China

swisschile.cl

China

Emerging Markets Outlook:

Plotting a new course after the Financial Crisis

Stefan Hofer

Emerging Markets Strategy Research

April 2010


Overview

1. Decoupling: Where are we in the global economic cycle?

2. China’s role in the post-subprime recession.

3. How has Latin America coped with the crisis?

4. Fiscal challenges in Developed Markets: the example of Japan.

2 Please find important legal information at the end of this document


Post-Lehman Brothers shock froze the global economy

Industrial Production Index

140

130

120

110

100

90

80

70

60

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

United States Japan Eurozone Brazil China Taiwan

Source: Datastream, Julius Baer

3 Please find important legal information at the end of this document


Major economies started to re-couple below growth

potential after the Lehman Brothers collapse

business

cycle

China

Asia ex JP World

Australia

Switzerland Japan

Germany

Eurozone UK

France

Italy

US

Canada

long-term

potential

growth rate

= stronger growth dynamics - status October 2008

= weaker growth dynamics - status October 2008

4 Please find important legal information at the end of this document

Source: Julius Baer


A turnaround materialised mid-2009, with China

overtaking most important economies

business

cycle

long-term

potential

growth rate

Asia ex JP

Germany

Eurozone, Switzerland

UK, Canada

US, France, Italy

World

Japan, Australia

= stronger growth dynamics - status June 2009

China

= weaker growth dynamics - status June 2009

5 Source: Julius Baer Please find important legal information at the end of this document


Non-synchronised global backdrop with all major

economies shifting forward in their cycle in early 2010

business

cycle

Germany, Japan

Asia ex Japan

China

long-term

potential

growth rate

Switzerland, US, World

Australia

Canada, Eurozone

France

Italy

UK

= stronger growth dynamics – status March 2010

= weaker growth dynamics – status March 2010

6 Source: Julius Baer Please find important legal information at the end of this document


Decoupling in its strongest form

rolling 4 quarter standard deviation of GDP growth

2

1.8

1.6

1.4

1.2

1

0.8

0.6

0.4

0.2

0

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Emerging economy GDP growth

Developed economy GDP growth

Source: UBS IB, Julius Baer

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EM domestic demand reported earnings outperformed

Rolling 12 month % change in reported EPS

80%

60%

40%

20%

0%

-20%

2002 2003 2004 2005 2006 2007 2008 2009 2010

-40%

Export driven earnings

Domestic demand driven earnings

-60%

Source: Datastream, Julius Baer

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China’s remarkable credit impulse saved the day:

Bank credit to the private sector

60

50

40

30

20

10

0

6 month % change, annualised

Dec 04 Jun 05 Dec 05 Jun 06 Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09

Asia ex China Latam Emerging Europe China Middle East

Source: IMF, Julius Baer

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It’s clear why China has been so proactive

% change, yoy

40

35

30

25

20

15

10

5

0

Loan growth

Industrial production

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Bloomberg, Julius Baer

10 Please find important legal information at the end of this document


China remains the lead EM exporter to the US

USDm

30000

Monthly exports to the US (USDm)

USDm

30000

25000

25000

20000

20000

15000

15000

10000

10000

5000

5000

0

1996 1998 2000 2002 2004 2006 2008 2010

0

China Mexico Vietnam

11 Please find important legal information at the end of this document


But competition in the region is heating up

6000

Monthly exports to the US

(indexed, Jan 1996=100)

60000

5000

50000

4000

40000

3000

30000

2000

20000

1000

10000

0

1996 1998 2000 2002 2004 2006 2008 2010

China Mexico Vietnam

0

12 Please find important legal information at the end of this document


Why China seeks to move up the value-chain

Manufacturing wage, USD per hour, 2007 estimates

18

16

14

12

10

8

6

4

2

0

Korea

Taiwan

Brazil

Mexico

China

Philippines

Sri Lanka

Source: US Bureau of Labor Statistics, JP Morgan, Julius Baer

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China: an insatiable appetite

China’s share of global consumption

Shortfalls of Chinese domestic production

Crude Oil

Soybeans

Soybeans

Crude Oil

Nickel

Nickel

Copper

Copper

Aluminium

Aluminium

Zinc

Zinc

0% 10% 20% 30% 40% 50%

-80% -60% -40% -20% 0% 20%

14 Source: Bloomberg, Julius Baer Please find important legal information at the end of this document


Are Chinese property prices dangerously high?

Growth rate (% y/y)

18

16

14

12

10

8

6

4

2

0

-2

2002 2003 2004 2005 2006 2007 2008 2009

Property prices

Land prices

Source: UBS IB, Julius Baer

15 Please find important legal information at the end of this document


The key risk in China is rising non-performing loans

5.00%

200%

4.00%

160%

3.00%

120%

2.00%

80%

1.00%

40%

0.00%

2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E

0%

Non-Performing Loans, % of total, lhs

NPL coverage ratio, %, rhs

Source: UBS IB, Julius Baer

16 Please find important legal information at the end of this document


Fed’s asset MBS program is coming to an end

USD bn

2400

2200

2000

1800

1600

1400

1200

1000

800

600

400

200

US Fed Assets

ASON DJ FMAM JJ ASONDJ FMAMJJ ASOND JFM

2007 2008 2009 2010

TSY TSY lend TAF & Repo CPFF

FX Swaps MBS & Agcy. Loans & SPVs

USD bn

2400

2200

2000

1800

1600

1400

1200

1000

800

600

400

200

17 Source: Fed, Julius Baer Please find important legal information at the end of this document


It’s not the time for an exit:

Further write-offs and tighter banking regulation are a burden

for the multiplier

10

US money multiplier

10

9

9

8

8

7

7

6

6

5

5

4

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Average +/- Std.Dev. M2/Money Base

4

18 Source: Fed, Julius Baer Please find important legal information at the end of this document


Global imbalances are going to persist for some time

in % of GDP

14

12

10

8

6

4

2

0

-2

Borrowing by sectors

in % of GDP

14

12

10

8

6

4

2

0

-2

-4

60 65 70 75 80 85 90 95 00 05

Financials Business Government Households

-4

Source: Datastream, Bank Julius Baer

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The Fed normally waits for the labour market to recover

bps

200

150

100

50

0

-50

-100

-150

-200

-250

-300

-350

-400

%, inverted

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

85 87 89 91 93 95 97 99 01 03 05 07 09 11

Fed funds target rate - 6mth change (l.s.) Unemployment rate (r.s.)

20 Please find important legal information at the end of this document


US labour market flexibility facilitate higher productivity

Companies are quick to regain profitability, which is typical in the current stage of

the business cycle

Index

109

US profitability

Index

109

107

107

105

105

103

103

101

101

99

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2006 2007 2008 2009

Recession Unit labour costs Productivity

99

21 Source: BEA, Julius Baer Please find important legal information at the end of this document


Retail sales up to February point to robust rise in private

consumption in Q1

% Y/Y % Y/Y

6

US private consumption

12

4

2

8

4

0

-2

-4

-6

00 01 02 03 04 05 06 07 08 09 10

Private consumption (l.s.) … monthly (3MAV, l.s.)

Retail sales (3MAV, r.s.)

0

-4

-8

-12

22 Source: BEA, Julius Baer Please find important legal information at the end of this document


Brazil has seen very robust job creation

thousands of jobs

400

200

0

-200

-400

-600

-800

-1000

Jun 08 Sep 08 Dez 08 Mrz 09 Jun 09 Sep 09 Dez 09

CAGED formal net job formation

US non-farm payrolls

Source: Bloomberg, Julius Baer

23 Please find important legal information at the end of this document


Brazil has responded to shifts in end demand

Main export partners as % of total

35%

30%

25%

20%

15%

10%

5%

0%

US China Europe Argentina Asia ex-

China

Jan 2008 - July 2008 Jan 2009 - July 2009

Rest

Source: BAML, Julius Baer

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Brazil has not been immune to fiscal campaigning

7.5%

% of GDP

7.0%

6.5%

6.0%

5.5%

5.0%

4.5%

Social security

Current spending

Personnel

4.0%

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Source: Deutsche Bank, Julius Baer

25 Please find important legal information at the end of this document


Mexico has gained market share in US car imports

% change, y/y

150%

100%

50%

0%

-50%

Car production for US Car production for domestic market

-100%

Jan 08 Jul 08 Jan 09 Jul 09 Jan 10

Source: Datastream, Julius Baer

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Capital flows started to return to emerging markets

Net capital flows (% GDP, 3 month moving average)

15%

10%

5%

0%

00 01 02 03 04 05 06 07 08 09

-5%

-10%

Total Asia Latin America CEE

Source: UBS IB, Julius Baer

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How rapid capital outflows can cause markets to melt

Index Level

1600

1400

1200

1000

USD billion

0

-50

-100

800

600

400

200

0

-150

-200

-250

Q1 1994

Q1 1995

Q1 1996

Q1 1997

Q1 1998

Q1 1999

Q1 2000

Q1 2001

Q1 2002

Q1 2003

Q1 2004

Q1 2005

Q1 2006

Q1 2007

Q1 2008

Q1 2009

Q1 2010

Cumulative net capital outflows, rhs

MSCI Russia, lhs

Source: UBS IB, Julius Baer

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EMU debt reversibility chart: 2007 vs. 2011 figures

0

Debt Debt ot to GDP, %

0 25 50 75 100 125 150

Interest rexpense to total revenues

2

4

6

8

10

12

14

16

Finland

Germany

France

Portugal

Spain

Belgium

Italy

Ireland

Greece

Belgium

Germany

Ireland

Greece

Spain

France

Italy

Portugal

Finland

18

Source: EU Commission

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Markets appear to have priced-in weak fiscal health in

Greece, Portugal and Spain it has yet to do the same for

US, U.K., Japan, France and Ireland

700

700

600

Iceland

600

500

500

CDS Spread

400

300

Greece

400

300

200

100

0

Portugal

Ireland

Italy

United Kingdom

Japan

France

United States

Spain

Austria

Belgium

Germany

Sw eden

Finland

New Zealand

Sw itzerland

Australia

Denmark

Norway

-2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5

Fiscal Health Score

200

100

0

30 Source: Julius Baer Please find important legal information at the end of this document


Debt service concerns in EM would be misplaced

Sovereign external debt service as a % of Exports

50

45

40

Brazil Mexico Russia Turkey China

35

30

25

20

15

10

5

0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009F 2010F

Source: JP Morgan, Julius Baer

31 Please find important legal information at the end of this document


Japan will need to roll about USD 2.3 trn in this year

US and U.K. need of USD 538 and 135 bn look modest

% of GDP % of GDP

50

45

40

35

30

25

20

15

10

5

0

Debt distribution

45

40

35

30

25

20

15

10

5

0

Japan USA UK

2010 2011 2012

50

32 Source: Bloomberg, IMF, Julius Baer Please find important legal information at the end of this document


Japan’s personal savings ratio dropped the first time

below zero

% Y/Y % Y/Y

18

16

14

12

10

8

6

4

2

0

-2

Personal savings ratio

16

14

12

10

8

6

4

2

0

-2

85 87 89 91 93 95 97 99 01 03 05 07 09

US Japan

18

33 Source: Datastream, Julius BaerPlease find important legal information at the end of this document


Traditional domestic financing sources are drying out

JPYtrn

270

JPYtrn

270

240

240

210

210

180

180

Japan Postal System savings (in JPYtrn)

150

150

1996 1998 2000 2002 2004 2006 2008

Source: Bloomberg, Julius Baer

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Why demographics is an immediate, not longer term issue

% of Population

25

20

15

10

% of GDP

5.5

5

4.5

4

3.5

3

5

1975 1979 1983 1987 1991 1995 1999 2003 2007

2.5

Proportion over 65 years old

Source: JP Morgan, Julius Baer

Social security expenditure (RHS)

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Diminishing fiscal flexibility

Interest payments as % of government revenue

100%

80%

60%

40%

20%

0%

BBB

AAA

1998 2002 2006 2010 2014 2018

JGB yields rise by 100 bps JGB yields rise by 200 bps

JGB yields unchanged

100%

80%

60%

40%

20%

0%

Source: JP Morgan, Julius Baer

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Yet markets seem to be pricing normal risk

CDS level

500

400

300

200

100

CDS level

500

400

300

200

100

0

Nov 08 Feb 09 Mai 09 Aug 09 Nov 09 Feb 10

Japan UK Greece China

0

Source: Bloomberg, Julius Baer

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