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Key financial market driver 3 - China growth outlook Key questions First interest rate cut since 2008 e When will the economy bottom out? F 8 e What economic policy responses can we expect to support the economy ahead? e How significant is the contagion risk from a possible downturn in the Eurozone? 7 ClO View (Probability: 70%*) Modest policy easing to support growth in 2H12 e The latest economic data suggest that economic activity is showing signs of stabilization, albeit at a comparatively low level. However, we have yet to see meaningful pick-up in activity. We think that policy 2 4 measures to support the economy should have more visible effect on activity in the second half of the ; SL year. ; ¢ To this effect, the People's Bank of China (PBoC) has recently cut interest rates by 25bps — the first such move since late 2008. With investment demand still sluggish, we don't expect the measure to have a significant near-term effect on growth. Still, the cut confirms the leadership's commitment to support the 0 economy. Importantly, with the rate cut, measures were announced to increase the banks' ability to set interest rates, which should bolster private household spending power in the future. ¢ The rate reduction took place against a backdrop of falling price inflation. Thus, inflation is no obstacle for further measures to ease monetary policy. However, at this point we don't expect further rate cuts this source: Bloomberg, UBS CIO, as of 18 Jun 2012 year; especially since increased interest rate flexibility should contribute to an easing of monetary conditions ahead. If anything, we think the PBoC may implement more reductions in banks' reserve . i. . requirement rates to ensure sufficient liquidity provisions. Thus, we think the real focus has to be on the Pick-up in infrastructure investment fiscal policy measures now, including possibly an acceleration of infrastructure investments, measures to support consumer spending and selective relaxation in the property market (while keeping home-purchase un-03 un-04 un-05 un-06 un-07 un-08 un-09 un-10 un-11 un-12 === |-year lending rate ——= 1-year deposit rate restrictions intact). . 50 A A Positive scenario (Probability: 20%*) Higher-than-expected growth — 40 ; ¢ Chinese GDP grows above 8.5% in 2012. For this we would probably need to see stronger-than-expected = 30 ta fiscal and monetary policy support from the government. A speedy improvement in the Eurozone debt crisis could also lead to this positive scenario. Year-on-ye ar & Negative scenario (Probability: 10%*) Hard landing 10 Ili ¢ Chinese GDP growth below 6%, i.e. a hard landing of the economy. This could be triggered by a global 0 ul financial crisis/recession, causing a slump in Chinese exports. Other risks include a sharp decline in Chinese 7 residential property prices — which would slow investment growth, a large-scale default of local 10 government debt, or a surge in inflation that forces the PBoC to significantly tighten monetary policy. 05 06 OF o8 o9 10 11 «12 Key dates 1 Jul Manufacturing purchasing managers index (Jun) 13 Jul Fixed asset investment, industrial production (Jun), 2Q12 GDP Source: Bloomberg, UBS CIO, as of 18 Jun 2012 11-15 Jul New bank lending, M2 (Jun) Note: Past performance is not an indication of future returns. 22-25 Jul HSBC flash manufacturing purchasing managers index (Jul) ‘SBERHAIG prebabilitieeaks based single lieatiiee SSsessiniehe. am UBS For further information please contact CIO analyst Gary Tsang, gary.tsang@ubs.com, Glenda Yu, glenda.yu@ubs.com, Patrick Ho, patrick-ww.ho@ubs.com 1 Please see important disclaimer and disclosures at the end of the document. HOUSE_OVERSIGHT_024145