970s Japan experienced an outbreak of inflation. significantly reducing firms‟ incentives to maintain high rates of investment (Figure 12). Fig. One of the relatively few robust findings to emerge from the empirical literature on leading indicators of banking crises is that rapid domestic credit growth increases the likelihood of a problem (Kaminsky and Reinhart. In a survey of credit booms in 28 emerging market economies during 1970-2002. while the development “catch up” to advanced foreign technology was virtually complete in the early 1970s.5% and 59. with a rising investment-to-GDP ratio and falling consumption-to-GDP ratio. Japan faced a marked narrowing in the difference between the return and cost of capital. in part driven by the 1973-74 oil crisis. What accentuates the macro risks of China's investment boom is the credit boom associated with it. Japan achieved high GDP growth over the period 1955 to 1970.

the official NPL ratio has steadily declined and by June 2011 stood at just 1. compared to a decade ago China‟s banks today are better capitalized. 14: Credit-to-GDP ratio versus GDP per Capita Credit to GDP. the official auditor of Liaoning province reported in a speech that 85% of LGFVs in Liaoning had insufficient income in 2010 to cover debt-servicing payments. such as new loans granted for unapproved projects or used to repay existing debt. but… 11 In July 2010. Rating agency Moody‟s expects China‟s NPL ratio to rise to 8-12% in coming years. China's credit-to-GDP ratio stands as an outlier compared with other countries of a similar income level (Figure 14). as at June 2011 by 11 the State Audit Office. have higher loanloss provisioning. Since 2002. 12 Before the establishment of asset management companies. although some private estimates are much higher. end-2010 (%) 350 300 250 200 150 100 50 0 China Cyprus 0 Jun-91 Jun-96 Jun-01 Jun-06 Jun-11 10 20 30 40 50 60 70 GDP per capita. have higher loan-loss provisioning and face more stringent There is little doubt that the NPL ratio will rise again – the question is by how much China‟s banks today are better capitalized. the earliest official data on the NPL ratio of the major commercial banks was 23. 13 The State Audit Office sent a warning in June 2011. Source: IMF Global Financial Stability Report. it is the combination of various imbalances. they set up over 6.0% for all commercial banks. given that China's credit-to-GDP ratio has surged to just shy of the record high in 2003. 20 . To do so. 4 Fig. or 27% of 2010 GDP – albeit still far short of the RMB20trn projected by Professor Victor Shih at Northwestern University. a level that is not far from the peak in 2003 (Figure 13).1trn. in particular the simultaneous interactions of rapid credit growth. Reflecting the paucity of data and the uncertainties involved. unofficial estimates put the peak NPL ratio in 1999-2000 at about 40%. The OECD estimates that the total cost to the government of recapitalizing the banking sector in the early 2000s was some 30% of GDP (OECD 2005). 2009 (PPP. Rather. thousands of US$) Source: IMF. violated regulations.7trn but raised its estimate in November 2010 to RMB9. of over 15% of GDP.500 Local Government Financing Vehicles (LGFVs). China's credit-to-GDP ratio stands as an outlier compared with other countries of a similar income level Fig. However. In July 2011. that were carved out and transferred to newly created asset 12 management companies a few years earlier. September 2011. As far as we know. estimating how high NPLs may rise and the potential fiscal cost of recapitalizing the banks can 13 vary widely. Whatever the true figure of local government debt is.6% in 2002. CEIC and Nomura Global Economics. Fig. 13: Domestic credit-to-GDP ratio % of GDP 160 150 140 130 120 110 100 90 80 70 60 50 Jun-81 Jun-86 Fig. there is little doubt that the NPL ratio will rise again –the question is by how much. or 17% of total loans outstanding. The latest official estimate of local government debt outstanding was RMB10.7trn. the China Banking Regulatory Commission (CBRC) first estimated total local government debt outstanding at RMB7. Local governments are not allowed to directly incur debt. 5 China's credit boom over 1998-2003 led to a banking crisis. at RMB10. where the data are opaque. but this excludes a large volume of bad loans. a broader analysis can be gleaned from IMF data which show that total domestic credit (private and government) surged from 121% of GDP in Q4 2008 to 147% in Q2 2011. or higher. To be sure. Analysis of China's recent credit boom has tended to focus on local government borrowing. and so finance infrastructure projects by borrowing from banks. Moreover. when after a lengthy audit of the five major banks it found that RMB58bn. or 27% of 2010 GDP. rapid increases in asset prices and an investment boom – rather than any one of these alone – that increases the likelihood of problems.7trn.Nomura | Asia Special Report November 2011 and Lowe (2002) use annual data since 1960 for 34 countries to show empirically that an investment boom by itself may pose little threat to the stability of the financial system. The latest estimate in June 2011 by the State Audit office was even higher.

9 33. under more drastic scenarios of higher NPLs and lower recovery rates. % 30 40 7. then the cost to the banking sector – or failing that.8 17.3 28. estimates that of the RMB702.5 14.1 14. 500 0 Dec-96 % Dec-99 Dec-02 Dec-05 Dec-08 Dec-11 Source: CEIC and Nomura Global Economics.7 9.6trn.8 23.000 ratio. at this year's Shanghai Autumn Property Exhibition.5 50 5.6 24. both local governments and property developers are heavily indebted. nationwide property prices have risen 60% since the end of 2006 (IMF 2011c). more than half of the 30 developers rated by S&P would have “weak liquidity”. 16 The increasing use of desperate sales gimmicks by property developers is one micro-level sign that property supply has moved ahead of demand.6 7. 14 In May 2011.8bn of new entrusted loans in Jan-Jun 2011.500 Fig. 15: Difference between floor space started and floor space sold: Millions of Sq. This has fueled speculative property investment and an ominous sign is the large gap that has opened up between the combined floor space of residential.9 11.2 18. But on the other hand. 6 October 2011).6% of 2011 GDP (Figure 16). Lucy Fung.3 months. which according to S&P‟s definition means overarching credit risk and an issuer credit rating at the “B” level or lower.5% of total outstanding credit by the end of 2013 and 150% of non-performing debt. 12m rolling sum 2.500 Floor space started Floor space sold NPL 10 20 30 40 50 8. forms of financing in the shadow banking sector. estimated to be almost as large as the official banking sector (see chapter: Rudimentary monetary architecture). 16: Assessing the cost of potential financial sector problems.4 35.1 10. 21 .1 41. so-called “Soho” apartments – offices equipped with private bathroom and kitchens – have been marketed as they are not classed as homes (South China Morning Post.6 60 4. office and commercial property that builders have started work on. 15 This year. the government – would be RMB1. But if property sales fell by 30% in 2012.3 16. However.8 2.000 1. 16 compared to the floor space sold (Figure 15). it is possible that the total cost could be over 30% of 2011 GDP. we see two important reasons for concern: 1) a big and largely unregulated shadow banking sector has emerged in recent years.9 23. According to official data.8% and at an average duration of 11. Source: CEIC and Nomura Global Economics. tighter credit conditions have led property developers to seek other. more expensive. In a back-of-the-envelope exercise simply to illustrate how much estimates can vary.7 29. Nomura‟s China Bank analyst. Note: % of estimated 2011 GDP. the CBRC ordered systemically important banks to have bad-loan provisions that are no less than 2. For example.4 1.2 21. % of GDP Loan recovery rate. which raises the risk of a vicious spiral if there is a major correction in property prices given that 30-40% of local government revenue is made up of proceeds 15 from land sales and other property-related activities. if we assume that China's NPL ratio rises from 1% to 10% and that 70% of these loans could be recovered. 46% were granted to property developers at an average interest rate of 15. notably new entrusted loans. Stress tests by ratings agency Standard & Poor‟s (2011) estimate that the property developers could absorb a 10% decline in property sales in 2012. meters.2 17.7 70 3. … a big and largely unregulated shadow banking sector has emerged in recent years Fig.Nomura | Asia Special Report 14 November 2011 regulations and supervision.7 14. to exploit the law which prohibits the purchase of more than two residential apartments. or 3. and 2) this time.

56% (Figure 17).e. is losing its effectiveness in managing an economy that is rapidly becoming more open and sophisticated. The PBC could also incur substantial capital losses on its balance sheet if USD was to crash. credit quotas and bank window guidance.5% to 21. The PBC needs to place less emphasis on quantity-based instruments such as the bank reserve requirement ratio (RRR). product markets have become increasingly competitive and market forces are now generally the main determinant of price formation and market behaviour”. The PBC could try and recapitalize itself by earning profits from increased seigniorage. from 15. leaving it with negative capital. but not all three. or it could be recapitalized by the government but at the cost of losing some of its monetary policy independence and heightening the risk of a major inflation problem. an 18 all-time high. central bank bill issuance. and instead adopt the interest rate as the primary policy tool. the benchmark 1yr bank lending interest rate has been increased only five times. “after three decades of liberalization. With capital flowing more freely. p. The larger the stock of FX reserves the greater the potential quasi-fiscal cost if the return earned on the foreign assets is less than the interest paid on the PBC‟s sterilization bills. OECD (2005. At the root of the problem is China‟s inflexible exchange rate.Nomura | Asia Special Report November 2011 2. China‟s inflexible exchange rate regime requires the PBC to conduct substantial open market operations to sterilize. it is repressing the freefunctioning intermediation role of the banking sector 20 15 10 Benchmark 1yr bank lending rate Bank reserve requirement ratio 5 0 Oct-91 Oct-95 Oct-99 Oct-03 Oct-07 Oct-11 Source: CEIC and Nomura Global Economics. Market-based instruments are less distortionary and can have powerful indirect economywide effects by enhancing competition. Rudimentary monetary architecture China‟s monetary policy. or “mop up” excess domestic liquidity arising from FX intervention. it is repressing the freefunctioning intermediation role of the banking sector.102). The essential problem stems from Professor Robert Mundell‟s “Impossible Trinity”: that a country can simultaneously choose two.5%. of a managed exchange rate. i. we estimate that the PBC has effectively "locked up" nearly onequarter of total bank deposits that otherwise could have been used for more profitable commercial business. printing more currency. 17: Bank reserve requirement ratio and the benchmark bank lending rate % 25 China‟s monetary policy is losing its effectiveness in managing an economy that is rapidly becoming more open and sophisticated At the root of the problem is China‟s inflexible exchange rate While the PBC is successfully sterilizing its FX intervention. which has increased FX reserves to an 17 extraordinary USD3. such as lending. Meanwhile. 18 Combining these two sterilization measures. A rigid exchange rate reduces the central bank‟s ability to use market instruments such as interest rates to manage aggregate credit growth and instead perpetuates a reliance on administrative measures such as credit quotas. an open capital account and monetary policy autonomy. China risks losing more control over its monetary policy if it continues to heavily manage the exchange rate. In the words of the OECD. which significantly hinders the PBCs ability to tailor monetary policy to domestic objectives. 17 The massive accumulation of FX reserves to USD3. A precondition for this is a more flexible exchange rate. efficiency and risk management. 22 .2trn is not necessarily costless. The sterilization measures include aggressively issuing low-yielding central bank bills and raising the RRR of large banks 12 times since January 2010. hindering efforts to make the banking system more commercially orientated. While the PBC is successfully sterilizing its FX intervention.2trn as at September 2011. Fig.31% to 6. from 5. by evolving too slowly toward market price-based instruments.

5% of deposits for large banks be reserved at the PBC earning only 1. which typically are loans repackaged as short-term investment vehicles and are held off-balance sheet.5% in Jan-Sep 2011 (Figure 18). while the benchmark 5yr or longer lending rate has been increased by only 114bp. Perhaps in response. in this latest tightening cycle the PBC has hiked interest rates on longer-term bank deposits by a larger magnitude. Moreover. this seems to be forcing banks to price credit risk more actively by charging borrowing rates that are higher than official benchmark rates on more of their loans: in June 2011. PBCs sterilization operations impose considerable cost on the banking The 6 sector. which traditionally is what China has done. versus 44. p. This has been particularly onerous on depositors in the past year because of the sharp rise in inflation. averaging -2. However. According to Xinhua news agency. the requirement that 21. which means most households given a lack of alternative investment opportunities. Interestingly. banks have been finding it more difficult to attract deposits and so are turning to wealthmanagement products. So. it has proved difficult to cool speculation in the property market. a record-high 61.6pp. since September 2010 the 1yr bank deposit rate been increased by 125bp. 7 It should come as no surprise then. and the 5yr rate by 190bp. fat margins simply shift the cost of financial repression from the banks to depositors. by mid-2011 China had RMB7trn in outstanding wealth management products. In the last decade. For example. 18: 1yr inflation-adjusted real deposit rate % p. China maintains an interest rate ceiling on bank deposits. With bank assets mainly tied to longer-term loans.a.50% for 5yr deposits. which currently ranges from 3. that despite waves of macro-prudential tightening measures. and can offer annualized returns of about 8%. For a third time in the past eight years (after 2004 and 2008) the real rate of return on 1yr bank saving deposits has sunk deep into negative territory.Nomura | Asia Special Report November 2011 Fig. there is a growing problem of duration mismatch between bank assets and liabilities. 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 Sep-97 Sep-99 Sep-01 Sep-03 Sep-05 Sep-07 Sep-09 Sep-11 Source: CEIC and Nomura Global Economics.3% in Negative real bank deposit rates have contributed to property market speculation and the explosion of wealthmanagement products 23 .4% – substantially higher than the 1.2% of loans were priced above benchmark rates. but this shifts the repression from the banks to depositors Fig. These products are typically short term. The IMF (2011a. Fig.34) finds that a 1pp increase in the real rate of return on bank deposits lowers the urban household saving rate by 0. maturing within one month. triple the amount at the end of 2010.50% for 1yr savings deposits to 5. with negative inflation-adjusted returns. restricting banks from allocating a larger portion of their portfolios to higheryielding loans and investments. which has shifted some of the costs of financial repression back to the banks. One way to help ease this financial repression is to allow a wide interest rate margin. more than double that on 1yr bank deposits.4% average in the 1990s. One way to help ease this financial repression is to allow a wide margin between the benchmark bank lending and deposit rates.62% interest is akin to an implicit tax on the banking sector. the spread between the 1yr bank lending and saving deposit rates averaged 3.

Financial repression is also encouraging off-balance sheet bank activities and other lessregulated activities outside the official banking system Fig. which totaled an annualized RMB7. Fig. lhs Bank reserve requirement ratio. the sum of other forms of financing more than tripled from RMB1.0x the benchmark 1yr lending rate. Yet with an obligation to lend to large SOEs. disintermediation and other less-regulated activities outside the official banking system. bank acceptance bills. 19: Proportion of new bank loans charged above the benchmark lending rate % share 65 60 55 50 45 40 35 30 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Source: CEIC and Nomura Global Economics.5trn. The total social financing statistic likely still does not capture all informal financing activities. with the shadow banking sector comprising a stunning 42% of the total. the PBC deregulated commercial bank lending rates.Nomura | Asia Special Report 19 November 2011 September 2010 (Figure 19). lhs % 25 20 15 10 5 0 Net new other forms of financing. Source: CEIC and Nomura Global Economics. the results are revealing. 8 Financial repression is also encouraging off-balance sheet bank activities. movements in the bank RRR are closely correlated with the aggregate data on net new non-bank financing activities (Figure 20). but even so. forcing them to borrow in the shadow banking sector at punitively higher interest rates (see chapter: The privileged state-owned enterprises). which in addition to net new bank loans includes net new trust loans. rhs 9 6 3 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 Jan-Sep 2011 Note: Jan-Sep 2011 is an annualized figure.1trn.6trn in Jan-Sep 2011 and total social financing was RMB13. 19 On 1 January 2004. the PBC introduced a new statistic in February 2011 called “total social financing”. allowing banks to charge 0. In an attempt to monitor informal financing activities.9-2. On 29 October 2004 the ceiling on commercial bank lending rates was scrapped altogether (except for credit cooperatives). corporate bonds.9trn in 2008 to RMB6. Fig.3trn in 2010 – although the annualized rate in Jan-Sep 2011 had eased to RMB5. non-financial corporate equity and funding from insurers (see Box 4: Shadow banking in the US and China compared). 20: Bank RRR and net new bank loans and other forms of financing RMBbn 18 15 12 Net new bank loans. Outside net new bank loans. banks are increasingly rationing credit to private companies. 24 . A sign of the costs of financial repression. Add on net new bank loans.

The result is a more than four-fold rise in total funds outstanding in the shadow banking sector.Nomura | Asia Special Report November 2011 Utilizing the new social financing statistics. revealing just how explosive the growth in 20 economy-wide financing has been (Figure 21). or 177% of GDP. which increased more than five-fold from RMB0. Summing up outstanding bank loans. We estimate that total banking and shadow banking funds outstanding totaled 177% of GDP as at September 2011 Fig.2trn at the end of 2007 to RMB52.5trn at the end of 2007 to RMB18. lhs Corporate bonds. 21: Our estimate of total banking and shadow banking funds outstanding RMBtrn 80 70 60 50 40 30 20 10 0 % of GDP 180 Shadow banking. we simply accumulate the other components of the social financing statistics. Data are available on outstanding RMB bank loans. These estimates are also more in line with the broad money supply. lhs Total as a % of GDP.5trn by September 2011. and outstanding corporate bonds.9trn by September 2011.2trn by September 2011. as at September 2011 – a 57% of GDP increase since the global financial crisis in 2008. To gauge total funds outstanding in the shadow banking sector. from RMB4. we have attempted to tally the stock of total funds outstanding in China‟s economy.8trn at the end of 2007 to RMB4. Fig. 9 20 FitchRatings (2011) arrives at a similar number. which in September 2011 equaled 175% of GDP. corporate bonds and funds in the shadow banking sector gives a grand total of RMB75. of which the data first began in 2002.6trn. which nearly doubled from RMB26. estimating that total economy-wide financing would increase to 185% of GDP by the end of 2011. that is the official banking and shadow banking sectors combined. lhs RMB loans. rhs 170 160 150 140 130 120 110 2002 2003 2004 2005 2006 2007 2008 2009 2010 Sep-11 100 Source: CEIC and Nomura Global Economics. which is a net flow of funds concept (new issuance less redemptions and write-offs). and assume that the outstanding amount before 2002 was zero for each component. 25 .

lending by domestic non-bank financial institutions and financial claims on mainland 21 entities by Hong Kong-based banks. or shadow banks. 26 . Even today. hold-to-maturity lending conducted by banks into a more complex. Shadow banking transforms risky. or 13% of the total assets of Hong Kong banks. McCulley (2007) coined the term “shadow banking system”. wealth managementrelated trust products. CDO-squareds ABCP. the volume of credit intermediated in the US by the shadow banking system was nearly USD20trn. often listing only a single mobile phone number next to names such as "Easy Heaven Investments" and "Treasure Beautiful Gold Credit". credit hedge funds 2(a)-7 MMMFs. from 1Q 2009 to 2Q 2011. ABS issuance. structured by broker-dealers Hybrid. nearly twice as large as the USD11trn of credit intermediated by the traditional banking system. which in the US includes loan origination. non-bank financial intermediation occurs through credit-related trust products. We estimate that Mainland China-related exposure of Hong Kong financial institutions has nearly tripled from HKD1. entities and funding techniques involved in shadow credit intermediation Function Step (1) Loan origination Step (2) Loan warehousing Step (3) ABS issuance Step (4) ABS warehousing Step (5) ABS CDO issuance Step (6) ABS intermediation Step (7) Wholesale funding Shadow banks Finance companies Single and multi-seller conduits SPVs. enhanced cash funds. equivalent to 27. The latter has mushroomed in recent years as Chinese companies and banks seek cheaper funding overseas. On the eve of the global financial crisis. in which a bank acts as an agent on a third-party loan between a depositor and a borrower. repo $1 NAV shares (shadow bank "deposits") Source: “Shadow banking”. money-like instruments through a granular set of steps (Figure 22).13-14) “the shadow banking system decomposes the simple process of depositfunded. 10 October 2011. including letters of credit from domestic trust companies. pp. TRS/repo conduits.2% of the total assets of Hong Kong banks (Figure 22 23). Figure. 22 To put this surge in Hong Kong bank mainland-related claims into perspective. SIVs. bonds ABCP ABS ABCP. loan warehousing. the different types of offbank balance sheet or non-bank financial activities are less regulated. Shadow banks' funding* CP. In China. FitchRatings argues that the official social financing statistic fails to fully capture some RMB3.Nomura | Asia Special Report November 2011 Box 4: Shadow banking in the US and China compared To the best of our knowledge. One is that the bank RRR. The growth of shadow banking presents new challenges for China‟s policymakers Adding to these challenges is the opaqueness of the data 21 A micro example of the flourishing "underground market" for loanable funds can be gleaned from the advertisements on the back pages of city newspapers. 10 The growth of shadow banking presents new challenges for China‟s policymakers. ABS CDO issuance. domestic property-related lending by Hong Kong banks rose by HKD410bn to HKD1. brokerdealers' trading books SPVs. Financial Times. almost by definition.5trn of shadow banking activity. Adding to these challenges is the opaqueness of the data. 458. MTNs. ABS intermediation and wholesale funding”.1trn in 1Q 2009 to HKD3. heightening the risk of too much credit being generated and of credit being misallocated. Another is that. Ashcraft and Boesky (2010. But the biggest form of shadow banking is in entrusted loans. Adian. Fig. lease financing and credit guarantees. structured by broker-dealers LPFCs. 22: Illustrative examples in the US of the steps. ABS warehousing.7trn in Q2 2011. suggesting that China‟s shadow banking sector could be a lot larger than the official social financing statistic suggests. To quote Pozar. loan quotas and other quantitativebased monetary policy instruments aimed at the official banking sector are becoming less effective as they target what is a shrinking share of the overall financial system. Federal Reserve Bank of New York Staff Report No. short-term. July 2010. securities lenders. etc. repo ABS CDOs. MTN. securities arbitrage conduits.7trn. wholesale-funded securitization-based lending process that is performed by a variety of non-bank financial intermediaries. long-term loans into seemingly credit-free. the US shadow banking system is about the same size as the traditional banking system. and books a fee.

500 HK financial institutions' external claims on banks in the mainland (LHS) Hong Kong financial institutions' mainland-related nonbank exposure (LHS) Hong Kong financial institutions' mainland-related exposure as a % of total assets (RHS) % 30 25 20 2.500 3.000 2. Fig.500 1.Nomura | Asia Special Report November 2011 Fig.000 3. 23: Hong Kong financial institutions’ exposure to the mainland HK$bn 4.000 500 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 15 10 5 0 Source: HKMA and Nomura Global Economics. 11 27 .000 1.

However. 2005. The massive fiscal stimulus following the global financial crisis seems to have benefited SOEs more than non-SOEs. While the authorities closed thousands of SOEs in the late 1990s. given that most large construction and transportation companies – and the steel and cement companies supplying them – are SOEs. versus 3. Fig. 2005. whereas in most other countries it is the opposite. The privileged state-owned enterprises At their peak in 1978. 24: The SOE share of total urban employment and stock of fixed assets % share 90 80 70 60 50 40 30 20 10 0 1950 Share of total urban employment Share of total stock of assets of industrial enterprises 1960 1970 1980 1990 2000 2010 Source: CEIC and Nomura Global Economics. SOEs employed 21% of the total non-farm workforce. as it is driven by: 1) large declines in employment and 2) massive capital accumulation The SOE sector‟s growth in total factor productivity has been relatively weak 28 . p. One is that labour productivity. By contrast.6% per year in the SOE sector.Nomura | Asia Special Report November 2011 3. p. The massive fiscal stimulus following the global financial crisis seems to have benefited SOEs more than non-SOEs Fig. or output per worker. The SOE sector‟s high labour productivity is misleading. at less than two-thirds of that in the private sector (OECD.111). state-owned enterprises (SOEs) produced 78% of total industrial output and employed 60% of the non-farm workforce. produced 27% of gross output in the industrial sector and controlled an eyepopping 44% of the stock of fixed assets. By 2009. despite accounting for only 4. labour productivity averaged 5. In 1999 to 2007. highlighting their capital intensity (Figure 24).7% of the total number of firms. including many of China‟s largest companies with oligopoly power in many important sectors.6% per year in the private sector (OECD. the SOE sector‟s high labour productivity is misleading. growth in total factor productivity (TFP) – measuring output gains over and above increases in inputs of labour and capital – has been relatively weak in China‟s SOE sector. as it is driven by: 1) large declines in employment and 2) massive capital accumulation (Figure 25).110). 12 The performance of China‟s SOEs is puzzling in two respects. TFP is driven by innovation by new technologies and managerial skill and is a better gauge than labour productivity of real efficiency gains. in the SOE sector has been much stronger than in the private sector. thousands remain.

despite preferential treatment.9 0.7 13. 24 workers rights and work place safety (e. In many cases the industrial land is provided cheaply or even free to companies in order to attract investment.1 0. despite relatively low TFP.0 000 yuan per employee 82. but savings are even higher). and capital. the SOE sector as a whole has remained profitable.2 51.9 16. p.2 13.9 200. p. One study estimates that these factor market distortions could be costing the economy almost 10% of GDP in terms of lost efficiency (Huang 2010).8 0. many of the smaller SOEs still make losses or barely break even – in 2007.0 97. and goes completely against efforts to rebalance GDP growth from investment to consumption (see chapter: The setting in of growing pains). where managers have complete de facto autonomy in corporate decisions from the state. Another study of a sample of over 3.0 2003 2007 Source: Product Market Regulation and Competition in China” . 23 land..6 11. one in five SOEs earned a negative return (Conway.7 74. Government support for the massive yet inefficient use of capital by SOEs is likely contributing to wasteful investment of scarce resources and environmental degradation. while the cost of electricity is also relatively low (IMF 2011a. SOEs as a whole have remained profitable due to a raft of generous government subsidies Government support for the capital-intensive goes completely against efforts to rebalance GDP growth from investment to consumption 23 The latest estimates of the IMF‟s Consultative Group on Exchange Rates indicate that the RMB is undervalued by 3-23%.5 0.g.3 % of value added 2.5 68. Herd.0 17.000 firms shows empirically that private firms. allowing low or no dividend payouts. 13 A related puzzle is that.3 9.2 19. such as energy.8 229. p. while nearly all product markets have been liberalized. with high retained earnings to plough back into new investments. water. 823. under-pricing key inputs.2 11. 2008). do indeed have better operating efficiency under various metrics (Gan et al. The price of water in China is about one-third of the global average. Subsidies include low effective tax rates. coal mines). all land belongs to the state and local governments who have the discretion to sell industrial land use rights to companies for up to 50 years.7 716. Despite relatively low total factor productivity.2 19.Nomura | Asia Special Report November 2011 Fig.3 % of total exports by sector 25. This is because after almost 30 years of economic reforms. 29 .0 193. keeping the RMB undervalued.1 6.7 % of total assets 22. 2010. barriers to entry in some industries. the factor markets remain heavily distorted through a raft of generous government subsidies to SOEs (see Box 5: Investment is high.7 86.6 1. 24 In China. charging little or no royalties on resource extraction.0 887. 20).19). 2010 Fig. and only lightly enforcing environmental protection. Chaalaux.1 250.1 8.18).8 90.OECD Economics Department Working Papers No.5 12.6 % of annual sales 27.1 364. In contrast. IMF (2011a. 25: Industrial structure of SOEs and private firms – a comparison 1998 Employment Public sector Non-state sector Capacity intensity Public sector Non-state sector Inventory Public sector Non-state sector Long-term liabilities Public sector Non-state sector Exports Public sector Non-state sector Subsidies Public sector Non-state sector Average number of employees 662.

this one differs for China‟s banks in two respects: 1) the bank RRR is at a record high 21. which are still majority state-owned. to almost the same level as household savings. capital. gross savings can be roughly decomposed into three sectors: that done by households (23% of GDP). maintain a strong bias to lend to SOEs. after the 2008 global financial crisis. China needs to focus more on TFP improvements by reducing SOE subsidies and creating a more competitive business landscape. SOE-related sectors. but savings are even higher China‟s gross domestic investment rose from an already high 35. RMB appreciation is just one of many reforms available to achieve this. by a GDP accounting identity. while deposit rates are subject to a ceiling. Government saving has also been rising and is high by global standards. So.3% of GDP in 2000 to 48. resorting to even greater interventionist policies to quickly revive the economy by instigating a massive credit-fueled investment boom.2% of GDP in 2010). saving in the corporate sector. the problem is that China‟s banks are pricing credit in an increasingly distortionary way. a low return on bank deposits and the lack of diversification opportunities for financial assets. because of a shrinking labour force and limited room to increase an already very high contribution of capital (see chapter: The setting in of growing pains).2% of GDP in 2010. including healthcare. largely irrespective of credit risk (Yeung 2009. And for the first time they are starting to do so: in June 2011. largely irrespective of credit risk From the accounting identity. land. indicating a larger-than-usual impact on the banks. particularly given that the low-hanging fruit of productivity gains from surplus rural labour migrating to the cities is set to diminish (see chapter: The Lewis turning point). A more enduring challenge to reforming China‟s industry structure relates to an asymmetric information problem in the banking sector. Unlike past monetary policy tightening cycles. To ensure that the slowdown in potential growth is gradual. capital intensive.2% of new loans were priced above benchmark lending rates. the authorities did the reverse. However. a record-high 61. increasing the urgency to boost total factor productivity A more enduring challenge to reforming China‟s industry structure relates to an asymmetric information problem in the banking sector China‟s four largest banks.5% and the interest rate margin squeeze is more severe. by corporates (21%) and by government (10%). which reflects retained earnings and hence corporate profitability. reflecting robust fiscal revenues and land sales. and on IMF estimates. which started being gradually deregulated in 26 2004. 30 .Nomura | Asia Special Report November 2011 Box 5: Investment is high. Given that the current account surplus is. However. from the above analysis it follows that China needs to reduce corporate and household savings to narrow its current account surplus (5.9% over the same period. resources and environmental protection. but 2) commercial bank lending rates. but the band has been progressively widened and commercial bank lending rates are now only subject only to a floor. The second point is important because it provides a valve to ease the financial repression facing banks by allowing them to price credit risk more actively. has increased markedly in the past decade. China‟s saving rate is the highest in the world. These interventionist policies were to the advantage of the less efficient. the causes of which are relatively well known: a high precautionary motive to save because of inadequate social welfare. gross domestic savings is equal to gross domestic investment plus the current account balance. pensions. but gross 25 domestic savings rose even more. China‟s potential output growth looks set to slow this decade. charging higher lending rates for riskier customers. Podpiera 2006). 26 Until 2004. China‟s four largest banks. unemployment benefits and education. On the other hand. The rise in corporate saving reflects oligopoly or monopoly power in some industries and government intervention to artificially repress the prices of labour. Rightly or wrongly. the excess of gross domestic saving over investment. Household savings have been high for decades. which are still majority stateowned. it has been the mostly private SMEs that have borne the brunt of the credit tightening – and even more so than in 25 China‟s potential output growth looks set to slow this decade. creating a loan market that is segmented between SOEs and non-SOEs. interest rates set by commercial banks were not permitted to be more than 10% above the benchmark lending rate. Hence China‟s savings are higher than investment because of a current account surplus of 5. which is being exacerbated by the recent tightening of monetary policy. and so have exacerbated China‟s structural industry problems.6% in 2010. the SOEs are still perceived by the banks to have implicit government backing. maintain a strong bias to lend to SOEs. are no longer subject to a ceiling. from 37% of GDP to 53. A low dividend policy also explains a high level of retained earnings.

A growing number of SMEs have been denied bank credit altogether and have to turn to the less regulated shadow banking sector 27 Perhaps the most publicized Chinese company accounting fraud case this year was Sino-Forest. Box 6: The Akerlof market for lemons problem applied to China George Akerlof won the Nobel Prize in economics in 2001 for his work showing how markets can break down in the presence of asymmetric (or unequal) information. such pawn loans.com. But this is one example of more than two dozen listed Chinese companies that have shown accounting discrepancies or seen their auditors resign so far this year. Many of China‟s bank loan officers do not have the expertise or information to properly price risk. this leaves them no choice than to turn to the less regulated shadow banking sector. up from 5% per month last year.0% pa in December 2009 (Figure 26). which bear much higher funding costs. The example Akerlof used was of the used car market. causing. the market to seize up. Meanwhile. Now even owners of moderately good cars (borrowers of good credit standard) are unable to sell (borrow) at a fair price. that owners of good cars (borrowers of high credit standard) will not place their cars (seek loans) in the used car market (in the banking sector). This means. the average informal lending rate in the city of Wenzhou – the country's SME hub – rose to 25. 1 September 2011. According to the PBC. in the worst case. 28 According to the PBC's Wenzhou branch office. 31 . a growing number of SMEs with very low credit standards have been denied bank credit altogether. This can have a snowballing effect. where sellers have better knowledge of whether their car is a good or a bad one (a “lemon”). however.html. underground banking in the city is estimated to have reached RMB110bn by June 2011. and so he/she will only be willing to pay the price (charge an interest rate) of a car (loan) of average quality. thereby encouraging them to opt out of the loanable funds market and hence lowering the overall credit standard of the non-SOE loan market. overstating its forestry holdings in Yunnan province by some USD900m. and not being able to access the debt or equity markets. This kind of asymmetric information also exists in China‟s bank loan market. This is creating a serious asymmetric information problem for China‟s lenders who are under increasing pressure not to make bad loans.4% pa in September 2011 from 13. A growing number of SMEs have to rely on non-formal financing sources. equivalent to 18% of formal bank loans outstanding. As a result. creditworthy SMEs are being charged too high borrowing rates in relation to what they perceive to be their credit risk. China‟s bank loan officers still lack the skill and experience to properly assess credit risk – a task compounded by opaque company 27 reporting data. while local media report that the uncollateralized black market 28 lending rate is as high as 10% per month. The best guess of the car buyer (the China bank) is that the car (the loan) is of average quality. causing buyers (China banks) to revise downward their expectations of quality.cn/GB/15228039. according to an article by David Pilling in the Financial Times. which listed on the Toronto stock exchange in 1994. see http://zj. Nobel Prize laureate George Akerlof‟s famous “market for lemons” effect is starting to appear in China‟s non-SOE loans market (see Box 6: The Akerlof market for lemons problem applied to China). But that in turn lowers the average quality of cars (loans) in the market (banking sector). micro credit companies and even loan sharks. where the asymmetric information problem is even more lopsided. Yet at the grassroots level.people.Nomura | Asia Special Report November 2011 the past as banks are more actively starting to price credit risk.

For example. which varies by industry. SMEs by employment size are defined as <2.070 15.000 6.788 4. 32 .000 persons for industry.369 19. 14 The segmentation of China‟s credit market. on average.505 20.259 38.677 36.937 21. More significantly.074 431. the city government of Wenzhou set a ceiling on the interest rate of loans made by non-bank financial institutions at 4x the benchmark lending rate (6. they are also in many ways the life and blood of the economy: in 2009. 27: Gauging the importance of SMEs to the economy.057 61 Revenue RMB bn 54.Nomura | Asia Special Report November 2011 Fig. <500 for retail sales. Source: China Statistical Yearbook 2010.454 1. more productive than SOEs. Fig.110 99 Gross industrial output value current prices 54.252 18. through priority lending to large SOEs at the expense of SMEs. official benchmark lending rate % p. revenue and total capital size.313 37. Fig.000 SMEs generated two-thirds of total industrial output.228 2.137 1.cn.036 393.090 1. the government has urged banks to relax credit standards to SMEs 29 but the quid pro quo could be higher bank NPLs.000 for postal service and <800 for accommodation and catering. through priority lending to large SOEs at the expense of SMEs. China‟s 431.4364 3.581 15. <3.000 for transportation.250 68 Total Assets RMB bn 49. poses serious risks to the economy. the State Council on 12 October 2011 ruled that nationwide bank loan growth to small enterprises should not be lower than overall loan growth.000 for construction. paid two-thirds of tax revenues and employed over three-quarters of the workforce (Figure 27). 26: Informal lending rate in Wenzhou vs. 30 Wenzhou informal lending rate 25 20 Benchmark official bank lending rate 15 10 5 0 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Source: CEIC.a.182 67 Total profits RMB bn 3. 15 29 In late September 2011.312 15. < 200 for wholesale. <1.56%).831 17. 2009 Number of Enterprises Total Large enterprises Medium enterprises Small enterprises SME % of total: SME unit 43.365 69 Employment „00 persons 8.788 77 *Note: SMEs are classified on the official definition which is based on employment. For not only are the SMEs.261 30.796 14.831 2. www. while for banks the ceiling for the interest rate on loans to SMEs was set at 1. In recent months.044 2.wenzhou.3x the benchmark lending rate.gov. poses serious risks to the economy Fig. bank loans of RMB5m or less to small enterprises can be treated as retail loans in determining credit risk weights and can be excluded from the banks aggregate loan-to-deposit calculation. The segmentation of China‟s credit market. <3. Nomura Global Economics estimates.

firms can move capital to China by overstating export receipts and/or understating import expenses. or so-called “hot money” capital inflows. together with the. albeit gradual. with excessive investment and credit. increase the efficiency of capital allocation and support long-term growth.zhang@nomura. particularly in relation to the internationalization of the renminbi. 1998) is that financial liberalization serves to enhance competition. Meanwhile. as it is linked with other reforms. China's 12th Five-Year Plan. we estimate that other forms of net capital inflows totaled USD108bn. Unintended consequences of financial liberalization Based on international experience. is a natural development given the sheer size of China‟s economy and the exponential rise in its international trade (China‟s combined exports and imports totaled USD3. they do entail macro risks given the unbalanced domestic economy. Expectations of CNY/USD appreciation can also fuel speculative hot-money capital inflows. simply by subtracting the current account surplus and net FDI inflows from the balance of payments surplus. unveiled in March 2011. China will go through a series of financial sector reforms in the next five years. perhaps motivated by recently becoming the world's second-largest economy. 33 . listed capital account liberalization. in some ways. or perhaps over concerns of its exposure to foreign financial assets (China‟s FX reserves totaled USD3. Zhiwei Zhang +852 2536 7433 zhiwei. In 2009-10. Indeed. and it may be difficult to distinguish the two. On the other hand. but the sequencing and initial conditions are important: if it happens too fast and without a strong banking system and efficient accounting. This. despite structural problems and challenges in the domestic economy. These loopholes are not easy to control as the “desirable” flows are mingled with the “undesirable” flows.com Chi Sun +852 2536 7705 chi. China has made progress on capital account liberalization.3trn in 2010. including the flourishing shadow banking sector. One advantage is that China can learn from the experiences of financial crises in other emerging markets and.sun@nomura.com Pressures are building for China to accelerate financial liberalization China seems to have made a clear policy shift to accelerate the use of the renminbi in international trade and finance 30 For instance. with a more open and rapidly growing economy. the conventional view (see Johnson. it can cause financial and economic crises.2trn in September 2011). regulatory. China seems to have made a clear policy shift to accelerate the use of the renminbi in international trade and finance (see Box 7: A chronology of China‟s capital account liberalization). indeed. renminbi internationalization and interest rate deregulation as policy priorities. pressures are building for China to accelerate financial liberalization. In recent years. 6x larger than in 2000). supervisory and corporate governance frameworks. this has likely contributed to its gradualist approach to financial liberalization so far. move to a more flexible exchange rate. While these reforms are interrelated and indeed necessary for China to make its financial system more efficient and its monetary policy more effective.Nomura | Asia Special Report November 2011 4. it has become a challenge to restrict 30 non-FDI.

3% Opening investment abroad for selected Qualified Domestic Institutional Investors (QDII) CNY/USD daily trading range expanded to 0. The number of Chinese exporting firms who may participate in the program was also expanded Foreign companies were authorized to issue RMB-denominated bonds in Hong Kong Renminbi transactions in Hong Kong were further relaxed to allow: 1) renminbi lending for any purpose.Nomura | Asia Special Report November 2011 Box 7: A chronology of China’s capital account liberalization Date announced 1980 1996 1999 2001 2002 2004 2004 2005 2006 2007 2007 2008 2009 2009 Liberalization measure Liberalized FDI in four Special Economic Zones Current account transactions were liberalized FDI liberalization extended to all provinces. daily trading range of CNY/USD is set at 0. Guangdong. but have yet to be fully implemented. Jiangsu first in October 2010 and expanded nationwide on 1 January 2011) US companies and residents can trade renminbi in US branches of Bank of China. Guangzhou. Dongguan and Zhuhai) and Hong Kong.5% Domestic financial institutions allowed to issue RMB-denominated bonds in Hong Kong subject to approval Domestic commercial banks allowed to provide loans to firms for use in cross-border M&A Local firms allowed to register the source of their foreign exchange financing after their investment overseas rather than requiring approval in advance Introduced RMB as a cross-border trade settlement currency. 2) renminbi remittance to mainland by companies subject to approval by China's government Hong Kong banks involved in renminbi cross-border trade settlement allowed to access the on-shore interbank bond market Allowed export companies to keep their export revenues overseas (introduced to export companies in Beijing. Macau and ASEAN countries (open to all Chinese importers but only a small number of exporting firms) RMB as cross-border trade settlement currency program was expanded to include trade transactions between Chinese firms in 20 provinces and cities and the rest of the world. Investment banks are also allowed to issue RMB-denominated derivative warrants based on renminbi shares 2010 2010 2010 2010 2010 2011 2011 2011* Note: * These planned measures were announced by Vice Premier Li Keqiang during a special visit to Hong Kong on 17 August 2011. Source: Nomura Global Economics. Shandong. but restricted to trade between five Chinese cities (Shanghai. the services sector is opened up to FDI. 34 .000) Introduced pilot scheme on allowing qualified foreign institutions to make private equity investment in China To launch Renminbi QFII. including the financial sector Opening the domestic capital market for selected Qualified Foreign Institutional Investors (QFII) The approval requirement for firms' overseas investment was repealed Allowing Hong Kong residents to open RMB deposit accounts at Hong Kong banks RMB de-pegged from USD. Shenzhen. but subject to limits varying by sector Under WTO commitment. Shenzhen. which would allow foreign investors to invest in mainland securities with an initial quota size of RMB20bn To expand the renminbi trade settlement scheme nationwide To allow Hong Kong firms to invest directly into mainland China using renminbi To expand Treasury bond sales in Hong Kong To launch an ETF linked to Hong Kong stocks in mainland China 2011 Allowed Hong Kong listed companies to raise renminbi through share placements or rights issues. Individual accounts can convert US$4000 a day into renminbi (annual quota is US$10.

while trade settled in renminbi through banks in Hong Kong has increased 35x from RMB27bn (USD4bn) in H1 2010 to RMB953bn (USD146bn) in H1 2011. fueling rapid credit growth. internationalization of the renminbi is adding pressure for China to accelerate capital account liberalization.14). the offshore use of the renminbi has grown tremendously. rising NPLs and a loss of investor confidence triggering capital flight. China‟s government has allowed about RMB50bn (USD7bn) in Hong Kong to be invested in China‟s interbank bond markets. At the same time. whether it be foreign portfolio investment or China's banks and companies stepping up borrowing from overseas. including those in Asia in the late 1990s. Yet even following the best practice of carefully sequencing capital account 31 liberalization . a similar amount to return as inward FDI and plans are underway to launch an RMB-based QFII (Qualified Foreign Institutional Investors) scheme of RMB20bn (USD3bn) to invest in China‟s capital markets (IMF.7bn (USD15bn) in July 2010 to RMB609bn (USD95bn) in August 2011. if capital account liberalization happens too fast. if the renminbi is to become truly an international currency. China is not. through diminished competitiveness. lhs 4 3 2 1 0 400 200 0 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Source: CEIC and Nomura Global Economics. comprising one-third of total trade between Hong Kong and China (including offshore trade). Without a strong regulatory infrastructure and appropriate safeguards. Internationalization of the renminbi is adding pressure for China to accelerate capital account liberalization Based on international experience. p. capital can be misallocated. and foreign direct investment before portfolio investment – have the appeal of simplicity. leaving much of the renminbi being deposited at the Hong Kong clearing bank earning a low return. is that foreign capital can come pouring in. The economic boom can then turn to bust. it can cause financial crises 31 Although certain rules about sequencing capital account liberalization – for example. Fig. Source: CEIC and Nomura Global Economics. vulnerable to a balance of payments crisis. in our opinion. 16 Fig. 29: RMB deposits in Hong Kong % 7 6 5 Total amount of RMB deposits in Hong Kong. the range and accessibility of renminbi financial instruments outside China is still small relative to the volume of renminbi that is building up offshore.Nomura | Asia Special Report November 2011 Over the past year.8% of total deposits in Hong Kong (Figure 29). However. 35 . Indeed. China‟s capital controls will have to be eliminated so that foreign investors can freely invest in RMBdenominated assets and easily repatriate their capital and income. a freer capital account amid severe financial repression can increase the incentive for China's savers to flee negative real bank deposit rates in favour of higher returns abroad. the lessons from other emerging markets. without appropriate safeguards. 17 However. renminbi deposits in Hong Kong have grown exponentially from RMB103. As a result. countries should liberalize long-term flows before short-term flows. Renminbi deposits in Hong Kong have grown exponentially from USD15bn in July 2010 to USD95bn in August 2011 Fig. equivalent to 6. a worsening current account. but that does not rule out the possibility of large net capital outflows and a drawdown in FX reserves – particularly given that China's M2 money supply has swelled to 175% of GDP as of September 2011. the fungibility of capital makes their practical application difficult. Renminbi trade settlement has surged from almost zero in 2009 to 10% of China‟s total trade in June 2011 (Figure 28). rhs RMB bn 800 600 RMB deposits as a % share of total Hong Kong deposits. With a war chest of FX reserves and a large current account surplus. asset price bubbles and an overheated economy. 28: RMB usage for trade settlement % of China's total trade 12 10 8 6 4 2 0 Mar-10 Fig. 2011a.

By raising deposit rates and cutting lending rates it can shrink the profit margins of banks. 36 . undermining their effectiveness. domestic financial liberalization in Korea resulted in a crisis in 2003 when credit card debt as a share of GDP more than tripled between 1999 and 2002. However. if the primary instrument of monetary policy is to be the policy interest rate. heightening the risk of a financial crisis. Indeed.5trn (USD226bn) in 2010 (Figure 30). but since then regulations have been relaxed and debt issuance by non-finance firms more than tripled to RMB1. the risk could stem from other forms of financial deregulation. by companies increasing borrowing from overseas). such as credit quotas. There are a number of advantages in deepening the debt market in tandem with capital account liberalization and interest rate deregulation. and the average number of credit cards for every adult in the country rose from one to three. This happened in Japan in the 1980s and contributed to its unprecedented asset price bubble (see Box 8: Risks associated with financial liberalization: lessons from Japan). the conventional macro policy approach under a freer capital account is to gradually relinquish control over the exchange rate and focus instead on setting domestic interest rates.Nomura | Asia Special Report November 2011 Faster capital account liberalization can also speed up domestic financial deregulation.9x the benchmark 1yr lending rate) and a ceiling on bank deposit rates. While deregulating these interest rates should increase the efficacy of monetary policy. Until 2004. it is not without risks. 2) develop a yield curve and increase the potency of monetary policy. Without strong regulatory and supervisory frameworks. Deeper debt markets can: 1) help absorb larger capital inflows. quantitative-based monetary policy instruments. The overall loan quality in the banking system would decline. interest rate deregulation can pressure banks to engage in overly aggressive competition to 33 attract customers and maintain market share. it could also encourage them to start taking on riskier loans to compensate for the drop in profits. With freer capital movement it will become more difficult for the PBC to both manage the exchange rate and have autonomy over monetary policy. Without adequate supervision. China still imposes a floor on bank commercial lending rates (0. losing market share of high-grade corporate customers to the bond market could pressure banks to lower their credit standards to attract new customers. to be effective in influencing the price of money and credit it 32 becomes necessary to deregulate bank deposit and lending rates. With the exceptions of small and very open economies. leading to a drop in credit standards Another risk related to financial liberalization can stem from developing the local private debt markets Losing market share to the bond market could pressure banks to take on riskier loans to attract new customers 32 In China's current credit tightening cycle there has been a surge in mainland institutions borrowing from Hong Kong banks and debt issuance in Hong Kong's bond market. Faster capital account liberalization can also speed up domestic financial deregulation Interest rate deregulation can pressure banks to engage in aggressive competition. However. are easier to circumvent under a freer capital account (for example. like Singapore and Hong Kong. as large companies choose to increase borrowing directly from investors by issuing debt. China‟s private debt market was small and heavily regulated. 33 Rather than interest rate deregulation. such as relaxing controls on the issuance of new lending products which can be counterproductive when complimentary factors – such as commercially orientated loan officers and consumer familiarity with the risks of new financial products – are lacking. Another risk related to financial liberalization can stem from developing the local private debt markets. developing the private bond market can increase competition between banks. and 3) diversify credit risks away from the banks. For example. worse still.

Fig.200 1. Source: China Government Securities Depository Trust & Clearing Co.800 1. Ltd. Issuance of so-called medium-term notes was allowed from April 2008.400 1.600 Middle-term notes Commercial paper Asset-backed securities Corporate bonds 1. 30: Bond issuance by Chinese firms RMB bn 1. 18 37 .Nomura | Asia Special Report November 2011 Fig.000 800 600 400 200 0 2004 2005 2006 2007 2008 2009 2010 Jan-Sep 2011 Note: Commercial paper issuance was allowed from May 2005 for maturities of 1yr and below.

Banks were forced to complete aggressively against each other in seeking out a new client base. However. Due to high minimum standards. Interest rates for certificates of deposit were also rapidly deregulated in the 1980s. The annual average amount of corporate bonds issued tripled from JPY2trn in 1975-80 to JPY6trn in 1985. Financial institutions often lacked information on the credit histories of their new clients. See What Japan‟s 1980s experience means for China. targeting SMEs. Bond market liberalization The Ministry of Finance deregulated the bond market aggressively in the early 1980s.6trn (Figure 31). Japan‟s financial liberalization experience was gradual in the 1970s but accelerated in the 1980s under US pressure. lending standards often deteriorated. for deposits of JPY50m or more in April 1988.Nomura | Asia Special Report November 2011 Box 8: Risks associated with financial liberalization: lessons from Japan This box summarizes research by Tomo Kinoshita. Japan‟s bubble in the 1980s and its “lost decade” once the bubble burst in the early 1990s is usually attributed to the Plaza Accord in September 1985 – a coordinated effort by the G5 to depreciate the USD – which led to significant JPY appreciation. 38 . 31: Bond issuance by Japanese firms Yen trn 20 Bond with Warrants (overseas) Convertible Bonds (overseas) 18 16 14 12 Straight Bonds (overseas) Bond with Warrants (domestic) Convertible Bonds (domestic) Straight Bonds (domestic) 10 8 6 4 2 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: Japan Ministry of Finance and Nomura Global Economics. Fig. Furthermore. The interest rate deregulation schedule started by removing the interest rate ceiling for large deposits of JPY1bn or more in October 1985. the relaxation of the banks‟ lending stance created an opportunity to tap easy funds to speculate in property and stocks. and for deposits of JPY10m or more in October 1989.g. Abolishing the interest rate restrictions sparked fierce competition among banks to raise deposit rates to attract new customers. This increased to 25 in 1983 and further to 175 companies in 1985. individuals and property developers. The combination of rapid deregulation of the bond market and rapidly rising stock prices meant that issuance of equity-linked bonds (e. Nomura Asia Special Report. only two companies in the domestic market were allowed to issue convertible bonds (CBs) before deregulation. financial institutions started to seek out riskier customers that were willing to pay higher borrowing rates. The liberalization of the bond market enabled big companies to raise funds more cheaply and to repay their earlier bank loans. To reduce interest rate margin pressure. In the fierce competition for new clients that ensued. Bank deposit rates had long been set at low levels by the authorities to provide banks with sufficient interest rate margins. CBs and warrants) soared in 1989.. The proportion of total city bank loans (excluding trust accounts) made to SMEs and individuals rose to around 70% in 1990 from 47% in 1980. Interest rate deregulation Deregulation of interest rates made for another source of aggressive bank lending behaviour. hurting Japan‟s exporters and caused the Bank of Japan to aggressively ease monetary policy. resulting in a massive expansion of the primary market for corporate bonds. in 1985 unsecured straight bonds were issued for the first time since the Second World War. peaking in 1989 at a yet-tobe surpassed JPY19. bond market liberalization and interest rate deregulation were also important underlying reasons for Japan‟s asset bubble in the 1980s. For borrowers. for deposits of JPY500m or more in April 1986. 19 October 2009.

that is flat – increased labour demand does not affect the wage level – but as the economy develops there will be a point when the manufacturing labour supply curve will kink because of a diminishing supply of surplus rural labour. work by Minami and Ma (2010). In Japan it was in 1965 when employment in the secondary sector (manufacturing and construction) overtook that in the primary sector (mostly agriculture) that real manufacturing wages started to surge (Figure 33). employment is still largest in the primary sector. strengthening the wage bargaining power of industrial workers. the manufacturing labour supply curve can be elastic. The Lewis turning point Over the past decade. On the other hand. the LTP. The Lewis turning point is when the supply of surplus rural labour starts to diminish. largely through migration. 32: A stylized diagram of the Lewis turning point Wages Lewis Point Labour supply D2 D1 Labour pool Source: Nomura and inspired by Stephen Jen at SLJ Macro Partners Fig. Wang (2010) and Garnaut (2010) conclude that the LTP has yet to be reached. but on current trends it will be overtaken by employment in the secondary sector in 2015. raising the wage bargaining power of industrial workers Fig. In China. Yang and Wang (2010) and Cai and Wang (2008) conclude that China is at. Du and Wang (2010). A strikingly similar phenomenon happened in Korea in 1987. China‟s urban population has increased by about 20m per year while its rural population has fallen by 13m per year. This has become known as the Lewis turning point (LTP) and in a stylized chart can be thought of as a “kink” in the labour supply curve when wages can take-off (Figure 32). we find an interesting pattern in countries that have already passed the LTP. Zhang. Taking a different approach. empirical studies have reached no firm 34 conclusions on whether China is at the LTP. In the early stage of economic development. 19 Surveying the recent literature. Deng and Li (2011). However. Nobel Prize-winning economist Arthur Lewis (1915-91) observed that in developing economies a point is reached when the supply of surplus rural labour starts to diminish. 39 . Empirical studies have reached no firm conclusions on whether or not China is at the LTP 34 Knight.Nomura | Asia Special Report November 2011 5. The seemingly endless supply of cheap rural labour migrating to the cities has helped contain average wages. or near.

the average wage grew by 13. as evidenced by the surge in labour disputes. commonly the payrolls of migrant workers would have to rise by at least 35-40%. resulting in there being fewer young. not just wages. and it is true that lower-end manufacturing is moving inland to areas where labour is more plentiful and cheaper. and the same pattern happened in Japan in 36 the early 1970s. rhs Secondary. However.3% and the average minimum wage jumped 22.9% and by a similar magnitude in 2011.8% in 2020. work injury insurance (1%). the 15-24 age cohort was 20. but not yet at. 40 .6% in 2015 and 12. not just wages 35 According to research by Huang (2010).8% of the total population in 2010 to 14. the focus should be on total labour benefits. Mn 20 18 16 14 12 10 8 6 4 2 0 1978 1986 1994 Primary. As in Japan in the early 1970s. 36 In the early 1970s Japan experienced an outbreak of inflation. in part driven by the 1973-74 oil crisis. 33: Primary. The first is demographics (see chapter: The setting in of growing pains). if companies strictly follow policies on social welfare contributions. maternity benefit (0. Second.3% in Japan in 1965 and 21. Mn 30 20 10 5 0 -5 ent.1% in Korea in 1985. but other components of labour compensation have surged even more. Fig. lhs Source: Japan‟s Ministry of Internal Affairs and Communications and Ministry of Health and Labour. but also the flow of surplus rural labour moving to the cities started to diminish in the 1960s. In contrast. suggest to us that the LTP is upon China. China‟s wages are growing strongly: in 2010.Nomura | Asia Special Report November 2011 Fig. lhs Tertiary. 1973). there are signs that China‟s workers are becoming increasing aware of their “fair share” of entitlements – from social welfare benefits to better working conditions – as evidenced by the surge in the 35 number of labour disputes. productive workers willing to leave the countryside to work in factories. It is intriguing that there was a structural break in China‟s labour disputes in 2008. We believe that most studies have ignored three factors that. Mn 60 50 40 South Korea % y-o-y 20 15 10 China % y-o-y 25 20 15 10 5 0 -5 -10 -15 -20 2010 Employment. leading to increased worker bargaining power. including contributions to pensions (20% of payroll). employment benefit (2%). 20 At first glance it would appear that China is near. suggest to us that the LTP is upon China The1994 is demographics first 2002 The second is to focus on total labour benefits. Based on projections by the United Nations. Mn 0 1954 1968 1982 1996 -10 2010 Employment. taken together. medical insurance (6%). taken together. we believe that most of the recent empirical studies have ignored three critical factors that. not only for higher wages but also better working conditions – the so-called Lewis turning point (Minami. secondary and tertiary employment and real wage growth Japan Employment.8%) and housing entitlements (5-10%). the LTP. CEIC and Nomura Global Economics. lhs % y-o-y F 450 400 350 25 20 15 300 250 200 150 100 10 5 0 -5 -10 50 0 1953 1969 1985 2001 -15 -20 2017 2002 Real wage growth. China‟s 15-24 year-old age cohort1986 will 1962 1970 1978 fall from 16. coinciding with the wage surge there (Figure 34).

22 The third reason is the rising opportunity costs of migrating from the agricultural sector. lhs No. of labour disputes in China in 100 thousands. such as greater use of biofuels. In these economies. The rigid hukou household registration system. The coming surge in food prices. Food prices have soared in recent years and we expect them to continue to climb. 35: Growth in wages versus total labour compensation % y-o-y 35 30 25 20 Wages Total labour compensation 15 10 5 0 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: CEIC and Nomura Global Economics. China‟s Ministry of Human Resources and Social Security and Nomura Global Economics. Nomura Global Economics. it shows that this broader measure of firms‟ labour costs grew much faster than average national wages in 2008-09. while agricultural supply faces many constraints and uncertainties. as costs in the cities rise. 34: Number of labour disputes – Japan versus China Number 12 10 No. by making it extremely difficult for rural migrants to obtain a permanent urban resident permit and thereby gain the same access to the deepening social welfare systems as locals. The third reason is the rising opportunity costs of migrating from the agricultural sector 41 . If we aggregate data measuring compensation of labour in China‟s 31 provinces. paying salaries on time. It is also now easier for workers to file complaints against employers in the arbitration tribunals or courts. Fig. lhs Japan's real wage growth. The new labour laws have empowered low-paid workers by making it mandatory to have written labour contracts. 21 This may have been triggered in part by China‟s new labour laws in 2008 and the exponential increase in user-penetration of the internet and mobile phones. if food prices keep rising. rhs % y-o-y 12 9 8 6 4 2 0 1960 1970 1980 1990 2000 6 3 0 -3 -6 2010 Source: Bank of Japan. and being enrolled in a social security program. enforcing the payment of overtime. underpinned by burgeoning demand from the world‟s rapidly developing – and most populated – economies. global warming and increasing water scarcity (see Special Report. lifting incomes in the countryside. of labour disputes in Japan in thousands. Fig.Nomura | Asia Special Report November 2011 Fig. although both series returned to a similar rate of still-fast growth of around 16-17% last year (Figure 35). which is based on the income measure of GDP. diets are changing towards a higher calorie intake. could also become a growing constraint on urbanization. 8 September 2010). This may have been triggered in part by China‟s new labour laws in 2008 Fig.

China: The case for structurally higher inflation. particularly if productivity growth fades. then it can eat into profit margins. trigger a serious outbreak of inflation. because of the LTP. 21 September 2011. if passed on to consumers.Nomura | Asia Special Report November 2011 A surge in wages is no doubt positive for household consumption and helps facilitate internal rebalancing. 42 . see Asia Special Report. erode export competitiveness and. Indeed. but if it happens too fast. compared to 2% over the past decade. our base case is that CPI inflation will average around 5% from 2011 to 2015. but also due to the need to deregulate the government's underpricing of key natural resources and a likely multi-year surge in food prices.

0 1. % 15-64 Total dependency ratio . a shrinking labour force and a sex ratio heavily skewed toward males Fig. males per 100 females Sex ratio at birth.7 31. of male births per one female 2000 1269 857 29.4 16.1 1.5 11.51 0. of daughters per woman Population sex ratio.5 40. the share of 15-24 year-olds in the total population is projected to fall from 16. 36: Key demographics indicators and projections for China.newton@nomura. The combination of slower trend growth but higher structural inflation creates a more challenging environment to implement much-needed reforms.69 108.Nomura | Asia Special Report November 2011 6. the UN projects the share of people aged over 60 in the total population to rise from 12. China faces a rapidly ageing population. child births per woman Net reproduction rate.68 107.5 1.64 0.3 11. urban couples to having only one child. % 15-64 Child dependency ratio .5 16.1% in 2015 and to 17. millions Working age population.aged 0-14.aged 0-14 and 65+. 43 .21 2010 1341 971 34.0 10. Fig. 23 37 China‟s one-child policy officially restricts married.9 21. increasing the number of 60+ year-olds over this period by 76m.8 1. decreasing the number of 15-24 year-olds over this period by 47m.8 23. ethnic minorities and parents without any siblings themselves.9 22. by the United Nations Population.com China is facing growing pains from worsening demographics and increasing strains on natural resources and the environment Demographic challenges China is in the midst of a huge demographic shift.4 23. Alastair Newton +44 20 710 23940 alastair. while the experience of other emerging economies is that slower trend growth can cause problems festering below the surface – such as hidden bad debts – to bubble up to the surface.5 37. China‟s age pyramid is projected by the UN to change shape dramatically in the next two decades (Figures 37 and 38).20 2015 1370 996 36.4% in 2020.3 42.7 20.8% in 2010 to 14.16 2025 1395 981 40.7 15.5 10. while the World Bank (2011a) expects total employment to start to shrink from around 2015. This combination can also make it more challenging to address China's high income inequality.aged 65+.2 17. For example. although it allows exemptions in several cases. % total Elderly population aged 60+.71 108.2 1.9 38.14 Source: United Nations and Nomura Global Economics. Yet failing to reform the SOE sector will make it tougher to increase the efficient usage of natural resources. including for rural couples.72 107.1 13.8 1. The one-child family policy was introduced in 1978 and has brought the fertility rate down to about 1.58 0.7 1.3 1.80 0. capital intensive SOE-related sectors. No.78 107.18 2020 1388 989 38.4 37. % 15-65 Fertility rate. a shrinking labour force and a sex ratio heavily skewed toward males are 37 creating new challenges (Figure 36).2 45.6% in 2015 and to 12. it will likely become politically more difficult to remove the myriad government subsidies to the relatively less efficient.18 2005 1308 923 32.2 19.56 0.2 14.2 10.5 1.1 1.15 2030 1393 960 42.0 1.0 41. Because of low fertility and rising life expectancy.3 26. A rapidly ageing population.6. The setting in of growing pains China is starting to face growing pains from worsening demographics and increasing strains on natural resources and the environment. and inflation to be structurally higher.9 10.1 11.53 0. Meanwhile.7 48.1 12.69 107. reduce environmental degradation and rebalance GDP growth away from investment towards consumption.2 1.8% in 2020.5 1.8 12.8 17. % total Old age dependency ratio .0 24. This will almost certainly cause the economy's potential growth to slow over the course of this decade.70 0.1 1. No.73 107.4 24.3% in 2010 to 15. millions Median age.6 15. years Young population aged 15-24.

3pp in 1978-94 to 1. there were 51m more men than woman in the country. potential output growth looks set to slow. the highest in the world (Figure 39). The implication is that China‟s potential output growth. well below the replacement figure of just over unity. Fig. possibly quite sharply in the next 5-10 years . there will not be enough brides for as many as one-fifth of today‟s baby boys when they get to marrying age. The sex ratio among newborns is 120 boys for every 100 girls. Women are bearing only 0. In 2010. will find themselves with four parents to look after and will themselves have only one child (known in China as the 4-2-1 phenomenon). possibly quite sharply in the next 5-10 years.e. The rapidly ageing population will increase the strain on the relatively undeveloped health and pension systems. and could increase tensions in society Fig. At this rate. could slow abruptly this decade unless total factor productivity (TFP) can be boosted. 2010 100+ 90-94 80-84 70-74 60-64 50-54 40-44 30-34 20-24 10-14 0-4 Fig. Young urban couples. 2011 Fig. the decreasing contribution of labour to China‟s potential output growth was not a major concern as it was offset by capital deepening. 37: Age pyramid. In the past two decades. many of them without siblings. 25 China‟s rapidly ageing population will increase the strain on the country‟s relatively undeveloped health and pension systems. 24 Fig. and is projected to decline further to -0. with capital accumulation adding a hefty 5. and could increase tensions in society (see section in this chapter: Rising inequality and an aspiring middle class). limiting the scope for further increases in the contribution of capital to potential output growth. i. 2030 100+ 90-94 80-84 70-74 60-64 50-54 40-44 30-34 20-24 10-14 0-4 Female Male Female Male 70 60 50 40 30 20 10 0 10 20 30 40 50 60 70 Millions 70 60 50 40 30 20 10 0 10 20 30 40 50 60 70 Millions Source: United Nations and Nomura Global Economics Source: United Nations and Nomura Global Economics 7.Nomura | Asia Special Report November 2011 Fig. Perhaps the more alarming concern for population sustainability is the large imbalance between baby girls and boys. heightening the risk of social tensions. 26 As a result of China‟s ageing population. The contribution of labour to China‟s potential output growth is estimated by the World Bank to have declined from an average of 3. But capital deepening has lifted the investment-to-GDP ratio to an extraordinarily high level of almost 50%. unless China uses its labour and capital more 44 China Korea India Hong Kong Greece Ireland Singapore Australia Czech … Denmark Germany Italy Japan Malaysia Netherlands New Zealand Philippines Poland Portugal Russia Spain Sweden Thailand Brazil Canada Colombia Egypt Finland France Iceland Indonesia Mexico Norway Pakistan Switzerland Turkey UK US Vietnam Argentina Sri Lanka Saudi Arabia South Africa The prospect of a shrinking workforce means that China‟s potential output growth is likely to slow. 39: Country rankings of sex ratio at birth Number of male births per 100 female births 120 117 114 111 108 105 102 Source: United Nations and Nomura Global Economics.8pp to potential growth in 1995-2009.71 girls over their lifetime. which has been remarkably stable in the last three decades. 38: Age pyramid.0pp in 1995-2009.5pp in 2016-20 (Figure 40).

environmental concerns and social tensions. with half of the 1. The World Bank is not optimistic.9 2016-20 7. 40: Estimates of potential output growth – past and future % y-o-y Potential output growth Employment growth Labour productivity growth .. No surprise the authorities in Beijing are introducing stringent measures to limit motor vehicle ownership.0 -0. but at the risk of generating other negative externalities 38 As economies develop it is common for the initial high rates of TFP growth to slow.4mn in 2005 to 19. Fig.0 3. which generate economies of scale due to specialization.2 Source: Kuijs. where the population has soared from 15.3bn population living in urban areas. A good example is Beijing.8 2010-15 8. dwarfing the 2. as productivity “catch up” and the flow of surplus labour from the less productive agricultural sector to the more productive manufacturing and services sectors starts to ease. providing economies of scale and greater scope for modernization. the strain on the bigger cities is intensifying in terms of resource constraints.5 2.0% in 2016-20. China Research Working Paper No. The number of university graduates rose more than 6x between 2000 and 2010 to 384mn. although a large share are struggling to find jobs. However.Nomura | Asia Special Report November 2011 efficiently. In turn. 9. while helping to encourage urbanization and labour mobility. Already. a cumulative increase of 27.From capital deepening 1978-94 9. of which the return on capital tends to be relatively lower than private investments and can take longer to be realized.6 2.2 2. Relaxing the hukou system.5% increase in the nationwide population over this five-year period (Figure 41).From total factor productivity (TFP) growth . the recent investment boom has been led by public infrastructure projects. this could boost TFP given that productivity in agriculture is about 6x less than in the rest of the economy. could be relaxed (see Box 9: China‟s hukou household registration system). the capital city.4 1995-2009 9. new policies could be implemented. excess demand 38 could fuel runaway inflation and/or swing the current account into deficit.0 8. L. More specifically for China.4% in 2010-15 and to 7.9 3. it would also facilitate the much-needed consolidation of farmland holdings.6% in 1995-2009 to 8. should help ease the wide income inequalities and encourage more labour mobility and faster urbanization.3 5.2 8. risk generating other negative externalities. One hope to lifting China‟s TFP is from a boost in human capital.4 0. information spillovers and clustering. “China Through 2020: A Macroeconomic Scenario”.3 5. which discriminates against the social rights of migrant workers. the challenge is that these reforms. 45 . To try to avoid a shrinking workforce.4 3. which links most health and education benefits to the area where the person is registered rather than living. In the countryside. World Bank. hence boosting agriculture productivity.6mn in 2010. China could relax the hukou household registration system to encourage urbanization.6 1. projecting China‟s potential output growth to slow from an average of 9.3 6. If potential growth slows too sharply. June 2009.5 7.7 5. and in August 2011 shut down 23 schools for migrants across the capital.5%. For example. China‟s hukou household registration system. Urbanization also creates larger cities.

or hukou. % 35 30 25 20 15 10 5 0 -5 -10 Shanghai Tianjin Guangdong Beijing National Jiangxi Heilongjiang Shandong Zhejiang Jiangsu Mongolia Chongqing Ningxia Gansu Liaoning Source: CEIC and Nomura Global Economics. the government could find itself under increasing pressure from the less well-off to distribute wealth more evenly. was introduced in the 1950s to keep as many people as possible in farming. rising incomes and living standards have so far satisfied the aspirations of China‟s growing middle class without the need for political reform. while the latter would not be a politically popular move ahead of the transition to the fifth generation of leaders in early 2013. 2005-10 Cumulative growth. It was also an element of the government‟s social control structure. was described by British newspaper The Independent in 2010 as There is little if any risk of contagion to China from the “Arab Spring” Rising living standards have so far satisfied the aspirations of China‟s growing middle class However. in part to control the pace of urbanization. However. Starting in the late 1990s. their children cannot attend local public schools. but it would take decades to have an impact on employment and risks exacerbating China‟s social. However. despite comparisons between Tahrir Square in 2011 and Tiananmen Square in 1989. However.or under-employed urban youth. the former would also strain China‟s resources and environment. in order to maximize food production. Chinese Communist Party (CCP) chief in the municipality of Chongqing. Many migrants are not entitled to pensions or medical care. we see major differences between the MENA and contemporary China – and little. relatively well educated and often un. At the forefront of the protests in Tunisia and Egypt in particular were middle-class. restrictions were eased to allow migrants to register as temporary urban residents and the right of police to expel unofficial migrants was abolished in 2003. In essence. Another reform could involve relaxing the 1978 one-child policy. and has not been changed since 1951 – would likely have a more immediate impact on employment. resource and environmental problems.Nomura | Asia Special Report November 2011 Fig. rising inequalities within China could spur increasing civil unrest… 46 Guizhou Xinjiang Shaanxi Qinghai Shanxi Jilin Sichuan Yunnan Fujian Guangxi Hunan Hainan Henan Hubei Hebei Anhui Tibet . Allowing greater immigration or increasing the official retirement age – which is currently 60 for men and 50 for women. 27 Box 9: China’s hukou household registration system China‟s household registration system. However. Rising inequality could threaten social stability Bo Xilai. They cannot enjoy a housing subsidy. Rising inequality and an aspiring middle class Events in the Middle East and North Africa (MENA) at the start of this year triggered a good deal of thought over other countries which could be vulnerable to similar outbreaks of civil unrest. particularly as social media has become a powerful tool for the underclass to mobilise and to share its grievances. 41: Cumulative population growth. if the gap between rich and poor and between cities and countryside continues to widen. risk of “contagion”. Overall the hukou system is still very much in force. the main problem remains: migrants do not have the same social rights as locals with permanent resident permits. if any. acting as a major constraint on migration and hence on urbanization. attributing to income inequality. Fig.

China‟s Gini coefficient has risen 40 still further to 41. Asked about human rights in China. close to internationally recognised danger levels”. marrying leftist rhetoric/policies with a strong anti-corruption drive. China's most charismatic politician. So. makes a bid for power” by Clifford Coonan. 40 The Gini coefficient ranges theoretically from 0. and has risen further to 39. inequality is therefore now at a level where it may pose a significant risk to social stability. and within urban areas. when everyone has exactly the same income.8 in 1981 to 38. Newton and Subbaraman (2002) noted that China‟s “Gini coefficient – a common measure of income inequality – rose from 28.5 3. The Independent.5 in 2005 (latest data available). highlighting the fact that China still has over 250mn citizens living close to the poverty line despite the tremendous strides it has made in poverty alleviation over the past three decades or so.0 in 1999. among others. The data support these concerns. average income of households in the top 20% income decile have risen to more than eight times that of households in the bottom 20% income decile (Figures 42 and 43). nevertheless has a firm foundation in contemporary China. it is in our view safe to assume that with his July 2011 public statement in support of greater social equality – “dividing the cake up well in addition to making the cake bigger” – he was again striking a chord with many Chinese which. Notably.5 1978 1982 1986 1990 1994 1998 2002 2006 2010 2 1985 1990 1995 2000 2005 2010 Source: CEIC and Nomura Global Economics.0 Urban income ratio: top 10%/bottom 10% 8 Urban income ratio: top 20%/bottom 20% 2. head of the CCP in Guangdong 39 “Bo Xilai. he has proved himself to be adept at striking a chord with “ordinary” Chinese through a combination of his crackdown on corruption in Chongqing since he assumed his current post in 2007 and his media-savvy skills. By a widely recognised yardstick.0 4 1. 42: Urban-rural household income ratio Fig. President Hu Jintao seemingly made a similar point during his joint press conference in Washington with President Barack Obama in January 2011. China‟s average household income in urban areas has increased to more than three times that in rural areas. while arguably populist. he placed great emphasis on economic rights. 29 Calls for more redistributive policies in response do not enjoy universal support One way of addressing this issue would be through the adoption of more redistributive policies – which some commentators (e. as we look forward to the handover of power to the fifth generation leadership a year or so from now. in a study published in 2002 not long before the handover of power to the current (“fourth generation”) leadership.Nomura | Asia Special Report November 2011 39 “China‟s most charismatic politician”.5 6 2. the Economist Intelligence Unit (EIU) in an article published on 30 September 2011) have suggested Bo Xilai (who is experimenting with a property tax in Chongqing) was advocating as part of what has become known as the “Chongqing model”. to 100 when a single individual receives all the income of a society. Indeed. 47 .g.8 in 1995. … and standard measures support the view that there may be some risk to social stability Fig. 8 March 2010. On simpler but more timely yardsticks of income inequality. Source: CEIC and Nomura Global Economics. Certainly. Wang Yang. According to the United Nations‟ 2010 Human Development Report. 28 Fig. Fig. 43: A gauge of urban household income inequality: the ratio of highest and lowest income deciles Ratio 10 Ratio 3. This approach is widely seen as an alternative to the so-called “Guangdong model” promoted by.

In effect. which adopts a more liberal approach both politically and economically – but one which. Will Freeman. Furthermore.” Although we agree that there is no reason to believe that even the upper estimates of social unrest pose an immediate threat to the CCP‟s grip on power. with others. Stress in the city According to China‟s 2010 census. The hukou system officially restricts labour mobility thereby effectively discriminating against farmers moving to work in the city. according to research by Huang Yiping (2010). this appears to be an ideological struggle which may be a key determinant in the make-up of the fifth generation leadership and the policies it pursues. these contrasting approaches can be viewed as a de facto election issue. However. respectively. Financial Times. in our view. However. We believe that the hukou system helps perpetuate inequality in the cities… … but we see no reason to believe that the CCP‟s grip on power is currently under threat Gauging the true extent of social unrest remains difficult… 41 “The accuracy of China‟s „mass incidents‟”. we also accept that no government can be sure of its longevity in the face of increasing unrest and a failure to address the underlying causes. riots that erupt from seemingly minor incidents and reflect general discontent rather 41 than specific rights violations. pp. unrest to which regimes are especially vulnerable. the continued existence of the hukou household registration system (see Box 9: China‟s hukou household registration system) means that in today‟s China there is a significant overlap between “rural” and “urban” citizenship.163-165).Nomura | Asia Special Report November 2011 province and Bo Xilai‟s predecessor in Chongqing. 48 . According to the OECD (2011. around 670mn people now live in towns and cities – almost exactly half the total population. often violent. rather than rural. the Ministry of Public Security has not published data since it cited 87. furthermore. for bolder political reform and faster economic reform) recently weighing in. including Premier Wen Jiabao and his predecessor Zhu Rongji (calling. Total labour compensation of migrant workers without a hukou is sometimes only half of that of urban residents. 2 March 2010. However.000 upwards per year for “mass incidents” – the majority historically revolving around environmental issues (where the Green movement has emerged over the past decade as the most notably organised manifestation of civil society in China). has the potential to generate greater public dissatisfaction. even if they perform the same job functions. as Will Freeman of GaveKal Dragonomics noted in an article published last year: “Anecdotal evidence over the last five years suggests a rise in „angerventing‟ mass incidents – large-scale. the definition of “mass incident” is not clear-cut and official reporting may not be entirely reliable. China‟s 2005 census estimated the total number of rural-to-urban migrants without a local hukou at 74mn and unofficial migrants in urban areas at 39% of the urban labour force in 2005 (Figure 44). But how extensive is social unrest in reality? Gauging the true extent of “social unrest” in China is far from straightforward.000 incidents of “public order disturbances” (a broader category than “mass incident”) in 2005. History (including recent events in the MENA) teaches us that it is urban. with both Bo Xilai and Wang Yang widely seen as potential candidates for promotion to the Politburo Standing Committee next year. The international press frequently cites numbers from 80.

That said. the current system. There is some recent evidence that.1 16.9 4.5 1.2 57. i. 30 If the status quo persists. the tensions to which these inequalities inevitably give rise look set to deepen.8 As % of population or employment living in an area 13.Nomura | Asia Special Report November 2011 Fig.1 76.4 7.4 39.6 5.1 2. as The Economist pointed out in its June 2011 special report on China. the recent case of industrial action by cab drivers which spread to a number of cities).7 Source: "China" .g. but not until the second half of its expected period of office.9 15. the introduction of new and higher taxes on the middle classes – e. that is. February 2010. improving labour regulation and permitting local unionisation and a degree of collective bargaining. Indeed.9 Coming from rural areas 73. as the EIU notes in its May 2011 “Risk Briefing” on China. that the latter‟s expectation of continuing economic betterment is fulfilled. reform of the status quo – whatever its direction – stands to run into headwinds from constituencies which benefit from.OECD Economic Surveys.4 149.7 4. as part of an overall more redistributive shift – may “stir demands for a say in how their money is spent”. and therefore favour.4 22. it has long been our view that the implicit understanding between China‟s leaders and its citizens is that political reform would be a nettle to be grasped by the fifth generation leadership. Volume 2010/6.5 3.1 4. However. In response. i.3 23.7 126.9 50. Notable among these is China‟s burgeoning middle class.0 16. These include: raising the minimum wage. is the driving force behind increasing labour unrest and strikes in an at least a partly successful quest for better pay and conditions.1 11.7 106. the authorities have adopted a range of policies which are broadly supportive of workers.e.4 0. According to a report published early in 2011 by China‟s National Population and Family Planning Commission. the next decade will see a further 100mn Chinese migrate from rural to urban areas.1 9.e.0 19.8 Total 126. whose aspirations to date have been satisfied without political reform.6 22.6 45.6 18.g. the EIU continues to place only a “moderate probability” on a labour movement emerging in the foreseeable future which could pose a significant challenge to the government. from 2017 onwards – provided. Fig. at least in part to try to address discontent arising from socioeconomic inequality. 44: Origin and destination of unofficial migrants Absolute number (millions) Population Living in urban areas Living in rural areas Total Employment Living in urban areas Living in rural areas Total Population Living in urban areas Living in rural areas Total Employment Living in urban areas Living in rural areas Total Coming from urban areas 52.2 61. modern communications are facilitating wider cooperation (e. workers born since 1980 who account for nearly half of the total number of internal migrants. No taxation without representation? On the other hand.6 3.1 91.1 10. … and that persisting with it risks increased labour and wider unrest… … despite recent measures which are supportive of workers Any reform of the status quo is likely to run into headwinds from vested interests… 49 . Indeed. another recent report – this one by the Hong Kong-based China Labour Bulletin – claimed that the so-called “new generation” workforce.0 6. despite the authorities‟ efforts to prevent a mass labour movement from developing.

may have significant consequences on the aspirations of the middle classes in particular (as well as being something of a set-back to China‟s highspeed rail (HSR) programme). an accident (attributed by the head of the official inquiry to an as yet unspecified “design flaw”) near the eastern city of Wenzhou on 23 July 2011 involving two high-speed trains. compounded by growing inequalities. according to the 2011 annual budget unveiled on 5 March 2011. in which 40 people were reportedly killed. 6 August 2011. in turn. more speed All that being said. pay. Indeed. Quite how China will evolve politically is far from clear. HSR is a high prestige project which has enjoyed the full backing of the top leadership and which is supposed to showcase China‟s ability to absorb and improve imported technologies. both the press (including the state-controlled media). In particular. environmental issues and corruption – are set to continue. is 42 rising already in cities in China where the gender skew is greatest. a national uprising remains unlikely. But what is clear is that. cross-border trafficking and even wider conflict. we believe that Deng Xiaoping‟s famous analogy of crossing the river one stepping stone at a time is likely to prevail. Furthermore. it may. and even that this could. she finds statistical evidence that crime. Ms Hvistendahl goes on to suggest that such imbalances can be as destabilising as climate change. as The Economist put it in its June 2011 special report on China: “For now the party would rather deal with angry underdogs than with an embittered bourgeoisie”. and the consequences of a world full of men. As the EIU‟s May 2011 “Risk Briefing” reflects. “Curiouser”. in turn. potentially sparking crime. and China‟s weibo networks (i. Especially with no official channels such as elections through which citizens can register their opinions. political reform may come more quickly than previously expected Unnatural Selection: Choosing boys over girls. 42 … so reform is likely to remain incremental China‟s gender imbalance could also pose a threat to stability Overall. is now higher and growing faster than defence spending. Nevertheless.Nomura | Asia Special Report November 2011 “Stepping stones” prevail for now For the time being at least. The Economist. as the EIU concludes “… rapid economic growth and the lack of a figurehead… make a national uprising unlikely for the time being”. 2011). This may in part at least account for the recent boost in spending on internal security which. Less haste. military service being a safety valve historically for the pressures which surplus male populations can create. for the time being at least Nevertheless. If that is correct. A recent book by science journalist Mara Hvistendahl (2011) examining the implications of the gender imbalance in China (and in India) pointed to a possible link with the expansion over the past several years of the paramilitary People‟s Armed Police. Compounded by what is widely perceived as the authorities‟ clumsy handling of the aftermath of the crash. bear on the speed with which the fifth generation feels able or obliged to initiate some sort of political reform process. for example. Some commentators have suggested that the slow official response may reflect high-level disagreement over how to handle the matter. the domestic equivalent of twitter) have repeatedly and strongly challenged official statements and even openly criticised the government. 50 . discussed in the previous section. Mara Hvistendahl (Oxford University Press. 43 See. factory closures. spill over into the selection process for the fifth generation 43 leadership. the status quo looks increasingly unsustainable in the medium-term and that evolution there will have to be if something more wrenching is to be avoided.e. however. including violent crime. Another reason behind this could be China‟s demographics. despite official warnings to desist from “negative reporting”. as with labour disputes. local protests over a whole range of issues – notably inflation. just as is the case with labour policy. these can and do act as a valuable safety valve. modern communications (which already facilitate the organisation of social unrest at the local level) bring with them a greater risk of “copycat” action and even the emergence of a regional or national protest movement of some sort.

rising incomes over the past two decades in particular have stimulated increasing demand – initially in urban areas. food price inflation – the original cause of the protests in Tiananmen Square in 1989 – remains a politically sensitive issue which. 44 notably over-grazing. Furthermore. remains a top priority Undernourishment and dietary shifts both contribute to increasing food demand… … and food price inflation remains a politically sensitive issue China risks falling short of its target of 95% food selfsufficiency 44 Furthermore – and directly related to the issue of food security – analysis of the composition of cereal production reveals that since the 1980s growth of output of corn (at 3. despite major efforts over many years to counter land degradation. Resource and environmental strains Writing during the run-up to the handover of power to the 4 generation leadership. But the chatter on the weibo networks does appear to have been of a very different nature to the established patterns of social unrest.” Official estimates put the minimum average requirement of grain per person per year to meet not only subsistence but also animal feed and processing requirements at 400kg. very much to the fore. commented that: “We should not excessively turn farmland into urban areas. around 6. this growth in corn production has been achieved not simply through improved productivity but also through the reallocation of land out of rice and wheat into corn. environment. Yang Weimin. scientific and cultural) demands continued high economic growth which. Food security to the fore Guaranteeing food security for all its citizens confronts China with two overarching challenges.000 hectares pa. experts such as Robert Ash (2011) believe that China could be approaching a plateau in rice productivity and that switching 51 . remain a very high foreign and domestic policy priority for the foreseeable future. far from it. economic.5% of the country‟s total). Almost 30% of China‟s total land area is desert and. the Secretary-General of China‟s National Development and Reform Commission. but now increasingly in the countryside too – for non-staple foods. th Commodity security. not impossible that the 23 July train disaster will be looked back upon in due course as a benchmark moment in accelerating China‟s socio-political evolution.Nomura | Asia Special Report November 2011 That is not to contradict our earlier suggestion that the “Arab Spring” was unlikely to spread to China: indeed.e. commodity security will. as Yang Weimin was suggesting. requires commodity security in general and energy security in particular. the most recent food insecurity report of the Food and Agriculture Organisation (FAO). both energy and food/water security bear strongly on yet another dimension – that of environmental security. Coupled with its target of 95% self-sufficiency. loss of land to urbanisation is only part of the story. military. However. in our view. the rate of desertification nationwide is currently running at (an admittedly significantly slower rate than was the case a decade ago) a 250. Underpinning this was the recognition that China‟s quest for “comprehensive national power” (i. As the fifth generation prepares to take power.2%). exchange rate and even defence. there is also the added dimension of food – and therefore water – security. largely due to human activities. political. stands to influence a raft of policy areas including agriculture. Second. Grain security should be given priority. in turn. for the period 2005-07. including food and water. Newton and Subbaraman (2002) noted that energy security would be a top foreign policy priority for China in the following decade. It is. therefore. Based on the experience of Japan. in our view. Critically. However. Furthermore. Furthermore.e.3mn hectares of arable land lost to urbanisation since 1999 (i. technological. achieving this goal is being jeopardised by urbanisation. this suggests that China will need to produce at least 580mn tons of grain pa by 2020 (from 546mn tons in 2010).5%) and rice (1. even though it is one of the few countries on track to meet its Millennium Development Goal target of halving hunger by 2015.5% pa) – the key crop for the biofuel industry (as well as animal feed) – has been significantly faster than is the case for wheat (2. noted that around 10% of China‟s population was affected by undernourishment. First. in contrast to the early 1980s when food production was rooted in the subsistence level. Reflecting at least some of these challenges and speaking at a forum on urbanisation in March 2011. with 8.

promises: A „breakthrough‟ in land reform? Or a damp squib?” The Economist. natural disasters continue to threaten steady progress. However. as The Economist concedes. 45 “Promises. When an estimated 20mn workers were laid off in early 2009 as a result of the global financial crisis. As The Economist put it in an article published shortly after the Central Committee‟s announcement: Chinese academics have long argued that a freer and better-regulated rural property market is essential if peasants are to enjoy more of the fruits of growth. Thus. where leases are restricted to a maximum of 30 years. Currently. One obstacle is ideological… 46 many in the party still regard collectivism as a sacred principle. They say it would encourage the consolidation of tiny. restricting the ability of farmers to detach themselves from their land also protects a valuable social safety net. 46 “Where do you live?”. many were able to return to their family farms maintained by their relatives. Jiangsu and Shandong (four provinces which accounted for almost two-thirds of total wheat output in 2009). too much in the land from rice to corn may therefore prove to be increasingly difficult unless China is prepared to import an increasing proportion of its rice. pose a continuing threat to productivity 52 . Land reform could boost productivity but remains politically challenging… …and could threaten social stability Natural disasters. 16 October 2008. we see little prospect of real progress on land reform unless. Academics also think that a proper land market would protect farmers from indiscriminate land grabs by local officials who often take collective ownership to mean 45 control by themselves. or until. an alternative social safety net is in place. some hoped that the party had come to see land ownership as the key to modernizing and collectivizing agriculture. as The Economist reports in an article on urbanisation published in mid-2011: Thorough going land reform. Henan. the People‟s Bank of China opined that: The agricultural sector is still a weak link in the national economy facing a lot of problems and challenges… agricultural infrastructure is relatively backward. and the land-output ratio. especially drought. Such periodic droughts compound the underlying problems caused by uneven distribution of water supply nationwide – in very simple terms. inefficient plots of land leased to farmers by collectives and allow peasants to cash in on their land‟s market value.Nomura | Asia Special Report November 2011 Land reform – A boost to productivity but politically challenging In its report on monetary policy in the first quarter of 2011. despite the potential boon it would offer to agricultural productivity. the CCP‟s Central Committee promised “a new upsurge” in rural reform. However. When in October 2008. although all land is state-/collectively-owned. China could conceivably boost production consistent with achieving 95% self-sufficiency for some years to come. resource utilization ratio and labour productivity are still low… It is becoming increasingly difficult to guarantee national food security and to supply the major agricultural products. underlined by this year‟s severe drought in Hebei. enabling them to use the capital to go into business in the cities. especially given the impressive record of the Ministry of Agriculture in both policy formulation and R&D. The Economist. of the sort that would… encourage larger-scale farming… remains stuck. thereby significantly reducing the risk of unrest on the city streets. there is a vibrant market in (relatively long lease) urban land which contrasts starkly with the tepid market in rural land. mortgages are not permitted and selling land usage rights is very difficult. Nature will play its part Even so. Furthermore. 23 June 2011.

a fact which is fully recognised by the leadership – notably. China accounts for 13 of the world‟s 20 most polluted cities (admittedly down from 19 out of 23 in 2001). China needs to continue to increase energy efficiency and lift the share of low-carbon technologies.5mn tons in 2004 due to drought (Figure 45). 10m tons -15 -20 Aug-99 Aug-01 Aug-03 Aug-05 Aug-07 Aug-09 Aug-11 Source: CEIC and Nomura Global Economics Balancing priorities In 2008. m tons Coal. it remains on target to overtake the US as the world‟s largest consumer of energy within the next few years – and is already the world‟s largest emitter of carbon (in volume terms. a major cotton and wheat producing area where both surface and ground water is being depleted to dangerous levels.2% pa and the average energy intensity remains around current levels for the next 25 years. However. 10m tons Cereals. China already has the world‟s largest installed wind energy capacity. enhanced public transport. Evidence from China itself over the past five years underlines that this is not merely rhetoric. The efficiency of water use has increased. The practical implications of this can be illustrated by the fact that China went from being a net exporter of 1. and most targets are on track. According to a study by the World Bank (2008). as long ago as 2006 President Hu Jintao proposed a “new energy security concept” at the G8+5 summit in St Petersburg noting the need for “sustainable development of human society”.Nomura | Asia Special Report November 2011 south (which is prone to flooding. China consumed 43% of the world‟s coal (meeting 70% of its energy demands) and 10% of its oil.9mn tons of wheat in 2003 to a net importer of 6. compact city design. According to the World Bank. In response. yet how successful China is in meeting these challenges is of tremendous importance both domestically and globally. Sustaining economic growth without compromising the environment requires leapfrogging to a low-carbon urbanisation model which focuses on clean energy supply. but not by enough to achieve the targeted 20% reduction over 2006-10. m tons Copper. forest cover is expanding and the long-standing uptrend of both SO2 and CO2 emissions has finally started to reverse. Fig. green buildings and clean vehicles. water pollution and food standards) as the biggest single cause of civil unrest throughout the past decade. immense environmental challenges remain. if China‟s economy grows by 7. as experienced by other large economies during their early Balancing growth and environmental security poses major challenges… … as China‟s leaders have been quick to recognize in concrete policy measures 53 . although the incidence of drought is also increasing in some parts) and too little in the North China Plain in particular. this also matters in terms of social stability. Since anecdotal evidence consistently points to environmental issues (which include air quality. with rapid economic growth. 10m tons Soybean. it is far from being the largest). but if measured per head of population. Energy efficiency (the amount of energy per unit of output) has been improving. 45: China’s net imports of certain commodities in volume terms Tons 25 20 15 10 5 0 -5 -10 Crude petroleum. Good progress has been made toward a more resourceefficient and environmentally friendly economy.

If the 95% self-sufficiency target does indeed prove increasingly unattainable.750 million tonnes of coal equivalent by 2030 – about 87% of the world‟s 47 energy demand today. China's engagement in international grain markets will increase. been a net exporter of corn. one has to be concerned about the possibility that. 54 . Accurate data on the scale of such investments are hard to come by. See Land grab or development opportunity? Agricultural investment and international land deals in Africa.05 million between 2003 and 2009). Entering international markets China‟s impact on “hard” commodity markets over the past decade. in his recent book Water: Asia‟s New Battleground. resource security has been a major source of conflict – and it is one to which we are certainly not immune today. which has been described by UN Secretary General Ban Ki-moon as the first climate change war of the 21st century.4 million tons to a mere 0. Brahma Chellaney (2011) notes that China and India between them account for 37% of the world‟s population but command only 10. As this target is abandoned. subSaharan Africa. a similarly dramatic impact on international trade in food – and global food prices – over the course of the next decade 48 cannot. In an essay published earlier this year. 48 A second and related trend is China‟s purchasing and leasing of large tracts of farmland in. which has previously never wavered in its pursuit of basic food self-sufficiency. Accelerating demand for corn for both feed and biofuel is almost certain to outstrip domestic output growth in the coming years. by Lorenzo Cotula. thereby forcing China to resort to purchases from overseas – especially from Latin America and the United States – as a permanent feature of its agricultural trade. Without wishing to dismiss the importance of the conflict in the Darfur region of Sudan. a key source for all the countries in an arc from Afghanistan to Vietnam). Rebeca Leonard and James Keeley (IIED/FAO/IFAD. This will prove to be a watershed for China. Robert F. often violent. exacerbated by climate change. It is true that since 1996 China has. in our view. Furthermore. then by 2030 China is expected to import 75% of its oil and half of its gas.Nomura | Asia Special Report November 2011 stage of industrialisation. But it is striking that the scale of such exports has contracted dramatically (from 16. Historically. water could indeed be the cause of a literal battleground between Asia‟s two emerging superpowers in the not too distant future. especially energy. It may also prove to be a watershed for international food security through the impact on world cereal prices and supplies of China's emergence as a significant player in world cereal markets… However. much of India‟s water comes from the (China-controlled) Tibetan plateau (which is.8% of its water resources. China‟s energy consumption would reach around 12. be ruled out. A decline in self-sufficiency could have a dramatic impact on global food prices Resource security and conflict Throughout history. Peter Gleick (2008) st identified over 50 occasions since the start of the 21 century where water had been an issue in some form of. conflict ranging from Afghanistan to Yemen. Sonja Vermeulen. the cereal whose imports are likely to rise most sharply is corn. Ash concluded: The Chinese government will find it increasingly difficult to continue to fulfil its long-held target of maintaining 95% self-sufficiency in the provision of basic foodstuffs. 2009). both climate change and resource security have caused violent conflict… 47 The World Bank (2011a) estimates that if business as usual continues with respect to China‟s economic growth and energy efficiency. is well documented. in fact. in particular.5mn hectares of farmland had been allocated to foreign-owned entities in the five-year period since 2004 in just five African countries which the study considered. remarkably. Notably. Combined with the gender imbalance common to India and China. the impact of climate change on already stressed and/or disputed water resources may pose even bigger challenges for the international community as a whole in the foreseeable future. but a 2009 study prepared on behalf of the FAO and the UN estimated that nearly 2.

Ronald Findlay and Kevin O‟Rourke (2008) in their book Power and Plenty note a close correlation historically between the end of hegemon and rising protectionist pressures. at best. 55 .Nomura | Asia Special Report November 2011 Not that the definition of “conflict” should be restricted to acts of violence and/or war. which could encourage the House of Representatives to follow through on the Senate‟s recent action to pursue punishment of China over its alleged currency manipulation – and especially if US unemployment remains sticky. tenuous in our view. the recent passage through the US Senate of the Brown-Schumer bill seeking to punish China for its alleged “currency manipulation” clearly highlights the risk that history will 49 repeat itself. … as well as rising protectionist pressures 49 US presidential and congressional elections on 6 November 2012. While the economic justification – including any possible link to competition for resources – to rising protectionist pressures in the US is.

Global macro perspectives  Growth expectations: Naturally. Countries like Germany.  Naïve modelling suggests the following hierarchy for returns: EM equities (in USD terms) and commodities underperform the most. The USD index does well (and our C10 index correspondingly badly). which have at the aggregate growth level benefited the most from China's capital spending cycle. but business-model risk as investors question the post-crisis policy and supply chain environment. the Gulf. US high yield and EMBIG bond returns are similar to each other. are most at risk of a substantial fall in growth expectations. The persistence of some of the causes – true change may be required on a number of fronts. but expect more central bank balance sheet expansion.. and Regional credit strategy The key conclusions for strategy from the economic discussion are:     The size of the growth decline – a true growth recession. parts of sub-Sahara Africa.  Policy response – limited ammunition. a faster impact will be felt through lower “consumer” commodity prices – i. The ineffectiveness of policy – no rapid recovery. leading to markets pricing in medium-term disinflationary pressures. Countries like Hong Kong. Canada.e. oil.  Risk and uncertainty premia increase – not just business-cycle risk. but are both outperformed by IG.  Current account and government deficits deteriorate – implications for the EU bailout.  Inflation expectations: While measures of economic slack would increase as Chinese demand slows. Mongolia and others would be liable to terms-of-trade and volume shocks as commodity markets re-think the demand/supply picture and re-price accordingly. and implied vol as proxied by the VIX rises. Rates markets offer a safe haven. 56 . Sweden and Japan. Russia. Sectors ranging from aerospace through elevators via shipping would be in the front line.Nomura | Asia Special Report November 2011 Pricing a China hard landing – Strategy perspectives We discuss market implications of the economic scenario laid out above from the perspectives of:       Global macro strategy Global equity strategy Regional FX strategy Regional equity strategy Regional equity sector by sector and country by country implications. Australia. LatAm. Singapore and the Netherlands would be marked down from the impact of lower global trade volumes. and by extension food prices. the initial impact in terms of market pricing will be a rapid reassessment of the growth outlook for those economies and global sectors most linked to China's investment cycle. The nature of the growth slowdown – capex-led and balance-sheet constrained. G7 stocks are half as bad. and the potential for inventory dumping into the EU and US.

Asia ex-Japan FX perspectives  In a hard landing scenario. depreciation is unlikely for a number of reasons: domestic capital flight.Nomura | Asia Special Report November 2011 Global equity market perspectives  Chinese stocks have already underperformed and de-rated markedly. whose investment grade ratings have been underpinned by government support. we believe the four key areas of focus would be the impact on the sovereign and its ratings.  For earnings vulnerability. Asia ex-Japan credit perspectives  From a credit perspective. materials and industrials sectors having the most linkage. operational gearing is our guide.  In terms of valuations it is worth noting that the equity risk premium for Asia ex-Japan stocks and a high China CDS spread suggests investors are already discounting an extraordinary degree or risk.  If a hard landing is taken as a globally important systemic event. Malaysia and Australia at the higher end and Thailand. the worst balance of payments profiles. TWD). Asia ex-Japan equity perspectives  The hard landing scenario would undercut earnings expectations and dramatically up-end investor confidence across the entire Asia region. European markets are the most sensitive of the developed regions. particular markets would still be quite vulnerable. undermining their efforts to internationalize CNY.  While Japanese stocks are not highly correlated to developments in China. construction companies. Philippines and Vietnam at the lower. and lastly the Chinese SOE space. banks and property companies. Classically defensive sectors such as utilities. Nevertheless. and of being provocative towards the US. the most vulnerable currencies are unlikely to be those with the greatest fundamental linkages with China (e.  However. We also run through each key regional equity market and sector risks on separate pages. Hong Kong and Australia display a high beta to China equity risk. and the least central bank market power. China itself. 57 . staples and telcos show the weakest betas.  We would expect a significant underperformance of the highly levered SOEs. Korea. with energy. mining). of which Singapore ranks least vulnerable and India most vulnerable on our analysis. but those with inferior balance sheets. with India.g.  Sector correlations with China are higher than country correlations. whereas Japan would offer a relative regional safe haven.  Given the particular capital spending nature of the China scenario. Indonesia.  Despite this. one would naturally also consider capital equipment names. the banks and the availability of credit with implications for the HY property sector and industrials. USD/CNY change is likely to be put on hold as Chinese policymakers seek to avoid a tightening of monetary conditions. global equity markets would be at risk and we highlight consumer goods and commodity producing sectors (in particular. being perceived as „exporting‟ their domestic economic strife (China draws great credit from the fact that CNY was stable during both Asian and global financial crises).

Nomura | Asia Special Report November 2011  Chinese HY industrials would likely underperform the large cap HY property credits.  The Hong Kong banks that have extended their balance sheets to Chinese banks and SOEs would likely be dragged to wider spread levels once again. though we believe some of these issues could be unfairly penalized. 58 . impacted by significantly weaker earnings and credit profiles.  Expect significantly more scrutiny over the default risk of the smaller cap property credits.

Given the inherent uncertainty around the timing and extent of our scenario. Countries with relatively small manufacturing sectors as a ratio of GDP and employment would be affected at the aggregate headline level commensurately less. disentangling the effects of the euro area‟s crisis from market performance is non-trivial. Countries like Hong Kong.gaynor@nomura. Moreover. it is not clear what conventional demand management policy actions major Western economies could take. The key conclusions for strategy from the economic discussion are:  The size of the growth decline – a true growth recession. since fiscal policy would appear to be unavailable and monetary policy is now almost Kevin Gaynor +44 (0) 20 710 27800 kevin.matsuzawa@nomura. we would argue that our scenario is substantially more challenging than the one generally set out to explain recent market moves and that market participants have not fully thought through the implications of a persistent hard landing for non-Asian assets. Russia. Sweden and Japan. new. are most at risk of a substantial fall in growth expectations. individually. some downside skew has been attached to China-linked assets since the risks we highlight are not. Mongolia and others would be liable to terms-of-trade and volume shocks as commodity markets re-think the demand/supply picture and re-price accordingly. the initial impact in terms of market pricing will be a rapid reassessment of the growth outlook for those economies and global sectors most linked to China's investment cycle. Naturally. Sectors ranging from aerospace through elevators via shipping would be in the front line. specific trade recommendations are not sensible at this stage. Moreover.com Martin Whetton +61 (2) 8062 8611 martin. However. in particular from China.  The nature of the growth slowdown – capex-led and balance-sheet constrained. which have at the aggregate growth level benefited the most from China's capital spending cycle. A more serious impact on risk assets would occur as medium-term growth expectations are marked down.Nomura | Asia Special Report November 2011 Global macro perspectives It might be argued that the economic and policy scenario set out above has to some extent already been priced into markets related to Chinese growth and balance sheet health. Australia. timing and extent of the risk evolves. parts of sub-Sahara Africa. markets would look immediately to the policy response globally and from China.whetton@nomura. Growth Naturally. Singapore and the Netherlands would be marked down from the impact of lower global trade volumes.com 59 . LatAm. Instead we believe it appropriate to the tackle the issue from a largely top-down perspective. Canada. After the initial impact on these countries and sectors. The scenario laid out here suggests that while there would indeed be a policy response in China it is unlikely to have a rapid or large positive impact on growth.com Naka Matsuzawa +81 3 6703 3864 naka. Global growth estimates would be reduced. following up with specific trade ideas on a regional and assetclass basis as the nature. but we would argue the timing of this increased hard landing risk comes at a particularly difficult time for global activity – weaker than "normal" post-crisis domestic demand growth in the West makes for a higher-thannormal sensitivity to global manufacturing demand. and in some ways Europe‟s impasse may be masking and diverting market concerns about China. From this perspective we can bunch the issues under four different exposure headings: 1.  The persistence of some of the causes – true change may be required on a number of fronts.  The ineffectiveness of policy – no rapid recovery. the Gulf. but even they – for example the US – have seen important improvements in growth from global infrastructure growth. But there is much to think about even at a high level. Countries like Germany.

in any event. 46: OECD measures of economic slack 10 8 6 4 2 0 -2 -4 -6 1Q90 1Q93 1Q96 Unemployment Rate (%) Output Gap (%) 1Q99 1Q02 1Q05 1Q08 1Q11 Source: Nomura. would require a slower pace of reserve accumulation. Thus.Nomura | Asia Special Report November 2011 wholly reliant on the vague benefits of QE-style balance sheet expansion. Balance sheets Which brings us on to balance sheet considerations. Fig. Slower growth in the OECD would naturally imply higher unemployment. oil. adding to global imbalances rather than helping to close them. At the same time. 2. Nevertheless. 60 .. and the potential for inventory dumping into the EU and US. which could prove crucial to funding of Western government deficits in capital account deficit economies. This would no doubt increase investor concern about protectionist measures and tariff increases. as our scenario suggests. slower profit growth and lower income and consumption tax revenues The result would be forecasts of larger government deficits at the same time as smaller trade surpluses.e. Countries that have already undertaken substantial fiscal tightening would see headline deficit improvement stall or even reverse. the timing really could not be much worse. 3. While this softens the growth blow for Western consumers it is only temporary and it squeezes some corporate margins. to fall across developed markets initially from the fall in global traded goods and commodity prices. or larger trade deficits. What is more difficult to gauge is the medium-term impact on supply chains from a China shock of this scale and duration. we should probably expect capital outflows from China by both domestic and foreign investors. To keep the currency peg intact. While measures of economic slack would increase as Chinese demand slows.and medium-term Western growth forecasts. the multiplier effects of a China hard landing could be bigger than one may initially think for short. If this is a 2012 story. This happened during the Asian currency crisis and led to quite rapid durable goods price declines. thus undermining market confidence in their ability to support further periphery or bank sector needs. Supply chains and inflation A demand shock for China is also a supply shock for the countries it supplies. reserve accumulation globally would be expected to slow. a faster impact would be felt through lower “consumer” commodity prices – i. Investors would naturally fear inventory dumping turning into competitive devaluations across the region in an effort to take a larger share of a slower growing global demand pie. And those taking on responsibility for joint fiscal support in the euro area for example would see their own fiscal accounts deteriorate. leading to markets pricing in medium-term disinflationary pressures. although perhaps by not as much as might be priced in if the trade balance improves. OECD. It would be natural to expect investors to predict an initial increase in China‟s trade surplus in this scenario. We would expect headline CPI inflation expectations. and by extension food prices.

Sweden and Australia. Strategic conclusions Modeling can only get one so far in terms of predicting returns. A very simple VAR (vector auto regression) model of changes in China‟s PMI index. China‟s official data for external USD borrowing has increased quite substantially since the 2008 crisis and most of the increase is short-term debt. UK.Long and medium term 400 350 300 250 200 150 100 50 0 1Q03 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 Source: Datastream. but by no means all. G7 and EM equities. compare and contrast Australian and Canadian government debt. the starting points for debt are substantially different – for example. One could imagine the political complications of a widening US federal deficit during an election year. more central bank activism would be priced in. US IG. Financials would remain a source of pressure in this environment. Combine this backdrop with slower reserve accumulation and one has a perfect set of conditions to drive term risk premia higher on weaker fiscal countries. Without doubt. Clearly the global imbalances that have grown over the past 15 years are contributing and have contributed to domestic imbalances in the US. Naturally. Fig. But in circumstances such as this it can at least give some guidance on what to focus on. especially if another debt ceiling increase had to be passed. One might call this a distinction between business-cycle risk and business-model risk. a commodity index. A China hard landing would raise legitimate questions about what sort of global architecture for trade and currencies will hold after the event.Short term 450 External Debt . this increase in government bond supply expectations would apply equally well to the US. However. 4. US HY.Nomura | Asia Special Report November 2011 Of course. produces results that fit with one‟s priors as to how changes in Chinese growth might influence and feed back on those asset classes. China and the euro area. 47: China external debt (USDbn) 500 External Debt . we would argue. This. Wider credit spreads in investment grade and high yield would seem probable. markets would consider which entities are most exposed to China credit risk from these loans and would price accordingly. By extension. with the result that high risk premia and uncertainty premia should be attached to risky cash flows. will only add to heightened levels of macroeconomic uncertainty already in place. The cumulative six-month 61 . total returns for US Treasuries. Part of this is in the form of trade credits. leading to the belly of curves flattening along with weaker BEIs from lower commodity prices. Risk and uncertainty premia While the growth and inflationary implications of a China hard landing are reasonably clear. Nomura. A hard landing would only increase those risks. the EMBIG index and changes in the VIX index. Canada. the bigger uncertainties will be around future policy regime changes and therefore supply chain risks. one also sees markets price in a higher cost of capital for weaker corporate and financial balance sheet entities.

European credit markets would experience broad-based weakness within a more macro „risk-off‟ environment. 62 .Nomura | Asia Special Report November 2011 change in annual returns (or changes in terms of the VIX index) is shown in Figure 48. or flow of funds change (perhaps offset by QE3?). however. but decent balance sheet health and low refinancing risks generally should help credit to outperform equities in such a scenario. our global fixed income strategists provide the following colour: Government bond curves would flatten as forward monetary policy rate expectations are reduced and BEI expectations fall. or put another way. US high yield and EMBIG bond returns are similar to each other. the hierarchy seems fairly sensible: EM equities (in USD terms) and commodities underperform the most. be felt in the spreads of the more cyclical corporates. but are both outperformed by IG. In any event. whereas the credit metrics of chemical companies. and implied vol as proxied by the VIX rises by 10 points or so. Bunds naturally receive a safe-haven bid. the greatest impact in terms of sectors will. for example. Indirect impacts would be felt by sectors and issuers which have been offsetting the weak recovery in Europe thus far with growth in Emerging Markets. Interestingly. 48: Six-month cumulative response to a 1sd negative shock to Chinese growth 15 10 5 0 -5 -10 -15 -20 -25 -30 -35 VIX USD Index UST Index US IG Index EMBIG US HY MSCI G7 MSCI EM GSCI Index Index Source: Datastream. such as Luxury Goods companies or some of the Chemical companies for example. could be more vulnerable. say. Now. More specifically. Nomura. which would see high yield/leveraged loans underperform Investment Grade corporates and Financials. that we believe is not too controversial. G7 stocks are half as bad. but the effect on spreads could differ markedly depending on a wide range of balance sheet health profiles – luxury goods companies. SEK and NOK bonds. tend to have relatively strong balance sheets which would help absorb some of these pressures from a credit perspective. one should not place too much emphasis on the numerical outcomes of this – it is an extremely naïve and simple model. which in turn would also impact Shipping (a sector already under pressure). especially those directly affected such as Mining and Oil. the effect on equity valuations could still particularly weigh on the more levered issuers and levered products. Fig. a result that we do not put too much emphasis on. the UST index does not do very much. Weaker government markets. Certainly USTs also benefit despite open issues around future funding costs as reserve growth slows. The USD index does well. this provides a starting point to think about positioning for a China hard landing. That said. However. Principal safe havens are JGBs. we believe. may see higher embedded risk premia leading to underperformance relative to the peer group. AUD. but again open issues would be raised about fiscal union and support of peripheral bonds. On a more micro level. our Nomura C10 index would be a sell.

with the Nomura C10 index suffering commensurately. As a result. kinked around the 7yr sector (=JGB futures). confirmation of a slowdown and the follow on effects of this should cause the curve to steepen. USD. Chinese buying of JGBs has been increasing but is still too small to affect the JGB market directly and Japanese bank lending exposure to China is relatively small in their balance sheets. More generally. 63 . we believe any negative effects should be felt more by the equity market. so we would expect the yield curve to bull steepen. After that. banks‟ capacity to buy the long. We would expect AUD to take the first hit and is the most obvious trade. As such. in our opinion.Nomura | Asia Special Report November 2011 The impact on Japan would be felt mostly through the economic channel (a weaker economic outlook and further monetary easing) than the financial channel. JPY and CHF all outperform in the initial phase of a hard landing scenario. Australia offers a particularly popular angle to address this risk.and super-long end of the curve would be hampered by valuation losses on their equity holdings.

9 1. 49: Chinese equity market relative performance* 31 Jul 00 = 100 Chinese stocks have underperformed 800 Ian Scott +44 (0) 20 710 22959 ian. Nomura Strategy research Fig.1 0.3 1.9 0. 33 64 .7 Oct-01 … and an 18% discount compared with global emerging markets Oct-03 Oct-05 Oct-07 Oct-09 Oct-11 *12 month forward PE.1 0. Fig. 51: Chinese market multiple relative to global EMs* Ratio 1.scott@nomura.Nomura | Asia Special Report November 2011 Global equity perspective Before examining a “what if” scenario for global equities in the case of a hard landing in the Chinese economy. As Figure 49 demonstrates. and one has to go back to 2007 to see a period of trend outperformance. Fig.9 1. 32 Compared with other emerging markets. Source: IBES. 31 This underperformance has not been matched by a similarly poor earnings trend so that the market has been heavily de-rated to the point where the discount now being applied to the Chinese market is the largest since late 2005. it is important to first recognise that the market is already attaching a heavy discount to Chinese stocks.5 1. Nomura Strategy research Fig. Fig.9 0. FTSE.3 Oct-01 Oct-03 Oct-05 Oct-07 Oct-09 Oct-11 *12 month forward PE.7 1. FTSE. the Chinese market is also trading on a sizeable 28% discount. Chinese stocks have underperformed the global index by 18% since mid-April 2011.com Robertas Stancikas +44 (0) 20 710 23127 robertas. Source: FTSE.3 1.5 The market trades on a 32% discount to the global market multiple… 0.5 1. Source: IBES.7 0.7 1. Nomura Strategy research Fig.stancikas@nomura. as Figure 51 demonstrates. 50: Chinese market multiple relative to global developed market multiple* Ratio 1.com 700 600 500 400 Chinese stocks have underperformed the world index 300 200 100 0 Oct-01 Oct-03 Oct-05 Oct-07 Oct-09 Oct-11 *Versus FTSE World Developed (US$).

That said. 35 Mining stocks have the most to lose. 52: Global Consumer Goods sector 12M forward PE relative to market The global consumer Ratio 1.6 Oct-90 Oct-93 Oct-96 Oct-99 Oct-02 Oct-05 Oct-08 Oct-11 Source: IBES. FTSE. Nomura Strategy research Fig. Source: Datastream.6 The global consumer goods sector has been re-rated relative to historic norms. those investments are unlikely to prove profitable. Firstly. 34 Elsewhere. commodity producing sectors have been the beneficiaries of strong Chinese demand.4 1.8 0. 53: Relative performance of global oil and mining sectors 31 Dec 99 = 100 280 240 200 Of the commodity producers. Fig. mining companies have shown the highest sensitivity to developments in China 160 120 80 Oct-01 Oct-03 Oct-05 Oil & Gas relative performance Oct-07 Oct-09 Oct-11 Basic Materials relative performance Source: FTSE. Nomura Strategy research. where stocks have been re-rated relative to their historic valuation norms partly as a result of their exposure to China and other fast growing EM economies. there is little doubt that a hard landing in the Chinese economy would have a detrimental impact on them. Fig. 54: Chinese copper import volumes and copper price Tons 80 70 60 50 $/Ton 12000 10000 Copper demand remains relatively strong 8000 6000 4000 40 30 20 10 0 Oct-93 2000 Oct-96 Oct-99 Net imports in tons*(LHS) Oct-02 Oct-05 Oct-08 Copper price per ton (RHS) 0 Oct-11 *Imports of copper ore and concentrate. Here we would highlight Consumer Goods.2 1 0. Mining companies have invested heavily in recent years to expand capacity and if demand from China is not forthcoming. 65 .Nomura | Asia Special Report November 2011 That said. Although the valuations attached to these commodity producers are not as demanding as the global sectors exposed to the consumer. partly as a result of exposure to Chinese growth 1. there are the stocks and sectors with direct exposure.8 1. Fig. recent demand trends in China remain intact (Figure 54). Nomura Strategy research Fig. there is little doubt that a hard landing in China would have far reaching consequences for global equities. in our opinion.

There is little doubt that a hard landing in China would have far reaching consequences for stocks well beyond the country itself. the Japanese market has the lowest historic correlation to Chinese equities. from a regional perspective. Nomura Strategy research Fig. Until recently. so a hard landing would likely have much less impact on the Oil sector than the miners. FTSE.7 0. 56: Relative performance of European stocks exposed to Chinese demand and the relative performance of Chinese equities Index. Nomura Strategy research 66 . the stocks described in Figure 56 also Despite trade on a substantial 24% premium to the wider European market. Fig. Figure 56 shows the relative performance of a group of European companies heavily exposed to Chinese demand.Nomura | Asia Special Report November 2011 In the Oil sector.6 Sep-95 European companies with strong links to China would be especially vulnerable since they trade on a significant premium to the European market Sep-99 Sep-03 Sep-07 Sep-11 * PE for selected European stocks with high exposure to China relative to the European market Source: IBES.4 1. in recent weeks they have become more closely correlated to the news flow from China.6 1. However. Fig.3 1.9 0. typically acting as something of a safe haven. 57: PE relative for Europe’s Chinese exposed stocks* Ratio 1. the poor performance of Chinese stocks had little impact on the relative performance of these China-linked companies. with European stocks the most highly correlated of the developed markets outside Asia to movements in Chinese stock prices. US equities are the next least likely to be impacted.2 1. demand from China remains relative inelastic to movements in the world price. Lastly.1 1 0.5 1. 36 their recent underperformance.8 0. European stocks show the highest sensitivity of any developed market outside Asia 70 50 Oct-07 Oct-08 Oct-09 Asia Exposed European Stocks performance relative to Asia Oct-10 Oct-11 Source: FTSE. Oct 2007 = 100 150 130 110 90 While Japanese stocks are lowly correlated with developments in China. Datastream.

it is worth having a sense of the relative Sino-Asian linkages. The schema gives very different 50 51 As gauged by FX reserves owned as a percent of country‟s GDP. China‟s own political calendar is likely to induce conservatism during 2012.1% 16. Economics aside.gupta@nomura. Second.3% 6. if this view does not prevail.9% 15. and of being seen as provocative toward the US.com Craig Chan +65 6433 6106 craig.1% 5.4% 53. TWD). As the 18th Party Congress in Q4 approaches (the last before the leadership handover).g. CNY depreciation is also unlikely. In the hard-landing scenario. the worst balance of payment profiles. then the probability of China and the US entering a trade conflict clearly increases.1% 312.3% 21. and the 50 least central bank market power .a.8% 15.2% 3.8% 5.0% 15. In the more extreme scenario of a hard-landing. The order is from least vulnerable to the most vulnerable economy. China would be wary of a number of risks: domestic capital flight. Thus.9% 0. there is an argument in Chinese policy circles (albeit we believe a minority one) that a) the USD-CNY FX is macroeconomically unimportant.flint@nomura. those from countries with inferior balance sheets.chan@nomura.com Prateek Gupta +65 6433 6197 prateek.1% -1. both to our call for a „hold on CNY appreciation in the event of slowdown‟. and thus more inured to external pressure.5% 50. can be attributed to economic uncertainty.6% FX reserves and forwards USD bn 234 280 389 131 180 75 303 115 277 % GDP 97. This has certainly been past experience – 2008 most obviously. in the unlikely event that the shock is non-systemic and/or a Chinese hard-landing occurs while G3 prospects are improving. Bloomberg. Indeed.5% 10. but also the slower-than-expected move in early 2011.. Source: CEIC. especially given that the US is entering a tight Presidential race. The ranking is based on the average of the basic balance and FX reserves as a percent of GDP. A Chinese hard landing would likely be of systemic global importance.9% Simon Flint +65 6433 6504 simon. That said.8% 4. but rather. undermining efforts to internationalize the CNY.5% 27.2% 83.com Note: As per the latest data available.1% 3.0% 12. change in USD-CNY would likely be put on hold. and b) the wisest thing to do is placate the US in 2012 so that China can give its full attention to domestic challenges rather than international conflicts. the final point creates the greatest risk. and will probably seek to minimize economic uncertainty.0% 3. in 2012 from about 6% in 2011. 67 . First.0% 35. and of a trade conflict which could affect broader markets. 58: Asian FX vulnerability rankings (least vulnerable at top) 51 Short term external debt USD bn Singapore Hong Kong Taiwan Malaysia Thailand Philippines Korea Indonesia India 731 701 91 29 51 7 150 36 63 % GDP 328. Fig. Nomura. the most vulnerable currencies are not likely to be those with the greatest fundamental linkages to China (e.Nomura | Asia Special Report November 2011 Asia-ex Japan FX perspective Our baseline forecast is for the rate of CNY appreciation to slow to nearly 3% p.1% Basic balance USD bn 80 14 25 26 13 10 4 16 -35 % GDP 32. More importantly. the poor economic performance of its trade partners as well as its domestic challenges will likely act as an inhibitor to change in 2012. Chinese leadership will likely become more sensitive to internal criticism and growth concerns.1% 122. which is illustrated by our ranking in Figure 58.4% 2. being perceived as „exporting‟ their domestic economic strife (China draws great credit from the fact that CNY was stable during both the Asian and global financial crises). China will likely not wish to see any form of „tightening‟ in monetary conditions.

from local government debt issues to funding of micro. indicating that INR (for example) would be least effected. Source: CEIC. which shows Chinese exports/GDP for each Asian country).27%. external demand as a driver of China‟s growth now has less of a boosting effect. Meanwhile. SHIBOR IRS and repo IRS) have all started to invert and price in the potential for rate cuts – for example. 59: Asia rolling 12m exports to China / GDP 20% Latest 15% 2004 10% 5% 0% TW KR MY SG TH PH ID HK IN Note: As per the latest data available. Fig.Nomura | Asia Special Report November 2011 results. the 5yr IRS indexed to the 1yr deposit rate implies an average 1yr deposit rate in five years is 3. whilst TWD would be most vulnerable (see Figure 59. small and medium-sized enterprises (MSME‟s) and the property market. Given a weaker-than-expected recovery and potential downside risk in developed countries. 68 . there are more domestic risks growing as well. China IRS curves (deposit IRS. Nomura.

Nomura | Asia Special Report

November 2011

Implications for Asia regional equities
Given China‘s key role as a demand driver for Asian goods and underwriter of regional current account surpluses – and particularly given investor hopes that Chinese private consumption will ramp-up structurally to help supplant the US consumption growth ―lost‖ due to household balance sheet repair – we would expect a Chinese ‗hard landing‘ scenario to undercut earnings expectations and dramatically upend investor confidence across the entire Asia-Pacific region.
• In assessing earnings vulnerability, Operating Leverage (OL) would be a key

Research analysts:

Michael Kurtz
+852 2252 2182 michael.kurtz@nomura.com

Mixo Das
+852 2252 1424 mixo.das@nomura.com

Yiran Zhong
+852 2252 1413 yiran.zhong@nomura.com

determinant in projecting the degree to which a collapse in top-line revenues would transmit through to bottom-line profits. In the Figure below we rank the Asia-Pacific markets in terms of aggregate OL:
Fig. 1: Asia-Pacific operating leverage and gearing
Asia Pacific India China Malaysia Australia HK Japan Singapore Korea Taiwan Indonesia Thailand Philippines Vietnam Operating Leverage* 3.9 7.1 5.7 4.6 3.8 3.4 3.3 3.1 2.7 2.0 2.0 1.9 1.8 1.3 Net Debt / Equity (%) 39.1 34.0 24.6 28.4 27.0 18.7 54.4 25.5 43.9 12.0 28.0 48.6 34.9 34.7

* Note: Operating leverage calculated as (Revenue - COGS) / (Revenue – COGS - SG&A). Aggregated for all members of the respective MSCI index ex banks/insurance/diversified financials. Source: Bloomberg, Nomura Strategy research

図表 1 • In assessing the scope for damage to valuations, it is useful to keep in mind Fig. 1 ex-Japan Asian stocks are already discounting an extraordinary degree of that

risk, as illustrated by the ‗equity risk premium‘ (i.e. the differential between the consensus 12-month forward earnings yield and the available ―risk-free‖ cost of / opportunity return on capital in the 10-year US Treasury market).
• At currently 8.0%, this compensation for equity risk-bearing is fully 2.5

standard deviations above its long-term mean of 4.3%. While this by no means would alone insulate regional stocks from further volatility, it does suggest the degree to which Chinese structural concerns have already embedded themselves into asset values.
Fig. 2: MSCI Asia ex-Japan: Equity Risk Premium
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
May-01

Equity Risk Prem (%) +1 Std Dev.

LT Avg. -1 Std Dev.

Oct-01

Oct-06

Nov-03

Dec-05

Nov-08

Dec-10

Aug-02

Sep-04

Aug-07

Sep-09

Feb-05 Jul-05

Jun-08

Jan-03

Jun-03

Jan-08

Feb-10 Jul-10

Source: DataStream, Nomura Strategy research

図表 2 Fig. 2

69

May-11

May-06

Mar-02

Mar-07

Oct-11

Apr-04

Apr-09

Nomura | Asia Special Report

November 2011

Similarly, China‘s sovereign credit default swap (CDS) spread, at currently 137bp, stands fully 62bp above its 75bp January 2010-July 2011 average – suggesting China investor perceptions have already grown substantially more cautious.
Fig. 3: China Credit Default Spread
(bps)

210 190
170 150

130 110
90 70

50 Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Source: Bloomberg, Nomura Strategy research

図表 3 • Still, comparing current Asian equity index multiples to trough levels of the Fig. 3 decade does suggests particular markets would still be quite vulnerable past

(Figure below). Because earnings themselves become less reliable in times of greater demand uncertainty, the results below are ranked according to the more tangible Price-to-Book Value measure:
Fig. 4: Asia ex Japan market valuations versus historical trough
PER (since 2001) Current % to Trough 9.9 -21% 11.8 13.4 9.3 12.6 12.1 8.4 13.1 11.5 7.7 12.2 -69% -38% -40% -24% -32% -29% -28% -29% -14% -26% Trough 7.8 3.7 8.4 5.6 9.5 8.2 6.0 9.5 8.2 6.6 9.0 Date of Trough Oct-08 Apr-01 Oct-08 Oct-08 Aug-04 Oct-08 Mar-03 Oct-08 Oct-08 Oct-08 Oct-08 PBV (since 2001) Current % to Trough 1.6 -25% 3.9 2.6 2.0 1.7 2.5 1.3 2.1 1.5 1.5 1.2 -79% -67% -50% -37% -36% -35% -34% -28% -21% -21% Trough 1.2 0.8 0.9 1.0 1.1 1.6 0.8 1.4 1.1 1.2 0.9 Date of Trough Sep-01 May-01 Jan-03 Nov-08 Jan-09 Sep-01 Dec-01 Jun-01 Feb-09 May-03 Feb-09

MSCI Asia ex-Japan Indonesia Philippines Thailand Taiwan India Korea Malaysia Singapore China HK

Source: DataStream, Nomura Strategy research

図表 4 Fig. 4

70

Nomura | Asia Special Report

November 2011

Fig. 5: Asia ex Japan sector valuations versus historical trough
PER (since 2001) Current % to Trough 9.9 -20% 16.9 13.7 21.5 8.8 16.9 12.0 25.2 17.5 9.4 7.7 13.6 12.8 14.4 7.9 12.3 10.8 8.7 15.3 8.9 13.5 11.5 7.5 11.8 11.9 -82% -25% -64% -43% -37% -28% -52% -40% -39% -34% -45% -28% -40% -37% -50% -26% -25% -34% -13% -33% -40% -8% -26% -17% Trough 7.8 3.0 10.2 7.8 5.0 10.6 8.6 12.0 10.4 5.7 5.1 7.5 9.3 8.6 5.0 6.2 8.0 6.5 10.0 7.7 9.1 7.0 6.9 8.7 9.8 Date of Trough Oct-08 Feb-01 Oct-02 Jan-02 Mar-03 Nov-08 Oct-02 Apr-03 May-03 Oct-01 Oct-08 Oct-08 Oct-08 Mar-03 Oct-08 Oct-08 Jul-08 Oct-08 Oct-08 Oct-08 Mar-03 Jun-04 Oct-11 Mar-03 Mar-03 PBV (since 2001) Current % to Trough 1.6 -24% 2.9 3.0 3.3 2.3 6.8 1.7 8.9 3.4 1.3 1.4 2.5 2.7 2.4 1.7 1.2 1.5 1.3 3.3 0.8 1.4 1.8 1.4 2.0 1.8 -88% -77% -76% -67% -63% -61% -53% -51% -50% -46% -46% -46% -42% -37% -37% -35% -35% -35% -31% -29% -29% -23% -12% -3% Trough 1.2 0.4 0.7 0.8 0.8 2.5 0.7 4.2 1.7 0.6 0.8 1.3 1.5 1.4 1.1 0.7 1.0 0.8 2.2 0.5 1.0 1.3 1.0 1.8 1.7 Date of Trough Sep-01 Aug-01 Sep-01 Mar-01 Jan-01 May-03 Sep-01 Jun-04 Jun-02 Sep-01 Sep-01 Jan-01 Aug-01 Apr-03 Jan-01 Sep-01 Jan-09 Oct-02 Apr-09 May-03 Nov-01 Jan-09 Feb-09 Feb-09 Aug-01

Asia ex-Japan Fd/Staples Rtl Cons Svs Health Care Equip & Serv Auto & Compo Software & Services Div Fin Household & Pers Prod Pharmaceuticals Cons Dur/App Materials Retailing Commerical Serv & Supp Fd/Bev/Tob Energy Transpt Tech Hardware & Equip Cap Goods Media Real Estate Utilities Semiconductors Banks Telecom Insurance

Source: DataStream, Nomura Strategy research

図表 5

A look at recent years‘ statistical correlation between Asia-Pac indexes and Fig. 5 H-shares also offers insight into where the risk of equity market contagion China may be greatest. In most cases these correlations also comport with our fundamental sense as to how the real and financial effects of a China rollover would propagate through the rest of the Asia-Pac region.
• Based on US$-denominated weekly returns since 2007, Korea and Indonesia

exhibit the Asia-Pac region‘s two highest-beta relationships with China Hshares. This is interesting given the substantial disparity between these two economies and markets: the former largely a high-value-added manufacturer of capital goods and consumer durables, vs the latter predominantly a provider to China of primary goods such as coal, natural gas, and ore. Yet in both cases, the risks appear justified by China‘s rapidly increasing role in recent years as a key export growth market. Indonesia‘s broader sensitivity to any presumptive downdraft in global energy and commodity prices also places it squarely atop the ‗endangered list‘.
Fig. 6: Asia-Pacific Country Index Correlations w/ China H-shares
vs. HSCEI R^2 0.56 0.52 0.48 0.53 0.74 0.65 0.45 0.50 0.38 0.37 0.46 0.36 Slope 0.80 0.74 0.66 0.63 0.60 0.60 0.60 0.54 0.48 0.42 0.37 0.34

MSCI Korea MSCI Indonesia MSCI India MSCI Australia MSCI Hong Kong MSCI Singapore MSCI Thailand MSCI Taiwan MSCI Philippines MSCI New Zealand MSCI Malaysia MSCI Japan
Source: DataStream, Bloomberg, Nomura Strategy research

図表 6 Fig. 6

71

e. 7 72 . Staples. but Japan‘s domestic consumption-heavy GDP composition may help insulate it from a Chinese demand slowdown. and given prospective relief both on India‘s chronic current account deficit / terms of trade.83 0. lower-beta relationships (i.48 0. H-share returns) are generally found among the classically defensive sectors (e. these seem explainable in terms of direct real-economic (and in Hong Kong‘s case. as well as on its recently problematic inflation front if commodity prices were to recede.38 Energy Material Industrial Financials MSCI Asia ex Japan Consumer Disc IT Telco Consumer Staples Utilities Source: Bloomberg. Of note. • By contrast. Materials and Industrials sectors (at the GICS-1 level) that exhibit the strongest correlations with H-shares. Telcos). • Also noteworthy as a potential comparative safe haven is Japan. positive China-share performance should tend to be associated with outperformance in ‗riskier‘ assets (as seems intuitively logical). 7: Asia-Pacific Sector Correlations w/ China H-shares vs.80 0. Additionally – albeit tragically – the impact of 2011‘s Miyagi earthquake forced markets already to substantially downgrade expectations for Japan. Given China‘s predominant role as a driver of global marginal demand for energy and commodities (as discussed above in the Global context). also financial) linkages between those geographies and China. steady high dividend yielders (primarily among Asia‘s Telcos).48 0.79 0. • Among the riskiest markets in terms of historical return correlations are also Australia and Hong Kong (i.Nomura | Asia Special Report November 2011 • Although India offers the third-highest beta relationship with China over the 2007-11 period. Unlike in India‘s case.79 0. In other words.62 0. given still-modest trade linkages between the two economies. but a China-driven rollover could best be sidestepped within the Asian-regional equity space through exposure in low-cyclical names (Staples.66 0. Fig. Not only do Japanese stocks exhibit the lowest-beta relationship with China H-shares among the Asia-Pac markets. this strikes us more as coincidental (based on generalized BRICs risk tolerance/aversion) than fundamentally driven.82 0.59 Slope 0. Asian equity China correlations are generally stronger at the sector level than the country level (Figure below).g.59 0.63 0.81 0. vs.e.71 0. Nomura Strategy research 図表 7 Fig. we would be inclined to see India as comparatively more resilient in the Asian-regional context to a China rollover. HSCEI R^2 0.72 0. Indeed. the ‗pure‘ Hong Kong ex-China H-shares as found in MSCI HK). and Utilities where softer energy costs would offer the prospect of margin relief. within Asia-Pac it is the Energy.70 0.51 0. Health Care).54 0.75 0. Utilities.

Nomura | Asia Special Report

November 2011

China equities – the risk
Within China specifically, given the predominance of the investment component of GDP, a "China slowdown" scenario would have to equate with a Chinese investment slowdown.
• With this, the sectors most immediately adversely impacted would be those

Research analysts:

Michael Kurtz
+852 2252 2182 michael.kurtz@nomura.com

Mixo Das
+852 2252 1424 mixo.das@nomura.com

tied to China's investment cycle: Commodities and Basic Materials (e.g. Metals & Mining incl. Steel, Cement, etc.) as well as the Capital Equipment names and, possibly, the Construction Companies, depending on whether policymakers saw room to expand infrastructure project spending as a counter-cyclical tool as they did in 2008-10 (which we see as less feasible a second time, as discussed elsewhere).
• A dramatic slowdown in China‘s aggregate growth – alongside the credit

Yiran Zhong
+852 2252 1413 yiran.zhong@nomura.com And the China Research Team

constraints and rising real cost of capital discussed elsewhere – would also undermine the quality of assets in the domestic financial system. This would hurt asset-rich balance sheets, not least in China's large, state-owned Banks; and as such, composition of individual institutions‘ loan books and breakdown of their lending activity would be a key differentiator. By similar token, many Chinese property developers would find themselves under substantial financial stress from a combination of falling property prices and slumping sales volumes.
• The simultaneous cashflow constraints from a weaker Chinese economy along

with higher real cost of capital would make corporate balance sheets a key differentiator generally. We would expect the market to favor lower-geared (or net-cash) companies within any given sector, whereas higher gearing would be discounted. Similarly, companies with imminent capital needs such as near-term debt rollovers or refinancings would be discounted relative to those whose funding were mostly long-term secured.
• Given that one tipping-point for a Chinese growth slowdown would presumably

be ongoing/deepening weakness in the external sector (i.e. global double-dip risks), we would not expect export-driven China names (e.g. Shipping, Ports, Tech, Contract Manufacturing & Logistics) to be particularly defensive. Rather, "traditionally" defensive domestic names in Utilities (including Gas), Telecoms, Health Care/Pharma, and Fertilizer would likely be the outperformers among HK-listed China names.
• One area where Chinese policymakers may find some room to exercise

stimulus different than the largely infrastructure project-driven approach of 2009-10, would be domestic private consumption (for example through targeted credit growth, taxation, wage policy, etc). As such, we are inclined to regard domestic Consumer-sector stocks (both Discretionary and Staple) as comparatively defensive – although already high valuations diminish these attractions somewhat.
• One key litmus test as to the leadership's willingness to empower the domestic

private consumer may be the path of the RMB in any sustained slowdown scenario: Were Chinese policymakers to (unexpectedly) avoid the temptation to fall back on a stable (or weaker) RMB but rather allow appreciation to continue, we believe it would signal a commitment to press ahead with restructuring toward a more domestic/consumption-driven growth mix. Taking the above considerations into effect, we present in the following two Figures a short list of key Chinese names that we would expect to prove respectively more vulnerable and more resilient:

IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks, rather it takes a look at an extreme scenario including recessions in the US and Europe. None of this is in our macro or industry or company forecasts. Detailed assumptions are footnoted. See table in appendix for our current ratings.

73

Nomura | Asia Special Report

November 2011

Fig. 8: MORE VULNERABLE: Chinese companies in most-impacted sectors with high gearing*
TICKER 3323 HK 753 HK 1055 HK 2777 HK 2600 HK 2883 HK 3333 HK 267 HK 2318 HK 2007 HK 1109 HK 2866 HK 939 HK Com pany CHINA NATIONAL BUILDING MA-H AIR CHINA LTD-H CHINA SOUTHERN AIRLINES CO-H GUANGZHOU R&F ALUMINUM CORP OF CHINA LTD-H CHINA OILFIELD SERVICES-H CITIC PACIFIC LTD PING AN INSURANCE GROUP CO-H COUNTRY GARDEN HOLDINGS CO CHINA RESOURCES LAND LTD CHINA SHIPPING CONTAINER-H CHINA CONSTRUCTION BANK Industry Group Building Materials Airlines Airlines Real Estate Mining Oil&Gas Services Iron/Steel Insurance Real Estate Real Estate Transportation Banks HK Market Cap ($m n) 3,237 3,610 1,611 909 2,055 2,476 5,824 6,310 21,721 6,144 7,750 700 167,939 Sales ($m n) Net Debt / Equity 9,837 13,376 12,676 3,641 19,196 2,562 8,677 10,892 34,947 4,480 2,701 5,143 66,470 199 174 150 111 109 92 88 80 77 59 52 11 -

EVERGRANDE REAL ESTATE GROUP Real Estate

*Excludes Level I sectors: Consumer Disc. Staples, Healthcare, Utilities, Telcos; Net D/E > 50% (in most cases) Source: Bloomberg, Nomura Strategy research

図表 8
Fig. 9: MOST RESILIENT: Chinese companies in least-impacted sectors with positive net cash*

Fig. 8

TICKER 1688 HK 700 HK 168 HK 2238 HK 2319 HK 489 HK 941 HK 1880 HK 151 HK

Com pany ALIBABA.COM LTD TENCENT HOLDINGS LTD TSINGTAO BREWERY CO LTD-H CHINA MENGNIU DAIRY CO DONGFENG MOTOR GRP CO LTD-H CHINA MOBILE LTD BELLE INTERNATIONAL HOLDINGS

Industry Group Internet Internet Beverages Food Auto Manufacturers Telecommunications Retail

HK Market Cap ($m n) 6,057 41,823 3,683 2,227 5,692 4,717 197,004 15,733 12,058

Sales ($m n) Net Debt / Equity 925 3,596 3,183 8,843 5,193 18,753 76,294 3,991 2,521 -169 -77 -62 -61 -58 -55 -45 -30 -24

GUANGZHOU AUTOMOBILE GROUP-HAuto Manufacturers

WANT WANT CHINA HOLDINGS LTD Food

*Excludes Level I sectors: Financials, Energy, Industrial, Materials, level II sector: Tech; Net D/E < -20% Source: Bloomberg, Nomura Strategy research

図表 9
IMPORTANT: Our sensitivity analysis does not assess just the impact of a China hard landing on the mentioned stocks, rather it takes Fig. 9 at an extreme scenario including recessions in the US and Europe. None of this is in our macro or industry or company a look forecasts. The extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%; (2) China‘s GDP growth falls to 5%; (3) Substantial commodity price declines by end 2012. Base case and extreme case real GDP growth % assumptions: Australia (4.3, 0.5); China (8.6, 5.0); Hong Kong (4.5, -6.0); India (7.9, 3.0); Indonesia (7.0, 2.5); Malaysia (5.1, -5.8); New Zealand (3.5, 0.8); Philippines (5.7, 0.5); Singapore (5.3, -5.2); South Korea (5.0, -3.0); Taiwan (5.0, -5.0); Thailand (4.7, -3.0).

74

Nomura | Asia Special Report

November 2011

China risk: Australia
Risks to our current overall view
The sensitivity of the Australian equity market to a ―hard landing‖ in China (GDP growth of 5% which means US GDP of -3% and Eurozone of -5%) and a substantial fall in commodity prices would be dramatic, notwithstanding the fall in the equity market we have already seen this year. Such a scenario, should it eventuate, could see Australian GDP growth drop back to around 0.5%, assuming a vigorous policy response and a coincident weakening in the A$, which there would inevitably be.

Research analysts:

Richard Johnson
+612 8062 8412 richard.j.johnson@nomura.com And the Australia Research Team

Key areas of impact if China has a hard landing
One of the hardest hit would be the metals and mining sector, which would be heavily affected by the drop in US$ commodity prices, only partly mitigated by the likelihood of a much weaker A$. The effect of this would also inevitably flow onto volumes as well as demand would dry up, which would see capex programs scaled back or stopped, which would then have a major knock effect on the mining services sector. Sector earnings of the majors would enjoy some relative support from their low positions on the cost curve but all the same sector growth would decline in our view at least as much as commodity prices, with the junior and intermediate sectors in particular very hard hit. Many could disappear. The share prices of the major miners more than halved in the 2008 global financial crisis. Also caught in this web would also be the mining services sector, which would hit the likes of DOW and UGL. BLY would not escape as junior mining activity would slow and exploration spend generally would be scaled back materially. ORI and IPL are resource volume rather than price linked but an extended economic downturn would flow onto volume ultimately in our view and sentiment would inevitably also take a knock. The other key sector in the Australian market is Banks. Given its homogenous nature, our worst case stress scenario sees the major banks with broadly similar downside risks to FY12 earnings (22% - 28%) and share prices (29% - 35%). We assume a significant increase in BDD‘s (175bps to NHL, consistent with the global financial crisis experience) and no margin benefit (unlike the GFC) given a significant slowdown in China will reduce banks‘ ability to re-price margins. In a relative sense, however, we do not expect the banks to materially underperform the broader market under the extreme case scenario, given their strong capital positions, robust balance sheets and strong underlying franchises and market positions. Relative beneficiaries of this scenario may be parts of the Consumer sector, Healthcare, and Telstra has historically been a relative safe haven. Consumer Staples could benefit on a relative basis from an ‗Armageddon‘ scenario impacting global growth, although we note the absolute benefit is likely to be subdued. A lower AUD particularly against USD could result in higher costs of goods sold which might be difficult to pass on to consumers suffering the effects of lower GDP. On a relative basis we believe Coca-Cola Amatil and Woolworths are likely to outperform. Treasury Wine Estates could benefit from better transaction and translation rates, however, the absolute benefit would likely be mitigated by lower sales. Consumer Discretionary could be adversely impacted by slowing sales at the same time as COGS increase.

IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks, rather it takes a look at an extreme scenario including recessions in the US and Europe. None of this is in our macro or industry or company forecasts. Detailed assumptions are footnoted. See table in appendix for our current ratings.

Fig. 10: Potentially most vulnerable and most resilient companies in coverage in the extreme case*
Most vulnerable companies Boart Longyear Bluescope Steel Onesteel Orica Rio Tinto BHP Billiton Ticker BLY AU BSL AU OST AU ORI AU RIO AU BHP AU Industry Drilling equipment and services Steel solutions Steel long products Diversified chemicals Resources Resources Most resilient companies Amcor AGL Energy Coca-Cola Amatil Tabcorp Holdings Telstra Woolworths Ticker AMC AU AGK AU CCL AU TAH AU TLS AU WOW AU Industry Packaging Power and gas Food & beverages Gaming Telecoms Retail

Note: Base case represents our current forecasts and TP * Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%; (2) China‘s GDP growth falls to 5%; (3) Substantial commodity price declines by end 2012. Base case and extreme case real GDP growth % assumptions: Australia (4.3, 0.5); China (8.6, 5.0); Hong Kong (4.5, -6.0); India (7.9, 3.0); Indonesia (7.0, 2.5); Malaysia (5.1, -5.8); New Zealand (3.5, 0.8); Philippines (5.7, 0.5); Singapore (5.3, -5.2); South Korea (5.0, -3.0); Taiwan (5.0, -5.0); Thailand (4.7, -3.0) Source: Nomura estimates

75

New Zealand (3. would accelerate the fall in inflation and rates. combined with a collapse of growth in the US and euro area. but equity prices would have to adjust to a lower growth equilibrium. pharma.911 Although exposure to US is high. -6. -5.0). pharma is a nondiscretionary expense and growth for generics will be fuelled by the patent cliff.750 We assume flat US$ revenue growth in FY13F (led by a pricing cut of 5%). Multiples would also come down. Fig.5 Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. No direct China exposure but would be affected by global commodity fall. (INR) Most affected Tata Motors Ticker TTMT IN TATA Steel TATA IN NA 82. China (8.1. -3. See table in appendix for our current ratings. The market would have to contend with significant downside risk to earnings. growth-oriented and global cyclical sectors such as real estate. despite India‘s high growth and rate differentials.9 653 (11.7 (10.0).4) Crompton Greaves Least affected Dr.0). 11: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share 2011% 16 Base case EPS 2012 29.1 6. Taiwan (5. Reddy‘s CRG IN NA 12.5) 240 8.4 24 ITC ITC IN 0 8. A hard landing in China.0).com Nipun Prem +91 22 4037 5030 nipun. 3. Indonesia (7. Thailand (4. in our view.4 % y-y 7. India‘s WPI basket is largely commodity-driven and we estimate the fall in global commodities would eliminate inflation. Philippines (5. 2. Research analysts: Prabhat Awasthi +91 22 4037 4180 prabhat. steel prices falling by 40% and raw material prices by 60%. Singapore (5. Another overhang on the market has been India‘s high interest rate regime underpinned by high inflation and a high fiscal deficit.02 (45) DRRD IN 1 90.8) (118. Malaysia (5.0) Source: Nomura estimates 76 . 6% base case) price impact 4% vs.100 148.5. and a normalization of the fiscal deficit on the back of lower government subsidies would be key upsides. 137 We assume cigarette volume growth going to 0% (vs. causing sharp declines in EBITDA margins and profitability.prem@nomura.8).0).6) % y-y NA Target price Comments 31 Domestic CV and JLR volumes could come under pressure. a depressed growth outcome we have not seen in India in the two decades post liberalization. Where is potential for upside surprise? A collapse in the commodities complex would be considerably positive for India‘s perpetual twin-deficit problem which. Meanwhile. along with elevated inflation.5).2).awasthi@nomura.3.5). especially when domestic growth could potentially fall more than 4 percentage points to about 3% under the extreme case. 0. 0.21 (15. (2) China‘s GDP growth falls to 5%. 1.0. India (7.76 24 1. An improvement in the current account on the back of lower commodity prices.5. combined with a global growth collapse.3 3. Multiple for cig business down from 23x to 15x. None of this is in our macro or industry or company forecasts. we estimate downside risk to the extent of 20% under the extreme case. 0.2 229 6. Base case and extreme case real GDP growth % assumptions: Australia (4.0 Extreme case* EPS 2012 (11. especially oil (oil imports are more than 30% of total imports). metals.0. Hong Kong (4. utilities and telecoms would be defensive plays. A turnaround in inflation and mitigation of fiscal risk would be a major improvement in the macro backdrop for equities. South Korea (5. high beta.5 28.1 Target price 200. 100 Lower demand as well as intense competition from Chinese players in the power systems segment. defensives like FMCG.7. Detailed assumptions are footnoted. 5.9. rather it takes a look at an extreme scenario including recessions in the US and Europe. 5.1 14. would likely also be accompanied by substantial risk aversion globally. a US$/INR of 48 and no salary hike in FY13F. (3) Substantial commodity price declines by end 2012. P/E multiples down to 12x from 18x. despite a weaker rupee.5). 215 Assumed 65% utilization at European operations. and alleviate concerns on the twin deficits. 1.6.7. base case of 12%. has loomed large as a key overhang for market performance. We do not expect a high-beta market such as India‘s to outperform in this scenario.Nomura | Asia Special Report November 2011 China risk: India Risks to our current overall view We have a constructive view on Indian equities.8). IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.3. -3. -5.1) Infosys INFO IN 1 159.911 81.0.7 16. capital goods and autos would likely underperform.com And the India Research Team Key areas of impact if China has a hard landing A hard landing in China. Sector-wise. underpinned by our expectation of nearterm peaking of inflation and an ensuing turnaround in the rates cycle.

Philippines (5. Malaysia (5. a sharp fall in commodity prices would reduce disposable incomes in rural areas.700 4.000 High operating leverage to coal price. 12: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share 2011% 30 Base case EPS 2012 0. -5.400 16 72.6.8).ie@nomura. Government can boost infrastructure spending given low fiscal deficit of 1. 9.6%).Nomura | Asia Special Report November 2011 China risk: Indonesia Risks to our current overall view Despite the relatively closed economy and no sign of consumption slowdown to date. Indonesia (7.0.000 Demand proven to be relatively inelastic during crisis. None of this is in our macro or industry or company forecasts.com And the Indonesia Research Team Key areas of impact if China has a hard landing Domestic demand. -6. public debt to GDP is at 25% and banking system loans to GDP are less than 30%. Detailed assumptions are footnoted. Any disruption in funding due to a global liquidity crunch would be short term in nature.04 (USD) 275 924 2. -5.850 50 350 425 2.2).500 High operating leverage to coal price plus 43% net gearing.5).013 4.7. 1.8).5).750 Net loss Adaro Energy Harum Energy Astra Agro Astra International Least affected Gudang Garam Telkom Indonesia Jasa Marga ADRO IJ HRUM IJ AALI IJ ASII IJ 19 26 0 0 114 2. (2) China‘s GDP growth falls to 5%.500 (61) (60) (69) 61 11. motorcycles and clothing.0). rather it takes a look at an extreme scenario including recessions in the US and Europe. There is also a risk of China products flooding the Indonesian market at cheaper prices due to oversupply in China and the FTA with Indonesia. 3. (3) Substantial commodity price declines by end 2012. GGRM IJ TLKM IJ JSMR IJ 0 0 0 3.0). 0. 5. New Zealand (3. See table in appendix for our current ratings.3. as in 2008. 0. Expansion would slow and FDI would likely fall or be put on hold.000 2 28.5). Jasa Marga.189 629 376 22 65. Hong Kong (4.9. Policy response is likely to be easing through lowering interest rates (currently 6. Gudang Garam.0). and PGAS. (IDR) Most affected Bumi Ticker BUMI IJ 4. Indosat.000 4 21 8. Net cash.5% and commodity prices collapse.500 Demand proven to be relatively inelastic during crisis. lowering reserve requirements (currently 8% and was as low as 3% during the 2008 crisis). Thailand (4.5.950 2.5% benchmark vs inflation of 4. China (8. Fig. Research analysts: Wilianto Ie +62 21 2991 3341 wilianto.000 High operating leverage to palm oil price. Indonesian companies are low in leverage.000 Demand proven to be relatively inelastic during crisis. Net cash.7%.0). South Korea (5. Credit underwriting would be tightened and this would hurt consumption of large ticket items such as cars and motorcycles. (1) 15 6.550 598 357 Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. -3. especially for discretionary items such as cars. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks. managed intervention in currency and bond markets.0). 5.0) Source: Nomura estimates 77 . A sharp fall in commodity prices could hit coal and plantation earnings hard. 2. India (7.000 (40) 35.000 Automotive sales could drop 30% or more if GDP growth slows to 2.821 % y-y 154 Target price Extreme case* EPS Target 2012 % y-y price Comments N.1. Tariff increase is certain as it is regulated by law.0.5. Capital formation accounts for about one-third of GDP.0.7. Where is potential for upside surprise? Telecom sector could surprise on the upside as people travel less and communicate more through phone or internet. Under the extreme bearish scenario we would look toward staple consumer plays such as Telkom Indonesia. Consumer companies with pricing power and high commodity proportion in COGS would also benefit from easing cost pressure. Base case and extreme case real GDP growth % assumptions: Australia (4. would be hurt. This in turn would hurt demand for discretionary items and lead to slower growth in manufacturing. 0.3. Taiwan (5. 3. (2) 50. -3. Singapore (5.A 750 High operating leverage to coal price plus geared balance sheet (280% net gearing) at high cost of funds. The banking sector LDR is around 83%. 5.

677. 5. -5. Research analysts: James Kim + 852 2252 6203 james. Korean financials would likely face lower asset quality. also we don‘t take account of a China hard landing in our base case scenario. Singapore (5. 23. If a China hard landing scenario materializes a substantial drop in Korean exports would not be avoidable.000 -1.330 na Least affected KT&G Dongbu Insurance SKT KT LGU 033780 KS 005830 KS 017670 KS 030200 KS 032640 KS 3 6. increased loan loss provisions. 0. we expect Korean telcos would be largely insulated from the economic slowdown and domestic-consumption companies such as KT&G would be less vulnerable to the downturn. # Recent currency moves would imply 6. We cannot rule out the same magnitude of impact under the extreme case scenario as a substantial economic downturn tends to come along with capital flight.7. China (8.500 With SME concentrated loan portfolio. medical insurance. 0. weighing sharply on the Korean equity market.0) Source: Nomura estimates 78 .3.000 Korean telcos are largely insulated from the economic slowdown.000 2.5.000 Korean telcos are largely insulated from the economic slowdown. Detailed assumptions are footnoted.00 22.0. assuming a China hard landing and recession in the US and Europe. 65. interest rate cuts. Taiwan (5. 0.561 2.9. and in turn. 13: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share Ticker 2011% 053000 KS 105560 KS 024110 KS 086790 KS 0 0 0 0 Base case Extreme case* Target price Comments 4.000 Korean telcos are largely insulated from the economic slowdown.6. 3. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.000 3. the earnings growth of most Korean companies.0).000 6. -6.5).5. 5.101 793 (1) 178. plunging 42% in 1997 and 41% in 2008.3.380# 0 6.000 Export-oriented Korea‘s power demand is highly sensitive to China and global economic slowdown. when the Korean economy was in or close to recession.194 KEPCO 015760 KS 0 52 na 35.000 702 (9) 54.000 Less sensitive to interest rate cycle and their main product. 6. Under the extreme case scenario. Indonesia (7.492 4. (2) China‘s GDP growth falls to 5%.0). 15 (6) 53. greater impact on asset quality than peers in the case of recession.0. 5.400 Pressure from macro slowdown. as 25% of Korean exports go to China and.000 2. our Korean economist‘s 2012F GDP forecast is expected to be cut from +5% to -3%.828 6.031 (1) 178. Historically. Philippines (5.8).623 (15) 16. -5.4 62. interest rate cuts.5). However. At the same time. -3. 19. is stable in nature.0).8). (KRW) Most affected Woori FG KB FG IBK Hana FG EPS Target EPS 2012 % y-y price 2012 % y-y 2.5).000 793 10 25 0 22.kim@nomura. and hence would likely be affected most. 15. NIM should be more vulnerable due to weak deposit franchise. under the extreme case. Hong Kong (4. rather it takes a look at an extreme scenario including recessions in the US and Europe. severe recession should result in greater provisioning. India (7. Fig. at the same time. -3. any sharp slowdown in the Chinese economy would likely affect the cyclical Korean economy substantially. increased loan loss provisions. the Korean equity market got hit hard.000 617 (70) (61) (76) (52) 13.900 Due to inferior asset quality (high NPL and low coverage ratio). See table in appendix for our current ratings.464 10 66.010 Tobacco demand is relatively inelastic in response to economic cycle. South Korea (5. low loan growth and high provisions.745 12 18. (3) Substantial commodity price declines by end 2012.2). Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. the domestic industry would be hit too as 22% of tourists come from China.Nomura | Asia Special Report November 2011 China risk: South Korea Risks to our current overall view Although we currently remain positive on Korean equities‘ fundamentals and attractive valuations.0.070 (6) 6.com And the Korea Research Team Key areas of impact if China has a hard landing Our current sector recommendation focuses on earnings visibility as we believe developed economies will grow slowly but not fall into a deep recession. Base case and extreme case real GDP growth % assumptions: Australia (4.000 6.47 0 0 15 53.0). None of this is in our macro or industry or company forecasts. 2.0).496 0 0 6.400 Pressure from macro slowdown.1. New Zealand (3. Thailand (4.577 26 71. 70. Malaysia (5.7.

66 0.24 Assuming 2012 credit cost rises to 100bps (base case: 47bps) and OPR cut to 2. but soy lost market share to palm. people are more likely to switch to cheaper oils.147 10 Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. The increasingly realistic prospect of a hard landing would also affect a whole bunch of things: crude oil. Singapore (5.1.5).the public/private sector economy.00 Extreme case* EPS 2012 0. Its three key growth engines . 2.34 0. -5.15 12 4. -3. South Korea (5. However.85 6. If China has a hard landing.16 Assuming 2012 credit cost rises to 90bps (base case: 35bps) and OPR cut to 2. Thailand (4. Indonesia (7. New Zealand (3. India (7.com And the Malaysia Research Team Key areas of impact if China has a hard landing The hardest hit sector would be palm oil.5). In a severe slowdown. all of which could cause CPO prices to move down sharply in the ST either directly or via its substitutes.6. China (8. -5. margins squeezed (from a lower overnight policy rate) and credit cost could rise. futures. We are concerned about the impact on the banks too. None of this is in our macro or industry or company forecasts. For example only 13% of Hong Leong Bank‘s earnings are from China through Bank of Chengdu and 5% of Public Bank‘s earnings are from its Hong Kong listed Public Financial Holdings.5. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.0. Research analysts: Wai Kee Choong +60 3 2027 6893 waikee. 5.80 0.0% 3. 3.7. Malaysia would end up in a vulnerable position.8). Hong Kong (4.3.3.57 % y-y (2) 4 Target price 6. That said. we would see Malaysia‘s GDP growth falling to -5. and in tough times.9. manufacturing exports and commodity resources . Base case and extreme case real GDP growth % assumptions: Australia (4.0).choong@nomura.8% in 2012.30 % y-y (49) (44) Target price Comments 3. PO will always have the cost/yield advantage over soy oil (which the Chinese are also big consumers of and which is far more expensive). -6. 5. and has contributed 17% of the growth in the past decade. In such a world.0).0). 0. Malaysia (5. (2) China‘s GDP growth falls to 5%.8). the direct impact is negligible. Philippines (5. as was seen in 2009 — veg oil consumption growth remained steady.0). (MYR) Most affected Maybank CIMB Least affected Telekom T MK <2 0. 0.0% 4. Taiwan (5.Nomura | Asia Special Report November 2011 China risk: Malaysia Risks to our current overall view Malaysia is the third most open economy in Asia after Hong Kong and Singapore with exports to GDP at 97% as at 2010. The direct impact of any ST disruption could be significant – China is the 3rd-biggest consumer of CPO. Malaysia‘s exports to Europe and the US have been tapering off with China becoming the largest export destination in August.2). (3) Substantial commodity price declines by end 2012. with about a 60:40 split of usage for food and industrial.0) Source: Nomura estimates 79 . primarily from its global business and hence we believe impact should be limited. See table in appendix for our current ratings.5). 0.0). loans growth could contract. 14: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China Earnings share Ticker 2011% MAY MK CIMB MK n/a n/a Base case EPS 2012 0. As part of the diversification strategy. Industry average gross margin (upstream planters) has never dipped below 25% in the past 20 years. currency. Fig. rather it takes a look at an extreme scenario including recessions in the US and Europe.7. Detailed assumptions are footnoted.5.would be in much weaker positions.72 TM‘s exposures to North Asia are under 2%. -3.0.0.

a pullback in demand could affect the property sector. especially for FY2012.7. 1.5c 8.90 29c 3.0.7 24. India (7. 12. The China residential segment accounts for a further 14.5c 3.35 None of SingTel's subsidiaries/ associates have presence in China.30 CMA is the biggest component of CAPL's NAV.35c 4. 5. 0.6% of tourist arrivals in 1H2011 were from China.05 13.1%.5. Thailand (4. China (8. 3.0).0) Source: Nomura estimates 80 . A slowdown in China GDP will have direct impact and spillover effects on projects in SG as well.3.lim@nomura. rather it takes a look at an extreme scenario including recessions in the US and Europe. Detailed assumptions are footnoted. Oilseeds processing and consumer pack segments. the cumulative direct investments into China was S$58b as at end 2009. None of this is in our macro or industry or company forecasts.3. South Korea (5. 0.5 % of its NODX is to China while 10. With Chinese buyers forming an estimated 5-7% of property purchasers in Singapore over the past three quarters.0).0 #7-8% of assets in China. Hong Kong (4.5).0). Malaysia (5.5% by end June 2011. Research analysts: Jitsoon Lim. New Zealand (3. A hard landing scenario in China against the backdrop of a muted macro outlook for the US and EU could push Singapore‘s 2012 GDP growth to minus 5%. (2) China‘s GDP growth falls to 5%. (SGD) Most affected Capitaland % y-y (4. cost of equity edges up to 9.Nomura | Asia Special Report November 2011 China risk: Singapore Risks to our current overall view We remain cautious about the outlook for the Singapore market. Many Singapore companies.3 5. Fig.0.0.5% of which 32. We favor telcos. Base case and extreme case real GDP growth % assumptions: Australia (4.0 35c 12.45 23.5% before quickly rebounding to 92.0). representing 26. CFA +65 6433 6969 jitsoon. Keppel Land.9. listed and unlisted.10 12. 4.8).93c 0.2) Least affected SingTel ST SP 0.7 DBS Bank DBS SP 8# 130c 7.3 3. We continue to recommend a defensive portfolio amidst on-going external risks and further pressure on earnings growth. -3.0 13.5). See table in appendix for our current ratings. Singapore (5.1%).1. -5. We believe that the REIT will hold resilient through a downturn.2 4. 15: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share Ticker 2011% CAPL SP Base case EPS 2012 Target price Extreme case* EPS 2012 Target price Comments 3. Philippines (5. 3.7.5% (from 9.2 16. 28% of assets in Greater China.4% is attributable to China. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.5% of its NAV in China residential projects. Singapore‘s trade with its regional trading partners could also be dampened if they also suffer from a China slowdown. conglomerates and REITs.40 Volumes could decelerate mainly in Palm & laurics. Sustainable ROE reduced to 10% (from 11%). China is important for Singapore as 9.8).com And the Singapore Research Team Key areas of impact if China has a hard landing Singapore‘s exports to China would likely be negatively affected The services sector could be impacted if Chinese tourist arrivals slow down sharply.5c (34.5).90 19.7) % y-y (19.0 23.00c (16. Taiwan (5.21 KPLD has 32.53c (1.3) 25. Indonesia (7.8% and are reviewing our 2012 number with a downward bias. 2.7) Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%.1) Wilmar WIL SP 52. Losses by Singapore companies in China may have a dampening effect on Singapore. (3) Substantial commodity price declines by end 2012. Loan growth could decelerate to 2% (from 12%) and credit charges rise to 100bps (from 45bps). -3. -5.5.2).50c (3. According to official statistics. PE multiples may contract. Its STB portfolio was fully occupied through the financial crisis whilst its MTB portfolio reached a low of 90.0). 5. have operations in China. 3.3) A-REIT AREIT SP 0.6. We expect the impact of 'worst case' GDP growths of countries where it is present on the subscribers' wallets to result in <1% decline in SingTel's consolidated revenue. In addition to the direct effects.7 2.4 85. -6. We recently downgraded our 2011 GDP forecast to 4. Companies who have direct exposure in China that could be negatively affected include Wilmar. 0.00c Keppel Land KPLD SP 40.94 Minimal exposure to China. Capitaland and DBS Bank.0 15.

5.5 14. rather it takes a look at an extreme scenario including recessions in the US and Europe.5. -5.5 Significant earnings exposure to China. New Zealand (3. Where is potential for upside surprise? With Presidential elections on January 14 2012.7 Govt may support domestic consumption. Asia Cement.0. as Taiwan‘s developers have mostly de-leveraged since the Lehman crisis and face little pressure of inventory liquidation in a low interest rate environment.0.8). Lastly. We note that the negative beta could be higher in the handset foodchains (China equals 25%+ of global demand). (TWD) Most affected Asia Cement Synnex AirTAC Least affected Taiwan Mobile President Chain Store Ticker 1102 TT 2347 TT 1590 TT 3045 TT 2912 TT Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. -3.0 205.0 93. China (8.0) (25. as China now accounts for 20% of global tech end consumption.60 % y-y (30. (3) Substantial commodity price declines by end 2012.28 6.9.0).0) 31.8).0) (6. Gourmet Master). th IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks. the KMT-led government will likely react promptly and aggressively to boost the domestic economy.3 Target price 34.5).58 5.2).3.0) Source: Nomura estimates 81 .0) (20.6.e.wang@nomura. See table in appendix for our current ratings. Thailand (4.27 4. corporate Taiwan is normally debt-averse.5 19.21 3.Nomura | Asia Special Report November 2011 China risk: Taiwan Risks to our current overall view Any hard landing in China would be rapidly transmitted into Taiwan through multiple channels. Detailed assumptions are footnoted. 5.0 Extreme case* EPS 2012 2. with little contingent liability from stable banking system. Hong Kong (4. Last but not least.0).. More importantly.5). Research analysts: Jesse Wang +886 2 2176 9977 jesse.com And the Taiwan Research Team Key areas of impact if China has a hard landing Earnings downgrades would soon unfold from the tech sector. 240. That said.7. 192.3. Fig. We estimated that Taiwan‘s four major government funds have maximum capacity of TWD1. despite historically-high dividend payouts. -6.5. 0. if needed.2tn to engage in the share purchase program to support the Taiex. Taiwan government also has well-reserved fiscal strength to launch countercyclical infrastructure investments. Taiwan Cement. 2. followed by PCs and TVs (20%+) and NBs (15%+).53 7. given Taiwanese banks have not started commercial operations in China. 0. On the other hand. Chinese liquidity is little involved in Taiwan‘s property market while Chinese tourists contribute to only low-single digits of Taiwan‘s retail sales.0. which normally derive over 50% of revenue from China.0 300.85 5. 0.0 Significant earnings exposure to China. would also be significantly affected on the downside. (2) China‘s GDP growth falls to 5%. Firstly.0).0 8.5).0) (4. 76. Base case and extreme case real GDP growth % assumptions: Australia (4. thanks to the government policy of the intended economic isolation from the mainland during 1996-2008.5 Significant earnings exposure to China. taking advantage of its majority in the Legislative Yuan.60 % y-y (10.08 7. Taiwan Glass.0) Target price Comments 22.6 90. India (7. None of this is in our macro or industry or company forecasts. we would expect Taiwan‘s property prices to experience a healthy correction of 10% on average. The NPL influx should likely be manageable. China has yet to become a significant factor in Taiwan‘s domestic economy. 16: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share 2011% 45 60 86 0 4 Base case EPS 2012 2.0). Taiwan (5. Airtac. Secondly. and are thus little directly exposed to corporate China. we expect Taiwan to consider a repeat of the issuance of shopping coupons to boost domestic consumption. Cheng Hsin Rubber. Taiwan‘s banks now command the best balance sheet quality in decades. selective non-tech plays (i.80 11. 3. -5. South Korea (5. -3. Indonesia (7.1. Philippines (5. Singapore (5.0).7. Still. we see low risk of a domestic financial crisis. 89. Malaysia (5. with strong balance sheets.3 Diversified revenue stream.

5).5 30 6. Singapore (5.9. Indonesia (7.3 539bps credit cost hike to 5. Malaysia (5.0 (7.73) (0.7 13.1 19.2). -3.7 4-5% of assets in China.8 11.0).7. (2) China‘s GDP growth falls to 5%. -6.31) (0.3.0 Domestic. New Zealand (3.7 515. -5.828 14.63 416. Our back-ofthe-envelope calculations are tabulated below: Research analysts: The Asia Banks Team IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.61% 1.09) 617 (113) (112) (102) (70) 3.2 6.6%. See table in appendix for our current ratings.0 9.700 4. obviously – see us turn very cautious. 0. EPS 2012 % y-y Target price Extreme case* EPS 2012 % y-y Target price Comments Least affected CBA (AUD) WBC (AUD) NAB (AUD) BCA (IDR) Danamon (IDR) BRI (IDR) UOB (SGD) CBA AU WBC AU NAB AU BBCA IJ BDMN IJ BBRI IJ UOB SP 4.900 110bps higher credit cost to 3. Detailed assumptions are footnoted.3 Domestic. India (7.3. Base case and extreme case real GDP growth % assumptions: Australia (4.91 23.1.3 2.0).) A hard landing in China.0.4 5. 120.52 4.72 Our worst case estimates incorporate i) a significant increase in BDD‘s (175bps to NHL which is consistent with the GFC experience) and 17.6 7.5.51) (179. (We are Neutral in Australia where the drivers are different and bearish in Malaysia on valuations.78) (0. South Korea (5.5% 6. Loan growth could decelerate to 6% (from 12%) and credit charges rise to 65bps (from 44bps). -5.7 6. Sustainable ROE reduced to 16% (from 17%) while cost of equity remains at 10.000 (1.0).69 2. would – subject to valuation.3 135. direct linkage to capital-intensive and exportoriented industries and still fresh memories of the credit crunch in 2008-09.78) (0.76 0.2 440.05 322.6. Sustainable ROE reduced to 15% (from 16%) while cost of equity remains at 11.35 10 18.9) Krung Thai Bank (THB) KTB TB 2. rising credit costs. 5. -5. 0.54% 2. 20. Sustainable ROE reduced to 12% (from 13%) while cost of equity remains at 9.95% 2.02% 3.02 6. rather it takes a look at an extreme scenario including recessions in the US and Europe.71) (217. reflecting our house view that emerging markets should weather the macro situation better and would potentially rebound strongly in the event of a short-term shock. 130.2%.4 4.65) (0.5). Thailand (4.91 (as they achieved throughout the crisis) given we expect a significant slowdown in China will reduce 5. Loan growth could decelerate to 8% (from 12%) and credit charges rise to 65bps (from 48bps).4) (5.4 23.8 (11.0) Source: Nomura estimates 82 .5 162c (20) (19.5% 19.33) (0.3) Kasikornbank (THB) KBANK TB 12. severe recession should result in greater provisioning 36.0 Domestic. Loan growth could decelerate to 8% (from 12%) and credit charges rise to 55bps (from 38bps).900 Due to inferior asset quality (high NPL and low coverage ratio).200 banks‘ ability to re-price margins.51) (218.8 53 24. -3.Nomura | Asia Special Report November 2011 China risk: Asia banks Risks to our current overall view The financial sector will naturally be impacted by any seriously negative macro event because of its large market capitalization.9 3.36 1.0). China (8.5).0).900 8.82) (0.28) (150. Taiwan (5. accompanied by possible recessions in the US and Europe.5 7.5%.8 630. None of this is in our macro or industry or company forecasts.21 6% -4% 8% 12% 7. Hong Kong (4.1) (16.2 12.43 2.52 694bps credit cost hike to 7.0.8). especially in markets with high SME participation. 7% of assets in Greater China.55 0. 135bps higher credit cost to 1.69% 18 Weak profitability and thus big swing in earnings 46 Weak profitability and thus big swing in earnings 18 Weak profitability and thus big swing in earnings 4.5 529bps credit cost hike to 5.52 7.0.5 145.88 0.7 351. (3) Substantial commodity price declines by end 2012. Sustainable ROE reduced to 14% (from 15%) while cost of equity remains at 11.5%.49) (0.5 7. 2.400 21.2) (255.6 186c 5.8) (2) (12. Philippines (5.64 2.8% 4.28 599bps credit cost hike to 6. 0. we are on average sitting on bullish recommendations spreads within most markets in Asia.07 27.13 2. 17: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* Base case Ticker Most affected Minsheng (HKD) BOC (HKD) Citic Bank (HKD) CCB (HKD) CRCB (HKD) ICBC (HKD) BEA (HKD) WHB (HKD) DSF (HKD) Woori FG (KRW) 1988 HK 3988 HK 998 HK 939 HK 3618 HK 1398 HK 23 HK 302 HK 440 HK 053000 KS 0.5. Fig.29 18.7) (16.4 we do not prescribe banks with any margin benefit 20.29% 3.51 0. Numbers would have to come down across the board to reflect loan growth concerns and.79 (12. 3. At the moment.0 10.8 527bps credit cost hike to 6.7 589bps credit cost hike to 6.2) Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%.000 100bps higher credit cost to 3.8).33) (177.2 1. Loan growth could decelerate to 5% (from 10%) and credit charges rise to 85bps (from 59bps).9 18.04 15.66 0.7.5 24 84 50 18.5) Siam Commercial Bank (THB) SCB TB 9.

as the table below shows. 29 Main impact likely to be on discretionary COGS.3) HKD31.3 Pork is an essential item in Chinese daily meals.80 Asia/China growth story.3.5. 11. 100 100 3 n. 8.6 USD0.0 Beer.70 40.58 80 1. MPEL has low margin VIP-skewed earnings model.0).72 1. Research analysts: The Asia Consumer Team IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks. Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%.7 66. 0.400 21 19. 18: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share 2011% 8 100 Base case EPS 2012 % y-y 0. Thailand (4. -5.2 Extreme case assumes gaming revenue down 12%y-y in 2012.4 Lower AUD/USD benefits transaction and translation. -3. 3.11 170 CNY1.5 12 An affordable product in the key Australian market.2).60 19.8).0. aided by policy responses that would promote private consumption as we saw in the 2008-09 crisis. Fig.58 6. staples and tobacco.60 European exposure hurts. there could be plenty of relative value in the classic defensives of F&B. -6. 65.m. However.50 1.9.10 23 425 0.45 0.5).7. Hong Kong (4.Nomura | Asia Special Report November 2011 China risk: Asia consumer-related Risks to our current overall view Domestic consumption is generally expected to be resilient in most markets in Asia in the event of any negative macro event.3 HKD33.0 3. Philippines (5.57 6.013 1.0).55 76 1.1.09 0.380# 21 HKD6. Our forecasts would have to come down across the board and we could see significant valuation multiple compression as well. (2) China‘s GDP growth falls to 5%.4 24 21 26.19 0. HKD5.9 Not the most defensive as mainly discretionary foods (snacks).a.0.8 9.3 Assumptions same as Melco.30 27. New Zealand (3. reflecting our house view that emerging markets should weather the macro situation better and would potentially rebound strongly in the event of a short-term shock.5 28.5 Extreme case* EPS 2012 % y-y (0. China (8. India (7.6 1913 HK 32 (Asia) 1. Assumptions same as Melco. Singapore (5. 0.3.0 11. contracted target multiple of 10x across the board.0). which should offset lower demand. Malaysia (5. rather it takes a look at an extreme scenario including recessions in the US and Europe. 7. 13.5. Base case and extreme case real GDP growth % assumptions: Australia (4.0 11. At the other end of the spectrum. highbeta names may see their valuations change more dramatically than their earnings. -5. 11 VIP-centric earnings stream.000 3.30 2. Taiwan (5. Most resilient (earnings change) >90 USD0. Ticker Most vulnerable (earnings change) Esprit (HKD) Melco Crown (USD) 330 HK MPEL US Astra Agro (IDR) Galaxy Entertainment (HKD) Samsonite (HKD) Prada (HKD) Noble (USD) Li & Fung (HKD) SJM Holdings (HKD) Want Want (HKD) Tsingtao Brewery (HKD) Woolworths (AUD) China Mengniu (HKD) Coca-Cola Amatil (AUD) China Yurun (HKD) Huabao International (HKD) KT&G (KRW) Treasury Wine Estates (AUD) AALI IJ 27 HK 1910 HK NOBL SP 494 HK 880 HK 151 HK 168 HK WOW AU 2319 HK CCL AU 1068 HK 336 HK 033780 KS TWE AU 0 100 12 10 6 100 2.0).40 US exposure.23 180 CNY1. South Korea (5. None of this is in our macro or industry or company forecasts.09) (109) (0.97 2.66 0.15 (52) 174 Target price 8.07 0. there would be short-term negative impact on earnings as consumer confidence will likely dip if markets go into a tailspin in anticipation of a hard landing in China.000 High operating leverage to palm oil price.62 0.577 22 1.9) 30 HKD34.034 CNY1.90 17.50 14. -5. # Recent currency moves would imply 6.010 Tobacco.6. Indonesia (7. 20.60 Global supply chain impact.3 30 (8. 5.a.21 2 56 21 24 22. -3.0) Source: Nomura estimates 83 .7 10 37.0.55 0. 0.677.1 13.038 97 n. Detailed assumptions are footnoted. However.7 13. 9.8). (2. (3) Substantial commodity price declines by end 2012.5).5 10.0 Liquid milk is becoming a daily habit for most of the Chinese people. Asia/China growth story.81 (69) (20) (36) (28) (30) (23) (18) 13. 2.0).4 11. 12.9 HKD34.12 0.4 Tobacco. 5. See table in appendix for our current ratings. 3.5). >90 n. CNY1.8 10 26.51 0.07 0.02) (132) Target price Comments 4.7.00 21.

like Mindray (MR US). If China has a hard landing.0. (2) China‘s GDP growth falls to 5%. of which over 760 are class-3A.7 6.7 6. with Australia the most insulated. Indonesia (7. -6.0).94 30% revenues from exports. However.5.2). IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks. Malaysia (5. we expect the market to benefit from the following major policy targets of the NDRC and MOH: 1) the increase of two BMIS coverage ratios to over 90%. and hence in Chinese medical device sales.9. 19: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share 2011% 40 70 0 0 0 Base case EPS 2012 1.7.7% CAGR to more than 166mn over the age of 65 by 2020.80 No exposure to China. rather it takes a look at an extreme scenario including recessions in the US and Europe. -5.0.stanton@nomura.0 (10.8).0 11. (3) Substantial commodity price declines by end 2012.41 0. 3. Reform of the public hospital system is one of the major policy targets of ongoing healthcare reform in China.24 1.0) Source: Nomura estimates 84 . -3.38 0. which should benefit the domestic market leaders at the expense of some smaller manufacturers. would likely face a higher risk of slowdown than other segments as some smaller hospitals with restricted financial positions may delay equipment investment or replacement cycles. the medical equipment manufacturers. 0. 3. Given the increased need for tests and treatments.4 Target price Comments 25.com And the Asia healthcare team Key areas of impact if China has a hard landing Supply-demand and pricing: According to a United Nations forecast. there are over 1. we would see a potential slowing the reform agenda for China. of which about CNY100bn could be used to invest in the expansion of hospitals and basic healthcare institutions in rural areas. Industry evolution/development: Should there be a Chinese hard landing. 0. 5.24 1. We currently forecast as much as CNY60bn could be spent on purchasing of medical equipment in 2011-13.5).com Gideon Lo.59 0.lo@nomura.Nomura | Asia Special Report November 2011 China risk: Asia healthcare Risks to our current overall view Healthcare expenditure was RMD1. Hong Kong (4. 21.0). None of this is in our macro or industry or company forecasts. Detailed assumptions are footnoted.1. -5. Funding to these hospitals (which use relatively more devices) would likely be minimally affected. India (7. Impact on funding: At the top of China's hospital system hierarchy. a hard landing in the economy would accelerate market concentration. All this should lead to volume growth in Chinese hospitals. See table in appendix for our current ratings. Fig.4 Target price 34. CFA +852 2252 6190 gideon.7. we believe demand for medical devices will be strong.0 6.5). Singapore (5. 3) increase in minimum reimbursement ratio for in-patient treatment of not less than 70%. 2) increase in per capital contribution in NRCMS to CNY200 a year.5. 0.00 No exposure to China.9 18. New Zealand (3. -5. Taiwan (5.0).00 No exposure to China. and 4) increase in the maximum reimbursement amount equivalent to about 6x the average annual salary/disposal income/ farmer income in the respective cities or counties. Philippines (5. Policy and regulations: We continue to believe reform of the public hospital system is a major policy target of the Chinese government and hence is unlikely to be impacted to a great degree should China suffer a hard landing. Thailand (4.29 0.4 3.0). Research analysts: Dr David Stanton +612 8062 8410 david.81 % y-y 7.0).0 Extreme case* EPS 2012 1. China (8. 2. China targets to invest approximately CNY850bn to reform the healthcare system from 2009 to 2011.29 0. We think pricing declines are likely to be muted. -3. Ticker Most affected Mindray (USD) United Labs (HKD) Least affected Primary Healthcare (AUD) Ramsay Health Care (AUD) Sonic Health Care (AUD) PRY AU RHC AU SHL AU MR US 3933 HK Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%.6. 11.81 % y-y 20.3. Healthcare in the rest of the region should be much more defensive. South Korea (5.8 21.8).50 50% revenues from exports.5).82 0.9 18. Base case and extreme case real GDP growth % assumptions: Australia (4.720bn in 2009.9) 16.0.1) 16. Where is potential for upside surprise? For 2011.1 (1. China's aging population is expected to increase at a 3.3.200 class-3 hospitals. 5.

None of this is in our macro or industry or company forecasts.0. Base case and extreme case real GDP growth % assumptions: Australia (4. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.0).1.0. Indonesia (7. -6. Philippines (5.7. growth may be hurt as planned capacity growth may not be fully implemented if power demand does not recover.3.com Anirudh Gangahar +91 22 4037 4516 anirudh. but the overall exposure on the sector appears to be limited. 3. -5. Thailand (4.900 Volumes vary as a function of supply constraints instead of demand-pull factors 41 Highly insulated power purchase agreements 110 Highly insulated power purchase agreements PGAS IJ RATCH TB EGCO TB 0 252. Research analysts: Ivan Lee. New Zealand (3. China (8.82 NA NA NA Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. Indian IPPs and Korea utilities exposed to imported fuel. to which Korea is highly sensitive. Hong Kong (4.5. we would see a fall in fuel costs as a benefit for China and Indian IPPs. Taiwan (5.330) NA NA 115 30 10.7 NA 15.0. Singapore (5.8).gangahar@nomura. apart from Perusahaan Gas Negara. NA 110 Utilization levels would drop as we see a slowdown in industrial demand NA 29 Utilization levels would drop as we see a slowdown in industrial demand 3.8). See table in appendix for our current ratings.97 11. -3.lee@nomura.Nomura | Asia Special Report November 2011 China risk: Asia power Risks to our current overall view In Asia. whatever the economic situation. 20: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share Ticker 2011% 015760 KS ADANI IN LANCI IN 0 0 0 Base case (Local $) EPS 2012 52 15. -3.0). HK utilities should be defensive. Little is expected to change in terms of the power industry and capacity structure.5.lam@nomura. However if an economic slowdown persists. 0.7 3.2). interest rates may fall. Korea and Malaysia do not have that luxury.0).0) Source: Nomura estimates 85 . Government unlikely to adjust plans for or influence over the industry for long term stability.0). Malaysia (5. Slowing economic growth reduces power usage. and thus demand and sales. If China has a hard landing. 5. -5.7 % y-y Target price Extreme case* (Local $) EPS 2012 % y-y Target price Comments (Local curr) Most affected Kepco Adani Power Lanco Infra Least affected Perusahaan Gas Negara Ratchaburi Generating Electricity Generating NA 35. Impact on ability to secure funding appears limited unless situation persists and growth impairs.000 (1. and Tenaga Nasional. India (7. coal. this could help high gearing stocks like China IPPs and Korea Utilities. leaving power generators with no relief against weakened demand. CFA +852 2252 6213 ivan. (3) Substantial commodity price declines by end 2012.0).6.7.com And the Asia power team Key areas of impact if China has a hard landing Fall in fuel prices benefiting China IPPs exposed to domestic fuel supply. Where is potential for upside surprise? Favorable tariff.raats@nomura. Governments may hesitate to grant adequate tariff increases. In such a world. power companies in HK. Fig. CFA +852 2252 2106 joseph.3 2.900 252. coal price and interest rate movements would offset impacts from decline in demand. whose volume depends more on supply constraints. with earnings subjected to tariff.9.97 11.nam@nomura.5).com Daniel Raats +852 2252 2197 daniel. South Korea (5. Also. India and Thailand enjoy fuel cost pass through and fixed return on regulated asset bases. Detailed assumptions are footnoted. and Tenaga Nasional. translated earnings and exports. 2. 0. the impact on our investment stance might be largely neutral. which may be pleased to find itself relieved partially from costly distillates to supplement supply shortfalls.000 Export-oriented Korea‘s power demand is highly sensitive to China and global economic slowdown. -5.com Keith Nam +82 2 3783 2342 keith. (2) China‘s GDP growth falls to 5%. rather it takes a look at an extreme scenario including recessions in the US and Europe.com Joseph Lam.24 0 0 3. Potential drop in interest rates: improve liquidity and cut interest expenses.5).5). 0. Exchange movements would pose a further impact on imported fuel.82 NA NA NA 3. though in general the fall in sales volume and margin in case of an unfavourable tariff response shall be expected.3. demand and interest cost.24 41 110 3. while firms in China.

96 5.56 47.63 4. 0.469 10. 12 Fig.80 Vs.96 2.3.40 -0.17 2.8).6.75 Hist.57 -1.00 38.07 IMPORTANT: Our sensitivity analysis does not assess just the impact of a China hard landing on the mentioned stocks. Malaysia (5. The three differentiating factors that would set the various markets apart are: (1) Balance sheet strength – Would there be distress selling? (2) Supply outlook – How much unproductive stock would need to be unloaded? and (3) Valuations – Have stocks already priced in the downside? Fig. For REITs gearing is defined as total debt-to-total assets 図表 10 Fig. 21: Gearing levels across the region 80% Research analysts: Paul Louie +852 2252 6189 paul.91 0. 11 Fig. 11 HK Landlords HK Developers CH Property SG Developers SG REITs IN Property ID Property TW Property MY Property Average 20 Yr Avg 20 Yr Avg 6 Yr Avg 10 Yr Avg 9 Yr Avg 11 Yr Avg 5 Yr Avg 15 Yr Avg 11 Yr Avg Avg PB 0.610 63. Further.690 6. most resilient and best positioned Fig.0).40 7.670 13.733 0.SD (x) -1. New Zealand (3.20 4.0). Base case and extreme case real GDP growth % assumptions: Australia (4.0. 5. 10 HK office MY housing HK retail HK housing TW housing ID office ID retail IN office SG housing ID housing IN housing CH housing SG office (mn sf) (units) (mn sf) (units) (Households) (mn sqm) (mn sqm) (mn sf) (units) (ha) (mn sf) (mn sqm) (mn sf) Completion 2011 2012 0.36 -0.27 1. Avg -28% -34% -44% -29% -7% -45% -4% 2% 3% +/.49 826.86 198. -5.00 9.27 5.31 1.22 1.7.0).64 0.25 0.24 1.86 -0.96 1.68 Current P/B 0. Indonesia (7. rather it takes a look at an extreme scenario including recessions in the US and Europe. 22: How big is the supply overhang? Fig.269 148.50 523.25 0.5. 13 86 . Taiwan (5.17 2.00 250.5).26 1.5). None of this is in our macro or industry or company forecasts.2). Hong Kong (4. -6.0).15 0.73 2. 2011 図表24: Most vulnerable. (2) China‘s GDP growth falls to 5%.80 1. South Korea (5. -3.14 0.054 86. Thailand (4. 20 Yr Avg 8 Yr Avg 19 Yr Avg 14 Yr Avg 5 Yr Avg 4 Yr Avg 4 Yr Avg 2 Yr Avg 17 Yr Avg 4 Yr Avg 2 Yr Avg 6 Yr Avg 30 Yr Avg Metric 2.1. 2.0). (3) Substantial commodity price declines by end 2012. 12 China HK India Indonesia Malaysia Singapore Taiwan Country Most vulnerable Guangzhou R&F (2777 HK) Wharf (4 HK) DLFLtd (DLF IN) Agung Podomoro (APLN IJ) Malaysian Resources (MRC MK) CapitaLand (CAPL SP) Huaku (2548 TT) Most resilient China Overseas (688 HK) SHKP (16 HK) Oberoi Realty (OBER IN) Bumi Serpong Damai (BSDE IJ) SP Setia (SPSB MK) A-REIT (AREIT SP) Farglory (5522 TT) Best positioned under base case China Overseas (688 HK) SHKP (16 HK) DLF Ltd (DLF IN) Ciputra Dev (CTRA IJ) Man Sing (MSGB MK) Keppel Land (KPLD SP) Farglory (5522 TT) Source: Nomura Research 図表 13 Fig.5). Avg SD (x) 0. 0. with increasing globalization.57 0. While demand would be hit across the board.23 19.01 72.67 41.7.78 1.com And the Asia property team 60% 40% Net gearing 16% 58% 62% 63% 20% 0% 12% 22% 27% 28% 33% SG Developers HK Landlords HK Developers Source: Nomura Research Note: net-debt-to-equity for traditional property companies. we believe demand across all asset classes and all regions would be affected. -3.61 0.86 1.46 250.louie@nomura.861 1.0.Nomura | Asia Special Report November 2011 China risk: Asia property Three risks to consider While property is perceived to be a local industry and driven by local demographics.61 0. Singapore (5. Philippines (5. if China were to have a hard landing.700 70. See table in appendix for our current ratings The extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. 5.0). -5.40 172.0. 0.50 8.03 3. China (8.34 -0.15 0.41 Vs. past crisis have shown that no markets are immune in the event of a system-wide correction.80 1.28 1.549 7.8).9. India (7.5.28 1.064 102.61 1. we believe some property markets would fare worse than others.60 -0. 3.03 0.58 0. Source: Nomura Research Note: Current PB as of October 14.60 Surplus/Deficit to Avg 2011 2012 -64% -58% -58% -50% -50% -10% -44% -28% -31% -38% 12% 20% 13% 19% 13% -8% 15% 26% 22% 25% 26% 26% 35% 58% 364% 134% TW Property MY Property CH Property -20% ID Property IN Property -12% HK REITs SG REITs Source: Nomura Research 図表23: Valuation: How much have current trailing PB already discounted? Fig.3.96 185.00 704.11 10.407 181.

but sectors like wind. rather it takes a look at an extreme scenario including recessions in the US and Europe. nuclear and natural gas: FYP12 capacity/consumption targets would not be affected.0.0). and India. Japan.0).0) Source: Nomura estimates 87 . Research analysts: Ivan Lee.kumar@nomura. CFA +852 2252 6213 Ivan. (2) China‘s GDP growth falls to 5%.30) (0. Therefore. -5.05 We expect pure play companies to bear the brunt in the extreme case. given strategic plans to diversify from coal.6. neutral on wind. Utilization cuts reduce supply in solar industry. Supply-side consolidation as higher-cost producers are priced out of the market and demand elasticity may also remedy impacts to the solar industry. Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. China.00) (7. Thailand (4.5). 0. natural gas and nuclear industries are armed with a favorable fuel mix from FYP12 and capacity targets from NDRC‘s Roadmap. 25: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share Ticker 2011% Most affected LDK Solar (USD) Motech (TWD) JA Solar (USD) GCL (HKD) Trina (USD) Yingli LDK US 6244 TT JASO US 44 NA 52 (0. Indonesia (7. Where is potential for upside surprise? Sharper than expected drops in interest rates would favour valuation. India (7. while with backing of government policy and limited exports.16 (60.78) (5.00) NM NM USD3. with a potentially sharper impact in the event of worsening investor sentiments. especially US. 2.1. Taiwan (5.7. Philippines (5.Nomura | Asia Special Report November 2011 China risk: Asia renewables Risks to our overall current view Current views: bearish on solar. 20.5). the solar industry has seen sharp falls in ASP and volume growth while near term upsides are limited from severe demand headwinds. 3.0).50 GCL‘s lowest cost structure should help it remain breakeven in the extreme case.5. 1.7. China wind.5 7.com Nitin Kumar +65 6433 6967 Nitin. -5. See table in appendix for our current ratings. 0. we would see tighter regulation of financing across the solar sector and a sharp cut in utilization. New Zealand (3. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.00 We expect pure play companies to bear the brunt in the extreme case. China (8.lee@nomura.3. given lower ASPs enabling stronger demand from new regions. 0.70) CNY (7.32) NM NM NM 2. None of this is in our macro or industry or company forecasts. Asia governments would likely not alter renewable capacity targets despite a slowdown. natural gas and nuclear would not be affected.50) (0. Malaysia (5.8). -3.com And the Asia renewables team Key areas of impact if China has a hard landing Solar: Sharp utilization cuts at 30~40% for solar industry as demand declines continue amidst high channel inventories.80) (0.20 (50. South Korea (5.61) NM 2.00) (0.00 Trina‘s lowest cost structure and good balance sheet could help the company through the downturn.8). Approvals for government subsidy program may slow down for solar industry.6 39. -5. nuclear and natural gas.0 Yingli‘s lowest cost structure could help the company through the downturn.0 0. However. Detailed assumptions are footnoted.54) CNY (5.3. Approvals for tariff increases may relieve demand declines. (3) Substantial commodity price declines by end 2012. 4.30 We see LDK‘s financing issues getting exacerbated in the extreme case. Fig.9. FY12F earnings would likely fall 20~25% across the solar industry. 5. but supply-demand mismatch persists with supply 20~30% over demand. china wind and nuclear would meet with little impact.0. Wind.0). Hong Kong (4. If China has a hard landing.2). while it is unlikely for the government to revise wind installation capacity and FYP12 fuel targets.5.42) NM NM NM 1. likely subsidy cuts and new market penetration. -3.0 (1. Tighter regulatory control on refinancing possible for all renewable companies.0 2. Singapore (5.0.0).4 NM USD2. albeit needs improved financing availability. 1.5). Base case EPS 2012 % y-y Target price Extreme case* EPS 2012 % y-y Target price Comments Least affected 3800 HK TSL US YGE US >90 9 15 0. -6. Base case and extreme case real GDP growth % assumptions: Australia (4.

Two China LCD panel companies are ramping up their new 8G lines. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks. Thailand (4. respectively. 1 LCD panel maker.5).8).kim@nomura. Singapore (5.9. and 5% (similar to 2008).000 2618 HK 763 HK 992 HK 034220 KS 10 50 25 1.0). (3) Substantial commodity price declines by end 2012.4 160. the global no. 3. 5.1 USD2.000 Minimal exposure to China.558 1.7. None of this is in our macro or industry or company forecasts. -5. 58.2).4c 26 HKD5.0). South Korea (5. 4. 22 Sells equipment and phones to operators. which would extend the replacement cycle for PCs and handsets in matured cities. We do not recommend any pure LCD names in the supply chain such as glass.7% y-y for our global PC shipment growth forecast. LCD TV market growth could fall to 10%. 0. Detailed assumptions are footnoted. Indonesia (7. In terms of handset demand in China.3. China may introduce new subsidies to stimulate home appliance and TV demand in rural areas. We could see other capex cuts along the supply chain. Philippines (5.000 na 71. HKD4.303 na 7.com And the Asia technology team Key areas of impact if China has a hard landing We expect PC and handset shipment growth would be 9% y-y.89 1 68 11 (6) 2 na 7 Smartphone sales are driven by operator subsidies rather than the macro environment.0 75% earnings from China.8c Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%. driven by operators‘ handset subsidy policies.5. Malaysia (5.28 85 30 21 na 8 28 24. 5.5 na 20 Small exposure to China. -3.04 1.0.0).8). India (7.0. accounting for 15% of market volume in 2012F. We also expect 2012F LCD TV demand to grow 15% y-y to 49mn units in China. we expect 2012F IT industry growth in China to continue to outperform other geographic markets due to still-low penetration of LCD TVs.5. PCs and smartphones. Base case and extreme case real GDP growth % assumptions: Australia (4. Base case EPS 2012 % y-y Target price Extreme case* EPS 2012 % y-y Target price Comments 48 US3. We expect white-goods market growth could slow to around 10% due to the slower-than-expected income level growth. We expect the white goods market to still see ~20% y-y volume growth along with the rise of penetration rate in rural areas. Samsung SDI 006400 KS (KRW) LG Innotek (KRW) 011070 KS 9. rather it takes a look at an extreme scenario including recessions in the US and Europe. -5. Taiwan (5.0.6. following the big loss in 2011F. We expect 3G smartphone shipment volume to grow 45% y-y. 120. However. which is 5pps higher than global LCD TV demand growth. 0. we expect 15% y-y growth to 550mn units along with growing mobile subscribers.000 Minimal exposure to China. in our view.861 na 27 1.1.7 8. China (8.000 Supplies panels to Chinese set makers. We forecast China PC shipments will grow 11% y-y to 82mn units in 2012F vs. -6. James Kim +852 2252 6203 james. although we expect rising demand from tier-4 to tier-6 cities should help compensate. Where is potential for upside surprise? Microsoft‘s new OS Windows 8 official launch and rising interest in ultrabooks should help boost replacement demand in 2H12. polarizer.33 10.698 1.0). -3. 2. (2) China‘s GDP growth falls to 5%. the lowest over the past several years.000 0. Fig. 26: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share Ticker 2011% Most affected TCL (HKD) ZTE (HKD) Lenovo LGD (KRW) Least affected Acer (TWD) 2353 TT 14 5 5 2.0). and LED companies. 0. Hong Kong (4. LGD.0) Source: Nomura estimates 88 . 21. New Zealand (3. We see limited impact for smartphones in 2012 as the market is mainly driven by operators‘ subsidy policies. we anticipate that they may delay the full ramp up and all panel makers‘ profitability could be negative in 2012F.5).7.Nomura | Asia Special Report November 2011 Research analysts: China risk: Asia technology Risks to our current overall view Basically.3.5). See table in appendix for our current ratings. has cancelled its 8G line schedule and Samsung has decided to move an existing 8G line in Korea to China rather than build a new one as planned earlier.

0. (2) China‘s GDP growth falls to 5%. Base case and extreme case real GDP growth % assumptions: Australia (4. • There could be downward revisions to capex. -5.5.9. although we are already anticipating a drop in capex/sales from 20% in 2010 to 18% in 2012F. Indonesia.5). while the rest should be more resilient. Fig.2).Nomura | Asia Special Report November 2011 China risk: Asia telecoms Risks to our current overall view Overall we believe the Asian telecom sector should be relatively resilient to a macro slowdown or a China hard-landing. Ticker Most affected China Unicom Least affected China Mobile 941 HK 762 HK Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%.60 Have more high-ARPU subscribers.5. 0.8).9 (3. 0. YTD. but outperformance relative to other sectors and markets would be likely. Detailed assumptions are footnoted. -3.8). 5.0) Source: Nomura estimates 89 . 27: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* China sales share 2011% 100 100 Base case EPS 2012 (CNY) 0.com Danny Chu. See table in appendix for our current ratings. Taiwan (5.7. 89.0) 18. India. Malaysia (5.chu@nomura.50 90. 5.7. In the 2008 slowdown.0. Singapore (5. China (8.0). Indonesia (7. both on net adds and ARPUs. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks. Philippines (5. (3) Substantial commodity price declines by end 2012. CFA +852 2252 6209 danny.0). India (7.11 Target price % y-y (HKD) Comments 62. Thailand (4.00 Extreme case* EPS 2012 (CNY) 0.46 Target price % y-y (HKD) 79. -3. 2. None of this is in our macro or industry or company forecasts. the impact could be more visible in factories along the coastal areas which has a larger migrant population. Hong Kong (4. Our bias is also for stocks with network advantages.gupta@nomura. Research analysts: Sachin Gupta. however now the penetration rates are 10-20% higher. The impact of a slowdown could be more pronounced in the mid to low end pre-paid segment.51 6. CFA +65 6433 6968 sachin. with stable yields and EPS resilience. 3.1.0.3. We continue to prefer liquid stocks. South Korea (5.5 2.0).5).20 Revenue vulnerable due to low-ARPU.5). Thailand and the Philippines could be more exposed.7 18. especially as data economics can be challenging.0.0). -5. • We think telcos in China. rather it takes a look at an extreme scenario including recessions in the US and Europe. -6.3. Asian telcos is the only sector with positive returns (up 3%) – although this may not continue (as the sector does not look inexpensive at 14-15x P/E currently).56 6.com And the Asia telecoms team Key areas of impact if China has a hard landing • Consumer spend on telcos could be adversely impacted – telco spend as a percentage of GDP ranges from 3-6% across most Asian countries.0). For China specifically.6. there weren‘t many downward revisions to capex or revenue/EBITDA guidance. New Zealand (3.

Further. 5.Nomura | Asia Special Report November 2011 China risk: Asia transport Risks to our current overall view We currently have a negative view on shipping companies.5) 5. (3) Substantial commodity price declines by end 2012.0).0).60 0.60 y-y chg% are calculated based on re-current earnings Ticker Most affected CEA 670 HK % y-y na CSCL 2866 HK na (0.86 Target price of extreme case based on 2008's trough valuation P/BV of 0. None of this is in our macro or industry or company forecasts. it is unlikely that the Chinese transport companies would run into solvency issues given that most are state-owned and historically had been bailed-out by the government in crisis situations.7x 18.com And the Asia transport team Key areas of impact if China has a hard landing • Demand is expected to be impacted across the entire transport sector.18 Assuming the toll rate to remain stable post the toll rate review in 2012 for calculating the extreme case's earnings. while target price of extreme case to be based on 2008's trough PE multiple of 11.3.86 Target price of extreme case to be based on historical trough P/BV of 0.6. 2.29 (19. we assume overall 2012F freight rates would decline by a further 5% on a y-y basis while we assume all international freight rates in 2012F would decline by a further 10% from the base case in an extreme bearish case.69) Target price (HKD) Comments 0.65 (0. IMPORTANT: The sensitivity table below does not assess just the impact of a China hard landing on the mentioned stocks.5). rather it takes a look at an extreme scenario including recessions in the US and Europe. • While a hard landing may result in tighter funding.2). -6. Hong Kong (4.27 HKD2. -3.01 na Least affected HHI 737 HK 100 HKD0. 0. Detailed assumptions are footnoted. China (8.65x and assume CNY appreciation to remain flat y-y in 2012F 1. 0. See table in appendix for our current ratings. Indonesia (7. -3. 28: Earnings and target price sensitivity for most affected and least affected companies in coverage in the extreme case* Base case China sales share EPS 2012 2011% (CNY) % y-y 80 0. expressways. 14 90 . the impact to earnings is expected to be the largest for shipping companies and airlines given thinner profit margins. Where is potential for upside surprise? We believe that there is the possibility for an upside surprise for the expressways should toll-rate cuts (which have been at least partially priced in given the official announcement of a nation-wide toll-rate review at the beginning of this year) not materialize by May2012. India (7. Taiwan (5.39 In a bear-case scenario.0) Source: Nomura estimates 図表 14 Fig.8).38) na Yang Ming 2609 TT na -TWD2.3.5.95 (39.0. 0.5. nevertheless. -5. 3. -5. New Zealand (3. In contrast.39 (0.34 (3.5). Fig. a neutral to positive view on airlines.7. Singapore (5.1) BCIA Hopewell 694 HK 54 HK 100 65 0.85 32.1. 3.10 -TWD7. and a positive view on airports. Thailand (4.9. South Korea (5. • A hard landing may increase regulatory risk especially on pricing for the expressways.3 5. -5.0.065) Extreme case* Target price EPS 2012 (HKD) (CNY) 4.wong@nomura.0).20 (0.0) (28. (2) China‘s GDP growth falls to 5%. Philippines (5. Our positive position on airlines would be most at risk in a China hard landing scenario. we assume overall 2012F freight rates would decline by a further 5% on a y-y basis while we assume all international freight rates in 2012F would decline by a further 10% from the base case in an extreme bearish case.6 52.1) Note: Base case represents our current forecasts and TP *Extreme case assumes (1) US real GDP falls 3% and euro area GDP falls 5%.lee@nomura.0).91 na TWD7.17 HKD0. Base case and extreme case real GDP growth % assumptions: Australia (4.00 53.8).0.7.11 In a bear-case scenario.69 HKD0. and ports.com Andrew Lee +852 2252 6197 andrew. TWD3. a hard landing is not expected to have any price impact for airports and just minimal impact on the ports and expressways.2x and assume earnings to decline by another 20% to reflect the possible toll rate cut 2.19) na 1. Malaysia (5. a hard landing may impact the pricing for both the shippers and the airlines.5).0). Research analysts: Jim Wong +852 2252 2195 jim.

To our U. Another area that will be closely tracked will be the property sector.com    Ahead of a China hard landing playing out. Chinese HY industrials would underperform the large cap HY property credits. whose investment grade ratings have been underpinned by government support. we do not hold out this Desk Commentary as being impartial in relation to the activities of this trading desk.K. we believe the signs would be borne through the ripple effects of the tightening of onshore credit with an explosion in shadow bank lending followed by a focus on the government‟s ability to manage the knock-on consequences. and lastly. On the back of the above views and backdrop we lay out our trade ideas on China: Sovereign – We expect CDS to remain highly volatile and subject to macro headlines with likely buyers on any meaningful tightening as we saw at the end of last week. which has been on an uninterrupted upward trajectory in terms of supply and prices. We do not see much in terms of downward pressure on foreign credit ratings. where CDS went from a recent peak of 207bp down to the current 140bp. law. In our view. when considering the direct consequences of a China hard landing.mohinani@nomura. particularly in top-tier cities. the repercussions for the Chinese SOE space. the banks and the availability of credit. a China hard landing would have the following consequences for Chinese credit:  Significant underperformance of highly levered SOEs. Chinese credits – already reflecting the risks of a China hard landing From a credit perspective. As such. Significantly more scrutiny of the default risk of smaller cap property credits. For additional information concerning the role of trading desk analysts. The desk commentary portion of this report is not a product of the Fixed Income Research Department and is not covered by the research analyst certification provided in Appendix A-1. and Hong Kong banks that have extended their balance sheets to Chinese banks and SOEs would likely be dragged to wider levels. Desk Analyst Pradeep Mohinani +852 2536 7030 pradeep. clients: this portion of the Report has been produced by and for the primary benefit of a trading desk. We believe the risks of a slowdown are already starting to show in the recent underperformance of Chinese credit across both HG and HY relative to the rest of the Asian credit universe. This underperformance has been seen right through the sell-off since August through September. The supply overhang that has been created is finally starting to result in prices and transaction volumes crashing. If there is any pressure we would expect it to come from Fitch‟s 91 . please see the important conflicts disclosures beginning at page 101 of this report.Nomura | Asia Special Report November 2011 This portion of the Report has been prepared by a Desk Analyst and is not a research report under U. with implications for the HY property sector and industrials. we believe the four key areas of focus are the impact on the sovereign and its ratings.S. and the much less convincing participation in the rally that subsequently followed. though we believe the space could be unfairly penalized.

we see better sales execution and potential credit improvement in Shimao.5 cash points or Buy GJTLIJ 2014 at 84. China Metallurgical and China Resources Power have continued to benefit from investment grade ratings based on the expectation of government support.rating on Negative outlook relative to its foreign currency rating of A+. and Buy SHIMAO 2017 at 81.25 mid (13. In contrast. With a similar business size. a number of Chinese state-owned credits like Sinochem. in a distressed macroeconomic scenario.6%) to take out 0.75 and Buy WINSWY 2016 at 83. we believe support will vary based on the company‟s relative importance to the government.5 to pick up 50bp or 65bp respectively. we still see pockets of relative value trade ideas. we view high yield bond valuations as fair at current levels. China Resources Power has had its outlook revised to Negative on the back of aggressive capex plans and a stressed balance sheet.1%) to take out 3. That said.Nomura | Asia Special Report November 2011 local currency ratings. or Buy MIEHOL 2016 at 88 to pick up 310bp and 5 cash points. Sell FUFENG 2016 at 82 or WESCHI 2016 at 82. while China Metallurgical‟s credit metrics are only marginally better than the downgrade triggers. Switch trades among the industrial names: Sell CHOGRP 2015 at 93 and Buy HYVANL 2016 at 89 to pick up 165bp and 4 cash points. LONKIN 2016 at 89. In High Yield. However. 3) Switch to HPDLF 16s at 60 mid (28. similar market position but better liquidity profile.5 to pick up 1 cash point and obtain better security.75. Sell LUMENA 2014 at 85.75 mid (14.5. Of these issuers.5 or 2018 at 81. the agency having put its AA. Given that Citic Pacific‟s senior bonds traded in the low-70s in the recent sell-off after being downgraded to non-investment grade.5 and Buy TEXTEX 2016 at 76 to pick up 9. Agile is likely to miss its presales target on its underperformance in Hainan. we believe KWGPRO trading 450bp back of YLLG id unjustified.75.75 and Buy ROADKG 2015 at 80. as evidenced by its 70% sales target achieved in 9M11 compared to the latter‟s 36%. The group‟s recent RMB1.7%) from PWRLNG 15s at 71 mid (26%) to take out 11 cash points and pick up 2.7%) from AGILE 17s at 82. Yanlord‟s presales were slow in view of its perilous market position and its presales collection period is longer than its peers‟ due to attractive installment terms (up to 1 year) offered to cash buyers.75 cash points and pick up 210bp.5 mid (15.75 cash points and pick up 450bp. as well as the language of support used for outstanding debt.8bn land purchase in Zhuhai further adds pressure to its weakened liquidity profile. or at bond prices in the 70s-90s. we highlight the risk of these bonds seeing gappy downward movements.6%) from YLLG 17s at 82.  Switch ideas in China property: 1) Switch to SHIMAO 18s at 81. 2) Switch to KWGPRO 17s at 79 mid (18. Switch out of some expensive industrial names (exposed to the infrastructure and property sectors) into property issues to pick up more yield at flat or lower bond prices: Sell CHOGRP 2015 at 93. the larger-cap Chinese property and higher quality China industrial bonds are now trading between 12% and 15% yields. Powerlong‟s recurring income was not meaningful (7% of EBIT in 1H11) and our street check indicates low occupancy rates and poor traffic in its shopping mall. In High Grade. while the more defensive Indonesian corporates now trade at 6-8%. Hopson has a longer operating history and thus has better sales execution than Powerlong. especially on longer-dated larger-cap Chinese property bonds and switch trades among the China industrial and small-cap property space.5 or SHASHU 2016 at 92. 92   . especially as policy instruments. Despite marketing as a landlord.7% yield. we note that China Resources Power (Baa3/BBB-) and China Metallurgical (Baa2/BBB-) are both already on the verge of an S&P downgrade and being pushed into noninvestment grade territory. Sell LIANSU 2016 at 84 or WESCHI 2016 at 82. With the recent market rally.

Against this backdrop of heavy supply pressure.375% Pnc13). which have lagged behind in the latest rally. ICBCAS 2020 and FUBON 2020) into short-dated HK bank UT2 Pnc12 or Pnc13 with reasonably attractive YTCs (including BNKEA GBP 6. A number of banks such as Bank of East Asia and Citic Bank International have T2 refinancing needs in 1H12 and they recently established MTN programs and/or conducted roadshows to prepare for any potential LT2 issuance to refinance once the market stabilizes. we suggest investors take advantage of the recent rally to switch out of the HK bank LT2 2020s (particularly BNKEA 2020. according to Reuters. CINDBK 2020.6% and limited T2 refinancing needs until June 2013. 93 . although we do not see the rationale for such a move in the near term given a solid total CAR of 17. There was even market speculation that BOCHK was looking to issue a new 10yr LT2 earlier last week.Nomura | Asia Special Report November 2011 HK bank LT2 2020s will likely face high supply risk in the near term.125% Pnc12 and WINHAN 9. the sixth-largest commercial bank in China) at MS+300bp could open up the pipeline for more USD senior or LT2 issuance by other Chinese banks. The latest 3yr USD250 million CD issuance by China Merchant Bank (BBB.125% Pc12. CINDBK 9.

. Conway. Hong Kong University of Science and Technology. D. “Power and Plenty”. C. pp. Pacific Institute for Studies in Development. pp. Park and K. "Asset Prices. International Relations and Security Network/Swiss Federal Institute of Technology. 29 March 2011. D.(1970). P. 114.” China & World Economy. "What makes Privatization Work? The Case Study of China. “Water: Asia‟s New Battleground”. Muto (2011). (2008). (2010). H. “Chinese Banks: Growth of Leverage Still Outpacing GDP Growth”. ADB Economics Working paper Series No. Garnaut. Yang. September 2008. 2. Fang and M. Bank of Japan Working Paper Series No. Chellaney. “Water Conflict Chronology”. No. Hill (2010). Hsieh and Y. R. (2006). No.. Ash. Herd. pp. July 2002. P. P. F.121-136. C.” IMF Working Paper 06/291. OECD Economics Department Working Papers No. 1. December 2010. BIS Working Papers. Georgetown University Press. “Reforming China‟s Monetary Policy Framework to Meet Domestic Objectives”. “China‟s Financial Sector Reforms”. Wang (2010). 11-E-5. 2. Fukumoto. 3.181-190.. Wang (2008). 3. No. Shin (2011). Aziz. G. and K. "When Fast Growing Economies Slow Down: International Evidence and Implications for the People' Republic of China". 822. Herd and T. Vol. No. Findlay. 16. 488– 500. “A Counterfactual Analysis on Unlimited Surplus Labor in Rural China. Qian (2006). China Special Report. December 2006. O'Rourke (2008). R. Guo and C.” Quarterly Journal of Economics. Cai. and S. (2011). 94 . Borio C. (2011). “Discussions on Potential Bias and Implications of Lewis Turning Point. T. Vol. “Macro-Economic Implications of the Turning Point” China Economic Journal. Gan J. 11 October 2008. “Feeding Billions: Food Security in China”. “Rebalancing China‟s Economic Growth: Some Insights from Japan‟s Experience”. "The Return to Capital in China". J. R. Y. OECD Economic Department Working Paper No. Chalaux (2010). 262. Vol. Vol. Financial Monetary Stability: Exploring the Nexus". FitchRatings (2011). “The Market for „Lemons‟: Quality Uncertainty and the Market Mechanism. Lowe (2002). July 2011. and M. NBER Working Paper No. No.H..” China Economic Journal. “Rebalancing China‟s Economy: What Does Growth Theory Tell Us?. pp. 84. Bai. 747. Gleick.. 12755. July 2011. B.. B. R. Princeton University Press. Pigott. C. Xu (2008). and I.5165. Environment and Security. 2. June 2011.Nomura | Asia Special Report November 2011 References Akerlof. R. Eichengreen.

11/192. The Institute of Economic Research Hitotsubashi University. “China Through 2020 : A Macroeconomic Scenario” World Bank China Research Working Paper No. B. Manchester School of Economics and Social Studies. World Economic Outlook. (2007). A. PP. “Unnatural Selection: Choosing boys over girls. Vol. Lehman Brothers. "Are Credit Booms in Emerging markets a Concern?". June 2009. R. Chapter IV. IMF (2011a). Boesky (2010). Asian-Pacific Economic Literature. IMF (2004). No. 11/193. Minami. Nomura Asia Special Report. and the consequences of a world full of men”. 21 January 2002. Johnson. J. Y. “China‟s Great Ascendancy and Structural Risks: Consequences of Asymmetric market Liberalization. (2009). 2. The Institute for the Study of Labor Discussion Paper No. IMF (2011b). “Progress in China‟s Banking Sector Reform: Has Bank Behavior Changed?”. Lewis. Present Realities”. (1954). American Economic Review. Reinhart (1999). Issue 1. Knight. R. Paris. July 2011. Kaminsky G. OECD (2005). 4. Minami. H. No. and X. M. L. IMF (2011c). 473-500. Deng and S. (2011). Oxford University Press. OECD. 22. June 1999.5 in Global Financial Stability Report. Federal Reserve Bank of New York Staff Report No. Paris. IMF Finance and Development Magazine.. C. Subbaraman (2002). "Gauging Financial Stability Risks in China". No. (2009). 3. “People‟s Republic of China: Spillover Report of the 2011 Article IV Consultation and Selected Issues”. Kuijs. “The Turning Point in Economic Development: Japan‟s Experience”. A. 35. 14. Li (2011). 2995. 24.. 95 . Vol. Adrian. 3. pp. Vol. (1973). “China: Gigantic Possibilities. R. OECD. December 1998. July 2010. "The Twin Crises: The Causes of Banking and Balance-of-payments Problems". Economic Survey of China. “People‟s Republic of China: 2011 Article IV Consultation”. Q. Kinoshita T. OECD (2010). A. Prasad.S. IMF Working Paper No 06/71.” China Economic Review (forth-coming). 19 October 2009. Ashcraft. “The Puzzle of Migrant Labour Shortage and Rural Labor Surplus in China. E. 89.Nomura | Asia Special Report November 2011 Huang. (2010). “Is the Chinese Growth Miracle Built to Last?. Country Report No. Economic Survey of China.. “What Japan‟s 1980s experience means for China". R. China Economic Journal.163-179. (1998). T. Box 1. 9. Newton. Vol. Economic Research Series No. September 2011. Z.. Pozar. "Sequencing Capital Account Liberalization". Ma (2010). (2006). July 2011. 2011. “The Lewis Turning Point of Chinese Economy: Comparison with Japanese Experience”. “Shadow Banking”. 458. Vol. “Economic Development with Unlimited Supplies of Labour”. Country Report No. Podpiera. Hvistendahl .

pp. No. “Global Economic Prospects: Maintaining Progress amid Turmoil”. RatingsDirect. 26 September 2011. Nomura Global Economics. Asia Special Report. 2. Zhiwei.137-153. Wang.. June 2011 Yeung. G. Poverty Reduction and Economic Management Unit. (2010). 59. Journal of Contemporary China. “Securing the Present. “Stress Tests Show a Big Sales Slump Could Severely Strain the Liquidity of Many Rated Chinese Developers”. Sun and W. No. 96 . "China: The case for structurally higher inflation". Chen (2011). Vol. Shaping the Future”. M. Volume 1. “Mid-term Evaluation of China‟s 11th Five Year Plan”.Nomura | Asia Special Report November 2011 Standard and Poor‟s (2011). 3. Volume 3. Vol. 21 September 2011. World Bank (2011b). 18. (2009). “The Rise of Labor Cost and the Fall of Labor Input: Has China Reached Lewis Turning Point?” China Economic Journal. Z. 18 December 2008. World Bank (2011a). World Bank East Asia and Pacific Economic Update 2011. C. World Bank (2008). Global Credit Portal. “How Banks in China make Lending Decisions”.

2) The real 1yr bank deposit rate is calculated by subtracting % y-o-y headline CPI inflation from the nominal 1yr bank deposit rate. % deviation from long-run linear trend Lending attitude of banks as perceived by industrial enterprises. For the indicators that are available only on a quarterly or annual basis.0% 3. we identified 18 indicators to construct our China Stress Index. % of total social financing Property loans. The data are monthly and start in January 2000.0% 3.0% 5.zhang@nomura.0% 10.0% Direction of increased risk Up Up Up Up Down Down Up Up Up Up Up Down Up Up Up Up Up Up Notes: 1) The return on capital is estimated by % year-on-year nominal GDP growth and the cost of capital is approximated by the benchmark 1yr bank lending rate in % pa. wi is the weight for the i-th indicator . % of GDP Bank reserve requirement ratio.0% 5.0% 8.Nomura | Asia Special Report November 2011 Appendix: The Construction of Nomura‟s China Stress Index From our analysis of China‟s macro challenges and risks. survey diffusion index Industrial companies liability/asset ratio CPI inflation. and σi are the sample mean and standard deviation of the i-th indicator. or CSI for short. 97 . % of total loans by official financial institutions Residential property price.chen@nomura.0% 5.0% 5. % Funding from shadow banking sector.0% 3. % of GDP Residential housing starts less sales.0% 3.0% 3. 3) Average urban household income of the top 20% income decile as a ratio to those in the bottom 20% income decile.0% 4. cubic meters 3 A gauge of urban income inequality Number of nationwide labour disputes / total labor force 2 Data Frequency Annual Monthly Monthly Monthly Monthly Monthly Monthly Monthly Quarterly Quarterly Quarterly Quarterly Quarterly Monthly Quarterly Annual Annual Annual Weighting 10.0% 5. respectively.com Qilong Zhang +852 2252 6191 qilong.0% 5. CSI is then defined as a weighted average of standardized indicators as follows: Chien-Hua Chen +852 2536 7429 chien-hua. Source: Nomura. % year-on-year Inflation expectations. Indicators 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Gross capital formation. % of GDP Difference between year-on-year growth rates of nominal fixed-asset investment and retail sales Real estate investment. 12-month rolling sum 1 Return on capital less cost of capital Real 1-year bank deposit interest rate Domestic credit.0% 10.0% 8.0% 5. monthly series were interpolated from the longer frequency data.com Where CSIt is the composite CSI level at month t. survey diffusion index Industrial waste air emission per capita.

91 11.2 5.5 13 3.74 36.02 10.65 1.08 7.05 5.5 18.17 66.35 69.7 40.45 13.1 166.5 90 8 28 5.2 76.12 3.87 31.35 21.55 34 98 .1 4.4 3.42 19.85 32.46 21.48 3.3 0.3 3.3 53.11 24.5 17.7 Reduce Neutral Neutral Neutral Neutral Buy Buy Buy Buy Neutral Buy Reduce Neutral Buy Buy Buy Neutral Reduce Neutral Buy Buy Neutral Neutral Buy Buy Buy Buy Neutral Reduce Buy Neutral Buy Buy Neutral Buy Neutral Neutral Neutral Buy Buy Reduce 2.26 7.1 17.8 21 11 23.15 0.9 102.5 5.98 2.5 4.9 10.9 2.235 25.96 13.H ICBC Chongqing Rural Commercial Bank China Construction Bank-H Guangzhou R&F Properties China Overseas Land & Inv Wharf Holdings Sun Hung Kai Properties Melco Crown Esprit Samsonite Prada Li & Fung Galaxy Entertainment SJM Holdings Sands China Tsingtao Brewery Australia Bloomberg Ticker PRY AU RHC AU SHL AU ANZ AU CBA AU NAB AU WBC AU BLY AU AMC AU AGK AU CCL AU TLS AU WOW AU BSL AU OST AU ORI AU RIO AU BHP AU TAH AU WES AU MYR AU PBG AU TWE AU LDK US JASO US TSL US YGE US 3800 HK 762 HK 941 HK 2618 HK 763 HK 992 HK 670 HK 2866 HK 737 HK 694 HK 54 HK MR US 3933 HK 23 HK 302 HK 440 HK 2388 HK 11 HK 1988 HK 998 HK 3988 HK 1398 HK 3618 HK 939 HK 2777 HK 688 HK 4 HK 16 HK MPEL US 330 HK 1910 HK 1913 HK 494 HK 27 HK 880 HK 1928 HK 168 HK Price (LC) 26/10/2011 Rating Target Price (LC) 3.58 3.59 49.85 1.85 4.2 7.3 14.34 13.32 34.1 6.3 3.84 Buy Buy Neutral Neutral Neutral Buy Neutral Buy Neutral Buy Buy Neutral Buy Not Rated Not Rated Not Rated Not Rated Not Rated Not Rated Buy Neutral Neutral Neutral 3.57 0.4 97.65 3.14 30 39 2.19 7.69 5.1 21 23 30.15 24.6 2 7 3.04 22.9 1.98 25.64 2.02 21.1 43.14 37.26 12.52 7.5 8.36 14.94 2.4 2.9 19.9 6.43 6.4 24 84 50 28 120 7.3 2.1 23.5 53 31 24.5 6.4 6.57 3.5 11.06 28.9 2.16 16.19 3.43 12.Nomura | Asia Special Report November 2011 Appendix: Companies mentioned and ratings Company Name Primary Health Care Ramsay Health Care Sonic Health Care ANZ Commonwealth Bank National Australia Bank Westpac Banking Corp Boart Longyear Amcor AGL Energy Coca-Cola Amatil Telstra Woolworths Bluescope Steel Onesteel Orica Rio Tinto BHP Billiton Tabcorp Holdings Wesfarmers Myer Pacific Brands Treasury Wine Estates Hong Kong / China LDK Solar JA Solar Trina Solar Yingli Green Energy GCL Poly Energy China Unicom China Mobile TCL Communication Tech ZTE Corp Lenovo Group China Eastern Airlines China Shipping Container Lines Hopewell Highway Infrastructure Beijing Capital International Airport Hopewell Holdings Mindray Medical International United Laboratories Bank of East Asia Wing Hang Bank Dah Sing Financial BOC Hong Kong (Holdings) Hang Seng Bank China Minsheng Bank .3 3.95 22.31 18.1 5.2 18.96 15.45 4.H China CITIC Bank Bank of China .6 34 6.

54 3.H Ping An Insurance Group Country Garden Holdings China Resources Land Alibaba.86 10.2 2838.1 21.1 8.Nomura | Asia Special Report November 2011 India Indonesia Malaysia Singapore Huabao International China Yurun L'Occitane Want Want China Mengniu Air China LTD .H Evergrande Real Estate Group Citic Pacific LTD Guangzhou Automobile Group .44 7.85 6 4.75 231.95 6.H Dongfeng Motor GRP CO LTD .42 177.23 12.65 15 229.1 2.9 2900 4025 6850 8000 6650 4950 2250 2000 7850 20400 68400 58250 7400 3900 330 920 500 8.36 1.5 99 .3 139.19 12.5 10.H China Southern Airlines CO .1 212.05 4.7 21 22.79 10 260 200 653 240 1911 229 3100 115 30 270 284 3900 4500 7900 6700 8400 4900 4750 2850 11000 28400 72000 65000 8700 4950 330 1200 690 6.7 1.9 16.34 9.5 3.05 12.48 10.69 5.94 2.25 3.84 14.H Belle International Holdings Tata Motors Tata Steel Crompton Greaves Dr Reddy's Laboratories ITC Infosys Adani Power Lanco Infratech DLF Ltd Oberoi Realty Perusahaan Gas Negara Bank Negara Indonesia Bank Mandiri Bank Central Asia Bank Rakyat Indonesia Bank Danamon Indonesia Bumi Resources Adaro Energy Harum Energy Astra Agro Lestari Astra Internation Gudang Garam Tbk Pt Telkom Indonesia Jasa Marga Agung Podomoro Bumi Serpong Damai Ciputra Dev Maybank CIMB Group Holdings Telekom Malaysia Public Bank Hong Leong Bank Malaysian Resources SP Setia Mah Sing Group Capitaland Keppel Land Wilmar International DBS Bank Singapore Telecom Ascendas REIT UOB OCBC 336 HK 1068 HK 973 HK 151 HK 2319 HK 753 HK 1055 HK 2318 HK 2007 HK 1109 HK 1688 HK 700 HK 3323 HK 2600 HK 2883 HK 3333 HK 267 HK 2238 HK 439 HK 1880 HK TTMT IN TATA IN CRG IN DRRD IN ITC IN INFO IN ADANI IN LANCI IN DLFU IN OBER IN PGAS IJ BBNI IJ BMRI IJ BBCA IJ BBRI IJ BDMN IJ BUMI IJ ADRO IJ HRUM IJ AALI IJ ASII IJ GGRM IJ TLKM IJ JSMR IJ APLN IJ BSDE IJ CTRA IJ MAY MK CIMB MK T MK PBKF MK HLBK MK MRC MK SPSB MK MSGB MK CAPL SP KPLD SP WIL SP DBS SP ST SP AREIT SP UOB SP OCBC SP Noble (US$) mewah (US$) Olam NOBL SP MII SP OLAM SP 4.4 Buy Buy Buy Neutral Buy Buy Buy Buy Neutral Neutral Neutral Buy Not Rated Not Rated Not Rated Not Rated Not Rated Not Rated Not Rated Not Rated Buy Buy Buy Buy Buy Buy Neutral Buy Buy Buy Buy Buy Buy Reduce Buy Neutral Buy Buy Buy Buy Neutral Buy Buy Buy Neutral Buy Buy Reduce Reduce Buy Neutral Neutral Reduce Reduce Neutral Buy Buy Neutral Buy Neutral Neutral Neutral Buy Buy Reduce Buy 11.65 84.74 4.9 11.91 3.15 1593.45 2.15 4.9 5.1 6.42 2.35 1.2 16.45 2.19 1.03 8.75 3.5 7.8 11.H Aluminum Corp of China LTD .95 2.98 17.52 2.09 25.H China Oilfield Services .82 12.53 12.3 15.27 7.5 191.5 0.Com Tencent Holdings China National Building MA .85 1.4 3.48 0.04 13.46 4.48 53.9 6.6 34 11.26 4.75 97 3.8 451.

2 135 145 100 .75 19.5 20 28.5 108 Buy Neutral Neutral Neutral Buy Buy Neutral Buy Neutral Buy Buy Buy Neutral Reduce Buy Buy Buy Buy Buy Reduce Reduce Reduce Buy Buy Buy Buy Buy Buy Buy Buy Buy Neutral Buy 35000 24000 160000 71000 18000 62000 16000 54000 66000 71000 178000 53000 6000 32.4 50 39.6 90 300 102 550 205 39 27 7.1 26.5 14.4 118.3 85 67 41 110 188 23.2 73.Nomura | Asia Special Report November 2011 South Korea Taiwan Thailand KEPCO LG Display Samsung SDI LG Innotek Woori FG KB Financial Group Industrial Bank of Korea Hana Financial Group KT&G Corp Dongbu Insurance SK Telecom KT Corp LG Uplus Corp Asia Cement Synnex Technology AirTAC Taiwan Mobile Formosa International Hotels President Chain Store Motech Industries Acer Inc Yang Ming Marine First FHC E.6 19.35 68.5 455 173 59.85 14.75 80 143.2 35. Sun FHC Chinatrust FHC Huaku Development Farglory Land Development Ratchaburi Generating Electricity Generating 015760 KS 034220 KS 006400 KS 011070 KS 053000 KS 105560 KS 024110 KS 086790 KS 033780 KS 005830 KS 017670 KS 030200 KS 032640 KS 1102 TT 2347 TT 1590 TT 3045 TT 2707 TT 2912 TT 6244 TT 2353 TT 2609 TT 2892 TT 2884 TT 2891 TT 2548 TT 5522 TT RATCH TB EGCO TB Bangkok Bank (BBL) Krungthai Bank (KTB) Kasikorn Bank (KBank) Siam Commercial Bank (SCB) BBL TB KTB TB KBANK TB SCB TB 25100 24200 139000 75200 10300 42150 14650 39400 76700 45900 161500 37700 7110 36.65 12.1 167 86.

views and analytical methods of the persons who prepared them and Nomura is under no obligation to bring them to the attention of recipients of this communication. Additional.Nomura | Asia Special Report November 2011 Important Conflicts Disclosures Relating to Sales or Trading Desk Material Investors should be aware that Nomura engages or may engage in the following activities. to the extent that they are based on historical information. and (iii) is based upon information that we consider reliable. should not be relied upon as an accurate prediction of future performance. Disclaimer Relating to Sales or Trading Desk Material This material has been compiled by a Nomura Group sales or trading desk. ♦ The person who prepares trading desk material and his or her household members are not permitted to own the securities. and reach different conclusions from the information presented. Inc. hold or act as market-makers or advisors. important disclaimer information should be reviewed by following this link: http://www. “Nomura Group” is the global marketing name of Nomura Holdings.com/americas/fidisclaimer. which present conflicts of interest: ♦ The person distributing sales or trading desk material may have previously provided any ideas and strategies discussed in it to Nomura‟s traders. may have issued. 101 . and is made available to you through one of Nomura Group‟s global securities affiliates. options. its fixed income department and its overall profitability.shtml. directors. Those reports reflect the different assumptions. (ii) not to be construed as an offer to sell or a solicitation to buy any security or financial instrument in any jurisdiction where such offer or solicitation may be illegal. rights or derivatives). yields and opinions expressed are current opinions as of the date appearing on this material only and are subject to change without notice. however it should not be relied upon as such. products or financial instruments mentioned. may from time to time maintain a long or short position in. ♦ Nomura. and we are not soliciting any action based upon it. valuations and statistical analyses are provided to assist the recipient in the evaluation of the matters described herein and. and may in the future issue. sales and trading activity in securities or products of the relevant asset class. All projections. the profitability of Nomura‟s underwriting. Nomura and its officers. including persons involved in the preparation or issuance of this material (subject to company policy). and may not be relied upon as such. This information is neither investment research nor a research recommendation. ♦ Members of a sales or trading desk are compensated based on. (Tokyo) and its direct and indirect subsidiaries worldwide. This material is: (i) for your private information only. other reports that are inconsistent with. who may already have acted on them. among other things. Nomura may engage in these transactions in a manner that is inconsistent with or contrary to any recommendations made in sales or trading desk material. or purchase or sell a position in. brokers or commercial and/or investment bankers in relation to the products discussed in sales or trading desk materials or in securities (or related securities. financial products. of companies mentioned in trading desk materials or be represented on the board of such companies. through different sales or trading desks or its fixed income research department. warrants. ♦ Nomura does and seeks to do business with the companies referred to in sales or trading desk materials. Nomura usually provides bids and offers and may act as principal in connection with transactions involving such securities or products. For securities or products recommended by a member of a sales or trading desk in which Nomura is not a market maker. The desk‟s opinions may differ from views of Nomura Group's research department. partners and employees. Any prices.nomura.

Nomura International plc or any other Nomura Group company. which is defined as (Target Price . Middle East and Africa. Analysts may also indicate absolute upside to target price defined as (fair value . 41% of companies with this rating are investment banking clients of the Nomura Group*. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://go. Stocks A rating of 'Buy'.Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Important Disclosures Conflict-of-interest disclosures Important disclosures may be accessed through the following website: http://go.com/research/globalresearchportal/pages/disclosures/disclosures. A rating of 'Reduce'. a portion of which is generated by Investment Banking activities. A rating of 'Suspended'. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks 102 . public appearances. A 'Bearish' stance. 20% of companies with this rating are investment banking clients of the Nomura Group*.nomuranow. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009 Stocks Stock recommendations are based on absolute valuation upside (downside).com for technical assistance. multiple analysis. nor is it tied to any specific investment banking transactions performed by Nomura Securities International. the Target Price will equal the analyst's 12-month intrinsic valuation of the stock. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://go. US and Latin America for ratings published from 27 October 2008 The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis.nomuranow. etc. Marketing Analysts may also contribute to research reports in which their names appear and publish research on their sector. are classified as a Sell rating. Sectors A 'Bullish' stance. is. subject to limited management discretion.com. In addition. but not limited to. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. In most cases. Online availability of research and additional conflict-of-interest disclosures Nomura Equity Research is available on nomuranow. each research analyst identified on the cover page hereof hereby certifies that no part of his or her compensation was. for purposes of mandatory disclosures. Reuters and ThomsonOne. indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. Inc. Marketing Analysts identified in some Nomura research reports are research analysts employed by Nomura International plc who are primarily responsible for marketing Nomura‟s Equity Research product in the sector for which they have coverage. indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. 41% have been assigned a Neutral rating which. Explanation of Nomura's equity research rating system in Europe. If you have any difficulties with the website. A rating of 'Neutral'. indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months..nomuranow. indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. please email grpsupport-eu@nomura.. may not be associated persons of NSI. salesperson (1-877-865-5752) or email grpsupporteu@nomura. 10% have been assigned a Reduce rating which. unless otherwise stated in the valuation methodology. indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. As at 30 September 2011. and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies.current price)/current price. and trading securities held by a research analyst account. *The Nomura Group as defined in the Disclaimer section at the end of this report. Bloomberg. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner.com/research/globalresearchportal). 50% of companies with this rating are investment banking clients of the Nomura Group*. etc. Inc. indicates that the rating. Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Factset. Capital IQ. subject to limited management discretion. target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including.Current Price) / Current Price. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. In most cases.com for assistance. Sectors A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. for purposes of mandatory disclosures. A 'Neutral' stance. If you have difficulty with this site or you do not have a password. are classified as a Buy rating. Benchmarks are as follows: United States: S&P 500. Unless otherwise noted. indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. for purposes of mandatory disclosures. based on an appropriate valuation methodology such as discounted cash flow. when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Europe: Dow Jones STOXX 600.Nomura | Asia Special Report November 2011 Disclosure Appendix A-1 Any Authors named on this report are Research Analysts unless otherwise indicated Analyst Certification Each research analyst identified herein certifies that all of the views expressed in this report by such analyst accurately reflect his or her personal views about the subject securities and issuers. on 1-877-865-5752. the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules. is classified as a Hold rating. Distribution of ratings (Global) The distribution of all ratings published by Nomura Global Equity Research is as follows: 49% have been assigned a Buy rating which.com/research/globalresearchportal or requested from Nomura Securities International. directly or indirectly related to the specific recommendations or views that he or she has expressed in this research report. please contact your Nomura Securities International.aspx . or will be. A 'Reduce' recommendation indicates that potential downside is 5% or more. A 'Buy' recommendation indicates that potential upside is 15% or more. Inc.

Nomura Financial Investment (Korea) Co. and/or. Accordingly. or have long or short positions in. MCX: INE261299034). Plot F. indicates that the analyst expects the sector to underperform the Benchmark during the next six months. NIplc. India. („NIHK‟). if any. Global Emerging Markets: MSCI Emerging Markets ex-Asia. fit for any particular purpose or merchantable and does not accept liability for any act (or decision not to act) resulting from use of this document and related data. regulated by the Monetary Authority of Singapore). if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts. Mumbai. if appropriate. A rating of '3' or 'Neutral'. our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Sectors A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. P. deal as principal. Italian Branch („NIplc. Sectors A 'Bullish' stance. and it undertakes no obligation to update the analysis. which is defined as (Fair Value . including tax advice. India (Registered Address: Ceejay House. indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months.. Business Services: FTSE W Europe. ('NSI'). indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. Japan. („NSM‟). A 'Bearish' stance. within this horizon. the securities. Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008 Stocks Stock recommendations are based on absolute valuation upside (downside). A rating of '5' or 'Sell'. the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. Dr. agent. Nomura Australia Ltd. but has not been independently verified by Nomura Group. New York. Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe. Auto & Components: FTSE W Europe Auto & Parts. Tel: +91 22 4037 4037. Thailand. SEBI Registration No: BSE INB011299030. Nomura Group does not warrant or represent that the document is accurate. However. and by other risks related to the company or the market. subject to limited management discretion. Korea (Information on Nomura analysts registered with the Korea Financial Investment Association ('KOFIA') can be found on the KOFIA Intranet at http://dis. then the fair value may differ from the intrinsic fair value. and/or its officers. („NAL‟).. Nomura Group companies may also act as market maker or liquidity provider (as defined within Financial Services Authority („FSA‟) rules in the UK) in the financial instruments of the issuer. the 'Nomura Group'). Nomura Group is under no duty to update this document. („NSL‟). Nomura Securities International. A 'Buy' recommendation indicates that upside is between 10% and 20%. including the opinions and estimates contained herein. Nomura Singapore Ltd. Singapore (Registration number 197201440E. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or identified elsewhere in the document. are subject to change without notice. or otherwise. In most cases. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation. MSCI World Technology Hardware & Equipment. Inc. A rating of '4' or 'Reduce'. United States: S&P 500. and (iii) based upon information from sources that we consider reliable. may. Dubai‟). or distribution of this information. regulated by the Autorité des marches financiers and the Autorité de Contrôle Prudentiel. Opinions or estimates expressed are current opinions as of the original publication date appearing on this material and the information. therefore. Stocks labeled 'Not rated' or shown as 'No rating' are not in Nomura's regular research coverage. commodities or instruments. The achievement of any target price may be impeded by general market and macroeconomic trends. Taiwan. Fax: +91 22 4037 4111. Capital Nomura Securities Public Company Limited („CNS‟).or. Middle East and Africa. Madrid Branch („NIplc. Nomura International plc ('NIplc'). Madrid‟) and NIplc.. Nomura International (Hong Kong) Ltd. to the extent permitted by applicable law and/or regulation. reliable.Current Price)/Current Price. Nomura Securities Malaysia Sdn. Nomura Indonesia („PTNI‟). Where the activity of 103 . A 'Neutral' stance. of issuers or securities mentioned herein. Ltd. seek professional advice. Shivsagar Estate. Nomura Group does not provide tax advice.T. indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. Malaysia. Nomura Group. Indonesia. UK. and may not occur if the company's earnings differ from estimates. Nomura might not publish additional research reports concerning this company. indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months.kr ). Target Price A Target Price. Inc. price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. or buy or sell. indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A rating of '2' or 'Buy'. INE 231299034. ('NSC') Tokyo. Ecology Focus: Bloomberg World Energy Alternate Sources. Disclaimers This document contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein. if discussed. This material is: (i) for your private information. Banque Nomura France („BNF‟). (collectively. Nomura International (Hong Kong) Ltd. regulated by the Australian Securities and Investment Commission ('ASIC') and holder of an Australian financial services licence number 246412. Recommendations are set with a 6-12 month horizon unless specified otherwise. To the maximum extent permissible all warranties and other assurances by Nomura group are hereby excluded and Nomura Group shall have no liability for the use. („NFIK‟). indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. Taipei Branch („NITB‟). US and Latin America published prior to 27 October 2008) Stocks A rating of '1' or 'Strong buy'. Level 11. A 'Reduce' recommendation indicates that downside is between 10% and 20%. Europe. reflect in part the analyst's estimates for the company's earnings. INF231299034. complete. Dubai Branch („NIplc. include: Nomura Securities Co. misuse. Telecoms: FTSE W Europe Business Services. US.kofia. Any comments or statements made herein are those of the author(s) and may differ from views held by other parties within Nomura Group. projections. Clients should consider whether any advice or recommendation in this report is suitable for their particular circumstances and. Ltd.400 018. conclusions or other information contained herein.Nomura | Asia Special Report November 2011 under coverage is) a neutral absolute recommendation. A 'Neutral' recommendation indicates that upside or downside is less than 10%. estimates. Italy‟). and we are not soliciting any action based upon it. Nomura Financial Advisory and Securities (India) Private Limited („NFASL‟). NIplc. Affiliates and subsidiaries of Nomura Holdings. Australia (ABN 48 003 032 513). Annie Besant Road. Bhd. Worli. or options or other derivative instruments based thereon. directors and employees. Communications equipment: FTSE W Europe IT Hardware. Benchmarks are as follows: Japan: TOPIX. by sector Hardware/Semiconductors: FTSE W Europe IT Hardware. NSE INB231299034. indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. Hong Kong. In most cases. Mumbai. (ii) not to be construed as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such offer or solicitation would be illegal. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Strong buy' recommendation indicates that upside is more than 20%. A 'Sell' recommendation indicates that downside is more than 20%.

quantitative analysis and short term trading ideas. by any person other than those authorised to do so into Saudi Arabia or in the UAE or to any person located in Saudi Arabia or to clients other than 'professional clients' in the UAE. or related to. merchantability or fitness for a particular purpose with respect to any of this information. be redistributed to retail clients as defined by the FSA. It does not constitute a personal recommendation. in such case. photocopied. This document may contain information obtained from third parties. corrupted. and may not. legal fees. that may be associated with any investment decision. you represent that you are not located in Saudi Arabia or that you are a 'professional client' in the UAE and agree to comply with these restrictions. or contain viruses. Neither this document nor any copy thereof may be taken or transmitted or distributed.Nomura | Asia Special Report November 2011 market maker is carried out in accordance with the definition given to it by specific laws and regulations of the US or other jurisdictions. Where the information contains an indication of future performance. This document has been approved for distribution in Australia by NAL. Unless governing law permits otherwise. This document has been approved for distribution in the UK and European Economic Area as investment research by NIplc. this document has been distributed by NSL.com/research/globalresearchportal/pages/disclosures/disclosures. including any indices. expert or institutional investors as defined by the Securities and Futures Act (Chapter 289). compensatory. whether as a result of differing time horizons. The user assumes the entire risk of any use made of this information. but not limited to. exemplary. direct or indirect. completeness. Chinese Wall and Confidentiality policies) as well as through the maintenance of Chinese walls and employee training. simulations are based on models and simplifying assumptions which may oversimplify and not reflect the future distribution of returns. in no event shall MSCI. or related to. and should not be relied on as investment advice. Nomura Group manages conflicts with respect to the production of research through its compliance policies and procedures (including. computing or compiling the information have any liability for any damages of any kind. accuracy. futures and foreign exchange. may not be offered or sold in the US or to US persons unless they have been registered under the 1933 Act. MSCI. Recipients of this document in Singapore should contact NSL in respect of matters arising from. Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the related third party. financial situations. for distribution in Hong Kong by NIHK. MSCI. or take into account the particular investment objectives. Third party content providers give no express or implied warranties. incidental. completeness. They do not address the suitability of securities or the suitability of securities for investment purposes. or (ii) redistributed without the prior written consent of a member of Nomura Group. including ratings. which accepts responsibility for its contents in accordance with the provisions of Rule 15a-6. This document has also been approved for distribution in Malaysia by NSM. please request a hard-copy version. any warranties of merchantability or fitness for a particular purpose or use. by any means. In Singapore. by NSI. which is regulated by the Hong Kong Securities and Futures Commission. as the case may be. The sender therefore does not accept liability for any errors or omissions in the contents of this document. Disclosure information is available at the Nomura Disclosure web page: http://go. This document has been approved by NIHK. therefore. Any MSCI sourced information in this document is the exclusive property of Morgan Stanley Capital International Inc. Without limiting any of the foregoing. which is authorized and regulated by the FSA and is a member of the London Stock Exchange. including ratings. including ratings from credit ratings agencies such as Standard & Poor‟s. Any failure to comply with these restrictions may constitute a violation of the laws of Saudi Arabia or the UAE. Different groups of clients may receive different products and services from the research department depending on their individual requirements. Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates. as such. as defined by the FSA. this material is distributed in the US. any transaction should be executed via a Nomura entity in your home jurisdiction. then such transmission cannot be guaranteed to be secure or errorfree as information could be intercepted. special or consequential damages. or except in compliance with an exemption from the registration requirements of the 1933 Act. re-disseminated or used to create any financial products. including. such forecasts may not be a reliable indicator of future performance. Certain securities are subject to fluctuations in exchange rates that could have an adverse effect on the value or price of. Third party content providers do not guarantee the accuracy. No part of this material may be (i) copied. punitive. under the US Securities Exchange Act of 1934. Nomura Group publishes research product in a number of different ways including the posting of product on Nomura Group portals and/or distribution directly to clients. its affiliates and any third party involved in. methodologies or otherwise. the report should not be viewed as identifying or suggesting all risks. directly or indirectly. NSL accepts legal responsibility for the content of this document. or for the results obtained from the use of such content. where it concerns securities. and. If verification is required. Third party content providers shall not be liable for any direct. It is intended only for investors who are 'eligible counterparties' or 'professional clients' as defined by the FSA. this will be separately disclosed within the specific issuer disclosures. By accepting to receive this document. arrive late or incomplete. costs. this information and any other MSCI intellectual property may not be reproduced. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase hold or sell securities. or in connection with. among others. fundamental analysis. expenses. but not limited to. computing or compiling the information hereby expressly disclaim all warranties of originality. Nomura Group produces a number of different types of research product including. This document has not been approved for distribution in the Kingdom of Saudi Arabia („Saudi Arabia‟) or to clients other than 'professional clients' in the United Arab Emirates („UAE‟) by Nomura Saudi Arabia. the investment. and are not responsible for any errors or omissions (negligent or otherwise). Investors should consider this document as only a single factor in making their investment decision and. („MSCI‟). destroyed. The securities described herein may not have been registered under the US Securities Act of 1933 (the „1933 Act‟). Further information on any of the securities mentioned herein may be obtained upon request. Moreover. which may arise as a result of electronic transmission. regardless of the cause. timeliness or availability of any information. which is authorized and regulated in Australia by the ASIC.nomuranow. a US-registered broker-dealer. Figures presented herein may refer to past performance or simulations based on past performance which are not reliable indicators of future performance. this document. If this document has been distributed by electronic transmission. such as e-mail. Additional information is available upon request. Unless prohibited by the provisions of Regulation S of the 1933 Act. or needs of individual investors.aspx 104 . recommendations contained in one type of research product may differ from recommendations contained in other types of research product. or losses (including lost income or profits and opportunity costs) in connection with any use of their content. Without prior written permission of MSCI. issued by their foreign affiliates in respect of recipients who are not accredited. NIplc or any other member of Nomura Group. lost. indirect. or income derived from. This information is provided on an "as is" basis. or duplicated in any form. any of its affiliates or any third party involved in. Conflicts of Interest.

Sign up to vote on this title
UsefulNot useful