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Exhibit 28: Total Foreign Currency Holdings of China’s Official Sector If the recent pace of decline continues, China's reserves could soon fall below the IMF's adequacy threshold. US$ billions 5,000 Mmmm PB0C FX reserves Gu Other official FX holdings == Scenario 1 (avg. pace since Aug-2015) Scenario 2 {avg. pace in 2016) 4,500 - 4,000 3,500 | 3,000 | 2,500 + 2,000 1,500 - (with capital controls) 1,000 500 | Jan-15 f=} Jul-15 Jan-16 Jul16 Jan-17 Jul-l7 Data through November 2016. Source: Investment Strategy Group, CEIC, Bloomberg, IMF. time is different” is extremely dangerous for the investment well-being of our clients’ portfolios. China, in fact, faces greater risk of a financial crisis because of growing capital outflows. An astounding $1.3 trillion of capital has flowed out of China since August 2015, when it broadened the trading range for its currency against the US dollar. The outflows averaged $64 billion per month in According to the Center for Strategic and International Studies, China has installed anti-aircraft guns and other weapons systems on seven man-made islands in the South China Sea, including the Johnson Reef, shown above. Map data: Google, DigitalGlobe 2016. At that pace, China’s total official foreign currency holdings could drop below the IMF’s reserve threshold of $2.8 trillion by mid-2017, as shown in Exhibit 28. Of course, China’s leadership has not stood on the sidelines. Since September 2015, the People’s Bank of China and the State Administration of Foreign Exchange have introduced a series of measures to limit capital outflows. These measures have included orders to financial institutions to carefully check and strengthen controls on all foreign exchange transactions”! and strict oversight of Chinese companies’ outward investment in overseas property, hotels, cinemas and the entertainment and sports industries.” According to reports, leadership has also ordered increased oversight of trade activities to make sure companies are not over-invoicing the value of their imports or under-invoicing the value of their exports as a means of circumventing capital controls.*? Exports and imports are 20% and 15%, respectively, of China’s GDP. It is virtually impossible for China to halt capital flows in such a porous economy without slowing GDP growth rates. Thus, China will not be able to completely stem outflows despite all its measures to slow the pace as much as possible. Irrespective of the success of such capital controls, China’s growing debt problem poses significant risks to China’s growth trajectory. We estimate that the risk of a hard landing is only about 25% in 2017 but will increase rapidly to about 50% in 2018 and be closer to 75% in 2019. Therefore, while China is not a near-term risk, there is a high probability of an intermediate-term crisis that will reverberate through financial markets. We also know that we cannot anticipate the exact timing of such crises, especially given the uncertainty of how US-China relations will unfold under a Trump administration. US-China Relations Deteriorate Under the Trump Administration There is no doubt that US strategy toward China will shift; the only question is when and how. There are two channels by which the Trump administration could affect US-China relations: trade and foreign policy. Outlook | Investment Strategy Group 33 HOUSE_OVERSIGHT_014566