LI LI & FUNG China Sourcing Quarterly

IN THIS ISSUE :

Part One : 1Major Price Indicators

Part Two: 3Raw Material Prices

Part Three: 11Other Costs of Production (Energy, Transportation and Labour) and Exchange Rate

Part Four: 16

Highlights

LI & FUNG China Sourcing QuarterlyFebruary 2012 Issue 10

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Helen Chin, Timothy CheungTel: (852) 2300 [email protected]@lf1937.com

Li & Fung Research Centre10/F, LiFung Tower, 888 Cheung sha Wan Road,Hong KongTel : (852) 2300 2470Fax : (852) 2635 1598 E-mail: [email protected]://www.lifunggroup.com/ Li & Fung ReseaRch cenTRe

MeMBeR OF The Li & Fung gROuP

Part One: Major Price Indicators

1. china’s cPi growth further moderated on a year-on-year basis

The year-on-year (yoy) growth rate of China’s consumer price index (CPI)1 continued its downward trend in recent months, falling all the way from 6.1% yoy in september to 4.1% yoy in December. (see exhibits 1 & 2) Overall, FY11, China’s CPI growth was 5.4% yoy, up from 3.3% yoy in FY10. The deceleration in the CPI growth in recent months was due largely to the moderating growth of the food component, the CPI of which dropped from 13.4% yoy in september to 9.1% yoy in December.

On a month-on-month (mom) basis, the CPI growth dropped all the way from 0.5% in september to -0.2% in november, before rising to 0.3% in December. The rebound in the CPI growth in December was driven by the rise in vegetable prices, which could be associated with the seasonal fall in the supply of vegetables. also noteworthy is that the mom growth of the CPI of the non-food component turned negative in December, suggesting that non-food inflation may have started to ease.

Looking ahead, we expect that the yoy growth of China’s CPI will continue to decline in coming months, due to the higher comparison base and the softening non-food inflation. In the longer term, however, we expect the CPI growth to stay high, driven by factors such as increasing food prices, spiraling labour costs, degradation of land and water resources, abnormal weather conditions and natural disasters, etc.

exhibit 1: china’s cPi growth, Jan 2010 - Dec 2011

Jan 11 4.9%Feb 4.9%Mar 5.4%apr 5.3%May 5.5%Jun 6.4%Jul 6.5%aug 6.2%sep 6.1%Oct 5.5%nov 4.2%Dec 4.1%

Source: National Bureau of Statistics, PRC

1 The CPI, compiled by the national Bureau of statistics of China, measures the price of a basket of goods and services that a typical household purchases.

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LI & FUNG China Sourcing Quarterly

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exhibit 2: china’s cPi growth by selected commodity, Jul - Dec 2011

yoy growth (%) Jul aug sep Oct nov DecClothing 2.2 2.9 3.2 3.7 3.5 3.8 Household services, maintenance and renovation 2.7 2.8 3.0 3.1 2.9 2.5 Recreational, educational products & services 0.5 0.4 0.0 0.0 0.1 0.1


2. PPi growth dropped further in December The yoy growth rate of China’s producer price index of industrial products (PPI)2 dropped all the way from 6.5% yoy in september to a two-year low of 1.7% yoy in December. On a mom basis, the PPI registered negative growth of -0.7%, -0.7% and -0.3% in October, november and December respectively, indicating that ex-factory prices of industrial products have trended downward in recent months. (see exhibits 3 & 4)

Looking ahead, the PPI growth is set to stay low in the near term. Manufacturers are likely to further reduce prices of their products or cut production, in response to the weakening domestic and foreign demand. On the other hand, manufacturers will continue to suffer from increasing labour costs. according to the 12th Five-year Plan, the minimum wage is targeted to increase by at least 13% per annum in 2011 to 2015, and local governments in many provinces are widely expected to adjust the minimum wage levels in their jurisdictions this year. Manufacturers with pricing power may therefore raise prices of their products, in a bid to pass through the cost increases to customers.

exhibit 3: china’s PPi growth, Jan 2010 - Dec 2011



exhibit 4: china’s PPi growth by selected industry, Jun - nov 2011

yoy growth (%) Jun Jul aug sep Oct novTextile industry 13.3 11.7 10.0 8.8 6.1 0.8Textile, clothing and footwear production 3.8 3.7 3.8 3.6 3.8 3.1Leather, furs, down and related products 4.5 4.8 5.3 5.6 5.6 4.9Timber processing & wood, bamboo, cane, 4.4 4.6 4.3 4.1 4.0 3.5 palm fiber and straw products


2 The PPI, compiled by the national Bureau of statistics of China, measures the prices of industrial products when they are sold for the first time after production.

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February 2012 Issue 10


Part Two: Raw Material Prices

1. The purchaser price index of industrial products posted negative mom growth throughout 4Q11

The yoy growth rate of the purchaser price index of industrial products3 decelerated all the way from 10.0% yoy in september to 3.5% yoy in December, the lowest since January 2010. (see exhibits 5 & 6) On a mom basis, the purchaser price index posted negative growth of -0.7%, -0.7% and -0.4% in October, november and December respectively. upstream prices have trended downward in recent months.

Looking ahead, manufacturing sectors around the globe are set to expand at a slower pace, amid the weakening global demand. We therefore expect the demand for raw materials to stay weak in the near term, which will continue to put downward pressure on prices of production inputs.

exhibit 5: The purchaser price index of industrial products, Jan 2010 - Dec 2011 (% yoy growth)



exhibit 6: The purchaser price index of industrial products by selected commodity, Jul - Dec 2011

yoy growth (%) Jul aug sep Oct nov DecFuel & power 12.6 12.7 12.3 11.3 9.3 8.4non-ferrous metals 18.9 16.8 14.7 7.0 3.6 0.6Raw materials for the chemical industry 13.3 13.4 12.7 9.9 4.1 1.4Timber and paper pulp 4.2 4.3 4.5 4.4 3.4 -Textile raw materials 13.7 12.2 11.9 9.6 4.9 -


3 The purchasing price index of raw material, fuel and power was renamed the purchaser price index of industrial products, effective from January 2011. The price index, compiled by the national Bureau of statistics of China, measures the prices of production inputs such as raw materials, fuels and power purchased by industrial enterprises.

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(i) Purchaser price index of fuel & power

The growth rate of the purchaser price index of fuel & power dropped all the way from 12.3% yoy in september to 8.4% yoy in December. (see exhibit 6)

(ii) Purchaser price index of non-ferrous metals

The growth rate of the purchaser price index of non-ferrous metals has fallen markedly, all the way from 14.7% yoy in september to 0.6% yoy in December. (see exhibit 6)

(iii) Purchaser price index of raw materials for the chemical industry

The growth rate of the purchaser price index of raw materials for the chemical industry went down from 12.7% yoy in september to 9.9% yoy in October, and then dropped further to 4.1% yoy in november and 1.4% yoy in December. (see exhibit 6)

(iv) Purchaser price index of timber and paper pulp

after staying relatively stable at 4.3% yoy, 4.5% yoy and 4.4% yoy in august, september and October respectively, the growth rate of the purchaser price index of timber and paper pulp moderated to 3.4% yoy in november. (see exhibit 6)

(v) Purchaser price index of textile raw materials

The growth rate of the purchaser price index of textile raw materials has continued its downward trend, declining all the way from 12.2% yoy in august to 4.9% yoy in november. (see exhibit 6)

2. china’s cotton price indices have stayed relatively stable since mid-December

after making slight rebound in mid-august to late september 2011, China’s cotton price indices4 moderated in the following months, due to the slackening downstream demand, as well as the increasing supply of cotton. The CC Index 328, for example, declined all the way from 20,010 on 26 september to 19,058 on 13 December. since mid-December, the cotton price indices have stayed relatively stable. (see exhibit 7)

Looking ahead, the global cotton supply is likely to be abundant in the near term. The International Cotton advisory Committee forecasted in early January 2012 that the world cotton output would increase from 24.87 million tons in 2010/11 to 26.79 million tons in 2011/12, before decreasing to 24.91 million tons in 2012/13.5 With the stockpiling scheme of the Chinese government, cotton prices are unlikely to drop much, despite the abundant supply of cotton. Considering that the sharp decline in cotton prices could strongly discourage cotton production, the Chinese government introduced a stockpiling scheme on 1 september 2011, in a bid to ensure the domestic supply of cotton. according to the scheme, the government will buy cotton for its state reserve, if the market prices of cotton drop below the specific levels set by the policymakers.6

4 The indices, compiled by the China Cotton association, track cotton prices quoted from two hundred textile enterprises. http://www.china-cotton.org/5 http://icac.org/download/press-releases/pr_january_2012.pdf6 http://www.gov.cn/zwgk/2011-03/31/content_1835425.htm

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exhibit 7: china’s cotton price indices, Jan 2011 - Jan 2012

Source: China Cotton Association

3. The nanjing Wool Market composite index trended downward throughout august to December

after peaking at 91.13 yuan per kg at end-June 2011, the nanjing Wool Market Composite Index7, one of the major wool price indices in China, was generally on a downward trend, dropping all the way to 80.10 yuan per kg at end-December. The decline in the wool prices was due mainly to the weakening global demand for wool and the depreciation of the currencies of australia and new Zealand against the RMB.8 (see exhibit 8)

Looking ahead, we predict that wool prices will further soften in the near term, in the expectation of the softening global demand for wool.

exhibit 8: nanjing Wool Market composite index, Jan - Dec 2011 Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec Month-end index (yuan/kg) 72.86 75.70 80.83* 87.65 89.10 91.13 90.50 86.09 83.00 83.13 81.95 80.10

* Monthly average (instead of month-end index)Source: The Nanjing Wool Market

4. Price indices of polyester bottomed out in early December Due to the slackening downstream demand and the drop of upstream prices, the price indices of polyester9 trended downward throughout late september to late november 2011. (see exhibit 9) The price index of polyester FDY, for example, dropped from 16,450 on 21 september to 12,700 on 29 november. afterwards, given the low stockpiles of polyester and the rise in crude prices, polyester prices bottomed out in early December and have picked up since then.

Looking ahead, as downstream demand is likely to remain sluggish, we do not expect polyester prices to start a strong upward trend in coming months.

7 http://www.woolmarket.com.cn/8 The wool price index is significantly affected by the exchange rate movements of the currencies of Australia and New Zealand, as China

imports a large amount of wool from these two countries, the main wool exporters in the world.9 The indices are complied by the China Chemical & Fiber Economic Information network (CCFEI).

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exhibit 9: Price indices of polyester, Jan 2011 - Jan 2012

Source: China Chemical & Fiber Economic Information Network

5. Price index of acrylic staple fiber has rebounded slightly since late DecemberAfter staying stable at 23,000 throughout 11 August to 24 October, the price index of acrylic staple fiber10 fell markedly in late October to late november, going down to as low as 18,400 on 28 november. The drop of the prices of acrylic staple fiber was triggered by the sharp decline in the prices of acrylonitrile, a major raw material of acrylic staple fiber, as well as the weakening downstream demand. (see exhibit 10) afterwards, the price index stayed stable at 18,400 in late november to late December, and has rebounded since then. In our view, the recent rebound in the prices of acrylic staple fiber was largely the result of tight supply and increase in upstream prices.

Looking ahead, with the weak downstream demand, we expect the prices of acrylic staple fiber to stay soft in the near future.

exhibit 10: Price indices of acrylic, Jan 2011 - Jan 2012


10 The index is compiled by the China Chemical & Fiber Economic Information network (CCFEI).

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6. Price indices of nylon fell sharply throughout late October to mid-December The price indices of nylon11 plateaued during early august to mid-October 2011. They then fell sharply throughout late October to mid-December, owing to the drop of prices of caprolactam, one of the major materials of nylon. The price index of nylon FDY, for example, went down from 32,800 on 21 October to 27,200 on 16 December. since late December, the price indices have rebounded, as a result of the rise in caprolactam prices. (see exhibit 11)

Looking ahead, we expect nylon prices to stay at low levels in the near term, unless downstream demand picks up. according to the local media, many manufacturers have remained cautious about placing orders for nylon recently.

exhibit 11: Price indices of nylon, Jan 2011 - Jan 2012


7. Price index of viscose staple fiber fell markedly throughout late September to early December

Driven by the weakening downstream demand, the price index of viscose staple fiber12 fell markedly from 19,800 on 30 september to 15,500 on 1 December. afterwards, helped by the improvement in downstream demand, the price index rebounded slightly to reach 15,950 on 15 December, and has stayed relatively stable since then. (see exhibit 12)

Looking ahead, we expect the prices of viscose staple fiber to stay soft, unless the domestic cotton prices rebound strongly. As viscose staple fiber is commonly used as a substitute for cotton and cotton pulp is the major raw material of viscose, the price movement of viscose staple fiber has been significantly affected by cotton prices.

11 The indices are complied by the China Chemical & Fiber Economic Information network (CCFEI).12 The index is compiled by the China Chemical & Fiber Economic Information network (CCFEI).

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exhibit 12: Price indices of viscose, Jan 2011 - Jan 2012


8. Price index of aBs resin was on a downward trend in recent monthsafter gaining 1.8% mom in July and in august, the price index of aBs resin13 trended downward in the following months, down by 2.9% mom, 5.8% mom, 3.8% mom and 1.9% mom in september, October, november and December respectively, as a result of the decreasing downstream demand. (see exhibit 13)

Looking ahead, we expect aBs resin prices to decline further in the near term, unless prices of major raw materials of aBs resin such as styrene trend upward.

exhibit 13: Price index of aBs resin, Jan - Dec 2011 Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec aBs resin 0.5 1.0 2.5 -1.7 -1.9 -5.6 1.8 1.8 -2.9 -5.8 -3.8 -1.9 (mom growth %) aBs resin 28.6 27.7 23.1 16.3 12.2 8.2 11.2 9.3 3.2 -7.3 -14.1 -15.3 (yoy growth %)

Source: China Federation of Logistics & Purchasing

9. Price index of PP has declined for five consecutive monthsThe price index of polypropylene (PP)14 has declined for five consecutive months, falling by 0.5% mom, 1.8% mom, 1.9% mom, 1.0% mom and 4.7% mom in august, september, October, november and December respectively. according to the local media, domestic petrochemical enterprises have continued to reduce the ex-factory prices of PP, in order to reduce their inventories. (see exhibit 14)

Looking ahead, we expect PP prices to stay weak, amid the low downstream demand.

13 The index is compiled by the China Federation of Logistics & Purchasing (CFLP), which is the first logistics and purchasing industry association approved by the state Council. One of the CFLP’s missions is to push forward the circulation of factors of production in China.

14 The index is compiled by the China Federation of Logistics & Purchasing (CFLP).

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exhibit 14: Price index of PP, Jan - Dec 2011

Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec PP 0.3 0.4 2.4 0.9 0.2 -3.7 1.2 -0.5 -1.8 -1.9 -1.0 -4.7(mom growth %) PP 12.7 15.7 17.0 14.0 15.3 16.2 21.7 17.5 13.9 7.2 -1.4 -8.0 (yoy growth %)


10. Price index of natural rubber was on a strong downward trend throughout september to november

The price index of natural rubber15 fell sharply by 3.5% mom, 8.8% mom and 7.2% mom in september, October and november respectively, driven mainly by the increase in supply, as well as the weakening demand for natural rubber due to the softening auto sales in China. afterwards, in December, the price index rebounded slightly by 0.9% mom. (see exhibit 15)

Looking ahead, as harvest activities in major rubber producing regions in China decrease every December to april, the supply of natural rubber will become tighter in the coming months, which will in turn support natural rubber prices. Therefore, we do not expect the domestic prices of natural rubber to drop much in coming months, unless the global prices of natural rubber fall markedly.

exhibit 15: Price index of natural rubber, Jan - Dec 2011

Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec natural rubber 10.2 8.4 -5.8 1.0 -5.0 -2.2 -4.2 -4.0 -3.5 -8.8 -7.2 0.9 (mom growth %) natural rubber 54.3 68.4 55.0 51.3 50.8 47.5 43.7 33.9 22.2 -1.5 -17.0 -19.9(yoy growth %)


11. Prices of various types of non-ferrous metals were generally on a downward trend in the past few months

The price indices of copper, aluminum, lead and zinc dropped markedly in september to October. afterwards, except aluminum, these price indices rebounded in november: the price indices of copper, lead and zinc gained 4.1% mom, 3.7% mom and 3.3% mom respectively, while the price index of aluminum dropped further by 2.8% mom. In December, the price indices of copper, aluminum and zinc fell by 2.7% mom, 0.2% mom and 2.5% mom respectively, while the price index of lead stayed unchanged from the previous month.16 (see exhibits 16, 17, 18, 19 & 20)

Looking ahead, manufacturing sectors around the globe are set to expand at a slower pace, amid the weakening global demand. We therefore expect the demand for non-ferrous metals to moderate, putting downward pressure on prices of non-ferrous metals.

15 The index is compiled by the China Federation of Logistics & Purchasing (CFLP).16 The indices are compiled by the China Federation of Logistics & Purchasing (CFLP).

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exhibit 16: Price index of non-ferrous metals, Jan - Dec 2011

Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec non-ferrous metals 3.2 2.9 -1.7 0.4 -2.6 1.0 3.2 -1.8 -4.7 -7.0 0.4 -2.0(mom growth %) non-ferrous metals 5.6 15.3 10.5 9.4 14.9 22.1 22.1 14.3 6.8 -5.2 -5.8 -8.9 (yoy growth %)


exhibit 17: Price index of copper, Jan - Dec 2011 Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec Copper 4.7 3.7 -2.1 0.7 -4.2 0.4 3.6 -4.3 -7.3 -11.6 4.1 -2.7(mom growth %) Copper 16.6 29.2 20.1 18.3 24.2 30.6 30.8 18.2 6.2 -10.2 -8.0 -15.2 (yoy growth %)

Source: China Federation of Logistics & Purchasing exhibit 18: Price index of aluminum, Jan - Dec 2011 Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec aluminum 2.2 1.0 -1.1 0.5 -0.3 2.9 3.2 1.8 -2.8 -4.8 -2.8 -0.2 (mom growth %) aluminum -2.1 3.9 2.6 3.4 9.8 18.1 18.8 18.0 13.7 4.0 -0.7 -0.7(yoy growth %)

Source: China Federation of Logistics & Purchasing exhibit 19: Price index of lead, Jan - Dec 2011

Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec Lead 0.7 -0.2 0.7 -0.6 -6.2 -0.5 3.8 -2.5 -4.7 -5.1 3.7 0.0 (mom growth %) Lead 6.5 10.9 11.6 10.4 8.3 11.9 10.8 0.0 -4.6 -13.0 -12.6 -10.8 (yoy growth %)


exhibit 20: Price index of zinc, Jan - Dec 2011 Jan-11 Feb Mar apr May Jun Jul aug sep Oct nov Dec Zinc 2.9 1.2 -4.8 -1.1 -5.3 2.9 3.9 -5.3 -5.0 -6.6 3.3 -2.5(mom growth %) Zinc -7.9 5.6 -2.0 -4.4 3.7 17.4 15.4 0.3 - 8.1 -20.3 -14.5 -16.0 (yoy growth %)


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Part Three: Other Costs of Production (Energy, Transportation and Labour) and Exchange Rate

1. China’s crude prices have been fluctuating in recent months In line with the movement of global crude prices, the domestic crude prices were volatile from late august 2011 to early January 2012.17 For example, the Daqing18 crude price fluctuated within the range of US$ 101.85-119.98 per barrel during the period (as of 5 January 2012). (see exhibit 21)

Looking ahead, we do not expect the crude prices to start a strong upward trend in coming future, amid the slowing world economy and the weakening demand for crude. The future movement of global crude prices also depends on the global crude oil supply. It is noteworthy that, in mid-December 2011, the Organization of the Petroleum Exporting Countries (OPEC), whose members supply about 40% of the world’s crude oil, announced to maintain the current production level of 30.0 million barrels a day.19 On the other hand, on 23 January 2012, the Eu announced to ban oil imports from Iran, effective from 1 July 2012. Considering that Iran is the fourth biggest oil producer in the world, the introduction of the policy would greatly reduce the crude supply to the Eu and thus affect global crude prices.

exhibit 21: china’s crude prices, Jan 2011 - Jan 2012

Source: ifeng.com

2. Wholesale price index of refined oil products has stayed relatively stableThe wholesale price index of refined oil products has stayed relatively stable in recent months. After edging up by 0.4% mom in September, the wholesale price index of refined oil products20 fell by 1.4% mom in October, attributable to the government actions to reduce the maximum retail and wholesale prices of gasoline and diesel on 9 October. afterwards, the wholesale price index gained 0.5% mom and 0.1% mom in november and December respectively. (see exhibit 22)

17 From the year 2000 onwards, China’s crude prices were determined with reference to global crude prices.18 Daqing Field ( 大慶油田 ) is the largest oil field in China.19 The OPEC members will review the output target again at the next OPEC meeting, which will be held on 14 June 2012.20 The index is compiled by the China Federation of Logistics & Purchasing (CFLP).

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Looking ahead, the future movement of the wholesale prices of refined oil products will mainly depend on the movement of the global crude prices. According to the refined oil pricing mechanism, the government officials would consider adjusting fuel prices when the 22-day moving average of a basket of global crude prices has changed by more than 4%.

Exhibit 22: China’s wholesale price indices of refined oil products, Jan - Dec 2011


3. The benchmark Qinhuangdao coal prices have moderated since mid-november 2011

The benchmark Qinhuangdao coal prices trended upward throughout early september to late October, owing to the maintenance of the Daqin railway in late september, the railway which connects the major coal-producing region with the largest coal shipping port in the country, as well as tighter supply of coal due to the temporary suspension of some underground coal mines in shanxi province.21 (see exhibit 23)

21 In mid-September, a coal mine in Shuozhou owned by China Coal Energy Co. was hit by floods, which killed at least ten miners. afterwards, the shanxi provincial government ordered the coal mining enterprise to shut down all of its underground coal mines in the province for inspection.

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since mid-november, the domestic coal prices have started to moderate, amid the slowing domestic demand from coal-fired power producers, as well as the weakening export demand.

It is noteworthy that, on 30 november 2011, the national Development and Reform Commission (nDRC) announced that the spot prices of coal would be capped at the certain levels, effective from 1 January 2012.22 For example, the price of coal with calorific value of 5,500 kcal/kg would be capped at 800 yuan per tonne. (On 9 January 2012, the price of coal with calorific value of 5,500 kcal/kg was 785 yuan per tonne.) Looking ahead, given the newly announced price control policy, we expect the domestic coal prices to stay relatively soft.

exhibit 23: Qinhuangdao coal prices, Jan 2011 - Jan 2012

Source: Cqcoal.com

4. The china containerized Freight index has rebounded since early January after making slight rebound in august to early september, the China Containerized Freight Index (CCFI)23 trended downward again throughout mid-september to late December, as a result of slowing export orders and weakening demand for container transport. The index slid all the way from 996.35 on 16 september 2011 to 881.15 on 30 December 2011, the lowest since late august 2009.

In early to mid-January 2012, the freight index rebounded, and went up to 924.25 on 20 January, boosted by the improvement in demand for container transport. Besides, some major shipping companies have started to tighten the active capacities of their carriers in recent months, which could be another reason behind the rise in the container freight rates of several routes. (see exhibit 24)

The recent increase in the container freight rates may also be attributed to seasonal factors, as Chinese exporters probably rushed to ship out orders ahead of the early Chinese new Year this year. Looking forward, we expect that the demand for container transport will soften in February and the container freight rates may moderate then.

22 http://www.ndrc.gov.cn/zcfb/zcfbtz/2011tz/t20111130_448385.htm23 The index, compiled by the shanghai shipping Exchange, measures the freight rates of eleven freight routes. The destinations of these

routes include Hong Kong, Korea, Japan, southeast asia, australia and new Zealand, the Mediterranean, Europe, East and West africa, america West, america East, south africa and south america. The freight rates data are collected from major shipping companies in the market.

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exhibit 24: china containerized Freight index, Jan 2011 - Jan 2012

Source: Shanghai Shipping Exchange

5. average monthly wage of migrant workers in china increased by 21.2% yoy in 2011

according to the national Bureau of statistics of China, the average monthly wage of migrant workers in China rose strongly by 21.2% yoy in 2011, compared to the 19.3% yoy growth in 2010. In 2011, the average monthly wage of migrant workers reached 2,049 yuan in 2011, up from 1,690 yuan in 2010. We believe the rapid growth of the wage of migrant workers was attributable to factors such as the labour shortages and the upward adjustments of the minimum wage levels in many provinces in 2011.

Looking ahead, we expect that the average wage of migrant workers will continue to show double-digit growth in 2012.

6. The RMB appreciated by 5.1% against the us dollar in FY11The RMB depreciated against the us dollar in november, but appreciated again in December. Overall, in FY11, the RMB appreciated by 5.1% against the us dollar, compared to the 3.1% appreciation in FY10.

In January 2012, the nominal RMB/ USD exchange rate continued to fluctuate. The RMB depreciated against the US dollar in early to mid-January, and then appreciated in late January. The nominal RMB/ usD exchange rate advanced to 6.3115 on 31 January.

On the other hand, the RMB has appreciated against the Euro since early May 2011: The nominal RMB/Euro exchange rate advanced from 9.6413 on 5 May to the recent peak of 8.0104 on 16 January, before softening to 8.3006 on 31 January 2012. (see exhibit 25)

according to the Bank for International settlements, the real effective exchange rate (REER)24 of the RMB rebounded to 107.97 in December, after dropping from 107.35 in October to 106.58 in november. Overall, the RMB appreciated by 6.1% in real terms against its trading partners in FY11. (see exhibit 26)

24 The Bank for International settlements (BIs) calculates effective exchange rate (EER) indices for a total of 61 economies (including individual euro area countries and, separately, the euro area as an entity). nominal EERs are calculated as geometric weighted averages of bilateral exchange rates. Real EERs are the same weighted averages of bilateral exchange rates adjusted by relative consumer prices. The weighting pattern is time-varying, and the most recent weights are based on trade in 2008-10.

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In view of the slackening export demand, we expect the RMB appreciation against the us dollar to slow in coming months, as a rapid RMB appreciation against the us dollar could greatly harm the foreign demand for Chinese products, especially the low value added products. That said, we do not expect the RMB to depreciate against the us dollar in the foreseeable future, as the international pressure for the RMB appreciation is still intense. at a news conference concluding the asia Pacific Economic Cooperation (aPEC) summit on 13 november 2011, the us president Obama commented that the pace of the RMB appreciation was not fast enough. Trade tensions between China and its major trading partners will intensify if the RMB attempts to depreciate against the us dollar. all in all, we forecast that the nominal RMB/usD exchange rate will appreciate by around 2-4% this year to reach 6.06-6.18 at end-2012.

exhibit 25: RMB/usD and RMB/euro, Feb 2011 - Jan 2012

Source: State Administration of Foreign Exchange

exhibit 26: RMB ReeR, Jan - Dec 2011

Source: Bank for International Settlements

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Part Four: Highlights

1. The minimum wage levels in some provinces/ municipalities were adjusted upward in recent months

In recent months, the local governments in some provinces/ municipalities raised the minimum wage levels in their jurisdictions. see below for more details:

Yunnan province

On 1 september 2011, the minimum wage levels in various districts within Yunnan province were increased to 950 yuan, 845 yuan and 720 yuan respectively.25

Henan province

On 1 October 2011, the minimum wage levels in Henan province were adjusted upward to 1,080 yuan, 950 yuan and 820 yuan respectively, up from the previous levels of 800 yuan, 700 yuan and 600 yuan respectively.26

Hubei province

On 1 December 2011, the Hubei provincial government raised the levels of minimum monthly wage in various districts within the province to 1,100 yuan, 900 yuan and 750 yuan respectively.27

Qinghai province

On 1 December 2011, the levels of minimum monthly wage in various districts within Qinghai province were raised to 920 yuan, 910 yuan and 900 yuan respectively, up from the previous levels of 770 yuan, 760 yuan and 750 yuan respectively.28

Jiangxi province

On 22 December 2011, the Jiangxi provincial government announced to raise the levels of minimum monthly wage by 21.5% on average, effective from 1 January 2012.29

Sichuan province

On 1 January 2012, the minimum wage levels in various districts within sichuan province were increased to 800 yuan, 880 yuan, 960 yuan and 1,050 yuan respectively, up by 23.1-23.9% from the previous levels.30

Beijing

The minimum monthly wage in Beijing was raised from the previous level of 1,160 yuan to 1,260 yuan on 1 January 2012.31 The previous adjustment was made on 1 January 2011, when the minimum monthly wage was increased from 960 yuan to 1,160 yuan.

25 http://www.ynhrss.gov.cn/readinfo.aspx?InfoId=0b1a84301ad84d56b591869d61c8767b26 http://news.xinhuanet.com/local/2011-10/02/c_122116222.htm27 http://big5.xinhuanet.com/gate/big5/www.hb.xinhuanet.com/zhengwu/2011-11/18/content_24149679.htm28 http://www.qh.gov.cn/system/2011/11/16/010533403.shtml29 http://news.xinhuanet.com/local/2011-12/23/c_122473184.htm30 http://www.scspc.gov.cn/html/zhyw_11/2011/1222/64283.html31 http://www.bj.xinhuanet.com/bjpd_sdzx/2011-12/29/content_24440801.htm

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Shenzhen

On 30 December 2011, the shenzhen municipal government announced to raise the minimum monthly wage in its jurisdiction from the previous level of 1,320 yuan to 1,500 yuan, effective from 1 February 2012.32 The previous adjustment was made on 1 april 2011, when the minimum monthly wage was increased from 1,100 yuan to 1,320 yuan.

Overall, in FY11, the minimum wage levels in more than twenty provinces/ municipalities were adjusted upward. although the Chinese economic growth is likely to further moderate in 2012, we believe that the government will continue to increase the minimum wages levels in various provinces in the year, as part of its efforts to maintain social stability and to boost domestic consumption. also noteworthy is that, according to the 12th Five-year Plan, the minimum wage levels in China are targeted to increase by at least 13% per annum during 2011-2015.

2. new guidelines on salary rise were issued in some provinces/ municipalities/ cities

In recent months, the local governments in a few provinces/ municipalities/ cities have issued new guidelines on salary rise. (see exhibit 27) For example, according to the announcement issued by the guangdong provincial government, enterprises with average performance in guangdong are advised to raise the salaries for their workers by 15%, the 2011 pay rise benchmark; but wage growth should not exceed 20%, the upper limit of the pay rise benchmark. On the other hand, enterprises with relatively poor performance may consider offering lower pay rises to their workers, but wage growth should not be below 5%, the lower limit of the pay rise benchmark.33

although these guidelines are not mandatory for employers to follow, they will affect workers’ expectations of salary rise and are thus regarded as an important reference.

exhibit 27: guidelines on salary rise issued by local governments in recent months

Province/ municipality upper limit Benchmark Lower limit issue dateInner Mongolia 21% 16% 5% 27 september 2011guangdong 20% 15% 5% 12 October 2011guangxi 23% 13% 0 25 October 2011Hunan 20% 15% 6% 13 October 2011Henan - 16% 4% 18 October 2011Chengdu 20% 15% 6% 10 november 2011

Source: Announcements by various local governments

3. The chinese government raised the retail power tariffs for non-residential users on 1 December 2011

Triggered by the upward adjustments in the midstream on-grid power tariffs, the Chinese government raised the retail power tariffs for non-residential users by 0.03 yuan per kilowatt-hour on average in all provinces in China on 1 December 2011.34 (note that the retail power tariffs for residential users remained unchanged.) We believe that the higher power tariffs would help discourage excessive power consumption, thereby reducing power demand and easing power shortages.

32 http://big5.xinhuanet.com/gate/big5/www.gd.xinhuanet.com/newscenter/2011-12/31/content_24453812.htm33 http://www.gd.lss.gov.cn/gdlss/zcfg/zxzcfg/t20111014_129725.htm34 http://www.ndrc.gov.cn/xwfb/t20111130_448408.htm

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In fact, it was the second time in 2011 that the government adjusted the retail power tariffs for non-residential users. On 1 June 2011, the retail power tariffs for non-residential users in fifteen provinces were increased by 0.004-0.024 yuan per kilowatt-hour. (More details can be found in our Li & Fung China Sourcing Quarterly, Issue 8.)

Looking ahead, we expect the power shortages in China to ease in 2012, due to the slowing power demand amid the moderating economic growth as well as the government actions to increase incentives for coal-fired power producers to produce. On 30 november 2011, the government announced to raise the midstream on-grid power tariffs in China, effective from 1 December 2011, and to impose controls on the spot prices of coal, effective from 1 January 2012.

4. The us prices index for imports from china has continued its upward trend The us prices index for imports from China has continued its upward trend in recent months, according to the us Department of Labour. The prices index rose further from 104.4 in september to 105.1 in December, hitting record high again. Compared to the same month of the previous year, the prices index gained 3.6% in December. (see exhibit 28) We believe that the rise in prices of Chinese products was driven mainly by the RMB appreciation against the us dollar, as well as the higher labour costs in China.

exhibit 28: us prices index for imports from china, Jan 2010 - Dec 2011

Source: US Department of Labour

5. china’s export growth moderated in 4Q11China’s export growth moderated from 20.6% yoy in 3Q11 to 14.3% yoy in 4Q11, indicating the weakening export demand. Overall, China’s exports grew by 20.3% yoy to reach US$ 1,898.6 billion in FY11. The 2011 growth rate was significantly lower than the 2010 growth rate (31.3% yoy). (See exhibits 29 and 30)

China’s exports to the advanced economies and some major emerging economies such as Brazil, Russia, etc. recorded lower growth in 4Q11, compared to the growth rates recorded in 1-3Q11. For example, China’s export growth to the European union (Eu), Japan, the association of south East asian nations (asEan), Brazil and Russia were 14.4% yoy, 22.5% yoy, 23.1% yoy, 30.2% yoy and 31.4% yoy respectively in 2011, down from 17.4% yoy, 24.6% yoy, 24.7% yoy, 35.5% yoy and 35.8% yoy respectively growth recorded in 1-3Q11. On the other hand, China’s export growth to the us edged down from 14.7% yoy in 1-3Q11 to 14.5% yoy in 2011, indicating the relatively stable demand from the us.

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In 2011, China’s trade surplus narrowed to US$ 155.1 billion, compared to US$ 183.1 billion in 2010. Nevertheless, trade tensions between China and its trading partners are still intense. Recently, the us-China trade dispute over solar panels has caught the media's attention. In early november, the us government announced to launch anti-dumping and anti-subsidy investigations into solar panels imported from China.35

Indeed, we have become more concerned that the Chinese exporters will face rising risk of trade protectionism. as the unemployment rates in the developed countries are likely to stay high in the foreseeable future, the governments in these countries will continue to be under great political pressure to protect domestic industries from foreign competition.

Exhibit 31 plots the new export orders sub-index of China’s manufacturing PMI against the yoy growth rates of China’s exports. The correlation between the two is fairly high, with the new export orders index leading the export yoy growth rate by about 3 months. With the new export orders index dipping below the critical 50-mark, we have become more conservative in our export outlook. Besides, from exhibit 32 we can see that the new export orders index has been strongly correlated to the external economies, especially the developed economies. The OECD indicator36 slid all the way from its peak of 103.0 in February to 100.1 in november. We think China’s export growth will moderate to around 10% yoy or even lower in 1Q12 and 2Q12. Export orders in the coming months may fall drastically if the sovereign debt crisis and economic slowdown in the Eu and the us turn out to be much worse than expected, although China’s exports will continue to be cushioned by orders from emerging markets.

exhibit 29: china’s monthly foreign trade data, Jan - Dec 2011

USD billion (yoy growth) exports imports Trade BalanceJan 11 150.7 (37.7%) 144.3 (51.0%) 6.4 (-54.1%)Feb 96.7 (2.4%) 104.0 (19.4%) -7.3 (-199.7%)Mar 152.2 (35.8%) 152.1 (27.3%) 0.1 (-101.9%)apr 155.7 (29.9%) 144.3 (21.8%) 11.4 (704.5%)May 157.2 (19.4%) 144.1 (28.4%) 13.1 (-32.6%)Jun 162.0 (17.9%) 139.7 (19.3%) 22.3 (10.5%)Jul 175.1 (20.4%) 143.6 (22.9%) 31.5 (10.3%)aug 173.3 (24.5%) 155.6 (30.2%) 17.8 (-10.2%)sep 169.7 (17.1%) 155.2 (20.9%) 14.5 (-12.4%)Oct 157.5 (15.9%) 140.5 (28.7%) 17.0 (-36.5%)nov 174.5 (13.8%) 159.9 (22.1%) 14.5 (-34.9%)Dec 174.7 (13.4%) 158.2 (11.8%) 16.5 (31.0%)Source: China Customs

exhibit 30: china’s quarterly foreign trade data, 1Q11 - 4Q11

USD billion (yoy growth) exports imports Trade BalanceFY11 1,898.6 (20.3%) 1,743.5 (24.9%) 155.1 (-14.5%)

1Q11 399.6 (26.5%) 400.7 (32.6%) -1.0 (-107.3%)2Q11 474.9 (22.1%) 428.1 (23.1%) 46.8 (14.1%)3Q11 518.1 (20.6%) 454.4 (24.6%) 63.8 (-1.7%)4Q11 506.6 (14.3%) 458.6 (20.2%) 48.0 (-22.1%)Source: China Customs

35 http://www.reuters.com/article/2011/11/09/us-usa-solar-trade-idusTRE7a870M2011110936 The OECD composite leading indicator, compiled by the Organization for Economic Cooperation and Development, is designed to

provide early signals of turning points (peaks and troughs) between expansions and slowdowns of economic activity, and covers australia, austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, germany, greece, Hungary, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, netherlands, new Zealand, norway, Poland, Portugal, slovak Republic, spain, sweden, switzerland, Turkey, united Kingdom, and united states.

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exhibit 31: new export orders index and export growth, Feb 2007 - Jan 2012

Source: China Federation of Logistics & Purchasing, China Customs

exhibit 32: china’s export growth and OecD composite leading indicator, Jan 2007 - Dec 2011

Source: China Federation of Logistics & Purchasing, Organization for Economic Cooperation and Development

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