EFTA01451006.pdf

II December 2013 GEM Equity Strategy Outlook 2014 Debt situation is becoming critical to; materials and industrials sectors The debt levels of the Industrials and Materials sectors reveal how close the entire system is to reaching a tipping point. The balance sheet leverage of both sectors has risen sharply since 2008 (Figure 34 and Figure 35) despite a level of capital expenditure which has generally been falling relative to sales (Figure 36 and Figure 37). The implication is that whilst the listed companies have in general been behaving in a rational manner, the widespread provision of cost subsidies especially to A- or non-listed enterprises creates a level of overcapacity which drives returns far below the real cost of capital for entire industries. The situation is becoming increasingly critical in our view, since these enterprises are leveraging into an economy which is itself increasing leverage by a considerable amount, led by the local government financing vehicles, many of which offer direct support to the enterprise sector. There is no definitive figure for the extent of LGFV debt - the National Audit Office has been conducting an investigation, the results of which were supposedly going to be released in the lead up to the Plenum, but have failed to appear as yet for some reason. Our best guess is that the level is some way ahead of RMB20trn compared with the RMBI0trn in 2010, which was the last official estimate. I Figure 34: Chinese Materials - Debt/Equity (%), rolling 12m average Figure 35: Chinese Industrials - Debt/Equity (%), rolling 2m average 20% 1 20% 0% 1 "1' 8883 888888888888! 8888 3888888888822 3. 838383838383888353838 3888388838883838383838 111 E0Tionn0 492ntginbn of Sart oafs in ...XI EM Wel 111 accanniwageoniea of inievenwoo0a in MSCI EM Inds Sow* Deasore Bent ScornAn Fan»LP Sailor Paso* Bent, &oven Rown0i LP Figure 36: Chinese Materials - CapexiSales (%). lolling Figure 37: Chinese Industrials - Capex/Seles (%). rolling 12m average 12m average 14% 12% 'n1 8% 4% 1 SY n 0% ...........,...,...,.....,.... 8 8 8838888888 8 8 8 99: ;222 8 5 6- 11110 :Ore 3 8 5 8 3 8 3 8 3 8 3 8 3 8 3 8 3 8 3 8 3 8 3 8 3 8 5 8 3 8 3 8 3 8 3 8 5 8 3 rd 3 EI 3 8 111lasoni.•0 esseovibin of Most *Web In MSC Minds. 111lonen....0 sgsnrallon of .Ssn$ 4fricb %IWO EM rd.. Sans Drees &Int Screws Stew.LP Sans Danes ark Moran Fnine•CP Page 22 Deutsche Bank AG/London CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0 107098 CONFIDENTIAL SDNY_GM_00253282 EFTA01451006