Contents

I. Inflation and growth outlook
      Our   2008   and   2009   inflation   forecast   stands   at  6.8%   and   3.0%,   respectively,   and   the   growth-       Page 3
          inflation trade off will likely to be much worse in 2008 compared with 2007.

      We   expect   two   27bp   interest   hikes   in   2008,   frequent   reserve   requirement   hikes,   and   10%   CNY
          appreciation in 12 months’ time, in a gradual fashion.

II. Changing tides in corporate earnings
      Corporate   earnings   may   grow   slower   than   nominal   GDP   growth   in   2008   for   the   first   time   since  Page 13
          2001, which implies a significantly slowdown in profit growth in 2008-2009.

      Furthermore,          various   government      price  controls    have   distorted   sectoral   profit  distributions,
          favoring banks and non-state-owned-enterprises in the non-financial sector at the expense of state-
          owned-enterprises in downstream industries.

III. How fast is money supply really growing?
      We   find   that   the   M3   growth   rate   has   been   much   faster   than   that   of   M2   since   2Q2006,   likely Page 17
         reflecting the fast accumulation of capital-market-related financial assets, such as mutual funds and
         bonds held by non-depository institutions.

      We believe   M3 growth is a   more   comprehensive  indicator for monetary expansion, and a better
          leading indicator for activity growth and inflation for most mature economies.

IV. Renminbi: An unbearable straitjacket for the central bank
      The imbalance in China is not with robust domestic investment, but with excessive current account                          Page 19
          surplus, fueled by a significantly undervalued currency.

      This        external   imbalance    has   led  to  periodic    domestic    inflation,  particularly    asset  inflation,
         pressures. Hefty inflow of FX assets has also been increasingly crowding out the domestic credits.

V. What drives China’s trade surplus and what will it take to narrow it?
      Increasingly, China’s exports are composed of higher value-added investment goods, and are going                           Page 31
         to markets outside of the US.

      The trade surplus tends to rise when domestic  investment demand slows, and will narrow if the
          CNY effective exchange rate appreciates.

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