equity research asia/pacific economics report economics team december 2001 1 andy xie (852) 2848...

Equity Research Asia/Pacific

Economics Report

Economics Team

December 2001

1

Andy Xie (852) 2848 5220 [email protected]

Asia/Pacific Economics

1. The Post September 11 World:

Cyclical and Structural Adjustments

2. China: Economic Growth Drivers


Economics Report

Economics Team

Andy Xie (852) 2848 5220 [email protected] Please refer to important disclosures at the end of this report. 2

The Post September 11 World

Delayed Recovery Is the Bad News

Would Stimulus Work?

But Is It Just Cyclical?

US Slowdown: Cyclical or Secular?

The Other Challenge

“Flying Geese” Are Dead

Was It All a Bubble?

The Next Leg Down with US Consumption

Specialize or Be Poor Again


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Economics Team


The Post September 11 World - cont.

Tigers Have to Shrink Relative to China

Where to Look for New Winners

Asia Pacific Economic Forecast Summary


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Economics Team


The Next Leg Down with US Consumption

2000 H1 01 2001E 2002E WeightOld New Old New (%)

Global 4.8 2.1 1.8 3.4 2.1 US 4.1 1.9 1.4 1.0 2.6 1.0 Europe 3.3 1.8 1.6 2.5 1.5 Japan 1.5 -0.3 -0.8 -0.9 0.2 -1.0Asia/Pacific 7.6 4.5 4.0 3.3 5.6 4.3 100 ex-China 7.4 1.9 1.4 0.3 3.9 2.3 57.3 Hong Kong 10.5 1.4 0.2 -0.3 3.2 1.8 6.4 Taiwan 5.9 -0.7 -1.4 -2.0 2.6 1.0 12.1 Korea 8.8 3.2 3.0 1.3 5.0 3.0 17.9 Indonesia 4.8 3.4 2.7 2.9 3.5 2.9 5.9 Malaysia 8.3 1.7 0.9 -0.6 3.5 2.5 3.5 Philippines 4.0 3.3 2.5 2.7 3.3 2.6 2.9 Singapore 9.9 1.8 1.5 -1.5 5.3 3.0 3.6 Thailand 4.4 1.9 2.0 1.0 4.0 2.1 4.8 China 8.0 7.9 7.5 7.4 7.8 7.0 42.7

•The US terrorist attacks were a confidence shock. US consumption was maintained by borrowing and was vulnerable to shock.

•After an IT business investment-led downturn, US consumption is likely to drive the global economy down another leg.

GDP Growth Forecast (YoY % Change)

E = Morgan Stanley Research Estimates

Source: Morgan Stanley Research


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Delayed Recovery Is the Bad News

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GDP Growth Rate (YoY % Change)


•The IT downturn has hit the region hard. Consumer goods exports have a lower elasticity and will have a different impact than IT on the region

•We think the expected recovery has been pushed out by two quarters to 3Q02. The delay increases pressure on highly indebted companies, in our view.


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Would Stimulus Work?

Europe: Fiscal deficit rises to 1.9% in 2001 from 1.6% in 2000. This has a stabilizer effect. Monetary policy bears the burden of stimulus and is likely to aggressively follow the Fed in future.

Japan: Unsterilized currency market intervention. Supplemental budget for income support could come soon, perhaps at 0.5% of GDP.

US: Leads the world in stimulus. US$75 billion in tax cuts; US$125 billion could go into September 11 related spending. Fed funds rate cut by 400bps.

The global economy should respond strongly soon. However, balance sheet cleansing by consumers and corporates blunt impact of lower interest rates. We predict recovery delayed to 3Q02.


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But Is It Just Cyclical?

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US demand has been the growth engine in East Asia. Is the current downturn another cycle or is it a secular shift?

US GDP and Import from Pacific Rim (YoY % Change)


•If it’s purely cyclical, East Asia can treat the current downturn as before, even though it’s more severe than usual.

•If the US economy is in a secular downturn, East Asia must find other demand sources to grow.


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US Slowdown: Cyclical or Secular?

Cyclical

1) IT bubble has burst. The consumer bubble is bursting. Once the excesses are cleared, the US would resume 3.5% trend growth rate.

2) September 11 increases cost of doing business. This slows the economy down for a while before it is absorbed. However, it only affects two quarters.

3) Terrorist organizations crumble under pressure. Arab countries remain friendly to the West.

Secular

1) Faster productivity in the 1990s was a bubble phenomenon. After cleansing the excesses, the US grows at 2-2.5%.

2) The war on terror turns into a war against Islam. Oil production is permanently disrupted.

3) The US reacts to September 11 by building a Fortress America: subsidizes industries, erects tariffs on imports and reduces immigration.


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Economics Team


Was It All a Bubble?


Long Way to Fall?

Was the strong US economy in the 1990s just a bubble?

Suspicious characteristics:

1) Rising leverage

2) Dependency on foreign capital

3) Rising investment/GDP ratio

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The Other Challenge

What justification is there for Taipei salaries being 10 times Shanghai’s?

Your answer determines how economies, stocks and currencies will unfold in this decade.

In our view, there is absolutely no justification for the difference!


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Economics Team


‘Flying Geese’ Are Dead

• East Asian development has followed a flying geese pattern. The higher-income economies are also higher up in the export value chain.

• China has caught up in basic conditions for mass production, such as infrastructure and education. But wages don’t go up with a large surplus labor force. Hence, China is redefining prices and encompasses the whole value chain. Flying geese are dear.

Source: CEIC, Morgan Stanley Research

Exchange Rate GDP ($ billion) Pop Per Capita Income ($)Nominal PPP Nominal PPP (million) Nominal PPP

Japan 122 163 4,039 3,019 127 31,781 23,751 Hong Kong 7.8 8.8 162 145 7 23,657 21,055 Singapore 1.8 1.6 91 98 4 22,558 24,285 Taiwan 34.5 19.0 280 511 22 12,585 22,911 Korea 1282 704 517 941 47 10,938 19,913 Malaysia 3.8 1.6 90 210 23 3,854 9,015 Thailand 44.9 13.4 109 366 63 1,738 5,833 Philippines 50.8 10.2 65 325 71 917 4,577 China 8.3 2.0 1,080 4,530 1,266 853 3,578 Indonesia 8435 2198 153 587 210 730 2,802 Total 6,587 10,730 1,840 3,580 5,832

Wide Income Dispersion for Now


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Economics Team


Specialize or Be Poor Again

•Premium over China can no longer be sustained by more capital

•Specialization could protect some of the existing premium

–Finland specializes in telecom equipment and printing machinery. It has retained a premium in Europe

–Indonesia and Thailand are complementary to China

–Singapore can act as the middleman between China and Indonesia

–Hong Kong can manage Pearl River Delta trade

–Korea and Taiwan must search for niches


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Tigers Have to Shrink Relative to China

• Specialization will protect some of the premium that the tigers enjoy over China but not all.

• Regardless of how successful the tigers are at transforming themselves, their premium over China will decline substantially this decade, in our view:

–Are Finland’s wages 10 times Europe’s?

• The gap between China and the tigers will narrow via (1) faster growth in China, (2) depreciation of tigers’ currencies and (3) renminbi revaluation.

Source: CEIC, Morgan Stanley ResearchTigers include Hong Kong, Korea, Singapore and Taiwan

GDP Ratio of Tigers to China (%)

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China devalues to follow East Asian model

Post-1989 Slump

Devalue again to jump-start economy

Fixed exchange rate and disinflation

The Asian Crisis

IT bubble

Forecast post-2001


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Economics Team


Where to Look for New Winners• Manufacturing should remain a primary source of

GDP growth but not increased wealth.

• Property bubble is gone and price appreciation won’t support wealth creation, in our view.

• Wealth should grow in businesses that have pricing power in a deflationary environment. They should have brands, scale or intellectual property (IP).

• The key themes for wealth creation are:

–Lifestyle: Consumption is income- rather than lifestyle-driven, as in the past. Rising competition is likely to create low-priced lifestyle. Companies that cater to this trend should become valuable.

–Urbanization: China and others could create huge cities in East Asia. This brings opportunity in urban services and scale service business.

–Healthcare: Aging and growing income create the perfect combination for health services.

–Technology: Maths is replacing experience in IP creation. The law of large numbers of people will likely apply to East Asia in IP production.

Growth Determines Performance

1991-97 1998-00 1991-97 1998-00

Avg. Annual Sales Avg. RoA (%), 1997-00

Growth (%)

Consumer 14.7 0.6 8.2 5.8Property 19.5 -3.7 7.6 4.5IT Hardware 23.9 13.2 8.9 8.3Telecom 22.1 3.8 15.0 10.7All ex-Banks 17.7 7.1 7.8 5.2Avg. Nominal GDP Growth Rate (%)

16.2 7.1 ex-China 13 7.4Avg. Real GDP Growth Rate (%)

8.3 4.2 ex-China 6.7 2.7US Imports from Asia/Pacific IT 18.0 12.5 Non-IT 11.6 11.9

Asia/Pacific Japan Europe US

Avg Return on Asset (RoA), 1991-2000Consumer 7.5 4.7 10.9 13.5Real Estate 6.7 2.9 4.9 6.9IT Hardware 8.7 4.6 6.3 9.4Telecom 13.7 5.0 10.0 9.6All ex-Banks 7.1 4.5 7.9 9.8Avg. Annual Sales Growth (%), 1991-2000Consumer 10.5 -2.4 7.5 8.4Real Estate 12.5 1.5 10 8.8IT Hardware 20.7 3.8 2.4 8.7Telecom 16.6 7.7 9.9 12.7All ex-Banks 13.7 0.4 5.6 7.1



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Economics Team


Asia/Pacific Economic Forecast Summary

Source: CEIC, Morgan Stanley Research, E = Morgan Stanley Research Estimates

1997 1998 1999 2000 2001E 2002EReal GDP Growth (%)Non Japan Asia 6.3 2.1 6.5 7.3 3.7 4.5China 8.8 7.8 7.1 8 7.4 7Hong Kong 5 -5.3 3 10.5 -0.3 1.8India 5.6 6.4 6.3 5.8 4.8 5.2Indonesia 4.7 -13.1 0.8 4.8 2.9 2.9Korea 5 -6.7 10.9 8.8 2.2 3.5Malaysia 7.3 -7.4 6.1 8.3 -0.2 2.5Philippines 5.2 -0.6 3.4 4 2.7 2.6Singapore 8.4 0.1 5.9 9.9 -2.7 3Taiwan 6.7 4.6 5.4 5.9 -2 1Thailand -1.7 -10.2 4.2 4.4 1 2.1

CPI Inflation (%, Period Average)Asia Ex-Japan 4.1 6.2 1.7 1.5 2.4 2.1China 2.8 -0.8 –1.4 0.4 1 1.5Hong Kong 5.8 2.8 –4.0 –3.7 -1.3 0India 7.3 13.2 4.8 4.2 3.6 4Indonesia 6.2 58 24.1 3.8 11.4 8.9Korea 4.4 7.5 0.8 2.3 4.1 2Malaysia 2.7 5.3 2.8 1.6 1.3 1.4Philippines 5.1 9.7 6.7 4.3 6.4 5.8Singapore 2 -0.3 0.4 1.3 1.3 0.8Taiwan 0.9 1.7 0.2 1.3 0.3 0.8Thailand 5.6 8.1 0.3 1.6 1.7 1


Economics Report

Economics Team


Asia/Pacific Economic Forecast Summary-cont.

Source: CEIC, Morgan Stanley Research, E = Morgan Stanley Research Estimates

1997 1998 1999 2000 2001E 2002ECurrent Account as % GDPAsia/Pacific 1.8 6.1 4.2 3.5 2.7 2.1China 3.3 3.1 1.6 1.9 1.4 0.6Hong Kong -3.6 1.8 6.6 5.4 4.5 4.4India -0.8 -1.6 -0.6 -1.1 -1.1 -1.3Indonesia -2.3 4.4 4.1 5.2 4 2.9Korea -1.7 12.7 6.0 2.4 2.5 2.4Malaysia -5.9 13.2 15.9 9.4 7.8 6.3Philippines -5.3 2.4 10.3 12.5 3.7 3.5Singapore 19.0 24.6 25.9 23.6 23.9 21.4Taiwan 2.5 1.3 2.9 2.9 5.3 5.5Thailand -2.0 12.7 9.3 7.6 3.8 3.3Exchange Rate (Per US$, Period End)China 8.29 8.28 8.28 8.28 8.30 8.20Hong Kong 7.75 7.75 7.77 7.80 7.80 7.80India 39.20 42.70 43.50 46.70 49.00 51.20Indonesia 4,650 8,025 7,100 9,595 13,000 13,000Korea 1,415 1,208 1,145 1,260 1,280 1,350Malaysia 3.89 3.80 3.80 3.80 3.80 3.80Philippines 40.00 39.10 40.30 50.00 53.50 53.00Singapore 1.67 1.66 1.67 1.73 1.88 1.80Taiwan 32.60 32.20 31.40 33.20 36.00 35.00Thailand 45.20 36.20 38.20 43.10 45.50 44.50


Economics Report

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December 2001

17

China Economics

Economic Growth Drivers



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Economic Growth Drivers

How Does China Accumulate Capital?

How Does China Improve Human Capital?

How Does China Improve Its System?

Is China Ready for Takeoff?

Scale and Low Base Offer High Potential

Capital Market Reform: The Last Piece

Stock Market: Key to Corporate Development

Why Are Some People Poor?

Capital Efficiency Remains Low


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Economics Team


Economic Growth Drivers -Cont.

Structural Uplift I: Production Relocation

Structural Uplift II: Infrastructure Externality

Structural Uplift III: Super-Scale Urbanization

Structural Uplift IV: Technology

Structural Uplift V: Asset Sales Boost Consumption

Take-off Is Likely After WTO Restructuring

The Next US$10 Trillion Economy

China: Economic Forecast Summary


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Economics Team


Why Are Some People Poor?

Nominal PPPNominal/PPP (%)

US 35,900 35,900 100Japan 31,781 23,751 134Hong Kong 23,657 21,055 112Singapore 22,558 24,285 93Taiwan 12,585 22,911 55Korea 10,938 19,913 55Malaysia 3,854 9,015 43Thailand 1,738 5,833 30Philippines 917 4,577 20China 853 3,578 24Indonesia 730 5,832 13

Per Capita Income in 2000 (US$)

China Hong Kong Taiwan Korea Japan Singapore1970-79 34.9 24.6 26.8 30.7 36.01980-89 36.1 25.3 21.9 30.5 29.3 39.31990-97 39.3 29.7 23.6 36.8 29.4 35.71998-00 37.1 27.5 23.3 25.7 26.3 33.1

Gross Fixed Capital Formation (% of GDP)


• A person is poor because a) he didn’t go to school - no human capital, b) he can’t afford a machine - no physical capital, c) the society doesn’t offer opportunities - the system is inefficient.

• Becoming rich is, therefore, a combination of capital accumulation and improving system efficiency.


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How Does China Accumulate Capital?

High savings rate and FDI

One-child policy has decreased the dependency ratio and raised the savings rate substantially in 1980s. Savings were put into infrastructure and education. China now has:

a) a national highway system,

b) a national power grid with ample generating capacity,

c) a national telecom system with the largest mobile system in the world,

d) a national aviation system, and

e) US$250 billion in export earning power


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How Does China Improve Human Capital?

Increase enrollment

1) Nine-year education has become universal

2) Technical schools are readily available after secondary education

3) University system has been massively expanded. The total enrollment has increased to over 2 million a year (11% of age group) from 350,000 (or 1.5% of age group) 20 years ago.

4) Post-graduate education has increased significantly. 200,000 have gone abroad for graduate study. Over 20% of these have returned.

5) Expatriate population has risen to 250,000. About 500,000 Taiwanese live in China.


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How Does China Improve Its System?

Join the WTO

1) China used incremental measures to improve incentives for production. For example, family responsibility system in rural sector, corporatization of state-owned companies, township- and village-owned enterprises, special economic zones, foreign JVs, preferential tax treatment for foreign companies or export, etc.

2) As China has become big, the complicated incentive system is too difficult to administer. The distortion has created a lot of non-performing loans. Joining the WTO levels the playing field for everyone and connects China’s system with the global norm. Hence, China’s low cost structure is fully unleashed into the global economy.


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Is China Ready for Takeoff?

Takeoff: Fast growth and appreciating currencies

1) China used devaluation to make itself more attractive. Its currency has been stable for six years. However, foreign capital continues to pour in, as it has used system improvements to attract foreign capital.

2) Although devaluation strategy is over, currency appreciation is still five years away. China has 300 million surplus workers; 18 million join workforce every year. China faces pressure to appreciate its currency, but it can stop this by expanding money supply, which doesn’t cause inflation as wages are kept down by surplus labor. China to have fast growth and stable currency.

3) Beyond 2006 China’s surplus labor may have declined sufficiently to allow currency appreciation to begin.


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Scale and Low Base Offer High Potential

Prices don’t rise

1) Surplus labor keeps wages down. Hence, though total demand rises with more employment, individual purchasing power is not rising to allow price increases.

2) However, as more buyers emerge, businesses can leverage scale to reduce costs, which is the only way to maintain or increase margins.

3) The big payoff will happen, when surplus labor is sufficiently reduced to allow wages, prices and currencies to rise at the same. Between 2006-16 this virtuous cycle will emerge, in our view.


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Capital Market Reform: The Last Piece

The Stock Market Bubble

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1) China has high competition in the goods market, a flexible labor market, and commitments to a WTO-defined entry-exit environment.

2) The capital market is the only piece that hasn’t fallen into place. The banking system is saddled with bad debts. The domestic stock market is a bubble. Offshore listed companies are hampered by poor corporate governance.


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Stock Market: Key to Corporate Development

Stock Market Fund Raising


Chinese corporate development unfolds in three directions:

1) Foreign ownership through rising FDI

2) Corporatization and listing of SOE’s to sustain government ownership in key sectors

3) Nurturing private sector for employment generation

If the stock market fails in allocating capital to efficient companies, China will become largely foreign owned, which may not be in the best interest of the Communist Party in the long term.

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Capital Efficiency Remains Low

Share in Total Fixed Investment (%)


Capital efficiency remains low:

1) State sector remains dominant in capital formation

2) Private sector remains small

3) Household capital formation (e.g., property) is just beginning.

4) Foreign direct investment is the main source of efficiency

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Structural Uplift I: Production Relocation

• Taiwan is following HK in relocating its manufacturing to China. China’s labor and land costs are one fifth of Taiwan’s.

• Global downturn and WTO are forcing the pace of relocation. Half of Taiwan’s manufacturing sector survives on protection and must seek lower production costs after WTO. The IT sector is competitive, but has come under a margin squeeze in the global downturn. Moving to China is the only way to preserve margins.

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Economic development has been restricted to 20% of the population along the southeastern seaboard, which now accounts for 50% of GDP and 75% of exports.

Mid- and Upper-Yangtze valley has 30% of population, but 20% of GDP and 3% of exports. The population is dense enough to make infrastructure pay.

The western development program is likely to mainly create infrastructure for the intra-region and access to the coastal region. The Three Gorges Dam gives deepwater port access to Sichuan province.

Development of North and Northwest requires water, which will be available in 15 years.

Lower YangtsePop = 138 mnGDP = US$232 bnExp = US$72 bn

Pearl River DeltaPop = 128 mnGDP = US$325 bn Exp = US$130 bn

Mid/Upper YangtsePop = 371 mnGDP = US$244 bnExp = US$9 bn

Bohai BasinPop = 224 mnGDP = US$270 bnExp = US$45 bn

SouthwestPop = 128 mnGDP = US$70 bn Exp = US$3.8 bn

KoreaPop = 47 mnGDP = US$398 bnExp = US$172 bn

TaiwanPop = 22 mnGDP = US$285 bnExp = US$148bn

Northern PlainPop = 157 mnGDP = US$97 bnExp = US$4.5 bn

NortheastPop = 64 mnGDP = US$61 bnExp = US$12 bn

WestPop = 51 mnGDP = US$38 bn Exp = US$1.5 bn

Structural Uplift II: Infrastructure Externality

Source: CEIC, CIA, Morgan Stanley Research


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Structural Uplift III: Super-Scale Urbanization

• Urbanization lifts labor productivity and requires capital. China has the high savings rate to make it happen. Further, China can take advantage of massive economies of scale to reduce per-capita cost of urbanization.

• Hong Kong/Shenzhen already has a population of 14 million and will likely reach 20 million by 2010. Shanghai has already hit 16 million and will likely reach 22 million by 2010.

No Migration: Higher Relative Population

Population Density Looks Fine But Good Land Is Scarce

Source: LLASA LUC-GIS

Altitude(,000

sqkm)(% of Total) (million)

(% of Total) Density

<25 m 375 4 228 19.6 60825-100 584 6.2 267 23 458100-500 1648 17.4 355 30.6 216500-1000 1517 16.1 141 12.2 631000-2000 2291 24.2 129 11.1 562000-3000 572 6.1 30 2.6 52>2000 m 2463 26.1 10 0.9 4Total 9448 1160 123

Area Population

Population Country Density

(people/sqkm)China 123France 108Germany 235Japan 336UK 239US 30

•China could have 15 cities with over 15 million people by 2015 and 30 cities with over 30 million by 2030.


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Structural Uplift IV: Technology

• Less expensive and better technologies allow China to leapfrog competitors, lower costs and accelerate the pace of development, especially in communication, transportation and urbanization.

• Communication capex cost has declined by 80% or more. China is making advanced communication tools available to consumers with low per-capita incomes.

• Production of transportation capacity has declined by 50% in a decade. New bullet train technology could lower costs further. Inter-province expressways now reach 16,000 km, from zero in 1988.

• China could accumulate intellectual property soon. IP acquisition has become more dependent on math computation rather than experience, which favors China with its large population and effective mass education.

Source: China Statistical Yearbooks

Mobile Subs Freight Trafffic Passenger Traffic(million) (Ton trillion km)(Person trillion km)

1988 0.0 1.9 0.531990 0.0 2.2 0.471995 3.6 2.9 0.612000 85.3 4.1 1.17


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Structural Uplift V: Asset Sales Boost Consumption

• Households increased deposits less last year, as they put an extra Rmb54 billion into the stock market and Rmb75 billion more than last year into government bonds and property.

• In our view, the government can sell sufficient assets to cover its liability and boost consumption when it becomes necessary.

Allowing Households to Save Money

Government Balance Sheet (US$ billions)

Source: CEIC, Morgan Stanley

Adjusted for Inflation

Adjusted for Inflation

1994 1213 546 212 68 231995 1172 739 410 67 241996 941 945 724 66 391997 658 760 659 56 451998 493 722 757 92 961999 379 809 880 175 1832000 749 471 469 250 250

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GDP

Savings Deposit(Increase, Rmb billion)

Liability Assets

Household 750 Telecom savings deposit Wireless 200Foreign Debt 150 Fixed 150Fiscal bonds 100 Cable 100Unfunded 350 Other 50 social welfare Power 120Welfare cost 150 Transportation 100 For SOE layoffs Manufacturing 300Coins and Notes 160 Real estate 200

Services 100F/X Reserves 155

Total 1,660 1,475


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Take-off Is Likely After WTO Restructuring

• A developing economy takes off when rapid growth and real currency appreciation occur together.

• China has had fast growth but a weak currency for 20 years due to high demand for jobs and a low level of efficiency.

• The restructuring timetable for joining the WTO will likely lift the level of efficiency and remove barriers to high growth. China could experience a takeoff between 2006-15.

How Did Other Asian Economies Take Off


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China's GDP (1981 $, 1981=100)

Japan's GDP (1985 $, 1955=100)

Taiwan's GDP (1961 $, 1961=100)

Korea's GDP (1970 $. 1970=100)


Economics Report

Economics Team


The Next US$10 Trillion Economy

• If WTO-related reforms are carried out, China’s economy could be worth US$10 trillion by 2020.

• If China implements WTO-plus reforms, the economy could reach US$10 trillion by 2015.

• If reforms fail and China remains inefficient, the economy could hit US$10 trillion by 2025.

• Possible impediments: (1) instability, (2) corruption, (3) environmental degradation, and (4) containment by the West. Current reforms appear positive for China.

China’s GDP (US$ billions, 2000 $)

Source: CEIC , Morgan Stanley Research

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2000

2001E

2002E

2003E

2004E

2005E

2006E

2007E

2008E

2009E

2010E

2011E

2012E

2013E

2014E

2015E

2016E

2017E

2018E

2019E

2020E

2021E

2022E

2023E

2024E

2025E

Business as usual

WTO Scenario

Aggressive Restructuring


Economics Report

Economics Team

December 2001

36


China Economics

Privatization Success


Economics Report

Economics Team


Privatizations Completed (1999 - 2001)

Date Privatised Entity Amount Raised (US$ mn)

25 Jun 1999 Shandong International Pow er Development 299

28 Oct 1999 China Telecom 2,000

31 Jan 2000 Beijing Capital International Airport 231

30 Mar 2000 PetroChina 2,891

16 Jun 2000 China Unicom 5,651

12 Oct 2000 Sinopec 3,462

31 Oct 2000 China Mobile 6,867

21 Feb 2001 CNOOC 1,431

05 Dec 2001 Alimunium Corporation of China 458


Economics Report

Economics Team


Case Study - US$3.46Bn IPO for China Petroleum and Chemical Corporation

The Largest Ever Chinese H Share IPO

– On October 12, 2000, Morgan Stanley Dean Witter priced the largest Chinese H share IPO in history for China Petroleum and Chemical Corporation (“Sinopec”)

– Sinopec was priced at a 43.4% and 1.9% premium to PetroChina’s consensus 2000E and 2001E P/E, respectively. It was also priced at a 19.5% premium to Sinopec’s NAV (PetroChina was priced only at a 10% premium to its NAV)

– Landmark pre-IPO restructuring and corporatization achievement

– Significant strategic investment in the IPO from Exxon Mobil, the Royal Dutch Shell Group and BP Amoco

Offering Summary

Issuer: China Petroleum and Chemical Corporation(“Sinopec”)

Pricing Date: October 12, 2000

Offer Size (Pre-Greenshoe):- % Pro forma TSO

US$3.46Bn20.0%

Total Number of H shares/ADSs Offered: 16,780,488,000 Shares / 159,414,640 ADSs

- Greenshoe (15% of shares offered topublic):

1,258,536,000 H Shares / 12,585,360 ADSs

- ADSs Ratio: 100 H Shares for 1 ADS

Offering Structure: Hong Kong Public Offer – 5%

Institutional Placement – 45%

Strategic/Corporate investors – 50%

Offer Price: HK$1.61 per H share

US$20.645 per ADS

Price Range: HK$1.48 – HK$1.79

Listings: Stock Exchange of Hong KongNew York Stock Exchange

London Stock Exchange

Use of Proceeds: Funds for expansion and debt reduction10% to parent company

Joint Global Coordinators & JointBookrunners:

Morgan Stanley Dean WitterChina International Capital Corporation

Transaction Highlights

– Largest ever Chinese H share IPO– Third largest ever Chinese IPO in history– Extremely successful despite turbulent market conditions and fragile investor sentiment towards investing

in new issues:• Over US$4.1 billion of institutional and retail demand (over 3x subscribed)

• Over US$710 million of demand in Hong Kong Public Offer (over 4x subscribed)– Priced at attractive valuations:

• 43.4% premium to PetroChina’s consensus 2000E P/E

• 1.9% premium to PetroChina’s consensus 2001E P/E

• 19.5% premium to Sinopec’s NAV (PetroChina was priced only at a 10% premium to its NAV)– Landmark pre-IPO restructuring and corporatization achievement:

• 15 month process (from mandate) that involved the restructuring of a Chinese SOE comprised of approximately 100 multi-tiered, independent and cross-competitive organizations encompassing approximately 10,000 separate companies

• Significant balance sheet restructuring / rating agency process - achieved investment grade rating (BBB-) by S&P

• Significant regulatory restructuring– Significant strategic investment in IPO (committed prior to IPO) from Exxon Mobil, The Royal Dutch

Shell Group, BP Amoco, Asea Brown Boveri, Cheung Kong, Hutchison Whampoa, Henderson Group and Hong Kong & China Gas

– Emphasizes MSDW’s equity franchise in Asia: With this transaction, Morgan Stanley has lead-managed 6 equity-linked offerings of US$1 billion or above for Non-Japan Asia issuers since 1998, more than any other underwriter

70

75

80

85

90

95

100

105

9/ 11/ 00 9/ 14/ 00 9/ 19/ 00 9/ 22/ 00 9/ 27/ 00 10/ 02/ 00 10/ 05/ 00 10/ 10/ 00 10/ 13/ 00

P E T ROCHINA CO CNY 1 'H'SHS HONG KONG HANG SE NG

DOW J ONE S 30 INDUST RIALS 30 NASDAQ COMP OSIT E INDE X

HONG KONG HANG SE NG CHINA HONG KONG HANG SE NG CHINA

S&P 500 ST OCK INDE X 500 ST OCKS

Major Indices and Comp Performance Since Pre-Marketing (9/11/2000)

Breakdown of Demand

Morgan

Stanley &

CICC

52%

Dean

Witter

9%

PWM

27%

Syndicate

12%

Asia &

ROW

52%

Europe

27%

U.S.

21%

Pre-Marketing Launched

Roadshow Launched

Pricing

Source FactSet

Institutional By Region(1) Total Demand By Type

Note: (1) Excluding strategic, corporate and retail investors

1


Economics Report

Economics Team



The Sinopec Restructuring Story

The creation and corporatization of Sinopec was part of a massive restructuring effort:

– Restructuring of a Chinese SOE comprised of approximately 100 multi-tiered, independent and cross-competitive organizations encompassing approximately 10,000 separate companies

• 1.2 million employees

• Huge and sprawling geographic spread of assets; very diverse scale/efficiency and financial profile of the assets

• Significant operations outside of core business areas – Unprecedented accounting process

• KPMG Asia’s largest audit process ever - 8 month process

• 450 full time accountants for first 8 months, 260 full time accountants for year 2000 interim audits– Creation of ListCo and Non-ListCo holding companies

• Transfer of core assets (and related liabilities) to Sinopec ListCo, residual assets remain with parent

• Non-compete agreements, hundreds of related party contracts worth in excess of US$5 Bn– Significant balance sheet restructuring/rating agency process

US$4.0 billion debt-to-equity swap with domestic banks prior to IPO US$4.0 billion debt restructuring with parent Investment grade rating (BBB-) by S&P

– Important regulatory restructuring

• Liberalizing refined products pricing structure unlocked substantial value and eliminated regulatory uncertainty

– One of the most complex restructuring assignments in MSDW history

– MSDW was the key driver of the restructuring effort

– Actively supported lobbying efforts with the State Council

– Effectively led and achieved positive change in Sinopec’s corporate culture resulting in genuine focus on shareholder value creation and the development of systems and processes to support it

– A blue print for Chinese SOE reform

Landmark restructuring and corporatization story - 15-month process (from mandate) that was driven by senior management and the Morgan Stanley Dean Witter team and was a primary factor in the success of the IPO

3


Economics Report

Economics Team



Positioning Sinopec - An Attractive Growth Story / Premium to Petrochina

The key to differentiating Sinopec (in particular from PetroChina) was in highlighting its superior growth and return profile, which is driven by a number of notable structural factors:

– China is the world’s most attractive energy market

• Unprecedented absolute and relative growth potential– Sinopec is best positioned to capture China’s growth potential

• The Company’s principal market covers the highly attractive southern and coastal regions (73% of China’s population and 78% of GDP)

• Sinopec’s dominant infrastructure and networks in its principal market establish insurmountable barriers to entry, even post-WTO

• Unprecedented dominance in a consolidating market gives it unique pricing power• End-consumer orientation (versus pure commodity play) leaves it highly leveraged to China’s growth

– Sinopec will continue to benefit from a highly favorable regulatory and industry environment

• Recent regulatory changes toward a liberalized industry structure are to the benefit of Sinopec• Leveraged to cycle improvements in the refining and chemicals, but not dependent upon them• The effect of the WTO will be gradual and largely mitigated

– Sinopec has focused strategies for growth and returns across all of its business segments and the conditions to achieve its objectives are in place

• Sinopec is aggressively pursuing sustainable and profitable growth opportunities• Sinopec is taking advantage of the benefits of consolidation and corporatization by implementing a

comprehensive cost cutting and productivity improvement programs• Sinopec’s incentivized management, its centralized corporate structure, newly implemented advanced

information systems and its financial discipline ensure its ability to meet its objectives

– Succeeded in articulating and quantifying in simple terms a rather complex investment story

– The primary energy interface with the Chinese consumer

– A pure play on China’s growth potential

– Superior growth and returns to PetroChina

– Less exposed to crude oil volatility

– Conditions in place to achieve and surpass growth and efficiency objectives

Despite lack of a strong track record, a difficult market environment and other uncertainties, Sinopec at pricing was able to achieve a slight premium to PetroChina, implying a large premium on a fully-distributed basis

4


Economics Report

Economics Team


Case Study - $4.92 Bn IPO for China Unicom LimitedThe Largest Chinese IPO in History

– On June 16, 2000, Morgan Stanley Dean Witter placed the largest Chinese IPO in history - having generated over $16Bn in total demand

– China Unicom was priced near the high-end of the final price range of HK$13.80 - HK$16.00 at HK$15.58, which is 19.8% above the mid-point of the initial price range

– Asia, U.S., and Europe institutions generated 35%, 46% and 19% of the total institutional demand

Offering Summary

Issuer: China Unicom LimitedPricing Date: June 16, 2000Offer Size: % Pro forma TSO

US$4,916 MM (Pre-Greenshoe) 20.18%

Number of ADSs/Shares Offered: 245,912,700 ADSs/2,459,127,000 SharesADS Ratio: 10 Shares for 1 ADSOffer Price: HK$15.58 per share

US$19.99 per ADSInitial Price Range:Final Price Range:

HK$11.50 – HK$14.50HK$13.80 – HK$16.00

Offering Structure: Hong Kong Public Offer 5%Institutional Placement 95% (including strategic investor)

Listings: Stock Exchange of Hong Kong, New YorkStock Exchange

Use of Proceeds: To expand and upgrade Unicom’s cellular,long distance and data networks, as wellas the fiber optic transmission network

Joint Global Coordinators & JointBookrunners:

Morgan Stanley Dean WitterChina International Capital Corporation

Offering Highlights

– Largest ever Chinese IPO in history– Largest ever international equity distribution by an Asian issuer– Largest Hong Kong Public Offer IPO which generated approximately 3x of

demand– Over US$ 15 billion of institutional demand (approximately 4x subscribed)– Priced at a 19.8% premium to the mid-point of the initial price range

(HK$13.00) and near the top of the revised pricing range of HK$13.80 - HK$16.00

– Highly successful marketing program:The Company met with 88 institutions in one-on-one meetings during 3 weeks of roadshow in Asia, Europe and US, achieving an one-on-one hit ratio of 100%, 83% and 91% in Asia, U.S. and Europe

– Emphasis of MSDW equity franchise in Asia: With this deal, Morgan Stanley has lead-managed 4 equity offerings of US$ 1 billion or more for Non-Japan Asian issuers since 1998

Source Factset

Notes1. As of June 16, 2000.2.

80

90

100

110

120

130

140

5/12/00 5/18/00 5/24/00 5/30/00 6/05/00 6/09/00 6/15/00

CTHK

Emerging (2)

Developed (3)

Long Distance/Data (4)

Comps Performance since Pre-marketing (5/12/00)Indexed to 100

CTHK

Emerging

Developed

LD/Data

Asia & ROW33%

Europe16%

U.S.51%

Breakdown of Allocationby region

Roadshow launchedPre-marketinglaunched


Economics Report

Economics Team


Privatization of Aluminum Corporation of China Limited - A Case Study

Pre-Greenshoe Case Study

– On December 5, 2001, Morgan Stanley priced the IPO for Aluminum Corporation of China (“Chalco”), re-opening international equity capital markets for Asia Pacific issuers

– Chalco was priced at premiums of 94% and 64% to PetroChina’s and Sinopec’s 2001E P/E, respectively. It was also priced at a 22% premium to its own NAV; Sinopec and PetroChina IPOs priced only at 19% and 10% premiums to NAV, respectively

– Over 70% one-on-one hit ratio in each region

– Significant strategic investment in the IPO from ALCOA

– S&P “BBB” investment grade rating

Offering Summary Issuer: Aluminum Corporation of China (“Chalco”)

Pricing Date: December 5, 2001

Offer Size (Pre-Greenshoe): - % Pro forma TSO

US$457.9MM 25.0%

Total Number of H shares/ADSs Offered: 2,588,236,000 Shares / 25,588,236 ADSs

- Greenshoe (15% of shares offered to public):

Not Yet Exercised

- ADSs Ratio: 100 H Shares for 1 ADS

Offering Structure: Hong Kong Public Offer – 10%

Institutional Placement – 58%

Strategic Investor (ALCOA) – 32%

Offer Price: HK$1.38 per H share

US$17.69 per ADS

Price Range: HK$1.15 – HK$1.45 / US$14.74-18.59

Listings: Stock Exchange of Hong Kong New York Stock Exchange

Use of Proceeds: Funds for expansion, debt reduction, and general corporate purposes

10% secondary sale for mandatory contribution to PRC social security fund

Joint Global Coordinators & Joint Bookrunners:

Morgan Stanley China International Capital Corporation

Transaction Highlights

– First Metals & Mining sector equity issue out of China since 1998– Reopens international equity capital markets for Asia Pacific region

• First Asia Pacific ADR offering since September 11th

• Second largest ADR offering from Asia Pacific region in 2001

• Second major equity issue out of China this year after CNOOC’s IPO completed 10 months ago– Successfully marketed “deep cyclical” equity offering despite little visibility in global economic recovery during

uncertain and volatile equity and aluminum commodity market conditions– Priced at attractive valuations - premium to Chinese SOE comparables despite challenging market conditions:

• 24% – 90% premium to 2001 P/E multiples of Chinese SOE comparables

• 22% premium to Chalco’s own NAV; Sinopec and Petrochina priced at only 19% and 10% premiums to their own NAVs, respectively

– Exceptional quality and breadth of institutional demand:• Over US$2.8 billion of institutional and retail demand (over 10x subscribed)

• Top global and Tier 1 institutions constitute about US$1.5 billion or 60% of total institutional demand

• US$320 million of high quality supplemental orders from top institutions that did not have a one-on-one meeting with management

• Hong Kong Public Offer fully covered– Redefines nature of strategic investment for Chinese SOEs

• Alcoa (NYSE: AA) to own 8% of equity, have one board representative and form a 50/50 JV at one of Chalco’s integrated refiners and smelters

• 30 month lock-up; AA to fund 50% of JV’s capex; and significant corporate governance rights for AA

80

90

100

110

120

130

140

150

160

11/5/01 11/7/01 11/9/01 11/13/01 11/15/01 11/19/01 11/21/01 11/23/01 11/27/01 11/29/01 12/3/01 12/5/01

Hindalco Nalco Alcoa

Alcan Pechiney Hang Seng

S&P 500 Dow Jones

Major Indices and Comp Performance Since Pre-Marketing (11/5/2001)

Pre-Marketing Launched

Roadshow Launched

Pricing

Source FactSet

1Note: (1) Figure excludes PWM demand, includes orders from Canada

Morgan Stanley & CICC82.0%

PWM16.6%

Syndicate1.4%

Breakdown of Demand(Excluding Alcoa and HK Public Offer)

Institutional By Region(1) Total Demand By Type

Asia & ROW26%

Europe26%

U.S.(1)48%


Economics Report

Economics Team


China: Economic Forecast Summary

China: Economic Forecast Summary(YoY, %, nominal, unless otherwise stated)

1999 2000 2001E 2002EReal GDP 7.1 8.0 7.4 7.0Nominal GDP 4.6 9.1 8.5 8.6 Private Consumption 6.7 9.5 7.4 7.5 Public Consumption 8.4 13.8 4.0 5.0 Investment, Non-state 6.7 15.9 16.5 18.0 Investment, State 3.8 3.5 12.0 9.0 Change in Stocks, % of GDP 1.2 1.1 0.8 0.8 Net exports, % of GDP 2.7 2.4 1.8 1.0Current account, US$ bn 15.7 20.5 16.3 7.3 % of GDP 1.6 1.9 1.4 0.6Trade Balance, US$ bn 29.2 24.1 18.9 13.0Exports 6.1 27.8 6.5 8.0Imports 18.2 35.8 9.5 11.0CPI -1.4 0.4 1.0 1.5Sources: CEIC, Morgan Stanley Dean Witter Research.


Economics Report

Economics Team


Clauses

____________________________________________________The information and opinions in this report were prepared by Morgan Stanley Dean Witter Asia Limited ("Morgan Stanley"). Morgan Stanley has no obligation to tell you when opinions or information in this report change. Morgan Stanley and its affiliate companies are involved in many businesses that may relate to companies mentioned in this report. These businesses include market making and specialized trading, risk arbitrage and other proprietary trading, fund management, investment services and investment banking.

This report is based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We are not offering to buy or sell the securities mentioned or soliciting an offer to buy or sell them.

Morgan Stanley, Morgan Stanley DW Inc., affiliate companies, and/or their employees may have an investment in securities and derivatives of securities of companies mentioned in this report. These derivatives may be issued by Morgan Stanley or others associated with it.

The securities discussed in this report may not be suitable for all investors. Investors must make their own investment decisions based on their own investment objectives and financial position. Morgan Stanley recommends that investors independently evaluate each issuer, security or instrument discussed, and use any independent advisers they believe necessary. The value of and income from your investment may vary because of changes in interest rates or foreign exchange rates, changes in the price of securities or other indexes in the securities markets, changes in operational or financial conditions of companies and other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance.

To our readers in the Republic of China: Information on securities that trade in Taiwan is distributed by Morgan Stanley & Co. International Limited, Taipei Branch (the "Branch") and has been authored or reviewed by Dickson Ho, Head of Research. Such information is for your reference only. The reader should independently evaluate the investment risks. This publication may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities. The Branch may not execute transactions for clients in these securities.

This publication is disseminated in Japan by Morgan Stanley Japan Limited and/or Morgan Stanley Nippon Securities, Ltd.; in Singapore by Morgan Stanley Dean Witter Asia (Singapore) Pte., regulated by the Monetary Authority of Singapore; in Australia by Morgan Stanley Dean Witter Australia Limited A.B.N. 67 003 734 576, a licensed dealer, which accepts responsibility for its contents; in certain provinces of Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of this publication in Canada; in Spain by Morgan Stanley Dean Witter, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that this document has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., which accept responsibility for its contents; and in the United Kingdom, this publication is disseminated and approved by Morgan Stanley & Co. International Limited, regulated by the Securities and Futures Authority Limited. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International Limited representative about the investments concerned.

This report may not be sold or redistributed without the written consent of Morgan Stanley Dean Witter & Co. Morgan Stanley is a service mark of Morgan Stanley Dean Witter & Co.

Additional information on recommended securities is available on request H7638P

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