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Macro-economic Report Excerpt December 23, 2008

The People’s Bank of China Cut Deposit &

Loan Rates and Deposit Reserve Ratio Again
at Year-end to Ensure Economic Growth By Zhang Xinfa

1. Event:
In the evening of December 22, the People’s Bank of China announced:
1) To lower benchmark one-year deposit & loan rates by 0.27ppt and rates of other maturities respectively
from December 23, 2008; meanwhile, to down-regulate reloan and rediscount rates.
2) To bring down RMB deposit reserve ratio of financial institutions by 0.5ppt from December 25, 2008.

2. Our Analysis and Estimation:

1) Just less than one month after it sharply cut interest rates and deposit reserve ratio on November 27, the
People’s Bank of China suddenly announced to lower benchmark one-year deposit & loan rates and deposit
reserve ratio at 2008 year-end, which clearly showed that monetary policy would be further relaxed to
ensure economic growth. Although the decision was made surprisingly in Monday evening, it was quite
reasonable for monetary policy to be slacker at year-end. Just as we have predicted in the macro reports in
mid-December (see Commentary on November CPI Data-December 11, 2008 and Loan Growth
Accelerated to Boost Economy-December 15, 2008): “interest rates might be cut again by 27-54 basis
points in December 2008”.

From a domestic view, latest data indicates that economic slowdown is being further accelerated and
inflation is evolving to deflation, with the task of ensuring economic growth more and more severe. In
November, import & export data saw negative growth for the first time and generating capacity fell by 9.6%;
moreover, industrial added value acceleration sharply slipped to 5.4%, setting new low on monthly record.
Meanwhile, inflation has faded away quietly, yet deflation is getting closer; PPI and CPI both have declined
below 3%. In addition, money supply substantially slows down; in spite of rebound in credit growth,
commercial banks are still cautious about lending.

From an international view, central banks of every economy have sharply cut interest rates again and
economic stimulus packages are continuously rolled out. Global economy was particularly cold in this winter.

2) Small-ranged cut in interest rate and deposit reserve ratio conforms to the “flexible and cautious” principle
and accumulative force of loose monetary policy is considerable. According to our calculation, since material
flip-flop on money happened on September 15 (moderately relaxed monetary policy pitched later), People’s
Bank of China cumulatively lowered RMB benchmark deposit & loan interest rates (one year) by 1.89% and
2.16ppt (interest tax exemption of savings deposit included, Table 1) and RMB deposit reserve ratio of large
and small financial institutions by 2.5ppt (Table 2) and 4.5ppt.

From the effects, benchmark lending rate cut can reduce loan capital cost and improve production &
management and profitability of enterprises; moreover, it can release financial pressure of real estate
Report Excerpt

enterprises and the burden of purchasers to some extent, which can help inspire investment and lead
housing consumption. Meanwhile, benchmark deposit rate down-regulation can ensure “deposit & loan
interest margin” space of commercial banks and consider the interest margin earning; also, it can encourage
lending impulse and convert savings to consumption to expand domestic demand. Deposit reserve ratio cut
of financial institutions and cash flow ease can increase fluidity of commercial banks to strengthen their
loans issuance ability.

3. Our Conclusion and Forecast:

As economic slowdown continues strong downward trend; total price level is further descending and
deflation risk is approaching, we hold that monetary policy in 2009 will be further relaxed. In response to
such an adverse state, interest rate cut will be the major way to loose monetary policy, with deposit reserve
ratio down-regulation as auxiliary means; if only interest rate is cut to a certain extent and credit release
sees substantial increase, can deposit reserve ratio down-regulation be the leading factor.

As we judge, current economy faces more severe challenge than those of 1998 and 1999. At that time,
benchmark interest rates of deposit & loan (one year) were lowered from high point 10.98% to low 1.98%
(20% interest tax rate of savings deposits included) in February 2002 and 5.31% respectively, with large
periodic rate cut range; based on this point, bottom benchmark interest rates of deposit & loan shall be
0.63% and 3.69%. Thus, we adjust the forecast in 2009 macro annual report; interest rate cut space will be
further enlarged to 0.90% and 3.93%; however, we maintain the prediction that the bottom will be reached in
the first half 2009 unchanged.

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