5 January 2009
China Macro Strategy
China: Themes and
Strategy for 2009
Navigating a year of deceleration, deflation, and consolidation
Jun Ma, Ph.D
Chief Economist
(852) 2203 8308
jun.ma@db.com
Wenjie Lu
Research Analyst
(852) 2203 6187
wenjie.lu@db.com
Deutsche Bank AG/Hong Kong
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LOCATED IN APPENDIX 1.
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􀂄 We expect the current economic deceleration in China to be worse than that
during the Asian Financial Crisis. We forecast GDP growth to decline from 9%
in 2008 to 7% in 2009 and 6.6% in 2010.
􀂄 Our quarterly GDP growth outlook is a double-dip scenario. Following the first
dip to around 6% in Q4 2008, growth may tentatively recover in H1 2009 but
will likely slide again, until hitting the second trough in H1 2010.
􀂄 We expect 2009 to witness the worst deflation in 10 years, with CPI inflation
falling below -1% in February and PPI inflation declining to -7% in Q3.
􀂄 Our top-down analysis suggests downside risk of 15-20ppts to the current
consensus 2009 EPS growth estimate of 6% for the H-share index.
􀂄 We believe the market will likely be range-bound in the next two quarters
(from 8x to 13x 09PE), but a substantial rally may happen in H2 2009 (6-9
months ahead of GDP trough). Given this outlook, we will stay defensive in
the near term (e.g., in H1 2009), and switch to a more aggressive asset
allocation when signs of an end to analyst downgrades emerge -- hopefully by
the middle of 2009.
􀂄 For now, the key sectors we Underweight include banks, raw materials, dry
bulk shipping, consumer discretionary and property. We Overweight telecom,
oil refining, IPP, F&B, railway construction, healthcare, education and online
gaming.
􀂄 The following investment themes support our sector allocation strategy:
1. Deflation: negative for property, commodities, and banking, but positive
for F&B, IPP, and oil refining.
2. Counter-cyclical services: healthcare, education, and online gaming
should demonstrate significant resilience to the economic slowdown.
3. Consolidation: survivors in steel, non-ferrous, and property sectors will
be important long-term beneficiaries of the ongoing industrial
consolidation.
4. Rural reform: electronics – ST beneficiary, rural consumption – LT
winner.

Table of Contents
Macroeconomic outlook ................................................................... 4
2009’s growth outlook is worse than 1998-99’s.......................................................................4
Quarterly GDP profile for 2009-10: a double-dip scenario.........................................................5
Investment growth to fall to single-digit levels in 2010.............................................................6
Exports to decline in 2009; worst performance in 32 years......................................................7
Retail sales growth may slow to 13% in 2009 from current 21% ............................................8
Deflation could likely become a reality......................................................................................9
Monetary policy ........................................................................................................................9
Fiscal policy............................................................................................................................10
Real estate policy....................................................................................................................11
RMB outlook ...........................................................................................................................12
Market strategy ............................................................................... 14
Economic slowdown will likely be sharper and longer than market expectations ..................14
Further 2009 EPS growth downside of 15-20ppts..................................................................14
Sectors that benefit from government investments are very small ........................................16
Market valuation......................................................................................................................16
Market outlook........................................................................................................................18
Underweight banks, raw materials, dry bulk shipping, consumer discretionary and property 18
We Overweight telecom, refining, power, F&B, railway construction, healthcare, education,
and on-line gaming..................................................................................................................20
Our top picks..........................................................................................................................21
Theme #1: Deflation ........................................................................ 24
2009: worst deflation in ten years...........................................................................................24
Sources of deflation ................................................................................................................24
Beneficiaries of deflation: F&B, IPP, and refining....................................................................26
Victims of deflation: property, commodities, and banks.........................................................28
Theme #2: Beneficiaries and losers in the cycle ........................... 29
Comparison with the 1997-2003 cycles..................................................................................29
Beneficiaries in the decline phase: telecom, healthcare, consumer staples, and utilities .......30
Losers in the decline phase: materials, financials, and discretionary ......................................30
Beneficiaries in the recovery phase: materials, financials, consumer discretionary................31
Losers in the recovery phase: F&B and low-magin industrials................................................32
Differences between the current cycle and the previous two ................................................32
Investment implications ..........................................................................................................33
Annex: sub-sector revenue and profit growth during recent cycles........................................34
Theme #3: Industrial consolidation................................................ 36
Case study 1: Korea’s steel industry .......................................................................................36
Case study 2: China’s coal industry ........................................................................................36
Lessons from case studies .....................................................................................................37
Property, steel, and non-ferrous provide the most benefit for consolidators..........................38
Theme #4: Social services and low-cost entertainment .............. 41
Healthcare..............................................................................................................................41
Education ...............................................................................................................................44
Online gaming.........................................................................................................................46
Theme # 5: Rural reform ................................................................. 48
Rural income growth will likely slow to 5% 2009 from 13% p.a. in past years ......................48
Rural electronics subsidy program to benefit producers ........................................................50
Long-term benefits from land reform......................................................................................52
Market implications.................................................................................................................53

Table of Contents (Cont'd)
Theme #6: Government-sponsored investments.......................... 55
Government sponsored investments are far from sufficient to offset the slowdown in
corporate investments ............................................................................................................55
Financing and execution .........................................................................................................56
Impact on raw material demand .............................................................................................58
Investment implications ..........................................................................................................59
Appendix A: DB China Universe..................................................... 62