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The Latest Business Trends in China

8 April 2013

By: Montgomery Ho, Head of Commercial Banking, HSBC China

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China in a nutshell

1.3 Billion People

2nd Largest Economy (GDP of USD8.3tm after USA of USD15.7tm in 2012)

$3 Billion International Trade

(2nd largest USD3.80bn after USA of USD3.96bn in 2012)

2nd Largest Foreign Direct

Investment (FDI) recipient in 2012

2nd Outward Direct Investment

(ODI) source in 2011* * 2nd ODI source when combined with Hong Kong

Source: CIA Factbook; National Statistic Bureau; International Monetary Fund; UNCTAD

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China’s Economic Growth

Source: CEIC China Premium Database

%

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Looking ahead - China’s 12th Five Year Plan (2011-2015) Key Themes

Overseas development and “Going out”

1. Encourage and support mainland Chinese companies in “Going out”

2. Renminbi (RMB) internationalisation3. Role of Hong Kong / Taiwan

Transform China’s economic growth model to focus on quality,

balanced and sustainable growth

Drive domestic demand

1. Stimulate consumption through income growth

2. Establish better social safety net

A

B

CD

E

Structural reforms

1. State-owned enterprise (SOE) reform

2. Financial market reform

Lower carbon intensity and green growth

1. Cultivate the Emerging Strategic Industries (ESIs)

2. Industry upgrading, improve energy and emission efficiency

3. Accelerate development of service sectors

Urbanisation and regional development

1. Accelerate urbanisation and regional development

2. Improve agriculture / rural infrastructure and rural income

Source : China Parliament, National People’s Congress

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China’s Top 15 Foreign Direct Investment (FDI)

Source : CEIC China Premium Database Source

Ranking FDI into China by Countries

USD million

Foreign Direct Investment into China

2010 2011 % Change

1 Hong Kong 60567 70500 +16.4

2 Japan 4084 6330 +3.7

3 Singapore 5428 6097 +1.1

4 Korea 2692 2551 -0.2

5 United States 3017 2369 -1.1

6 Taiwan 2476 2183 -0.5

7 Germany 888 1129 +0.4

8 France 1238 769 -0.8

9 Netherlands 914 761 -0.3

10 Macau 655 680 +0.0

11 United Kingdom 710 582 -0.2

12 Switzerland 261 555 +0.5

13 Canada 635 468 -0.3

14 Italy 396 388 0

15 Malaysia 294 358 +0.1

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The Regional Economic Hubs

Source: National Bureau of Statistics of China

RegionsPearl River

DeltaYangtze

River DeltaBohai Rim

Western China

9 cities in Guangdong

Including Shanghai

Including Beijing & Tianjin

Including Chongqing / Chengdu /

Xi'an

Population 2011 million

105 157 246 362

GDP per capita 2011 (USD)

7,524 9,515 7,216 4,111

Main Economic Themes

Traditional manufacturing

Heavy industrial

Petrochemical, automobiles, steel

Heavy manufacturing

Economic integration with Hong Kong; CEPA

Shanghai: An int'l financial & shipping centre by 2020

Beijing : China's domestic financial centre

Mining

Progressing up the value chain to cover R&D, high tech, financial services, education and medical

Progressing up the value chain to cover high tech.

Key source of “Going Out” activity

-Tourism & agriculture-Emerging manufacturing

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China’s Top 15 Outward Direct Investment (ODI)

RankingODI from China by

Countries

USD million

Overseas Direct Investment from China

2010 2011 % Change

1 Hong Kong 38505 35654 -7

2 France 26 3482 +13292

3 Singapore 1118 3268 +192

4 Australia 1701 3165 +86

5 United States 1308 1811 +38

6 United Kingdom 330 1419 +330

7 Luxembourg 3207 1265 -61

8 Sudan 30 911 +2937

9 Russia 567 715 +26

10 Iran 511 615 +20

11 Indonesia 201 592 +195

12 Kazakhstan 36 581 +1514

13 Kampuchea 466 566 +21

14 Canada 1142 554 -51

15 Germany 412 512 +24

Source : CEIC China Premium Database Source

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Majority of China enterprises have the intention to expand their business overseas

Considerations for expanding to overseas Convenience for foreign trade (69%)

Expansion of sales/networks (59%)

Brand image improvement (46%)

Effectiveness of introducing products into new markets (40%)

Existing locations of the overseas offices

Asia

North America

US

Europe

Africa

South America

Oceana

85

24

22

22

15

14

12

Chosen for its lower trade barriers, investment incentive and favorable political environment

Chosen for its tremendous market potential, advanced technologies and strong R&D

Source: China Enterprise “Going out” Survey (4Q2012) with N=250 companies interviewed

%

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Whilst low price is main advantage for overseas competition, economic slowdown becomes the major concern for carrying out expansion plans

Low price

Advanced technology/ production line

Strong cash flow

50

40

40

Source: China Enterprise “Going out” Survey (4Q2012) with N=250 companies interviewed

Strengths for overseas competition

%

Fluctuation of local currency’s

exchange rate

Slow economic development

Intense competition from

local players

48

46

42

Top 3 challenges for overseas expansion

%

Major strengths and challenges for expanding overseas business in US

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Most companies appear to be optimistic about the growth on revenue from their US offices in the next three to five years

18

11

9

18

29

11

2

4

18

51

Expected contribution in next 3-5 years Current contribution

20% and above

15%-20%

10%-15%

5%-10%

Below 5%

Source: China Enterprise “Going out” Survey (4Q2012) with N=45 companies with branches in US

Increasing contribution from US offices to the revenue

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A global trade currency A global investment

currency

A global reserve currency1 2 3

China’s Currency Renminbi (RMB) Internationalisation – 3-phase Path

By the 2020s, HSBC expects RMB will be accepted across the world: 1) for investment, financing and payment purpose2) as a reserve, intervention and anchor currency 3) full RMB convertibility

Trade helps establish pools of RMB liquidity

worldwide

Investment and savings options make RMB useful

and attractive

Reserve use signals ‘arrival’ of RMB as a world

currency

Convertibility: RMB has been convertible under current account since 1996. It is partially convertible for certain capital items

Capital control: Gradual introduction of RMB FDI and ODI

Exchange rate: A managed float system pegged to a currency basket, becoming progressively more market sensitive

Trade and investment legs support each other

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Payables and Receivables

Asset and Liabilities

Foreign Exchange Cost Currency fluctuation premium Administrative Process

Customer Base Currency portfolio Risk Exposure

SAVE

HEDGE

DIVERSIFY

GAIN Potential RMB

Appreciation Onshore / Offshore

Investment Returns Importer/Exporter

Relationship

Potential Benefits of RMB Trade Settlement

Customers switching to RMB may reap various benefits, which will depend on their trading role and commercial bargaining power.

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1. Trade payments for goods

Mainland enterprises with import and export qualifications may export goods in RMB

2. Trade payments for services

Allowed (contract and invoice in RMB required)

3. Intercompany loans

Allowed subject to SAFE filing

4. Additional Capital Infusion

Allowed subject to MOFCOM approval

5. Foreign Direct Investment (FDI)

Allowed subject to MOFCOM approval

6. Expatriates Salaries

Not Allowed

1. Trade payments for goods

Mainland enterprises with import and export qualifications may import goods in RMB

2. Trade payments for services

Allowed (contract and invoice in RMB required)

3. Intercompany loans

Case-by-case approval by PBOC/SAFE

4. Capital investment overseas (ODI)

Allowed subject to MOFCOM approval

5. Dividend Payments / Repatriation of Profit

Allowed

6. Expatriates Salaries

AllowedOverseas-to-overseas RMB transactions are not regulated by People’s Bank of China (PBOC),

but may be subject to the local regulations elsewhere

PAYMENTS INTO THE MAINLAND PAYMENTS FROM THE MAINLAND

Mainland ChinaRMB Area

Permitted RMB Cross Border Flows

RMB cross-border flows are permitted for a growing range of purposes

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Contacts at HSBC China

Calvin MAN

Head of International Business, Commercial Banking, HSBC Bank (China) Company Limited

Email: calvinman@hsbc.com.cn

Jason HUCK

SVP & Head of North America & LATAM, Commercial Banking, HSBC Bank (China) Company Limited

Email: jason.a.huck@hsbc.com.cn

International Banking Centre

Email: china.cmb.ibc@hsbc.com.cn

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Disclaimer

This presentation is not intended as an offer of solicitation for business in the United States of America. The purpose of this presentation is to provide factual

information on China for corporate clients operating in or have an office operating in China, or for clients who wish to expand their operations into China.

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Questions?

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Appendices

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HSBC in China

Established in Hong Kong and Shanghai in 1865: a continuous presence in mainland China for 148 years

In April 2007, HSBC completed locally incorporation in China with HSBC Bank (China) Company Limited becoming a “local” bank

The largest and most active international banks in China .

Over 5,000 employees (Feb13), over 99% recruited locally and international staff from 15 different countries.

Registered Capital: RMB12.4billion, one of the highest for a foreign bank in China

Moody’s Rating: Foreign and local currency deposit and issuer ratings are A2/Prime 1 (as of Jun12)

One of the largest investors in China in the growth of its own operations and selective local financial institutions, including a 19% stake in Bank of Communications, an 8% stake in Bank of Shanghai.

Provides RMB banking services to corporate customers in 45 mainland cities. Our network in mainland China comprises 144 outlets. (as of Feb13)

All of our branches and sub-branches can provide RMB and FCY services.

The Leading Foreign Bank in China

IFC Shanghai, HSBC China Headquarters since April 2011

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Shenzhen

Guangzhou

Beijing

Suzhou

Tangshan

Jinan

Qingdao

Nanjing

Zhangjiagang

ChangshuKunshan

QingyuanShaoguan

Huizhou

Chaozhou

Shantou

ZhuhaiZhongshan

Foshan

ZhaoqingJiangmen

ZhanjiangMaoming

Heyuan

Yangjiang

Bohai Rim and Northeast China

Yangtze River Delta Pearl River Delta and South ChinaCentral Region of China

West China

Shanghai

Dalian

Hangzhou

Shenyang

Xi’an

Chengdu

Chongqing

Wuhan

Xiamen

Changsha

Ningbo

Zhengzhou

Taiyuan

Hefei

Tianjin

Harbin

Kunming

Wuxi

Nanning

HSBC China has 144 outlets across 45 cities in 21 provinces / municipalities

HSBC China – Largest network among foreign banks

144115 99

53 46

0306090

120150180

HSBC BEA SCB Citi HACN

Tota

l bra

nch

num

bers

Total branch numbers in China as at end-FEB13

Panyu

Panyu

Dongguan

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Awards for Excellence in China

Best Foreign Bank in China2001-2006, 2008-2011

Best Foreign Retail Bank in China 2009-2013

Best Risk Management Bank in China 2010-2012

Best Cash Management Bank in China 2010-2012

Best Trade Finance Provider in China 2011

Best Domestic Cash Management Bank in China 2011

Best Sub Custodian in China2012

Best International Trade Bank in China 2008-2009, 2011

Best Foreign Private Bank in China 2011-2012

Rated China No. 1 Leading Clients Top-rated Agent Bank 2009-2012

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China’s 7 Key Industries Under the 12th Five-Year Plan

Emerging Strategic Initiatives

Main policy content

Energy-saving and

environmental protection

Develop high-efficiency, energy-saving technical equipment and products.Develop recycling of industrial resources and improve the overall use of resources. Play a leading role in promoting environmental protection equipment and raise standards for pollution control.Promote commercialization of energy-saving environmental protection services.

Next generation information technology

Speed up construction of an integrated and safe broadband information networkExtend R&D into next-generation mobile communication and next-generation internet equipment.Develop technologies such as digital virtualization and promote development of cultural creativity.

Bio-technologyDevelop innovative areas of medicine such as biological medicine, new vaccines, diagnosis agents, Western medicine and modern Chinese herbal medicine.Promote green agricultural products and further the development of biological agriculture.

High-end manufacturing

Strengthen and expand the aviation industry. Promote construction of space infrastructure and the development of the satellite industry. Develop rail transportation. Develop ocean engineering equipment for exploration of ocean resources.

New energyDevelop new-generation nuclear energy technology and advanced reactors. Promotion and application of solar thermal energy. Further large-scale wind power development.

New materialsDevelop new materials such as rare earth, high-performance membranes, special glass, functional chinaware and semiconductor illumination materials. Actively develop new structural materials such as high-quality special steel and engineering plastics.

Clean-energy vehicles

Promote the use of plug-in hybrid-power vehicles and battery-only electric vehicles. Develop high-efficiency, low-emission, energy-saving automobiles.

Source : HSBC Global Research

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Theme A: Lower carbon intensity and green growthObjectives Government plan Outlook

*ESCOs is a commercial business providing a broad range of comprehensive energy solutions. The ESCOs also install the required elements and maintain the system to ensure energy savings during the payback period. The business grew in the late 1970s at the peak of the energy crisis in the US. Carrier, Chevron and Honeywell are example of players which have entered the market.

Source: HSBC Research and The Climate Group “Delivering Low Carbon Growth: A Guide to China’s 12 th Five Year Plan”, MAR11

1. Cultivate the Emerging Strategic Industries (ESIs)

Seven emerging strategic industries (ESIs) will be the primary drivers of a new phase of economic growth and lower carbon intensity for the 12 th FYP:

1. Energy-saving and environmental protection

2. Next generation information technology

3. Bio-technology

4. High-end manufacturing

5. New energy

6. New materials

7. Clean-energy vehicles

Target to increase the share of these sectors from 3% of GDP in 2009 to 8% in 2015, and 15% in 2020.

The State Council outlined various measures to promote the development of the ESIs:

i. Make funding including bank credit and land more easily accessible to investment in these industries.

ii. Increase government spending in these areas, via R&D spending, providing necessary infrastructure support, and providing tax incentives.

iii. Provide incentives by changing the price structure and setting industrial standards and quotas to direct development.

HSBC forecasts that the global climate business market could be worth USD 2 trillion by 2020.

Based on government’s targets, HSBC estimates the size of the ESIs to grow to RMB 5 trillion (USD 751 billion) by 2015 - CAGR of 35% for next 5 years - and to RMB 15 trillion (USD 2.3 billion) by 2020 – CAGR of 29% for the next decade.

HSBC estimates the ESIs will require about USD 800 billion in investment by 2015. Local media reported that the government may set an investment target of RMB 10 trillion (USD 1.5 trillion) in public and private investment including financial incentives and subsidies. The government has since refuted such claims.

Detailed policies with specific targets and guidance across sectors will be released overtime. Provincial energy-intensity reduction targets will also be issued.

Possible market mechanisms for low-carbon initiatives include:

- Proposed energy-trading market as an alternative to centrally-set prices for oil, gas and electricity.

- Fiscal measures / subsidies that use taxation and pricing to pursue environmental and energy goals.

- Establish Energy Service Companies (ESCOs)* to provide energy-efficient services to industries.

- Sector-specific and economy-wide carbon trading schemes.

- New energy quota system for energy-intensive industries and power companies alike.

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Theme A: Lower carbon intensity and green growthObjectives Government plan Outlook

2. Industry upgrading; Improve energy and emission efficiency

Technological upgrade via automation and better equipments, more spending on R&D both by the government and corporate sector.

Speed up consolidation to eliminate industry overcapacity (e.g. coal, cement), cut back on high pollution and energy consuming sectors.

Deepen reform of resource pricing and environmental protection charges to establish a resource products pricing mechanism reflecting market supply and demand, resource scarcity and environmental costs.

Achieve new energy targets of lower energy consumption and reduced pollutant emissions by 2015 (from 2010).

- Energy consumption per unit of GDP to fall by 16%

- CO² emission volume to fall by 17%

- Non-fossil fuels in primary energy consumption to increase by 11.4%

- Total discharge of major pollutants fall by 8%

Overall, the low-carbon tilt of the 12th FYP will have two major implications:

i) More efficient industrial energy use:

- Production growth in energy-intensive industries (e.g. metals, cement and chemicals) are likely to slow as overcapacity is eliminated.

- Stricter compliance with energy efficiency measures will promote consolidation among leading players in metals (e.g. steel, non-ferrous metals) and the cement sector will benefit the most.

i) Renewable energy sector will exceed government targets:

- By 2015, coal will fall as share of primary energy from 70% to an estimated 63% and the coal industry will also see more consolidation (from 11k enterprises in 2010 to 4k in 2015e).

- Gas consumption will increase, rising from 4% to 8% by 2015, and will slowly be a viable substitute for coal and oil.

- Renewable energy (wind, nuclear, solar and biomass) is expected to expand significantly to meet the target of 15% share of primary energy by 2020, from 7% in 2010.

Source: HSBC Research, “Decarbonising China’s Growth”, MAR11

3. Accelerate development of service sectors

The government will allow and encourage private sector entry in all service sectors including health care, tourism, utilities, culture and entertainment, and logistics.

Aim is to raise the share of services sector to GDP from 45% to 47% by 2015.

Consulting company APCO Worldwide identified the following service sectors poised to benefit: i) Education (domestic and overseas); ii) Health care (bio-tech, health care system, pharmaceuticals); iii) Technology (R&D, Intellectual Property Rights)

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Theme A – Appendix I: Market mechanisms for energy efficiency and low-carbon energy

Proposed energy-trading market as an alternative to centrally-set prices for oil, gas and electricity

Small changes to align energy and electricity prices are gradually being put in place to improve the efficiency of electricity supply. A proposed ‘price ladder’ approach to address the demand of electricity consumers under consideration by the NDRC would set consumer prices for different levels of energy consumption, in an effort to regulate residential energy demand and encourage efficiency.

Fiscal measures / subsidies that use taxation and pricing to pursue environmental and energy goals

The introduction of fiscal reform measures that use taxation and pricing in pursuit of environmental and energy goals is also set to be gradual. The initial focus is likely to be on increased subsidies and tax breaks for industries meeting energy-intensity targets. Also under consideration are gradual price increases for electricity, natural gas, water and fossil fuels to reflect social and environmental impacts.

Establish Energy Service Companies (ESCOs) to provide energy-efficient services to industries

ESCOs use performance-based contracts with client firms to implement energy-efficiency measures, deriving revenue from the resulting cost savings. The ESCO sector is still nascent in China and dominated by a handful of companies that have hitherto been unable to meet the needs of small and medium enterprises (SMEs) in the energy-intensive industries. An ESCO policy was established in APR10, setting tax breaks to encourage growth in the sector.

Sector-specific and economy-wide carbon trading schemes

China is currently assessing the relative benefits of sector-specific and economy-wide carbon trading schemes with an eye on EU experience.

Carbon trading schemes are expected to be carried out in 3 domestic pilot areas: i) Select low carbon pilot regions (there are currently five nationally-recognized, low carbon provinces and eight low carbon cities*). Guangdong has already proposed a regional carbon-trading pilot in 11 of its cities; ii) Energy-intensive industrial sectors (such as electric power, chemicals and oil); and iii) SOEs.

*In JUL10, NDRC selected provinces of Guangdong, Liaoning, Hubei, Shaanxi and Yunnan and the cities of Tianjin, Chongqing, Shenzhen, Xiamen, Hangzhou, Nanchang, Guiyang and Baoding as National Low Carbon Economy Pilots.

New energy quota system for energy-intensive industries and power companies alike

The quota will be accorded by regions and will require energy intensive industries to acquire a certain percentage of electricity from new-energy sources, as well as power companies to meet a percentage of generation capacity from ‘new energy’.

Source: HSBC Research and The Climate Group “Delivering Low Carbon Growth: A Guide to China’s 12 th Five Year Plan, MAR11

The following market mechanisms are proposed in the 12 th FYP, aimed at complementing existing regulations and standards directed at its energy systems and carbon emissions, shifting from a centrally-driven system to one better shaped by market forces .

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Theme B: Overseas development and “Going out”Objectives Government plan Outlook

1. Encourage and support PRC companies in “Going out”

The government remains committed to helping PRC companies to “Go out” and “Go global” by:

- Supporting major PRC enterprises and financial institutions in their international expansion to be multinational.

- Supporting overseas R&D investment. Help promote the international standing of PRC brand and network.

- Continuing to promote cooperation in energy, mineral resources and agricultural sectors overseas.

- Improving the facilitation of overseas investment. Safeguard PRC investment overseas.

Outward non-bond investment by PRC companies was USD 69 billion in 2011.

They were targeted at emerging markets including Asia Pacific (27%), Latin America (16%), Africa (16%) (as well as Australia and Canada) due to concentration in energy and commodity related investments.

Future investments will follow government directive targeting commodity, energy and agriculture related investments. China’s investment in emerging markets should grow steadily.

More M&As are expected, and PRC investment will be increasingly welcomed in emerging markets, and depending on political climate, in developed economies.

2. RMB internationalisa-tion

The government has committed to expanding the use of RMB in cross-border trade and investment (RMB trade settlement was introduced in JUL09, a trial programme that allows qualified Mainland enterprises to use RMB in overseas direct investments was launched JAN11).

Other impetus derived from the 12th FYP that will contribute to RMB development:

- Interest rate liberalisaton

- Exchange rate reform

- Convertibility of RMB under capital account

(also refer to Theme C, section 2)

State Administration of Foreign Exchange (SAFE) Director Yi Gang indicated that the medium term strategy for the globalization of RMB is to achieve capital account convertibility on a progressive basis during the 12th FYP period. SAFE also aims to boost the use of RMB in trade and investment, and further develop its foreign exchange market.

Singapore aspires to be a second RMB offshore centre after Hong Kong. PBOC will appoint a PRC bank for RMB clearing in Singapore, allowing the country to have direct access to onshore RMB.

Source: HSBC STG Research, MOFOM

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Theme B: Overseas development and “Going out”Objectives Government plan Outlook

3. Role of Hong Kong / Taiwan

For the first time, the government included a dedicated chapter in the 12th FYP on the functions and position of Hong Kong:

- Consolidate and enhance Hong Kong's position as an international financial, trade and shipping centre.

- Develop as an offshore RMB business centre and an international asset management centre.

- Nurture emerging industries and develop the six industries (services, medical services, testing and certification services, environmental industries, innovation and technology, cultural and creative industries) where Hong Kong enjoys clear advantage.

- Deepen cooperation between Guangdong, Hong Kong and Macau, and promote regional development.

- Deepen the economic co-operation between Mainland China and Hong Kong through the Closer Economic Partnership Arrangement (CEPA).

On Macau:

- Support Macau as a centre for tourism and leisure.

On Taiwan and cross-straits economic relations:

- Deepen cross-Straits economic cooperation through the Economic Cooperation Framework Agreement (ECFA).

- Promote bilateral investment and strengthen cooperation in emerging industries, finance etc.

- Support the development of the Western Taiwan Straits Economic Zone.

Hong Kong

Continued support of Hong Kong’s positioning as offshore RMB centre, platform for Mainland enterprises “Going out”.

Significant growth of RMB deposits in Hong Kong and appetite for RMB-denominated bonds is indicative of demand and space for RMB product innovation.

People’s Bank of China (PBOC) Shenzhen has issued guidelines on RMB cross-border lending in Qianhai, effective 28DEC12. The new guidelines allow corporations registered in Qianhai to borrow RMB from Hong Kong banks for the purposes of developing Qianhai, with a reported aggregate lending quota of RMB 50 billion (USD 8 billion).

Taiwan

China Securities Regulatory Commission (CSRC) has announced a series of market entry and capital flow liberalisation policies in JAN13, including:

- Securities JV: Allow one full license securities JV with up to 51% Taiwanese ownership in each of Shanghai, Fujian and Shenzhen, with no business nature requirement on the Mainland partner;

- Allow one full license securities JV with up to 49% Taiwanese ownership in each of the (unspecified) pilot financial reform areas, with no minimum ownership and business nature requirement on the Mainland partner;

- Fund management JV: Allow Taiwanese institutions to own 50% or more of a fund management company JV in the Mainland;

- RQFII: Allow Taiwanese entities to invest up to RMB 100 billion (USD 15.9 billion) in Mainland capital markets under the RQFII scheme.

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Theme C: Structural reformsObjectives Government plan Outlook

2. Financial market reform

Deepen the reform of state-controlled financial institutions and improve corporate governance and risk management, establish deposit insurance scheme.

Accelerate the development of multi-layer financial market system. Increase the share of direct financing. Actively develop bond market and promote financial derivatives market development.

Improve financial control mechanism (in relation to managing liquidity), establish a sound early warning financial risk prevention system, and improve the monetary policy mechanism and environment.

Steadily promote interest rate liberalisation.

Improve managed floating exchange rate scheme. Expand overseas expansion of RMB and gradually achieve convertibility of RMB under capital account.

Improve regulatory supervision of financial sector.

Support for Shanghai to be an international financial centre (no further details / changes to existing policies in 12th FYP).

As domestic corporates and industries expand in scope and size, they will demand more diverse funding sources and complex products. China's financial system will have to move beyond traditional bank lending to more market-efficient equity / debt capital markets and private sources i.e. private equity.

PBOC Governor Zhou Xiaochuan has indicated that China’s interest rate will gradually be more liberalised for a more effective monetary policy. He envisages a lending environment where the best-run banks receive better interest rate pricing power than less efficient ones.

On the regulatory governance front, talk of creating a super-regulator responsible for supervising the entire financial services sector (in particular, the supervisory responsibilities will shift from PBOC to CBRC) has come and gone. It remains unclear if this will be seriously considered under the 12th FYP period.

Major state-owned PRC banks are moving to establish 2nd headquarters in Shanghai.

1. State-owned enterprise (SOE) reform

Improve income distribution by strengthening the state asset revenue sharing mechanism (likely a reference to increasing dividend payments of the SOEs, and adjusting certain taxation structure).

SOEs are implicitly addressed in various themes under different industries such as encouraging PRC companies “Going out”, consolidation in energy- intensive industries.

SOE reform in corporate governance, operations etc. will likely make them larger with greater growth potential in the medium to long-term.

Opportunities for advisory services will prevail among SOEs in different industries i.e. M&A and consolidation in energy-intensive industries, IPOs domestically and overseas etc.

A separate supervisory commission may be established to oversee state-owned financial institutions in the form of a second China Investment Corporation (CIC)-type entity.

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Theme D: Driving income growthObjectives Government plan Outlook

1. Stimulate consumption through income growth

“Double-match” income growth i.e. household income growth matching GDP growth, and wage growth matching productivity growth.

Achieve a more than 7% growth rate p.a. for household income in the next five years to increase annual urban per capita disposable income towards RMB 26,810 p.a. in 2015 and rural per capita net cash income towards RMB 8,310 p.a. in 2015.

Speed up income distribution reform via better wage systems, increasing minimum wages¹ and reform personal income tax system² etc.

The government also aims to build 36 million subsidized public housing.

McKinsey's forecasts 76 million households in the upper middle class (incomes between RMB100k-200k pa) by 2015. And the number of middle-class households in China could quadruple over the next 15 years, to reach nearly 280 million.

Meanwhile, HSBC Research believes:

- The government will shift spending from new construction to education and healthcare.

- Consumer finance will be the alternative engine to driving domestic consumption and loan growth in the next few years in the form of mortgages, car loans, credit cards and student loans.

- According to HSBC Research, household savings rate as a percentage of household income (35% and still rising) will fall with rising cost of education and medical care.

1. Minimum wages differ according to regions, Shanghai being the highest at RMB 1,120 per month; 2. The current personal tax system is a 9-grade progressive system ranging from 5 to 45% (in excess of RMB 100k).Source: HSBC Research “China’s Consumer Wave”, JAN10; RNCOS, “China Insurance Market Sector Analysis”, FEB11

2. Establish better social safety net

Significantly increase the coverage of social safety net to include both urban and rural residents, mainly pension and health insurance system.

Reform the current pension system to establish a basic pension system pooled at the national level, fully fund the individual pension schemes, and make pension portable across provinces.

Encourage the development of company annuity schemes and commercial insurance as supplements.

357 million urban population to be covered by basic pension.

Ideally, this will drive national disposable income up and savings rate down.

As China grows wealthier with an aging population, people will increasingly demand longer-term solutions including pensions, insurance and asset management products.

According to market research company RNCOS, China’s life insurance market is expected to grow at 25% CAGR between 2011 and 2014.

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Theme E: Urbanisation and regional development

1. Accelerate urbanisation and regional development

Accelerate urbanisation process and raise the urbanisation ratio by 4 percentage points to 51.5% by 2015.

Implement regional development strategy :

- Western region: First strategic priority to further develop the region, focusing on Chongqing, Chengdu, Xi'an economic belt; and other regions including Tibet, Ningxia, Yunnan.

- Northeast China: Modernise industrial base, focus on development along belt of Liaoning and Shenyang.

- Central region: Improve investment environment to allow for transfer of industries from eastern region. Focus on city clusters including Taiyuan, Wanjiang, Wuhan, Zhongyuan.

- Eastern region: Continue to be the region leading development, focus on technology and innovation and be more internationally competitive. Promote the development of Bohai Rim, Yangtze River Delta and Pearl River Delta.

The economic push further inland to Tier-2 and 3 cities has begun, especially in lower-end manufacturing that is driven by rising costs and wages in coastal areas. Other factors include aggressive courting by inland provinces to attract investment.

Analysts expect the government to promote the development of industries close to the natural resources in inland areas through infrastructure and transportation development.

Transportation planning (railways and high-speeds trains) may give a relatively accurate indication of which regions / counties will develop and urbanise more quickly.

Objectives Government plan Outlook

2. Improve agriculture / rural infrastructure and rural income

Accelerate agricultural modernisation and ensure national food security through improving the agricultural production capacity, risk management and market competitiveness.

Increase farmers’ income by supporting efforts to improve income-generating capacity and vocational skills of farmers, increase rural income channels.

Improve rural productivity and environment via better rural development planning and rural infrastructure, especially the transportation of agricultural products.

Improve rural subsidies system and education allowances.

Develop new types of rural financial institutions.

Agricultural and rural infrastructure will continue to receive major support in investment and funding. Promoting access to financing in rural areas remains a key priority.

PRC banks are required to meet quotas to build new rural banks which will increase competition in rural banking.

According to Agricultural Bank of China Chairman Xiang Junbo, government subsidies and investment in rural areas totalled about RMB 1 trillion (or 2.5% of GDP) in 2010 alone, which is expected to increase in 12th FYP period.

30PUBLIC

Summary of 11th FYP Achievements vs 12th FYP Targets

Indicators11th FYP (2006-10)

Target

11th FYP (2006-10)Actual

2010Actual

12th FYP (2011-15)

Target

2015Target

Economic      

GDP (RMB trn) + 7.5% pa + 11.2% pa 39.8 + 7% pa 55.8

Service sectors as % of GDP + 3 pcpt + 2.5 pcpt 43 + 4 pcpt 47

Urbanisation ratio (%) + 4 pcpt + 4.5 pcpt 47.5 + 4 pcpt 51.5

Science and education          

R&D spending as % of GDP + 0.7 pcpt + 0.5 pcpt 1.8 + 0.4 pcpt 2.2

Emerging Strategic Industries (ESIs)

ESI sectors as % of GDP (%) na na ~3 8 8

Resources and environment          

Arable land (bn hectares) 120 121.2 121.2 121.2 121.2

Non-fossil fuel as % of primary energy consumption n.a n.a 8.3 + 3.1 pcpt 11.4

Reduction of energy consumption per unit GDP (%) ~ 20% 19.1% na 16% na

Main pollutant emission reduction (%) - sulphur dioxide 10 14.3 na 8 na

Main pollutant emission reduction (%) - chemical oxygen demand

10 12.5 na 8 na

Forest coverage ratio (%) + 1.8 pcpt + 2.2 pcpt 20.4 + 1.3 pcpt 21.7

Source: HSBC Global Research

31PUBLIC

Summary of 11th FYP achievements vs 12th FYP Targets - continued

Indicators11th FYP (2006-10)

Target

11th FYP (2006-10)

Actual

2010Actual

12th FYP (2011-15)

Target

2015Target

People's livelihood    

Urban disposable income (RMB) + 5% pa + 9.7% pa 19,109 + 7% pa > 26,810

Rural net cash income (RMB) + 5% pa + 8.9% pa 5,919 + 7% pa > 8,310

Urban residents covered by basic pension scheme (m)223 or + 5.1% pa

257 or + 8.1% pa

257 +100 357

Urban public housing (m units) na na 5.9 +36 41.9

Total population (m) 1,360 1,341 1,341 < 0.7% pa < 1,390

Source: HSBC Global Research