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China Business Dashboard January 2007 Key headlines • • • •

Bubbly growth expectations: Executives' confidence in China remains extremely high, particularly with regard to domestic sales prospects. Confidence about export growth is slightly mitigated by concerns over currency risk. China-based executives more bullish: In-country managers are more bullish about business prospects than their counterparts at HQ and have higher expectations of investment spending. Focus on traditional regions: Investment plans are geared to the traditional highgrowth regions of Shanghai, Beijing and Guangdong although executives based in China have their eyes on opportunities all along the eastern seaboard. Labour the main barrier to growth: Labour market concerns are identified as the biggest threat to business, thanks to rising costs and high levels of employee turnover.

About the China Business Dashboard The China Business Dashboard is published twice a year by the Economist Intelligence Unit, the business information arm of The Economist Group, publisher of The Economist. The Dashboard comprises the findings of our regular China business confidence index survey as well as a summary of our latest economic forecast. We surveyed over 400 executives at multinational companies with operations in China in October 2006. A quarter of the respondents are based in China; the rest are based in their firms' corporate headquarters outside China. Respondents were based at businesses across various sectors, with financial services (18% of all respondents) and professional services (12%) the industries most prominently represented. Around half the companies surveyed have global annual revenues in excess of US$1bn. Among the respondents themselves, 34% are C-level executives or board members, 23% describe themselves as head of either a business unit or department and 19% describe their position as that of senior vice-president, vice-president or director. The confidence index values are generated by calculating the balance of responses (whereby each question's negative responses are subtracted from its positive responses) on the following questions: - Expectations of economic conditions in China over the next 12 months - Expectations of revenue from domestic sales in China over the next 12 months - Expectations of revenue from exports out of China over the next 12 months - Expectations of profitability in China over the next 12 months - Expectations of investment in China over the next 12 months The balance of each of these questions is averaged to produce an overall confidence index, which can range in value from a maximum of 100 to a minimum of -100. The index was calculated for the first time in this survey and the result (62) is the benchmark value for all iterations of the index going forward.

China business confidence index: Overall findings Executives' confidence in China remains extremely high—the overall business confidence index value stands at 62 (out of a maximum possible score of 100; see chart). Despite our forecast of a gradual softening in economic growth, a majority of respondents (57%) expect economic conditions in China to improve over the next 12 months; 37% believe they will stay the same and just 5% believe that they will worsen. Respondents are particularly buoyant about prospects for domestic sales. More than threequarters believe that revenue from local sales will increase in the next year. Strikingly, executives based in China are even more upbeat than their counterparts at head office. Sentiment about export growth is also bouncy, with 66% of respondents expecting an increase in revenue from exports. The slight dip in confidence relative to expectations for domestic sales reflects widespread consensus among respondents that the renminbi will appreciate against the dollar over the next 12 months. The Economist Intelligence Unit is forecasting modest appreciation in 2007, with the exchange rate expected to average Rmb7.7:US$1. With revenue prospects so rosy, executives expect the money to keep flowing in. Of all respondents, the majority (69%) expect their companies to increase investment in China in the next 12 months. A greater proportion of executives based in China (78%) expect investment to increase than of their counterparts in HQs outside China. Fast top-line growth will be translated into profit growth at most firms. Three out of five respondents expect the profitability of their operations in China to increase over the next year, with little variation between executives based inside China and those at headquarters.

China business confidence index: Regional prospects Corporate activity continues to be dominated by China's traditional high-growth regions. Shanghai, Beijing and Guangdong are the regions in which the largest proportion of respondents expects both revenue growth and investment activity over the coming 12 months (see chart). Knowledge of the country at head office does not appear to extend far beyond these big three locations, however. Executives based outside China almost exclusively expect investment in these three locations, whereas executives based inside China see wider opportunities. Significant proportions of respondents on the ground expect investment all along the eastern seaboard, in Jiangsu (26%), Shandong (22%), Zhejiang (22%), Tianjin (16%) and Fujian (16%).

Source: Economist Intelligence Unit

China business confidence index: Threats to business Labour-market issues are arguably the biggest concern for companies operating in China. Human-capital risk is identified as one of the biggest threats to operations, alongside regulatory risk, corruption and intellectual property risk, these last two being particular preoccupations of executives at head office (see chart). Demand for staff remains extremely high—68% of all respondents expect to increase staffing levels in China within the next 12 months—and competition for the best people is fuelling employee turnover and wage inflation. Although there is widespread confidence that the quality of employee skills will improve over the next 12 months, few executives expect there to be any improvement in labour-market flexibility and almost two-thirds of respondents identify increasing labour costs as either a major or moderate problem for their businesses over the next 12 months. Those on the front line are particularly aware of the problem—while 58% of executives based outside China see rising labour costs as either a major or moderate problem over the next year, the figure rises to 72% for respondents based in China. Costs are escalating in other operational areas besides labour. Some 58% of all respondents see increases in the cost of property/rent as either a major or moderate problem and more than half say the same of rising energy costs.

Appendix 1: Economist Intelligence Unit growth forecast The economy is expanding at a feverish pace—an estimated 10.5% in 2006—and is forecast by the Economist Intelligence Unit to slow only modestly, to 9.6% in 2007 and 9.3% in 2008. The government’s efforts to rein in capital spending, mainly through targeted administrative measures such as restrictions on property development, curbs on lending and a rise in interest rates, have so far been unsuccessful. This is partly because the government is held back from more aggressive action to put the economy on a more stable path by its conflicting goal of sustaining the current economic boom, and partly because of structural factors, in particular the exceptionally high national savings rate, which depresses financing costs. Near-term risks are contained by the strong fiscal position of the government, which would enable the authorities to to increase spending substantially in the case of external or domestic shocks and also to bail out financial institutions that might come under pressure. In addition, Chinese producers of tradables could turn even more aggressively to world markets if domestic demand should falter. However, the odds of a painful economic slowdown will increase as long as the spending boom continues.

Appendix 2: Full survey results 1. Over the next 12 months, do you expect economic conditions in China to be better, the same or worse than in the previous 12 months? Better 57.5% Same 37.4% Worse 5.1%

2. Over the next 12 months, do you expect your company's revenue from its operations in China to increase, stay the same or decrease, compared with the previous 12 months? Stay the Not Increase same Decrease applicable Revenue from domestic sales 71.7% 18.2% 2.0% 8.1% Revenue from exports 47.1% 21.4% 2.9% 28.7%

3. In which provinces do you expect your company will see growth in domestic sales revenue in China over the next 12 months? Beijing 71.5% Chongqing 16.1% Fujian 14.4% Guangdong 49.4% Guangxi 10.7% Hainan 10.2% Hebei 9.6% Heilongjiang 7.3% Henan 7.9% Hubei 7.1% Hunan 10.5% Jiangsu 23.2% Liaoning 9.9% Shandong 19.5% Shanghai 74.0% Shanxi 10.7% Sichuan 17.8% Tianjin 24.3% Zhejiang 20.1% Other, please specify 4.8%

4. Over the next 12 months, do you expect your company's profitability in China to increase, stay the same or decrease, compared with the previous 12 months? Increase 60.3% Stay the same 34.3% Decrease 5.4%

5. Over the next 12 months, do you expect your company's level of investment in China to increase, stay the same or decrease in the next 12 months? Increase 69.3% Stay the same 28.5% Decrease 2.2%

6. If your company plans to expand in China over the next 12 months, by which mechanism(s) will this be done? Organic growth Joint ventures Mergers and acquisitions Greenfield investment in new locations Not applicable - we do not plan to expand in China in the next 12 months

53.2% 36.4% 20.4% 20.4% 14.8%

7. In which provinces in China do you expect your company to invest over the next 12 months? Beijing 50.6% Chongqing 8.4% Fujian 9.3% Guangdong 32.9% Guangxi 5.8% Hainan 4.7% Hebei 4.4% Heilongjiang 2.9% Henan 4.4% Hubei 4.4% Hunan 6.1% Jiangsu 12.5% Liaoning 4.9% Shandong 10.8% Shanghai 59.0% Shanxi 4.7% Sichuan 9.3% Tianjin 12.2% Zhejiang 11.6% Other, please specify 2.9%

8. Over the next 12 months, do you expect that your company's staffing levels in China will increase, stay the same, or decrease, compared with the previous 12 months? Increase 68.0% Stay the same 29.5% Decrease 2.4%

9. Do you expect increasing costs in the following areas to be a problem for your company's operations in China over the next 12 months? Major Moderate Not a Not problem problem problem applicable Labour costs 14.6% 47.3% 37.1% 1.0% Cost of property/rent 14.4% 43.7% 39.0% 2.9% Cost of energy and natural resources 14.1% 37.8% 37.8% 10.4% Tax rates 13.6% 35.6% 45.5% 5.2% Transportation costs 11.8% 43.6% 37.4% 7.1% Capital costs 9.3% 38.8% 46.8% 5.3% IT infrastructure costs 8.5% 39.3% 49.3% 3.0% Cost of other inputs 7.6% 44.5% 37.7% 10.2%

10. Over the next 12 months, do you expect China's business environment to improve, stay the same, or worsen in the following areas, compared with the previous 12 months? Stay the Don't Improve same Worsen know Quality of employee skills 47.2% 47.7% 4.6% 0.5% Quality of IT infrastructure 45.7% 48.6% 4.2% 1.5% Quality of transportation infrastructure 43.3% 43.1% 9.7% 3.9% Stability of financial system 31.2% 58.1% 8.3% 2.4% Protection of intellectual property 31.1% 57.0% 10.2% 1.7% Flexibility of labour market (ease of hiring and firing) 13.8% 67.1% 16.5% 2.7%

11. How significant a threat are the following risks to your company's operations in China over the next 12 months? Very high Very low risk risk 1 2 3 4 5 Intellectual property risk 21.7% 29.9% 25.1% 13.4% 8.3% Regulatory risk 17.2% 32.3% 27.6% 17.5% 4.7% Corruption 16.0% 34.5% 27.9% 17.0% 3.4% Human capital risk 13.7% 36.3% 32.4% 11.7% 5.4% Foreign exchange risk 7.3% 25.1% 38.2% 20.7% 7.5% Domestic political risk 7.0% 21.4% 26.9% 23.3% 19.4% International trade disputes 6.1% 27.4% 32.5% 19.6% 11.0% International political risk 4.9% 17.1% 29.8% 26.3% 19.0% Infrastructure risk 3.4% 18.1% 33.1% 29.4% 12.3% Crime and physical security 3.2% 17.7% 31.3% 28.9% 17.7%

Not applicable 1.7% 0.7% 1.2% 0.5% 1.2% 1.9% 3.4% 2.9% 3.7% 1.2%

12. How do you expect the renminbi will move against the US dollar in the next 12 months? Rise in value against the dollar 72.7% No change 15.9% Fall in value against the dollar 6.1% Don't know 5.6%

13. Do you think the recent Communist Party shakeup in Shanghai will affect that city's business environment? It will make Shanghai a less attractive place to do business 14.3% It will have no effect on the local business environment 49.5% It will make Shanghai a more attractive business location 18.7% Don't know 17.7% Demographics Where are you personally based? In mainland China Outside of China, at our corporate headquarters Neither of the above

27.5% 72.5% 0.0%

Approximately what percentage of your company's revenue comes from sales in China? None: we do not sell in China 7.8% Less than 5% 40.3% 5%-10% 19.4% 10%-15% 10.2% 15%-20% 4.9% 20%-25% 4.1% 25%-30% 2.4% More than 30% 8.5% All: we only sell in China 2.7%

What is your primary industry? Aerospace/Defence Agriculture and agribusiness Automotive Chemicals Construction and real estate Consumer goods Education Energy and natural resources Entertainment, media and publishing Financial services Government/Public sector

1.2% 1.7% 5.1% 3.1% 2.4% 6.3% 3.9% 3.6% 3.1% 17.6% 3.4%

Healthcare, pharmaceuticals and biotechnology IT and technology Logistics and distribution Manufacturing Professional services Retailing Telecommunications Transportation, travel and tourism

6.8% 8.7% 2.9% 10.4% 11.6% 1.9% 2.4% 3.9%

What are your company's global annual revenues in US dollars? $500m or less $500m to $1bn $1bn to $5bn $5bn to $10bn $10bn or more

37.4% 13.2% 16.9% 12.2% 20.3%

Which of the following best describes your title? Board member CEO/President/Managing director CFO/Treasurer/Comptroller CIO/Technology director Other C-level executive SVP/VP/Director Head of Business Unit Head of Department Manager Other

4.4% 18.2% 4.4% 1.2% 5.8% 18.9% 8.0% 14.6% 18.7% 5.8%

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