Country Risk Analysis

China

Dec 2005
Updated by: Sadegh Shirazi
Global Finance Chair
® All Rights reserved 2005
Political Map
 Country in Brief
BASIC INDICATORS China East Asia & Pacific
Total Population 1,292.27 1838
(Millions)
Urban Population 38% 38 %
Population Growth 0.8 % 1.0 %
Infant Mortality 30 (per 1000 births) 33 (per 1000 births)
Illiteracy (age 15+) 14 % 13 %
Life expectancy 71 years 69 years
Gross primary enrollment 106 % 106 %

Access to improved water 75 % 76 %

source
GNI per capita 950 USD 950 USD
Gini Index 40,3 (measures income equality; the higher, the worse)

Japan 24,9 Korea, Rep. 31,6 Malaysia 38,4

Vietnam 36,1 Thailand 41,4 Mongolia 33,2
 Country in Brief
ECONOMY AND 2002 2003 2004 (f) 2005 (f) 2006 (f)
FINANCE
(in billion US$)
Economic growth (%) 8.0 % 9.1 % 9,4 % 9,5 % 9%
Inflation (%) -0.8 % 1.2 % 3,9 % 2,2 % 2%
Public Sector Balance -2.9 % -2.7 % -2.4 % -1,9 % -2%
(% GDP)
Exports 325.7 438.4 583 753 935
Imports 281.5 412.8 552 652 823
Trade balance 44.2 44 30 101 112
Current account balance 35.4 45 30 114,6 123,4
Foreign debt (% GDP) 13.1 12.8 11.9 13,2 12,7
Debt service (% Exports) 6.4 % 4.1 % 3.4 % 2,8 % 2,4%
Currency reserves 9.9 10.2 10.3 12,7 12,8
(import months) Sources: World Bank & ADB, FT ,COFACE
 Content

Overview

Political
analysis

Economy analysis

BOP analysis

Risk analysis

Strengths & Weaknesses
 OVERVIEW

Location - Eastern Asia, bordering the East China Sea, Korea
Bay, Yellow Sea, and South China Sea, between North
Korea and Vietnam.

Area – 9,596,960 sq km

Land boundaries total: 22,117 km
border countries: Afghanistan 76 km, Bhutan 470 km, Burma 2,185
km, India 3,380 km, Kazakhstan 1,533 km, North Korea 1,416 km,
Kyrgyzstan 858 km, Laos 423 km, Mongolia 4,677 km, Nepal 1,236
km, Pakistan 523 km, Russia (northeast) 3,605 km, Russia (northwest)
40 km, Tajikistan 414 km, Vietnam 1,281 km,
regional borders: HongKong 30 km, Macau 0.34 km

Natural resources - coal, iron ore, petroleum, natural gas, mercury, tin,
tungsten, antimony, manganese, molybdenum, vanadium, magnetite,
aluminum, lead, zinc, uranium, hydropower potential (world's largest).

Land use - arable land: 15.4%
permanent crops: 1.25%
other: 83.35% (2001)
 OVERVIEW(cont’d)

Irrigatedland - 525,800 sq km (1998 est.)

Natural hazards -frequent typhoons (about five per
year along southern and eastern coasts); damaging
floods; tsunamis; earthquakes; droughts; land
subsidence.

Population – 1,306,313,812 (July 2005 est.)

Age structure -
0-14 years: 21.4% (male 148,134,928/female 131,045,415)
15-64 years: 71% (male 477,182,072/female 450,664,933)
65 years and over: 7.6% (male 47,400,282/female
51,886,182) (2005 est.)
 OVERVIEW(cont’d)

Population growth rate - 0.58% (2005 est.)

Ethnic groups - Han Chinese 91.9%, Zhuang, Uygur, Hui,
Yi, Tibetan, Miao, Manchu, Mongol, Buyi, Korean, and other
nationalities 8.1%

Religions -Daoist (Taoist), Buddhist, Muslim 1%-2%,
Christian 3%-4% note: officially atheist (2002 est.)

Languages – Standard Chinese or Mandarin (Putonghua,
based on the Beijing dialect), Yue (Cantonese), Wu (Shanghaiese),
Minbei (Fuzhou), Minnan (Hokkien-Taiwanese), Xiang, Gan, Hakka
dialects, minority languages (see Ethnic groups entry)

Literacy – 90.9% of total population
 Succinct approach to China’s History
For centuries China stood as a leading civilization, outpacing the rest of
the world in the arts and sciences, but in the 19th and early 20th
centuries, the country was beset by civil unrest, major famines,
military defeats, and foreign occupation. After World War II, the
Communists under MAO Zedong established an autocratic socialist
system that, while ensuring China's sovereignty, imposed strict
controls over everyday life and cost the lives of tens of millions of
people.
After 1978, his successor DENG Xiaoping and other leaders focused on
market-oriented economic development and by 2000 output had
quadrupled. For much of the population, living standards have
improved dramatically and the room for personal choice has
expanded, yet political controls remain tight.
Political Analysis
 Government and Political System

Conventional Name: People's Republic of China

Government type: Communist state

Capital: Beijing

Constitution: most recent promulgation in December 1982

Legal system: a complex amalgam of custom and statute,

largely criminal law; rudimentary civil code in effect since
1 January 1987; new legal codes in effect since 1 January
1980; continuing efforts are being made to improve civil,
administrative, criminal, and commercial law
Government and Political System (Cont’d)

chief of state:
– President: HU Jintao (since 15 March 2003)
– Vice President: ZENG Qinghong (since 15 March 2003)

head of government:
– Premier: WEN Jiabao (since 16 March 2003)
– Vice Premiers: HUANG Ju,WU Yi, ZENG Peiyan, and HUI
Liangyu (since 17 March 2003)

cabinet: State Council appointed by the National People's Congress (NPC).

elections: president and vice president elected by the National
People's Congress for five-year terms; elections last held 15-17 March
2003 (next to be held mid-March 2008); premier nominated by the
president, confirmed by the National People's Congress.
 Government and Political System (Cont’d)

Legislative branch - unicameral National People's
Congress or Quanguo Renmin Daibiao Dahui (2,985 seats;
members elected by municipal, regional, and provincial
people's congresses to serve five-year terms)

Elections: last held December 2002-February 2003 (next
to be held late 2007-February 2008)
Election results: percent of vote - NA%; seats - NA

Judicial branch: Supreme People's Court (judges
appointed by the National People's Congress); Local
Peoples Courts (comprise higher, intermediate and local
courts); Special Peoples Courts (primarily military,
maritime, and railway transport courts)
 Political Analysis

The PRC was a communist state for much of the 20th century,
and is still considered a communist state by many political
scientists. For over two thousand years, prior to 1949, the state
had been ruled by some form of centralized imperial monarchy
with strong Confucian influences, which have left significant
traces on subsequent political and social structures. This was
followed by a chaotic succession of largely authoritarian Chinese
Nationalist governments as well as warlord-held administration
since the first Chinese Revolution of 1912.

The PRC regime has variously been described as authoritarian,
communist, socialist and various combinations of those terms. It
has also been described as a communist government. This may be
called « state capitalist ». It appears China is slowly becoming
capitalist in its economic system.

China recently released an official statement on its political
structure, upholding the notion that the state should be ruled by
democratic means.
 Political Analysis

The government of the PRC is controlled by the Communist
Party of China. There are some other parties in PRC, though
they are often closely associated or subparties within the
CPC. The effect of the other parties on the government
remains minimal. While there have been some moves
toward political liberalization, in that contested elections are
now held at the village level and legislatures have shown
some assertiveness from time to time, the party retains
effective control over governmental appointments. While
the state uses authoritarian methods to deal with challenges
to its rule, it simultaneously attempts to reduce dissent by
improving the economy, allowing expression of personal
grievances, while keeping a strong control over media.
 Political Analysis(Cont’d)

Censorship of political speech is routine. The Communist
Party has a policy of suppressing any protests and
organizations that it considers a threat to its power, as was
the case after the Tianamen Square protests. However, there
are limits to the repression that the Party is willing or able to
achieve. The media have become increasingly active in
publicizing social problems and exposing corruption and
inefficiency at lower levels of government, although
recently the PRC has tended to increase crackdowns on
reporters. The Party has also been rather unsuccessful at
controlling information, and in some cases has had to
change policies in response to public outrage. Although
organized opposition against the Party is not tolerated,
demonstrations over local issues are frequent.
 Political Analysis(Cont’d)

The support that the Communist Party of China has
among the Chinese population is unclear, as there are
no national elections, and private conversations and
anecdotal information often reveals conflicting views.
Many in China appear appreciative of the role that the
government plays in maintaining social stability, which
has allowed the economy to grow without interruption.
Political concerns in China include the growing gap
between rich and poor in the PRC, and the growing
discontent with widespread corruption within the
leadership and officials.
Economy Analysis
 Economic overview

In late 1978 the Chinese leadership began moving the
economy from a sluggish, inefficient, Soviet-style centrally
planned economy to a more market-oriented system.
Whereas the system operates within a political framework of
strict Communist control, the economic influence of non-
state organizations and individual citizens has been steadily
increasing.

The authorities switched to a system of household and
village responsibility in agriculture in place of the old
collectivization, increased the authority of local officials and
plant managers in industry, permitted a wide variety of
small-scale enterprises in services and light manufacturing,
and opened the economy to increased foreign trade and
investment. The result has been a quadrupling of GDP since
1978.
 The true measure of China’s GDP?

Measured on a purchasing power parity (PPP) basis, China in 2004
stood as the second-largest economy in the world after the US,
although in per capita terms the country is still poor.

Agriculture and industry have posted major gains especially in coastal
areas near Hong Kong and opposite Taiwan and in Shanghai, where
foreign investment has helped spur output of both domestic and export
goods. The leadership, however, often has experienced - as a result of
its hybrid system - the worst results of socialism (bureaucracy and
lassitude) and of capitalism (growing income disparities and rising
unemployment).

In December 2005, China’s Statistical Bureau revised its current GDP
by 17% upward. This will impact on China’s voice in the IFIs as well
as in its negotiations with the US Treasury regarding exchange rate
management and the underlying economic growth engines, beyond
exports.
 Economic overview (contd)

China has periodically backtracked, retightening central controls at intervals.
The government has struggled to

(a) sustain adequate jobs growth for tens of millions of workers laid off from
state-owned enterprises, migrants, and new entrants to the work force;

(b) reduce corruption and other economic crimes; and

(c) keep afloat the large state-owned enterprises, many of which had been
shielded from competition by subsidies and had been losing the ability to pay
full wages and pensions.

From 100 to 150 million surplus rural workers are adrift between the villages
and the cities, many subsisting through part-time, low-paying jobs. Popular
resistance, changes in central policy, and loss of authority by rural cadres have
weakened China's population control program, which is essential to
maintaining long-term growth in living standards. At the same time, one
demographic consequence of the "one child" policy is that China is now one of
the most rapidly aging countries in the world.
 Economic overview (contd)

Another long-term threat to growth is the
deterioration in the environment - notably air
pollution, soil erosion, and the steady fall of the water
table especially in the north. China continues to lose
arable land because of erosion and economic
development. As part of its effort to gradually slow
the rapid economic growth seen in 2004, Beijing plans
to reduce somewhat its spending on infrastructure in
2006, while continuing to focus on poverty relief and
through rural tax reform.
 Economic overview(ctnd)

Accession to the World Trade Organization helps strengthen its
ability to maintain strong growth rates but at the same time
puts additional pressure on the hybrid system of strong political
controls and growing market influences. China has benefited
from a huge expansion in computer Internet use, with 94 million
users at the end of 2004. Foreign investment remains a strong
element in China's remarkable economic growth.

Shortages of electric power and raw materials may affect
industrial output in 2005. More power generating capacity is
scheduled to come on line in 2006. In its rivalry with India as an
economic power, China has a lead in the absorption of
technology, the rising prominence in world trade, and the
alleviation of poverty; India has one important advantage in its
relative mastery of the English language, but the number of
competent Chinese English-speakers is growing rapidly.
 Macro-economy analysis

Currency unit – yuan (US$ 1=8.0709 CNY)

SDR exchange rate for Chinese Yuan(15 Dec 2005):
11.660600 Yuan = 1 SDR

Major Trading Partners:

Imports: Japan 16.8%, Taiwan 11.4%, South Korea 11.1%, US 8%,
Germany 5.4% (2004)
Exports: US 21.1%, Hong Kong 17%, Japan 12.4%, South Korea
4.7%, Germany 4% (2004)

GDP - Purchasing Power Parity $7.262 trillion (2004

est.)
 Economic ratios diamond
Trade

Domestic Investment
savings

Indebtedness China

Lower-middle-
income group
Source: Wourld Bank
 GDP & Labor Force
composition by sector
100
90
80
70
60
%GDP
50
40 %Employment
30
20
10
0 Agriculture Industry Services
 Inflation
4,0
3,2
3,0
2,4 2,3
2
2,0
1,0 1,5
-1 -0,3 -0,4
0,0
1999

2000

2001

2002

2003

2004

2005f

2006 f
-1,0
-2,0
 Yuan Exchange Rate
(Yuan per US dollar)

8,28 8,28 8,28 8,28 8,28 8,28

8,3
8,2
8,09
8,1
8
7,9 7,85
7,8
7,7
7,6
19

20

20

20

20

20

20

20
99

00

01

02

03

04

05

06
f

f
 GDP Growth (%): risk of
overheating?
11

10

3
90

96

98

00

02

04
19

19

19

20

20

20
 China: one of the 6 giant global economies in 2005
(US$ billion)
11667 USA
12000
Japan
Germany
10000 UK
France
8000 China
Italy
6000 Canada
4623
4000
2714
2140 2002 1971
2000 1672
980

0
 GDP – Per Capita
1400

1150

900

650

400
1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004e
GDP per capita in US$
Source: IIF
900000
Foreign Trade (U. S. $ million)
800000
700000
Exports
600000
Imports
500000
Trade Balance
400000
300000
200000
100000
0
2001 2002 2003 2004e 2005f 2006f
Source: IIF
 Major Trading Partners

M a jo r Im p o rt T ra d in g P a rtn e rs M a jo r E x po rt T radin g P artne rs

U nited
R ussia
S tates
2% U nited
12% K orea
K orea R ussia S tates
4% HKSAR A S E A N 6%
16% 25%
4% 9%
E uropean Japan
ASEAN U nion 17%
17% 19% HKSAR
Japan E uropean
21%
28% U nion
20%

Source: NBSC
 Structure of Imports and Exports

Structure of Exports Structure of Imports

Others Food stuffs Others Combustibles Minerals &

Other
7% 5% 9% 9% Metals
Transport & manufacturing
6%
equipment goods
33% 22%
Other
manufacturing Transport &
Chemical
goods Chemical equipment
Products
50% Products 41%
13%
5%

Source: COFACE
BOP Analysis
• Liquidity ratio
• Solvency ratio
 Liquidity Ratio
Current Account / GDP (%)
8
7
6
5
4
3
2
1
0
1996

1997

1998

1999

2000

2001

2002

2003

2004

2005 f

2006 f
 Liquidity Ratio
Debt Service Ratio (%)
10
9
8
7
6
5
4
3
2
1
0
2000 2001 2002 2003 2004 2005 2006
(f) (f)
Source: COFACE
 10
12
14
16
18
20
22
24
19
96

19
97

19
98

19
99

20
00

20
01

20
02

20
03
Debt / GDP (%)
Solvency Ratio

20
04
e
20
05
(f
20 )
06
(f
)
 Composition of Debt-2005

41%
IFI's

Official bilateral
creditors
Commercial banks
28%
11% Other private
creditors
20%

Source: IIF
Risk Analysis
 Banking industry Risk

CHALLENGES

LOW ASSET QUALITY
NPLS= 45% total loans!! or
US$864Bn @06/30/2003
+ Low loan loss provisions

INSUFFICIENT CAPITAL: at
US$109Bn @06/30/2003

LOW PROFITABILITY:
ROA<1%

High Information Risk

Rising credit to GDP: 138% in
02 vs 88% in 1995

STRENGTHS

FAST GROWING ECONOMY
BANKING SECTOR GREW 27% in
2002 vs 2001

GOVERNMENT SUPPORT&
CAPITAL INJECTIONS
(US$45Bn to BOC and CCB)

HIGH SAVINGS RATE

NON-CONVERTABILITY OF
CAPITAL ACCOUNTS

STRONG EXTERNAL FISCAL
CONDITION
 COUNTRY RATING
Rating : A3

Adverse political or economic circumstances

may lead to a worsening payment record that
is already lower than the previous categories,
although the probability of a payment default
is still low.

Source: Coface
 Corruption Perceptions Index 2005

Country Rank 2005 CPI score

China 78 3.2
India 88 2.9
Hong kong 15 8.9
Thailand 59 3.8

Source: Transparency International

Human Development Index (HDI)
Country Rank

China 94

India 127

Hong kong 23

Thailand 76
 Risk assessment

The expansion has continued at a pace exceeding the government's
objective amid robust private consumption and exports despite
corrective measures taken to temper investment growth in certain
overheated sectors. Meanwhile, China's greater integration into the
WTO has been conducive to continuing the opening-up process with
foreign investors remaining attracted to this growth dynamo.
However, China's economic ascendancy should not obscure the fact
that the country is in a transition phase with marked regional and
social disparities.

Furthermore, the support given to unprofitable state-owned
companies has continued to spur the flow of non-performing loans,
which have remained at high levels in state bank portfolios. In a
buoyant economic context, company payment behaviour has
generally been good. However, the frequency of late payments,
often linked to ineffective company management or even to non-
compliance with contract terms, should not be underestimated.
 Risk assessment

Although extra-budgetary commitments and the cost of
industrial and bank restructuring have undermined China's
public sector finances, external debt ratios have been
satisfactory and foreign exchange reserves have continued
to grow. The yuan's US dollar-peg regime will thus require
adjustment with moderate enlargement of its fluctuation
band. However, authorities do not envision implementation
of a more flexible system before consolidating the
financial system.
Politically, the current regime seems to be seeking more
balanced economic development while keeping the policy
focus on strong growth and structural reforms.
 Strengths

China has continued the structural-reform process
associated with its admission to the WTO.

External account surpluses have persisted thanks to
export-sector dynamism and competitiveness.

Foreign debt has been negligible in relation to GDP and
currency reserves that are the world's second largest
after Japan.

The savings and investment rates have been high.

Relatively well trained, the work force is still not very
costly.
 Weaknesses

Public sector restructuring has only been making slow
progress with the banking sector still hampered by the
extent of its non-performing loans with state-owned
enterprises.

Great disparities between the wealthy coastal provinces
and poor provinces have persisted.

Establishment of a genuine social safety net has proven
necessary amid increasing inequality and
unemployment.

Durable development will depend on mitigation of
environmental problems.

Relations with Taiwan have remained problematic.
 Country Risk overview

Economic growth prospects

Domestic financial stability

Social & Political stability

Debt servicing capacity

 Country Risk overview (II)

External competitiveness

Balance of payments sustainability

Overall MT perspectives
 Sources

Central Intelligence Agency (CIA)

Cofacerating

World Bank

The Institute of International Finance (IIF)

International Monetary Fund (IMF)

UNDP

Rating & Investment Information

Transparency International