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25                                                                                                                                                                                                               25
                                                                                                                                                                                                                       40                                                                                                         40
                                                                                                                                                                                                                                                                                              Manufacturing sentiment
                                                                                                                                                                                                                                                                                              declined on the back of
                                                                                                                                                                                                                                                                                              higher costs driven by the          30
20                                                                                                                                                                                                               20                                                                           weaker yen
                                                                                                                 "...is it time to act?                                                                                20
                                                                                                                 My answer is that
                                                                                                                 it’s still too early"                                                                                                                                                                                            20

15                                                                                                                                        "I think the issue has                                                 15
                                                                                                                                          to do with, not so
                                                                                                                                                                                                                          0                                                                                                       10
                                                                                                                                          much with the overall
                                                                                                                                          accommodation, but
                                                                                                                                          rather, with the mix of
                                                                                                                                          instruments being
                                                                                                                                                                                                                                                                                                                                  0
                                                               "...it seems to me the
10                                                             Chairman said we'll use the                                                used to provide that                                                   10
                                                                                                                                                                 "In appropriate                                      -20
                                                               patch (and use it flexibly),                                               accommodation"
                      "If the incoming data are                                                                                                                  combination, these two
                                                               and some in the markets                                                                                                                                                                                                                                            -10
                      broadly consistent with this                                                                                                               tools can provide the
                                                               reacted as if he said 'cold
                      forecast...it would be                                                                                                                     high level of policy
                                                               turkey'"
                      appropriate to moderate the                                                                                                                accommodation needed"
5                     monthly pace of purchases                                                                                                                                                                  5
                      later this year"
                                                                                                                                                                                                                      -40                                                                                                         -20
                                                                                                                                                                                                                                   Reuter Tankan manufacturing DI (lhs)

                                                                                                                                                                                                                                                                                                                                  -30
0                                                                                                                                                                                                                0                                                                                               Forecast
                                                                                                                                                                                                                      -60          Industrial production (rhs)
                                                                                      Stein 6/28
                                 Bernanke 6/19


                                                 Dudley 6/27


                                                                 Lockhart 6/27




                                                                                                   Lacker 6/28


                                                                                                                          Williams 6/28


                                                                                                                                                 Minutes 7/10


                                                                                                                                                                 Bernanke 7/10


                                                                                                                                                                                 Bernanke 7/17


                                                                                                                                                                                                 Bernanke 7/18
                Rate Decision




                                                                                                                                                                                                                                                                                                                                  -40
                    6/19




                                                                                                                                                                                                                      -80                                                                                                         -50
                                                                                                                                                                                                                              04     05         06        07         08      09        10      11        12         13




                                                                                                                                                                                                                     




                                                                                                                                                                                                                     


                                                                                                                                                                                                                      





     6.0                                                                                                                                                                                                              1.04

                                                                                                                                                                                                                      1.02
     4.0
                                                                                                                                                                                                                      1.00

     2.0
                                                                                                                                                                                                                      0.98

     0.0                                                                                                                                                                                                              0.96

                                                                                                                                                                                                                      0.94
    -2.0
                                                                                                                                                                                                                      0.92
    -4.0
                                                                                                                                                                                                                      0.90

                                                                                                                                                                                                                      0.88                    US Growth Risk
    -6.0

                                                                                                                                                                                                                      0.86
    -8.0                         Euro area CAI                                                                                                                                                                                                Europe Sov/Fin Risk
                                                                                                                                                                                                                      0.84
                                 Euro area GDP
-10.0                                                                                                                                                                                                                                         China Growth Risk
                                                                                                                                                                                                                      0.82

-12.0                                                                                                                                                                                                                 0.80
           06                   07                     08                        09                10                                     11                    12                          13                           Jan-13        Feb-13        Mar-13         Apr-13    May-13        Jun-13      Jul-13           Jul-13
                                                                         …From increasingly shadowy places
                                                                         Shadow banking in China as % of total corp./cons. debt and of GDP
                                                                                 50%


                                                                                 45%
                                                                                                 As % of total corporate and consumer financing

                                                                                 40%             As % of total GDP


                                                                                 35%


                                                                                 30%


                                                                                 25%


                                                                                 20%


                                                                                 15%


                                                                                 10%


                                                                                 5%


                                                                                 0%
                                                                                   2000   2001    2002    2003    2004    2005    2006    2007    2008   2009   2010   2011   2012




Concerning credit growth…
5-year change (2007-2012 for most) in domestic credit to the private
sector as a percent of GDP for a set of 181 countries
                                                                         Commodities exposed
                                                                         China net imports as a % of global imports
                                                                                 30%



                                                                                 25%



                                                                                 20%



                                                                                 15%



                                                                                 10%



                                                                                 5%
    -165%                                                     61.5%
    chg in                                                    chg in
  credit/GDP                                                credit/GDP           0%



                                                                                 -5%
                                                                                                                          A post-GFC credit boom
                                                                                                                          Debt-to-GDP ratio (percent of GDP)

                                                                                                                          250                                                                                                              240 Total debt as % of GDP
                                                                                                                                                                                                                                   230
                                                                                                                                                                                                                           219
                                                                                                                                                                                                                    209

                                                                                                                                                                                                      195
                                                                                                                          200                                                                                194

                                                                                                                                                                                               181                                                 Corporate leverage

                                                                                                                                                     161
                                                                                                                                                            156    155           153
                                                                                                                                                                          154           153
                                                                                                                                              149                                                                                          173
                                                                                                                          150                                                                                                      163
                                                                                                                                135    138                                                                                 151
                                                                                                                                                                                                                    142
                                                                                                                                                                                                      125                                          LGFV leverage (loan, bond)
                                                                                                                                                                                                             129
                                                                                                                                                                                               112


                                                                                                                                                     114           98     98     96     97
                                                                                                                                                            106
                                                                                                                          100
                                                                                                                                              107
                                                                                                                                       103
                                                                                                                                109
                                                                                                                                                                                                                                                   Govt. Leverage


                                                                                                                                                                                               24     25                   22      20      19
                                                                                                                                                                                                             22     23
                                                                                                                           50                                      13
                                                                                                                                                                          15     15     16
                                                                                                                                                     11     12
                                                                                                                                               9                                                                                   22      22
                                                                                                                                        7                                                             27            24     23
                                                                                                                                                                   32                          29            25
                                                                                                                                 0                   25     26            28     30     28
                                                                                                                                              24                                                                                                   Consumer loans
                                                                                                                                       22
                                                                                                                                22
                                                                                                                                                                                                                    20     23      25      26
                                                                                                                                                                                               16     19     19
                                                                                                                                               9     12     12     12     11     12     12
                                                                                                                                 4      6
                                                                                                                            0
                                                                                                                                                     2003
                                                                                                                                2000

                                                                                                                                       2001

                                                                                                                                              2002



                                                                                                                                                            2004

                                                                                                                                                                   2005

                                                                                                                                                                          2006

                                                                                                                                                                                 2007

                                                                                                                                                                                        2008

                                                                                                                                                                                               2009

                                                                                                                                                                                                      2010

                                                                                                                                                                                                             2011

                                                                                                                                                                                                                    2012

                                                                                                                                                                                                                           2013E

                                                                                                                                                                                                                                   2014E

                                                                                                                                                                                                                                           2015E
Less indebted than DM, but more than EM peers
Debt-to-GDP ratio, 2012 (percent of GDP)

450                                                                                                                 450

      392                                                                                   Debt by sector:
400                                                                                                                 400
                                                                                             Corporate

                                                                                             Household
350                                                                                                                 350
                                                                                             Government
              292
300                                                                                                                 300
                     256     253
250                                233                                                                              250
                                           211     209
                                                          198
200                                                                                                                 200

                                                                  151
150                                                                                                                 150

                                                                          105     103
100                                                                                                                 100
                                                                                           71
                                                                                                    59        58
 50                                                                                                                 50


  0                                                                                                                 0
      Japan   UK    France   US    Korea Australia China GermanyThailand India   Brazil   Russia Mexico Indonesia
                                                                              A wide range of past crisis outcomes
                                                                              Examples of banking crises outcomes over the past 25 years
                                                                              (% of GDP)


                                                                                                                                                                            Iceland 2008
                                                                                                     0.6



                                                                                                     0.5
                                                                               Peak NPL (% of GDP)




                                                                                                     0.4   Russia 1998

                                                                                                                               Japan 1997              Korea 1997
Around 1/3 of credit booms end in crisis                                                                                                                                   Thailand 1997
                                                                                                     0.3                          Malaysia 1997                                        Indonesia 1997
Result of 175 credit booms under IMF study between 1960-2010                                                                                            Turkey 2000

                                                                                                                  Philippines 1997     China 1998
                           Followed by economic                                                      0.2
                                                                                                          Norway 1991                    Mexico 1994
                            underperformance?                                                                                  Brazil 1994
                                                                                                                                                   Greece 2008
                                                                                                                               Finland 1991                            Ireland 2008
                                                                                                           Sweden 1991
                           No                 Yes               Total                                0.1
    Followed by                                                                                                      USA 2007
     financial              Percent of        Percent of        Percent of                               Spain 2008      UK 2007
      crisis?                                                                                                                 Netherlands 2008
                  Number       total   Number    total   Number    total                               0
                              cases             cases             cases                                   0             0.1            0.2           0.3         0.4             0.5           0.6
                                                                                                                                        Fiscal Cost (% of GDP)
        No          54          31%     64          37%   118           67%

       Yes          16          9%      41          23%    57           33%

       Total        70          40%     105         60%   175




                                                     1




1
                                                                                                







                                                                                                


 The PBOC has the a


 LGFV risks are manageable



                                                                                                The high cost of shadowy credit
                                                                                                % of GDP
                                                                                                14%
                                                                                                                                          Total corporate financing cost incl. shadow banking
 China banks have built up a sizeable provision cushion                                        13%
                                                                                                                                          Corporate loans' cost
                                                                                                12%

                                                                                                11%

                                                                                                10%

                                                                                                9%

                                                                                                8%

                                                                                                7%

Comforting cushion                                                                              6%
                                         Estimated general provision coverage
                          2007    2008        2009       2010        2011        2012   2013E   5%
Sector average           0.87%   1.30%       1.24%      1.44%       1.70%       1.83%   1.82%
H Share Average          0.90%   1.31%       1.29%      1.47%       1.70%       1.80%   1.72%   4%
                                                                                                      1994
                                                                                                             1995
                                                                                                                    1996
                                                                                                                           1997
                                                                                                                                  1998
                                                                                                                                         1999
                                                                                                                                                2000
                                                                                                                                                       2001
                                                                                                                                                              2002
                                                                                                                                                                     2003
                                                                                                                                                                            2004
                                                                                                                                                                                   2005
                                                                                                                                                                                          2006
                                                                                                                                                                                                 2007
                                                                                                                                                                                                        2008
                                                                                                                                                                                                               2009
                                                                                                                                                                                                                      2010
                                                                                                                                                                                                                             2011
                                                                                                                                                                                                                                    2012
                                                                                                                                                                                                                                           2013E
                                                                                                                                                                                                                                                   2014E
                                                                                                                                                                                                                                                           2015E




Big Bank Average         0.99%   1.43%       1.47%      1.64%       1.78%       1.86%   1.71%
Shareholding Bank Ave.   0.72%   1.20%       1.16%      1.38%       1.66%       1.75%   1.77%
City Bank Average        1.15%   1.44%       1.23%      1.41%       1.74%       2.00%   2.04%




                                                                                                We believe it is critical for China to take actions and reforms
                                                                                                now to constrain further systemic risks build-up, by:
                                                                                                 Achieving economic rebalancing by stimulating consumer
                                                                                                  credit and consumption




                                                                                                 Implementing further fiscal reforms



                                                                                                 Removing L/D ratio cap
                                                                              National People’s Congress
                                                                                            State Council
    Ministry of             People’s Bank              China Banking                    China Securities              National Development    China Insurance                        Ministry of Human Resource
     Finance                  of China              Regulatory Commission            Regulatory Commission           and Reform Commission Regulatory Commission                         and Social Security
      (MOF)                   (PBOC)                       (CBRC)                           (CSRC)                          (NDRC)                 (CIRC)                                      (MHRSS)
                               State Adm. of
    Central Huijin                Foreign                                  Investment         Future                          Insurance          Insurance             Personal                National Social
                                                           Securities                                        Regulates
     Investment                  Exchange                    Firms        Funds/Banks         Firms                          Holding Firms      Holding Firms      Insurance Firms             Security Fund
                                                                                                             Enterprise
                                  (SAFE)
                                                                                                              Bonds
                               Nat’l Assoc. of                                                                                                 Insurance Asset        Insurance                   Enterprise
                                                             Stock         Futures            QDils/                          Reinsurance
                               Fin. Mkt. Inst.                                                                                                    Mgt. Firms        Agency/Broker                 Annuities
                                                           Exchanges      Exchanges           QFils                              Firms
                                 Investors
                                 (NAFMII)
        Commercial                      Small and Med. Size                   New-type Rural                           State                         Financial Asset                     Other Financial
          Banks                         Financial Institutions              Financial Institutions                 Policy Banks                      Mgt. Companies                        Institutions
 • Large commercial                  • Urban credit                     • Village or township               • China Developmental              • China Huarong                       • Postal savings bank
   banks                               cooperatives                       banks                               Bank                               Corporation AMC                     • Finance companies of
 • Joint-stock commercial            • Rural credit                     • Lending companies                 • Export-Import Bank of            • China Great Wall                      enterprise groups
   banks                               cooperatives                                                           China                              Corporation AMC                     • Trust companies
                                                                        • Rural mutual
 • City commercial banks             • Rural cooperative                  cooperatives                      • Agricultural                     • China Orient                        • Financial leasing
                                       banks                                                                  Development Bank of                Corporation AMC                       companies
 • Rural commercial
                                                                                                              China                            • China Cinda
   banks                                                                                                                                                                             • Auto finance
                                                                                                                                                 Corporation AMC                       companies
 • Foreign banks
                                                                                                                                                                                     • Money brokerage firms
                                                                                                                                                                                     • Consumer finance
                                                                                                                                                                                       companies
Notes: The thickest connecting lines correspond to the highest levels of authority in financial policy making. The NPC promulgates all financial sector laws and the State Council executes financial regulation
and issues mandatory policy directives to all the financial regulatory and supervisory agencies. The dotted connecting lines indicate the three primary functions of the PBOC —formulating monetary policy,
maintaining financial stability, and providing financial services— and the triple role of the MOF as tax administrator, treasurer, and owner of several commercial banks. The thinner connecting lines emerging
from CBRC, CSRC, CIRC, and MHRSS reflect that these entities are mostly responsible for regulating and conducting supervision and oversight of their respective financial sectors. The SAFE is responsible
for foreign exchange operations of securities and insurance companies. Central Huijin exercise rights and obligations as an investor in major state-owned financial enterprises on behalf of the State. The
National Social Security Fund has also a dual role as an institutional investor and a stakeholder in some of the largest commercial banks. The NDRC regulates enterprise bond issuance, the CSRC regulates
corporate (listed co. and LLC) bond issuance and the National Association of Financial Market Institutional Investors (NAFMII) that is supervised by the PBOC regulates corporate CP and MTN.
Source: Das, Cihak, Lu, “The People’s Republic of China: Financial Stability Assessment Report”, IMF Country Report No. 11/321, November 2011, Goldman Sachs Global ECS Research.
  WHAT ABOUT THE COMMUNIST PARTY OF CHINA (CPC)?
  The Chinese Communist Party has considerable influence over personnel decisions at the financial institutions and their activities, such as the granting of large loans. The
  highest executives in the banks are all appointed by the Organization Department of the Party, comparable to the manner by which all high-level local government officials and
  central government officials are appointed. In practice, all executives in the large state-owned financial institutions are high-level government officials who have political ranks
  similar to local and central government officials. Many bank executives ultimately aspire to top government jobs.
  Source: Elliot, Yan “The Chinese Financial System”, John L. Thornton China Center at Brookings, July 2013.
A brief history of the banking sector in China: Shadow or not
In 1978, the People’s Bank of China (PBOC) functioned as both the central bank of China and as the only commercial
bank. In the 1980s, four state-owned banks were established out of parts of the PBOC: the Bank of China (BOC), the
Agricultural Bank of China (ABC), the China Construction Bank (CCB), and the Industrial and Commercial Bank of
China (ICBC). The PBOC has functioned as a more traditional central bank since then, without significant direct
commercial banking functions. During the late 1980s to early 1990s, joint-equity banks were founded by raising money
from both the government and the private sector. They are not completely privately owned, but the government’s
stakes in them are significantly less than the government’s stakes in the “Big Four” state-owned banks. A number of
smaller and local banks have since developed.

Historically, the supply of credit in China has been channeled mostly via the state-dominated banking system. But
over the past five years, there has been rapid growth in credit from the non-bank sector, or the so-called “shadow
banking” sector. Shadow banking credits in 2012 accounted for 24% of the total credit balance to corporates and
consumers (but 39% of the flow of new credit that year). The pace of shadow banking growth in China and the opacity
of the products means that it provides a source of latent risk. For more details, please see Ning Ma’s February 26,
2013 report titled “Casting a light on shadow banking.”

Defining shadow banking in China
There is no formal definition of shadow banking in China, but a common understanding is that shadow banking
encompasses credit exposures that are sourced from outside of the formal banking system. This does not necessarily
mean that these types of lending are unregulated or uncontrolled, although some shadow banking sectors do carry
higher risk. Adopting this definition means that shadow banking incorporates the following types of lending:
Corporate Bonds: While corporate bonds are often included in the classification of shadow banking, they are
relatively speaking a better regulated and more transparent area of shadow banking, with positive selection bias in
that only the better credit quality companies (non-LGFV) are able to issue corporate bonds with low funding costs.
Three regulators each regulate a sub-segment of the broadly-defined corporate bond market: NDRC (Enterprise
bonds issued largely by the SOEs and LGFVs), CSRC (Corporate bonds issued by listed companies and limited
liability companies) and PBOC (Corporate commercial paper (CP) and medium-term notes (MTN).)
Trust Loans: Trust companies can use trust funds to extend a loan to a corporate (LGFV or non-LGFV). The
corporate provides a guarantee on the trust loan and/or collateral to the trust. This is regulated by the CBRC. There is
no recourse to the issuing trust company. Trust products are typically sold to high net worth individuals and
professional investors; the incentive for participating is an interest rate that has been historically 100-200 bps above
the regulated bank deposit rate.
Entrust Loans: Entrust loans allows corporates to lend to each other. If Corporate A wants to lend to Corporate B,
they can do this through a bank by using an entrust loan structure. The bank acts purely as a book entry entity, and
Corporate A will bear all credit risk from lending to Corporate B. Regulated by CBRC.
Micro lending and pawn shops: Micro lenders and pawn shops are smaller, regulated parts of shadow banking. The
outstanding amount is comparatively small, and they target individuals/small businesses.
Informal Lending: This is an unregulated sector, and often used for SME lending. They do not have financial
institutions acting as intermediaries or as book entry entities.

What about wealth management products (WMP)?
WMPs are often described as part of shadow banking, but are in reality a distribution channel. WMPs are retail
products sold to individuals with certain minimum deposit balances, either through bank branches or through
securities brokers. The WMPs invest in a range of underlying products, which typically provide a fixed income return.
These products include corporate bonds, trust loans, interbank assets, securitized loans from the banks’ loan book,
and discounted bills, amongst other assets. The WMPs are managed by the banks/brokers, and the banks/brokers
typically do not provide guarantee for the payment of interest or principal. Any WMPs that are not principal guaranteed
are off balance sheet for the banks/brokers. WMPs issued by the banks fall under CBRC regulation, and WMPs
issued by the brokers fall under CSRC regulation.

Often times, a bank may purchase a corporate bond or other product, and inject it as one of numerous products that
comprise a WMP to resell to the individual. This has resulted in lack of transparency on WMP underlying products and
some mismatch of tenor issues. WMPs’ recent popularity has been underpinned by both attractive return yields vs.
bank deposits, and some perception of implicit guarantee by their sellers (banks or brokers), partly due to the lack of
significant prior default precedent (as the sellers did indeed cover some prior losses voluntarily) and partly as the
sellers often tend to be state owned businesses.
Source: Goldman Sachs Global ECS Research, Gao Hua Securities. Special thanks to Ken Ho and Ning Ma and teams.
Overview of shadow banking activities in China
  Source of Funds                                                                                                    Use of funds
                                                            Credit Intermediation                                                                   Regulators                         NPL loss absorption
    (deposits)                                                                                                       (borrowing)

Traditional commercial banks (intermediated)
                            Deposit taking banks, group finance companies and financial leasing companies, take                            CBRC/PBOC on CAR, L/D,
    Households/                                                                                                      Households/                                                Banks recover/restruture NPLs, and
                                                                   deposits,                                                               RRR, NPLs, lending
    Corporations                                                                                                     Corporations                                               use profits to absorb losses
                                                           originate and hold loans                                                        standards, etc

Shadow Banking activities

1. Non-intermediated

                                                                Informal loans                                        Individuals/                                              Lenders bear the losses.
       Individuals
                                                                                                                      Corporates           1. No regulators on specifc
                                                                                                                                           activities
                                                               Entrusted loans                                                             2. Interest rate cap at 4x of
                                                                                                                                                                                Lenders bear the losses. But
       Corporates                                                                                                     Corporates           PBOC's benchmark rates
                                                       Corporates lend to each other;                                                                                           banks may be hurt given the cross-
                                                      Banks work as book entry entities                                                                                         lending of corporate

2. Intermediated

                                                                                                                                           CBRC has some capital
 Qualified individual                                           Trust products
                                                                                                                                           requirements (50X+ leverage
     investors/                                   Trust companies structure/package loans,                            Corporates
                                                                                                                                           on AUM/equity) and product
    Corporates                                       equity investment, mezzanine debts                                                                                         Legally trust companies and banks
                                                                                                                                           marketing regulations
                                                                                                                                                                                are not liable for NPL loss for trust
                                                                                                                                                                                and WMPs, but in practice, they may
       Individuals/                              Banks Wealth Management Products (WMP)                                                    CBRC has some product                be asked to pay customers' loss
                                                                                                                      Corporates                                                after recovering the assets given
       Corporates                                   Banks package and securitize loans                                                     marketing regulations
                                                                                                                                                                                social stability concerns


                                                                                                                                           CSRC has some capital                For banks' loan securitization
       Individuals/                                           Brokers' WMP                                                                 requirements (50X+ leverage          through brokers' WMP, brokers
                                                                                                                      Corporates
       Corporates                     Brokers package and securitize loans, usually under banks' request                                   on AUM/equity) and product           expect banks to provide implicit
                                                                                                                                           marketing regulations                liquidity support


                                                                                                                                           Prior approvals from NDRC,           Investors should bear the loss
       Individuals/                                          Corporate bonds
                                                                                                                      Corporates           CSRC, PBOC; disclosure               though some local government
       Corporates                        Brokers/banks as underwriters to help corporate issue bonds
                                                                                                                                           requriement                          tends to bail-out local SOE debts


Source: Gao Hua Securities. Special thanks to Ning Ma and team.




The complex relationship between traditional banks and shadow banking

                                 WMPs                      Formal banking and shadow banking sectors very inter-related,                                  Corporate bonds
                                                               but formal banking might end up bearing a lot of risk
                        •   Assets: RMB 7.1 TRN                                                                                                      •     Size: RMB 7.0 trn
                        •   Credits: RMB 1.8 trn            • Deposits shift back and                             • Banks and their WMPs
                                                              forth between traditional                             bought about 52% of
                                                              banks and WMPs                                        corporate bonds issued
                                                            • WMPs securitize loans                               • Banks underwrite a
                                                              as a channel to banks                                 significant portion of
                                                            • WMPs generate fee                                     corporate bonds
                                                              income for banks


                                                                                     OFFICIAL BANKING SYSTEM

            Informal loans                   • Informal loans work as            •   Assets: RMB 131 trn                             • Entrusted loans work as                 Entrusted loans
   •      Size: RMB 4.5 trn                    bridge loans of SMEs/             •   Loans: RMB 67 trn                                 bridge loans of                     •   Credits: RMB 5.7 trn
                                               property firms to repay/                                                                corporates to repay/
                                               rollover bank loans               •   Banks, group financing companies,                 rollover bank loans
                                                                                     financial leasing firms




                                                            • Banks distribute trust                              • Brokers securitize
                                                              and make fee income                                   loans as a channel to
                                                            • Trust companies                                       banks
                                                              securitize loans as a
                            Trust companies                   channel to banks
                                                                                                                                                         Brokers’ asset mgmt.
                        •   AUM: RMB 7.0 trn                                                                                                          •    Credits: RMB 1.0 trn
                        •   Credits: RMB 5.3 trn


 Note: As of End-2012.
 Source: Gao Hua Securities. Special thanks to Ning Ma and team.
Lending to local governments and corporate sectors with overcapacity = highest risk
Credit matrix as of end-2012; red = highest risk; out of non-LGFV corporate bank loans, only lending to overcapacity sectors is highest risk
End of 2012, Rmb bn               Central gov't     Local gov't     Financial        Consumers      LGFV       Non-LGFV      Total      As % of    5-yr CAGR
Financing approach                                  municipal      institution                                 corporate                   total       (08-12)
Bank loan                                     -              -                             11,398     9,200         46,692    67,290       56%           19%
Bank acceptance bill                          -              -               -                -                      5,895     5,895        5%           45%
Bond                                        7,810            650           9,017              -       2,543          4,344    24,364       20%           21%
Trust loan                                    -              -               -                -       1,650          3,774     5,424        4%           85%
Entrust loan                                  -              -               -                -       1,138          4,551     5,689        5%           43%
Informal lending +micro lending               -              -               -              1,368       -            3,193     4,561        4%           19%
Bank restructuring debt                     3,137             -                  -            -            -           -        3,137       3%            6%
Others                                        -               -                  -            -            -         4,313      4,313       4%
Total                                      10,947            650           9,017           12,766    14,531         72,762   120,673
As % of total                                  9%             1%              7%              11%       12%            60%
                                        China corporate leverage on the high side
                                                        (Corporate debt as a % of GDP, 2012)

200


160


120


 80


 40


   0




 Note: Partly shaded portion represents LGFV debt
 Source: BIS, CEIC, Goldman Sachs Global ECS Research. Special thanks to Andrew Tilton and team.


               China corporate leverage still on the rise, other debt more stable
                                   (Credit/GDP, 2000 to 2013E)
                                                                                                                219      Informal lending
                                                                                                        209     7.0
210                                                                                                     7.1              Loans made by HK banks
                                                                                        195     194
                                                                                                                         Micro lendings
                                                                                        9.0     8.5
                                                                                181
                                                                                                                         Credits in brokers' AM business
180                                                                             7.0
                                                                                                                         Trust loans not in PBoC data
                                161
                                        156     155
                                8.2                      154    153     153                                              Pawnshop loans
                        149             8.9     7.4
150                                                      7.3    6.9     8.7
                138     7.6                                                                                              Bank acceptance
       135
                7.2
       7.0                                                                                                               Entrust loans

120
                                                                                                                         Trust loans in PBoC data
                                                                                87      85
                                                                                                        90      91
                                                                                                85                       ABS
                                103             87
                                        94               85     78
                        98                                              75
 90                                                                                                                      Medium-term notes
                95
       101                                                                                                               Corporate bonds

                                                                                                                         Corporate loans (excl. LGP loans)
 60                                                                                     22.7
                                                                                22                      17.7    16.9
                                                                                                19.0                     Convertibles
                                                13              14      15
                                        11               14
                                10                                                      7.8             6.0     5.3
                        8.9                                                     9.2             6.6
                                                12.9            9.0     10.0                                              LGP loans
                7.3             9.6     10.6            11.0                                                    17.4
 30                                                                                     19.4            17.7
        0.0             10.8                                                    19.6            17.9
                11.9                                            20.6                                                     NPLs carved out for bank
       13.1                     15.5    15.1    18.7    17.2            18.1                                             restructuring
                        13.6
                10.0                                                                            18.8    20.0    23.0     Government bonds
       9.2                                                                      15.6    18.7
                        8.9     11.6    12.4    11.9    11.1    12.3    11.9
       4.3      6.4
  0                                                                                                                      Consumer loans
                                                                                                                 2013E
        2000

                 2001

                         2002

                                 2003

                                         2004

                                                 2005

                                                         2006

                                                                 2007

                                                                         2008

                                                                                 2009

                                                                                         2010

                                                                                                 2011

                                                                                                         2012




                                                                                                                         Total loans and debt as % of GDP

Source: PBOC, Wind, Gao Hua Securities Research estimates. Special thanks to Ning Ma and team.
Close, commodity-producers most vulnerable
Exports to China, % of local GDP

       16
       14
       12
       10
        8
        6                                                                                                                                             Low inflows
        4
        2                                                                                                                                             12-month rolling portfolio inflows, USD bn
        0                                                                                                                                                      400
                                                                                                                                Mexico
                                                    Germany
                                                              EM




                                                                                                 Canada
                                            Japan




                                                                            Brazil
            Korea
                    S. Africa
                                Australia




                                                                                     Euro Area




                                                                                                                           US




                                                                                                                                                 UK
                                                                                                                                         Italy
                                                                   Russia




                                                                                                          India
                                                                                                                  France




                                                                                                                                                                       12-month rolling portfolio inflows
                                                                                                                                                               350                             CEEMEA

                                                                                                                                                               300                             Latam

                                                                                                                                                               250                             EM Asia ex-China

                                                                                                                                                               200                             China

                                                                                                                                                               150                             Total EM

                                                                                                                                                               100

                                                                                                                                                                50

                                                                                                                                                                 0

                                                                                                                                                                -50

                                                                                                                                                               -100

                                                                                                                                                               -150
                                                                                                                                                                      00    01    02     03     04     05   06    07   08   09   10   11   12   13
    




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
                                                            Tight financial conditions = weak construction activity
                                                            Index (lhs), China property new starts - % change yoy (rhs)
                                                               106                                                                 120%
                                                                     Tightening financial conditions
                                                               105                                                                 100%

                                                               104                                                                 80%

                                                               103                                                                 60%

                                                               102                                                                 40%

                                                               101                                                                 20%

                                                               100                                                                 0%

                                                                99                                                                 -20%

                                                                98                                                                 -40%

                                                                97                                                                 -60%

                                                                96                                                                 -80%

                                                                95    Loosening financial conditions                               -100%

                                                                94                                                                 -120%
                                                                     Jan-05
                                                                     May-05
                                                                     Sep-05
                                                                     Jan-06
                                                                     May-06
                                                                     Sep-06
                                                                     Jan-07
                                                                     May-07
                                                                     Sep-07
                                                                     Jan-08
                                                                     May-08
                                                                     Sep-08
                                                                     Jan-09
                                                                     May-09
                                                                     Sep-09
                                                                     Jan-10
                                                                     May-10
                                                                     Sep-10
                                                                     Jan-11
                                                                     May-11
                                                                     Sep-11
                                                                     Jan-12
                                                                     May-12
                                                                     Sep-12
                                                                     Jan-13
                                                                     May-13
                                                                                 GS China FCI          China property new starts




All about China
Change in world copper demand over the past decade, ‘000t
   6000


   5000


   4000


   3000


   2000


   1000


      0


   -1000


   -2000
                    China                      Ex-China
  PBOC:                                    USD cash                      Onshore bank: D
  the last resort for                                                 Onshore USD LC provider
                                         CNY deposit                  (bank registered onshore
                                                                        serving B as a client)
                                                                                                                                              The issuance of LC from D
                                                                                                                                              and the swap of USD for
                                                                  USD         USD           CNY                                               CNY between B and D is
                                                                                                                                              now being targeted by
                                                                                                                                              SAFE's new regulations.
                        Offshore trader A sells warrant of                                                                          Onshore entity B sells and re-exports the copper by
       ①                                                                 Onshore entity B:
                                                                                                                   ②
                        bonded copper (copper in China's                                                                            sending the warrant documentation (not the physical
                                      Copper
                        bonded warehouse that is exempt                                                                             copper which stays in the bonded warehouse
                        from VAT payment before customs
                                      warrant                         Demander of financing deals                                   'offshore') to the offshore subsidiary C (N.B. B owns
                        declaration) or inbound copper (i.e.                                                                        C), and C pays B USD or CNH cash (CNH =
                        copper on ship in transit to bonded) to       (typically an onshore trading                                 offshore CNY). Using cash from C, B gets bank D to
                        onshore party B (i.e. B imports copper
                        from A) for price X and A is paid USD
                                                                           house, consumers)                                        convert the USD or CNH into onshore CNY, and
                                                                                                                                    trader B can then use CNY as it sees fit.
                        LC, issued by onshore bank D.
                                           Copper                                         Copper
                                           warrant                      USD               warrant                        USD cash
Onshore
Offshore
                                                                                Copper
                                                                                warrant
                   Offshore entity A:                                                                                          Offshore entity C:
                    Owner of copper in                                                                                                 B's offshore
                    bonded warehouse                                                                                                    subsidiary
                   (typically an offshore                                      USD cash
                       trading house
        Repeat Steps 1 - 3 as many times as possible during the                           Offshore subsidiary C sells the warrant back to
4       period of the LC (usually 3-12 months). This could be 10-
        30 times with the limitation depending on the time it takes
        to clear the paperwork. So, total notion LCs issued for a
        particular tonne of copper would be 10-30 times the value
                                                                                ③         A (again, no move in physical copper which
                                                                                          stays in the bonded warehouse 'offshore'), and
                                                                                          A pays C USD or CNH cash with a price of X
                                                                                          minus $10-20/t, i.e. a discount to the price sold
                                                                                          by A to B in Step 1.
        of the physical copper involved.
China capital market in perspective                                                                 Surprising spike


 Sector          Bank            Stock            Fixed        Insurance             Asset          20                                                                                                                20
                                                                                                                                         In a break from past
                 Credit                          Income                              Manag.                                              patterns, the PBOC did not
                                                                                                                                         step in to inject liquidity
                                                                                     Comp.

 Size                                                                                               16                                                                                                                16

 (China)            10.7            3.7             3.4              1.2               0.4
 Size                                                                                               12                                                                                                                12
 (US)               7.6            18.7              38              4.8                36                                                                                                 The PBOC stated its
                                                                                                                                                                                           intention to maintain
                                                                                                                                                                                           sufficient interbank
 % GDP                                                                                                                                                                                     liquidity, calming the
                                                                                                                                                                                           markets
 (China)         128%              44%             41%              14%                5%            8                                                                                                                8

 % GDP
 (US)               48%            118%            240%             32%              230%
                                                                                                     4                                                                                                                4
                                2,                                                     Q1
 No te: A ll values end year 201 except fo r Chinese B ank Credit, which are thro ugh 1 3.



                                                                                                      0                                                                                                               0
                                                                                                    4/15/2013 4/26/2013 5/13/2013 5/24/2013                 6/6/2013       6/21/2013           7/3/2013




Large companies levering; small companies de-levering                                               Bond financing flying


8                                                                                                   30,000
                                                                    Largest quintile                                LGFV bonds
                                                                                                                    Corporate bonds (ex. LGFV bonds)
                                                                    Second quintile                 25,000
6                                                                                                                   Financial bonds
                                                                                                                                                                                                                    3034
                                                                                                                                                                                                             2921
                                                                    Third quintile                                                                                                                    2543
                                                                                                                    Government bonds                                                           2088
                                                                                                                                                                                        1770
                                                                    Fourth quintile                 20,000                                                                       1547
4                                                                                                                                             1351                        1351
                                                                                                                                                                   1189
                                                                    Smallest quintile                                                                       1166
                                                                                                                                        944          1079
                                                                                                    15,000
                                                                                                                                  621
2
                                                                                                                            254
                                                                                                    10,000
0
     2001    2002    2003   2004    2005    2006    2007    2008    2009    2010      2011   2012
                                                                                                     5,000

-2
                                                                                                         -

-4




Where we go from here: “proactive” or “forbearance”?
Policy              Associated policy moves may include                                                  Max potential            Policy implications to growth, equities and
Strategy                                                                                                 credit loss est          credit markets
Proactive           Prudent monetary policy/decelerating credit growth                                   Rmb 9trn                 Cyclical pressure, more sustainable long-term
                    Regulate shadow banking closely/pre-emptively                                        (~10% of GDP)            Weaker equities during transition; re-rating long-term
                    Fiscal / SOE reforms; interest rate deregulation                                                              More credit differentiation between strong/weak
                    Set up AMCs; prevent moral hazard/improve awareness


                    Likely path:                                   Proactive bias interspersed with periods of forbearance


Forbearance Monetary policy based on near-term inflation outlook                                         Rmb 19trn                Delay the issues in favor of cyclical stability
                    Enforce existing rules; deal with current problems                                   (~21% of GDP)            Stable equities short-term but limited re-rating
                    Roll over loans/restructure when needed                                                                       Credit market muddle through
                    Lower interest rates to alleviate pressures
                             GDP Growth (% yoy)                                 FX                                       Equity                            Rates (% eop)                                   Revision Notes

                             2013                2014               3-mth                 12-mth             3-mth                    12-mth            Policy            10-yr
                       GS       Cons       GS       Cons      GS       Cons          GS       Cons      GS      Cons          GS          Cons     2013     2014     2013     2014



     Global            2.9          3.0    3.8          3.7     -           -         -            -     -           -            -            -    -            -    -            -



                                                                    EUR/$                 EUR/$              SP500                    SP500


                                                                                                                                                                                       Annual GDP revisions coupled with weak growth so far this
       US              1.5          1.8    2.9          2.7   1.34      1.29         1.40     1.26     1700     1673         1825         1750     0.13     0.13     2.75     3.25
                                                                                                                                                                                       year have weighed on 2013 yoy GDP growth estimates.


                                                                    EUR/$                 EUR/$        Eurostoxx 50          Eurostoxx 50



 EURO AREA            -0.6       -0.6      0.8          0.8   1.34      1.29         1.40     1.26     2900     2845         3150         2977     0.50     0.50      -            -



                                                                    EUR/$                 EUR/$              DAX                       DAX



   GERMANY             0.2          0.4    1.9          1.6   1.34      1.29         1.40     1.26       -           -            -            -    -            -   1.80     2.00



                                                                    $/CNY                 $/CNY              HSCEI                    HSCEI



     CHINA             7.4          7.5    7.7          7.6   6.16      6.14         6.16     6.07       -           -      10200              -   6.00     6.25      -            -



                                                                    $/BRL                 $/BRL         BOVESPA               BOVESPA
                                                                                                                                                                                       On July 12 we revised our $/BRL forecast weaker given
                                                                                                                                                                                       increasing cost competitiveness issues, a gradually
                                                                                                                                                                                       deteriorating current account position, and so far little
     BRAZIL            2.3          2.5    2.8          3.2   2.30      2.19         2.35     2.23       -           -            -            -   9.25     9.25      -            -   impact of intervention measures aimed at containing the
                                                                                                                                                                                       weakening trend in the face of poor domestic
                                                                                                                                                                                       sentiment driven by weak fundamentals and, more recently,
                                                                                                                                                                                       by heightened political and social uncertainty.
                                                                    $/JPY                 $/JPY              TOPIX                    TOPIX



     JAPAN             2.0          1.9    1.5          1.5   105       102          110      107      1250          -       1400              -   0.10     0.10     1.00     1.25



Commodities               Brent crude oil ($/bbl)                      Copper ($/mt)                               Gold ($/toz)                              Corn ($/bu)                                   Revision Notes

                          3-mth              12-mth                 3-mth                 12-mth             3-mth                    12-mth            3-mth             12-mth
                       GS       Cons       GS       Cons      GS       Cons          GS       Cons      GS      Cons          GS          Cons     GS       Cons     GS       Cons



                      105       105       105       106       7000          -        6600          -   1300          -       1175              -   4.75          -   4.75          -



Note: Recent revisions marked in red; GDP consensus is Consensus Economics, all other consensus is Reuters, commodity 12-mo consensus is Reuters for 2014 average.
Source: Goldman Sachs Global Investment Research.
Disclosure Appendix
Reg AC




Global product; distributing entities




General disclosures

				
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