11 December 2013 GEM Equity Strategy Outlook 2014 r Figure 38: Chinese Materials - FCF/Sales (%), rolling 12m !Figure 39: Chinese Industrials k-FCF/Sales (%), rolling average i 1 2rn average vr . . . . - . . . . - . . . . - . . . . - . . . - . . . . - . . . - . . . - . Si soul "1 -'0% -It% .20% -25% -33% • El 8 8 E E 8 8 8 8 6 6 8 8 8 8 ° ° " " 5 8 3 8 5 8 5 8 5 8 3 8 5 8 5 8 5 8 5 8 3 8 III Boaorn-41090Inaign of rillev•ni woes In 1ASCI EM Ind 1, Seurat &kat Bin% Blorning Area LP 8 8 E S 8 8 8 8 6- 5 8 8 8 5 8 5 8 5 8 3 8 5 8 3 8 5 8 8 0 0 5 8 3 8 5 8 5 8 II) Bosom )4, Anc00alon or nitwit moos in 1ASCI EM oda Sant Dassebe Bonk &nip Awns LP No concrete measures in Plenum to deal with debt fiscal issue The authorities in Beijing need to completely re-engineer the fiscal system to address the issue of underfunding of local government in order to deal with the rapid build-up in debt at the corporate and local government level. Unfortunately, while the post-Plenum document devoted a lot of space to a discussion of fiscal issues, this appears to have been more a declaration of intent rather than a programme of specific measures for implementation. Michael Spencer who has a much more bullish view of the prospects for China than we do, believes that significant fiscal reforms will only take place on a ten-year time horizon; my own view is that this timescale will be far too long for borrowers and investors alike to keep pumping cash into sectors where the returns are visibly deteriorating. Blurred boundaries between state and private sector impede financial reforms The bulls argue that China can grow round the fiscal and debt problems by financial reforms which will help to promote the private sector at the expense of the state enterprises. Whilst this may appear a coherent strategy from a macro perspective, it breaks down at a micro level in our view because of the blurred boundaries between private and state-controlled compa