FOR PROFESSIONAL INVESTORS

Increasing Volatility in the Chinese Market: How can Asia’s Capital Markets cope with this?

Alex Ng Chief Investment Officer, Asia Pacific BNP Paribas Investment Partners

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Topics for discussions:

1. Economic Volatility Hard landing vs New Normal 2. Stock Market Volatility 40.5% from peak vs 31.3% from 12 months ago* 3. Currency Volatility Competitive Devaluation vs Flexible Exchange Rate

* CSI 300 total return performance as of 15 Sep 2015 (Source: Bloomberg)

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1. Economic Volatility Hard landing vs New Normal

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Welcome to the New Normal Trend growth in China steadily heading lower ● The World Bank assumes that China

can achieve 7% growth from 2016-20 “assuming steady reforms and no major shock”. Trend growth steadily declining thereafter as technological catch-up slows down.

● Unchanged growth pattern leads to: – Economic risks – Social risks – Environment risks – External risks

● Long-term success is not guaranteed because of the “middle income trap”. Of 101 middle-income countries in 1960, only 13 became high income by 2008.

Source: World Bank, “China 2030”, March 2013 http://www.worldbank.org/content/dam/Worldbank/document/China-2030-overview.pdf

9.9%

8.6%

7.0%

5.9%

5.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

1995–2010 2011–2015 2016–20 2021–25 2026–30

Potential labour force growth (%) Potential productivity growth (%)

Annual % contribution to potential GDP grow th

9.9% 8.6%

7.0% 5.9%

5.0%

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The GFC led to a rapid increase in Chinese loans

Source: Federal Reserve Bank of St Louis, July 2015

Source: Bloomberg, National Bureau of Statistics of China, July 2015

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China’s Economic Rebalancing towards Consumption and Services

Source: National Bureau of Statistics of China (Aug 2015) Source: CEIC, BNPPIP (Aug 2015)

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Innovation to drive productivity Patent application by patent office and country of origin

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000Total Patent applications by applicants' office and origin

China Japan Republic of Korea United States of AmericaSource: WIPO Statistics Database, Aug 2015

China

Japan USA

Korea

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Source: CEIC, Nomura Strategy Research, SSI Vietnam, Apr 2014

FDI flows into ASEAN has exceeded that into China

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New Silk Road (One-Belt One-Road) ● Helps unleash a regional

infrastructure boom by connecting China with Asia, Africa and Europe by and by sea

● Extends the “go west” policy

● Facilitates RMB internationalisation along the way

● Helps China export its excess capacity

Source: Xinhua Finance Agency, Aug 2015

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2. Stock Market Volatility 40.5% from peak or 31.3% from 12 months ago*

* CSI 300 total return performance as of 15 Sep 2015 (Source: Bloomberg)

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Recent Decline was compounded by Margin Lending

Source: Bloomberg (Aug 2015)

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Index Volatility belies a heathier development in earnings

Source: Bloomberg (Aug 2015)

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China offers a broad range of companies

Note: Grouped by GICS Industry Group and GICS Industry Sub-Group Source: Factset, MSCI (Aug 2015)

% WeightMSCI

China AMSCI China

MSCI Japan

MSCI India

MSCI Korea

MSCI Taiwan

MSCI Singapo

re

MSCI Hong Kong

MSCI Indones

iaNew Economy 22.1 18.8 19.0 37.1 36.8 56.6 5.1 0.5 6.1Pharmaceuticals Biotechnology & Life Sciences 6.2 1.4 5.8 12.1 1.5 - - - 3.1Technology Hardware & Equipment 4.7 1.4 7.5 - 26.0 24.7 - - -Independent Power and Renewable Electricity Producers 3.5 2.7 0.2 0.7 - - - - -Software & Services 2.6 11.4 2.4 22.5 4.9 - - - -Media 2.0 0.3 0.6 1.2 0.2 - 2.9 - 3.0Aerospace & Defense 1.6 0.2 - - 0.7 - 2.2 - -Health Care Equipment & Services 0.8 0.9 2.1 0.5 - - - - -Semiconductors & Semiconductor Equipment 0.8 0.5 0.5 - 3.5 31.9 - 0.5 -

Old Economy 77.9 81.2 81.0 62.9 63.2 43.4 94.9 99.5 93.9Banks 14.5 22.9 9.5 13.7 8.5 10.5 37.7 8.3 36.0Capital Goods (ex Aerospace & Defense) 14.3 5.2 12.5 5.4 9.7 1.5 9.1 10.5 2.8Materials 9.3 1.8 5.6 6.0 7.9 9.2 - - 4.9Diversified Financials 6.7 2.7 2.6 1.7 1.9 3.9 2.7 7.6 -Real Estate 5.9 5.7 4.5 0.1 - 0.4 16.6 27.9 4.3Food Beverage & Tobacco 4.5 2.2 4.2 6.3 3.4 2.2 3.5 0.8 7.0Insurance 4.1 10.0 3.0 - 3.9 3.8 - 18.4 -Transportation 3.9 2.2 5.1 1.4 1.1 0.9 7.1 2.4 0.9Consumer Durables & Apparel 3.8 1.5 4.0 - 2.1 3.0 - 3.2 -Automobiles & Components 2.8 2.1 13.7 7.6 10.5 0.9 - - 10.5Energy 2.7 8.9 0.9 9.8 2.0 0.6 - - 1.2Commercial & Professional Services 1.6 0.2 2.6 - 1.9 0.6 1.5 - 3.6Consumer Services 0.9 0.4 1.1 - 0.8 - - - -Telecommunication Services 0.8 11.7 5.7 4.4 1.0 4.9 14.6 1.4 14.7Utilities (ex Independent Power and Renewable Electricity Producers) 0.7 - 0.5 - 1.0 - 2.1 6.3 -Retailing 0.7 2.0 2.6 1.0 2.3 - - 12.7 2.7Food & Staples Retailing 0.5 0.7 1.8 - 0.8 0.9 - - -Household & Personal Products 0.2 0.9 1.3 5.6 4.4 - - - 5.3

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China H/Red chips/P chips/B share

China A China

Oversea Korea

Taiwan

South Africa

Brazil

India

Mexico

Russia

Others

China will make up 44% of MSCI EM Index after full inclusion

Current status Partial inclusion(5%*) Potential Additional Steps: Partial inclusion

(>5%*)

Potential Full inclusion (100%*)

1. Further improvements in quota allocation mechanism and size of overall quota

2. Further relaxation on capital mobility and other market accessibility constraints

1. Abolishment of the quota system 2. Full liberalisation of capital mobility restrictions 3. Alignment of international accessibility

standards

China: 44%

Steps to be done Steps to be done

China H/Red chips/P chips/B

share 25%

0%

0%

Korea 15%

Taiwan 13%

South Africa 7%

Brazil 7%

India 7%

Mexico 5%

Russia 4%

Others 17%

China H/Red chips/P chips/B share 25%

China A 1%

China Oversea

3% Korea 14%

Taiwan 12%

South Africa 7%

Brazil 7%

India 7%

Mexico 4%

Russia 4%

Others 16%

China 29-44%

China 29%

China 25%

China H/Red chips/P chips/B share 20%

China A 21%

China Oversea

3% Korea

9%

Taiwan 10%

South Africa

6%

Brazil 6%

India 5%

Mexico 4%

Russia 3%

Others 13%

Source: MSCI, BNPP IP, June 2015 *The percentage number refers to the Inclusion Factor applied to the free float-adjusted market capitalisation of China A-share constituents in the pro forma MSCI China Index. China A-share securities are subject to a foreign ownership limit

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Asia ex-Japan’s valuation is already at relatively low levels

Source: MSCI, Aug 2015

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3. Currency Volatility Competitive Devaluation vs Flexible Exchange Rate

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Source: Bloomberg, BIS (Aug 2015)

CNY FX vs BIS RMB REER

CNY is no longer undervalued

Source: IMF Staff Completes the 2015 Article IV Consultation Mission to China Press Release No. 15/237 May 26, 2015

“…our assessment now is that the substantial real effective appreciation over the past year has brought the exchange rate to a level that is no longer undervalued…” “… On the exchange rate system, we urge the authorities to make rapid progress toward greater exchange rate flexibility…”

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CNY does not have a history of competitive devaluation

Source: BNPPIP, Bloomberg, Aug 2015

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Diverging real effective exchange rates in Asia

Source: Bloomberg, BIS (Aug 2015)

As of: 31/08/2015 China 160.4 Philippines 157.3 Singapore 123.7 Thailand 123.0 Indonesia 111.7 Malaysia 99.6 India 96.9 Korea 94.2 Japan 66.0

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Recap:

* CSI 300 total return performance as of 15 Sep 2015 (Source: Bloomberg)

1. Economic Volatility Hard landing vs New Normal 2. Stock Market Volatility 40.5% from peak vs 31.3% from 12 months ago* 3. Currency Volatility Competitive Devaluation vs Flexible Exchange Rate

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