Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

G3
US Dollar
FX Forecasts: We continue to expect cyclical near-term Dollar weakness, followed by a gradual Dollar recovery
further out. Our EUR/$ forecast remains at 1.55, 1.55 and 1.35 in 3, 6 and 12 months. Our $/¥ path remains unchanged
at 98, 98 and 105. Current GSDEER: EUR/$ 1.20; $/¥ 107.

Motivation for Our FX View: In the near term our Dollar-bearish views are driven by a combination of weak BBoP
fundamentals, expectations of very easy US monetary policy and a constructive outlook for cyclical assets globally.
Given the strong negative Dollar vs risky asset correlations currently observed, the latter would be consistent with
Dollar weakness remaining in place for some time. Further out, however, we see potential for Dollar strength; the exact
timing is uncertain but we have it pencilled in on a 12-month horizon. This is mainly due to potential structural factors,
such as a possible recovery in capital inflows combined with a much narrower current account deficit, which together
would ultimately push the BBoP into Dollar-supportive territory.

Monetary Policy and FX Framework: The Fed has a dual growth and inflation target. As a result, monetary policy
has generally been more volatile and reactive than in pure inflation-targeting countries. The exchange rate floats freely;
however, the US Treasury and the Fed both occasionally comment on currency issues.

Growth/Inflation Outlook: We recently rolled out our 2010 and 2011 outlook for the US economy. We expect real
GDP to grow +3% annualised in the fourth quarter, slowing to a 1.5% pace in late 2010, and then gradually
reaccelerating in 2011. We expect the unemployment rate to continue to creep up, reaching 10.75% by mid-2011. We
also expect the large output gap to underpin disinflationary pressures, with core inflation expected to ease to 0%yoy by
late 2011.

Monetary Policy Forecast: We expect the large output gap, high unemployment rate and disinflationary impetus to
keep the Fed on hold through 2011. The main risks to our Fed view are a much faster than expected pace of economic
recovery, or if we see a large run-up in asset prices, which could prompt earlier hikes than justified from a real-
economy perspective.

Balance of Payments Situation: We expect continued gradual improvement in the current account deficit, which
should stabilise at around 2.5%. The trend narrowing in the US trade deficit means the US should have less difficulty
attracting the necessary funding than in previous years. For now, though, we are not seeing strong capital inflows, apart
from US Treasuries, which are likely to be largely FX-hedged anyway.

Things to Watch: The Dollar may be sensitive to rate hike expectations in response to strong activity data. Overall risk
sentiment also continues to be an important factor. Year-end dynamics often lead to Dollar weakness, in particular
relative to European currenceis, and need to be watched in the next few weeks. We continue to monitor capital flow
trends in the monthly TIC data, given the potential for Dollar-supportive flows upon further stabilisation in the US
economy, as mentioned above.
Mark Tan

% GDP US: BBoP vs. Current Account The Outlook for the US BBoP
4-qtr ma
2
$bn 2004 2005 2006 2007 2008 2009*
1
Current Account -631.1 -748.7 -803.5 -968.8 -706.1 -406.5
0
Net UST Flows 93.6 132.3 -58.2 89.1 196.6 62.0
-1
Other Net Bond
-2 236.2 297.6 315.7 208.5 -121.7 -346.6
Flows
-3
Net Equity Flows -25.2 -98.4 2.4 110.3 55.8 5.7
-4
Net FDI Flows -170.3 76.4 -1.8 -163.8 -12.3 -70.3
-5
BBoP BBoP -496.8 -340.8 -545.4 -724.6 -587.7 -755.7
-6
-7 Current Account % of GDP -3.8 -2.6 -4.1 -5.2 -4.1 -5.4

-8 Official Buying 314.9 213.3 310.8 269.9 543.5 237.1

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Adjusted BBoP -181.9 -127.5 -234.6 -454.7 -44.2 -518.5
% GDP -1.3 -1.0 -1.6 -3.1 -0.3 -3.7
*H1 Annualised

1 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

US Dollar
% yoy M2 Growth & CPI Inflation
% yoy Industrial Production & GDP
15 14

12 Industrial Production 12 M2
9 GDP 10 Consumer Price Index
6
8
3
6
0
4
-3
2
-6
-9 0

-12 -2
-15 -4
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Current Account Balance Index Terms of Trade

US$bn % GDP 1990=100
20 1 110
0 0 108
-20 -1 106
-40 -2 104
-60 102
-3
-80 100
-4
-100 98
-5
-120 96
-6
-140 94 TOT
-160 -7 Improvement
92
-180 Current Account (rhs) -8 90
-200 Current Account % GDP (lhs) -9 88
-220 -10 86
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 90 92 94 96 98 00 02 04 06 08

% yoy Trade Volumes Index GSFCI & Real GDP % yoy

3-mth ma 87-95=100
20 97 6
16 98 5
12 99 4
8 100 3
4
101 2
0
102 1
-4
103 0
-8 Exports 104 -1
-12 Imports 105 -2
-16
106 -3
-20 GSFCI (lhs, inverted) GDP (rhs)
107 -4
-24
108 -5
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
96 97 98 99 00 01 02 03 04 05 06 07 08 09

2 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Euro
FX Forecasts: We are maintaining our EUR/$ forecasts at 1.55, 1.55 and 1.35. EUR/¥ forecast is at 151.9, 151.9 and
141.8 in 3, 6 and 12 months. Current GSDEER for EUR/$: 1.20.

Motivation for Our FX View: We continue to expect moderate upside for the EUR/$ given our expectation of broad
Dollar weakness in the near term. We think the backdrop of robust global growth (outside of the relatively weaker G3)
and low real interest rate environment is one that will be supportive of risk assets in general. As such, we continue to
expect the broad cyclical forces driving Dollar weakness to remain in place. That said, further out our view of a
potential Dollar recovery remains intact. This is driven by the possibility that overall US broad balance of payment
(BBoP) flows may turn supportive for the Dollar further down the road, on an improvement in portfolio inflows and a
narrowing current account deficit. The ECB is also expected to 'normalise' policy rates before the Fed.

Monetary Policy and FX Framework: The ECB is a strict inflation targeter. As a Central Bank serving 16 countries,
the ECB is arguably the most independent Central Bank in the world. The Euro is a freely-floating currency. FX policy
responsibility is not clearly defined, but in practice the ECB is unlikely to act in FX markets, without Eurogroup
approval.

Growth/Inflation Outlook: We expect a relatively solid recovery in Europe. Following a contraction of -3.7% this
year, we expect Europe (EU-27) to grow by +1.7% next year and by +2.3% in 2011. As a result of the still significant
output gaps throughout Europe, we expect core inflation in the Euro-zone to decline further to about 0.5% before
slowly recovering. We forecast headline inflation in the Euro-zone at 1.1% next year and 1.6% in 2011.

Monetary Policy Forecast: We expect the ECB to begin its gradual exit through the first half of next year, as also
hinted at in its latest press conference. Specifically, we now see the ECB hiking the policy rate to 1.25% during the
fourth quarter of 2010, and then following this with 25bp hikes every quarter during 2011. This is a marginally later
start to official rate hikes than we previously thought, partly due to greater concern about the strong Euro.

Balance of Payments Situation: The current account balance is now close to flat, while the BBoP is in healthy surplus
on a trend basis. The broad balance of payments is expected to remain positive going forward, due to strong net
portfolio inflows.

Things to Watch: The Euro will be sensitive in the near term to concerns over fiscal sustainability issues in some
Euro-zone countries. The state of overall risk sentiment will also continue to be an important driver, on which we
remain constructive. Reserve diversification talk also continues to be in focus and needs to be watched. This is at the
margin positive for the Euro, given that it remains the only credible alternative to the USD currently. Seasonal patterns
suggest the Euro could rally into year-end.

Mark Tan

EUR/$ The Outlook for the Euroland BBoP

1.70

EURbn 2004 2005 2006 2007 2008 2009*

1.50

Current Account 61.6 11.7 -10.0 10.7 -143.4 -75.1

1.30

Net Bond Flows 46.6 3.5 98.1 57.5 373.3 324.9

1.10
Net Equity Flows -2.3 105.0 90.6 93.7 -22.9 108.1
0.90
Spot
Net FDI Flows -79.6 -205.7 -160.3 -72.7 -189.1 -98.4
GSDEER
0.70
BBoP 26.3 -85.5 18.4 89.2 17.9 259.6

0.50
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 (% of GDP) 0.3 -1.1 0.2 1.0 0.2 2.9

*First 9 months annualised

3 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Euro
% yoy
Industrial Production & GDP % yoy M3 Growth & CPI Inflation
yoy%
10 5.0 14
8 4.5
12 M3 CPI
6 4.0
4 3.5 10
2 3.0
8
0 2.5
-2 2.0 6
-4 1.5
-6 1.0
4
-8 0.5 2
-10 0.0 Inflation target
-12 Industrial Production (lhs) GDP (rhs) -0.5 0
-14 -1.0
-2
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
90 92 94 96 98 00 02 04 06 08 10

% GDP Euroland: BBoP vs Current Account Index

Terms of Trade
12-mth ma 2000=100
125
3
120
2
115
1 110

0 105

100
-1
95 TOT
-2 Improvement
BBoP 90

-3 Current Account 85

80
-4
90 92 94 96 98 00 02 04 06 08
98 99 00 01 02 03 04 05 06 07 08 09 10

% yoy Trade Volumes EUR/USD: 3-mth Risk Reversals

3-mth ma
20 1.6
16 1.2
12
0.8
8
0.4
4
0 0.0

-4 -0.4
-8 -0.8
-12 Exports Imports
-1.2
-16
-1.6
-20
-24 -2.0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 99 00 01 02 03 04 05 06 07 08 09 10

4 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Japanese Yen
FX Forecasts: We maintain our $/¥ forecast at 98, 98 and 105 in 3, 6 and 12 months, respectively. Our EUR/¥ forecast
is at 151.9, 151.9 and 141.8 in 3, 6 and 12 months. Current GSDEER: $/¥ 107.

Motivation for Our FX View: The main fundamental reasons for a weaker Yen are that financial conditions in Japan
are too tight, leading to a very weak growth outlook. The JPY also remains significantly expensive on GSDEER.
However, certain factors, such as US-Japan rate differentials, have not been supportive for upside moves in $/JPY.
Rate differentials may yet move in favour of $/JPY upside further out as US yields reprice after hitting bottom (as we
have seen in recent weeks), while Japanese yields should remain low. We are expressing our view of Yen weakness via
the short Yen leg in our long PLN/JPY recommended Top Trade for 2010.

Monetary Policy and FX Framework: The Bank of Japan (BoJ) has effectively shifted back to a zero interest rate
policy (with the overnight target now at 0.10%). The Yen is formally a freely floating currency, but the Ministry of
Finance is in charge of FX policy and has often intervened in the past. The last period of actual intervention was in
2003-2004.

Growth/Inflation Outlook: We are forecasting moderate GDP growth for 2010-11, at +1.5% for 2010 and +1.6% for
2011. Exports will likely remain the main driver, while we see a modest recovery in domestic demand, assisted by the
fiscal stimulus efforts. We expect consumer prices to continue to decline through 2011. Our CPI forecast is -1.0% for
2010 and -0.4% for 2011.

Monetary Policy Forecast: The BoJ decided on further monetary easing at its unscheduled Monetary Policy Meeting
on December 1, introducing a ¥10trn fund supply facility "to encourage a further decline in longer-term interest rates".
Tightening in financial conditions caused by factors such as Yen appreciation should make further easing by the BoJ
inevitable, i.e., we expect more quantitative easing (QE) to come. We think more direct QE is feasible via increasing
its outright purchases of JGBs no later than 1Q2010.

Balance of Payments Situation: The broad balance of payments (BBoP) remains deeply negative. Continued
Japanese buying of foreign assets, together with the sharply narrower current account balance, is likely to keep Japan's
broad balance of payments in deficit this year.

Things to Watch: The current administration appears to be increasingly focused on the negative growth impact from
Yen overvaluation, as signalled by recent MoF communications. We also think there is a reasonable chance that the
Bank of Japan initiates additional QE measures soon. Also, there has been increased hedging activity by exporters and
institutional investors due to lower hedging costs from low US interest rates. Any turn in the trend has to be monitored
and could potentially be key for $/JPY upside. Speculative positioning appears skewed towards Yen strength currently.

Mark Tan

$/¥ The Outlook for the Japanese BBoP

300

¥trn 2004 2005 2006 2007 2008 2009*

250
Spot Current Account 18.6 18.3 19.8 24.8 16.4 13.1
GSDEER Net Bond Flows -4.8 -13.4 9.4 5.9 -15.3 -21.9
200
Net Equity Flows 7.1 12.3 5.4 2.3 -13.9 -7.1

150 Net FDI Flows -2.5 -4.7 -6.6 -6.0 -10.7 -6.2

BBoP 18.5 12.4 28.0 27.0 -23.5 -22.2

100 (% of GDP) 3.7 2.5 5.5 5.2 -4.6 -4.6
*First nine months annualised
50
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

5 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Japanese Yen
% yoy Industrial Production & GDP % yoy M2+CD Growth & CPI Inflation
15 14
Industrial Production
12
10 GDP M2+CD CPI
10

5 8

6
0
4
-5 2

0
-10
-2
-15 -4
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

% GDP Japan BBoP vs Current Account Index Terms of Trade

12-mth ma 2000=100
8 130
6
120
4
110
2
100
0

-2 90

-4 80

-6 70 TOT
BBoP Current Account Improvement
-8
60
-10
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 50
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

% yoy Trade Volumes USD/JPY: 3-mth Risk Reversals

3-mth ma
20 2
15
10 0
5
-2
0
-5
-4
-10
-15 -6
-20
-25 -8
Exports Imports
-30
-10
-35
-40 -12
-45 99 00 01 02 03 04 05 06 07 08 09 10
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

6 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Europe
British Pound
FX Forecasts: Our current EUR/GBP forecast path is at 0.84 flat in 3, 6 and 12 months, respectively. This translates
into GBP/$: 1.85, 1.85 and 1.61 over the same horizon. Current GSDEER for EUR/GBP is 0.77 and for GBP/$ 1.56.

Motivation for Our FX View: We have been constructive on Sterling for some time, mainly on the back of the large
easing in financial conditions, which should boost growth. Recent PMI readings suggest growth is tracking at about
+2%-3%, which is faster than what actual activity data suggests, although the latter is subject to heavy revisions in the
UK. Earlier monetary policy tightening than consensus expects towards the middle of next year could lead to
substantial Sterling strength given that speculative positioning remains short, when judged by IMM data, for example.
Concerns about the fiscal outlook in the UK and the need to cut expenditure suggest that the appreciation potential is
limited, and we strongly believe that Sterling will stay on the weak side of our EUR/GBP GSDEER estimate.

Monetary Policy and FX Framework: The Bank of England is tasked with price stability, defined as CPI at 2% over
time. If inflation falls below 1% or rises above 3%, the BoE must write a letter of explanation to the Chancellor of the
Exchequer. Sterling operates under a free float but the BoE regularly comments on currency moves in the context of
growth and inflation.

Growth/Inflation Outlook: We are above consensus on UK activity. This is particularly true for 2010, when we
expect the economy to grow by 1.9% vs a consensus view of 1.0% and by 3.4% in 2011. We note that the Bank of
England is also becoming more constructive on UK growth. The improvement in PMIs, labour market and housing-
related data supports the view of improving activity. Worries about the fiscal outlook pose downside risks to UK
activity. In terms of inflation, we expect a sharper rebound than the MPC in 2010, as the VAT cut is reversed.

Monetary Policy Forecast: The Bank of England cut rates to 0.5% at its March meeting and announced the start of
quantitative easing. We think the MPC will not want to extend its programme of bond purchases beyond the current
£200bn. We expect the BoE to be one of the first major central banks to tighten towards the middle of 2010.

Balance of Payments Situation: The UK current account deficit decreased to around 1.6% of GDP during 2008
(compared with a deficit of 2.7% in 2007). We expect deficits of around 1.8% and 0.6% of GDP in 2009 and 2010.
Portfolio flows are notoriously difficult to assess in the UK given large gross cross-border flows linked to London as a
banking hub for all of Europe.

Things to Watch: A monetary tightening through an early QE exit could surprise markets and lead to Sterling
strength. Speculative Sterling positioning is still skewed towards shorts, and as a reverse indicator this points to
potential strength in the short term. FX markets have become quite sensitive to the fiscal debate linked to the
forthcoming elections. Revised GDP estimates could boost Sterling.
Thomas Stolper

Index EUR/$ and £/$ EUR/£

Jan 98 = 1.0
1.00
1.5

1.4 0.90
EUR/$
1.3 £/$ 0.80

1.2 0.70

1.1
0.60
1.0
0.50 Spot
0.9 GSDEER
0.40
0.8

0.7 0.30
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
98 99 00 01 02 03 04 05 06 07 08 09

7 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

British Pound
Industrial Production & GDP M2+CD Growth & CPI Inflation
% yoy % yoy
10 20
8 18 Notes and Coin
6 M4
16
4 RPI
2 14
0 12
-2 10
-4
8
-6
Industrial Production 6
-8
-10 GDP 4
-12 2
-14
0
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
84 86 88 90 92 94 96 98 00 02 04 06 08 10

% GDP
BBoP Index Terms of Trade
4-qtr ma
2000=100
25 110

20

BBoP Current Account 105

15

10

100
5

0
95 TOT
-5 Improvement

-10
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 90
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

% yoy Trade Volumes GBP/USD: 3-mth Risk Reversals

3-mth ma
35 1.0
30
0.5
25
20 0.0
15 -0.5
10
-1.0
5
0 -1.5
-5 -2.0
-10
-2.5
-15
-20 Exports Imports -3.0
-25 -3.5
-30 99 00 01 02 03 04 05 06 07 08 09 10
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

8 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Asia
Australian Dollar
FX Forecasts: Our A$/US$ forecasts are 0.95, 0.95 and 0.90 in 3, 6 and 12 months. A$/EUR: 0.61, 0.61 and 0.67 in 3,
6 and 12 months. Current GSDEER: 0.79.

Motivation for our FX view: It is hard to isolate the factors that could undermine the upward trajectory of the AUD.
On virtually every screen that we believe is important, the AUD looks set to move higher. Specifically: i) our forecasts
are for already high interest rate spreads to widen further; ii) after recording the mildest downturn in the developed
world, we expect the strongest growth among the major developed nations in 2010; iii) the AUD correlates strongly
with the improving global industrial cycle and Australia's terms of trade is set to rise in 2010; iv) Australia has been a
recipient of quality capital inflow in recent quarters; and v) as volatility in FX markets declines, carry could become an
independent source of AUD strength.

Monetary Policy and FX Framework: Inflation targeting: The RBA aims to keep CPI inflation between 2% and 3%
on average over the cycle. Operationally, this is implemented by attempting to keep underlying inflation within this
target band, but allows sufficient flexibility for policy to take account of short-run developments in employment and
economic growth. The FX regime is free-float, although the RBA intervenes if market moves are disorderly.

Growth/Inflation outlook: Recent activity data has confirmed Australia as the most resilient economy in the
developed world. After appearing to expand by 1.0% in 2009, we expect the Australian economy to grow by 3.5% in
both 2010 and 2011. This remains above consensus, and above the RBA's and the Treasury's revised growth forecasts.
Inflation is forecast to rise by 2.8% and 3.3% in 2010 and 2011.

Monetary Policy Forecast: Reflecting the resilience of the Australian economy and the initial low level of rates, the
RBA has already delivered 75bp of tightening in three consecutive meetings. Given the solid growth outlook and that
the economy is beginning an expansion with a limited amount of spare capacity, we expect further normalisation of
rates in early 2010, with 25bp rate hikes at each of the next three meetings (to 4.50%). We expect rates to be 4.75%
and 5.50% at year-end 2010 and 2011, respectively.

Balance of Payments Situation: The rollover of annual contract prices at sharply lower levels for Australia's two
largest exports has driven a full 3ppt of GDP deterioration in the trade accounts in just two quarters. Looking ahead,
risks look more balanced. Although the inventory cycle will underpin a significant rebound in imports, this is likely to
be offset by reflating commodity prices.

Things to Watch: With a number of downside tail risks previously facing the Australian economy now receding, the
key point to watch is the lack of spare capacity in the economy, and the rate at which aggressive policy accommodation
(both monetary and fiscal) is unwound, as well as the impact of this on confidence. A key upside risk is if evidence
emerges that the unemployment rate is peaking ahead of expectations and the degree of reflation in asset prices.

Tim Toohey

% GDP
4-qtr ma
Australia: BBoP A$/$
3 1.6

2 Current Account BBoP

1.4
1 Spot
0 GSDEER
1.2
-1
-2 1.0
-3
0.8
-4
-5
0.6
-6
-7 0.4
82 84 86 88 90 92 94 96 98 00 02 04 06 08 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Economist: Tim Toohey tim.toohey@gsjbw.com

Copyright 2008 Goldman Sachs JBWere Pty Limited ABN 21 006 797 897 All rights reserved.

37 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Australian Dollar
% yoy
% yoy
Consumer Sentiment & GDP % M1 & M3 Growth & CPI Inflation
60 35

50 30

40 25

30 20

20 15

10 10

0 5

-10 0

-20 -5
Consumer Sentiment M1 M3 CPI
-30 -10
GDP
-40 -15
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Index Terms of Trade

Index Commodity Price Index* vs A$/$ 2000=100
150 1.4 200
190

RBA commodity price 180

120 1.2 TOT
170 Improvement
A$/$ (rhs)
160
90 1.0 150
140
60 0.8 130
120

30 0.6 110
100
90
0 0.4
80
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
* Source: RBA.

% yoy Trade Volumes AUD/USD: 3-mth Risk Reversals

65 1.0

55 0.0

45 Imports Exports -1.0

35 -2.0

25 -3.0

15 -4.0

5 -5.0

-5 -6.0

-15 -7.0

-25 -8.0
96 98 00 02 04 06 08 10 99 00 01 02 03 04 05 06 07 08 09 10

38 December 2009
Goldman Sachs Global Economics, Commodities and Strategy Research The Global FX Monthly Analyst

Chinese Yuan
FX Forecasts: We maintain our forecast that the USD/CNY rate will remain flat over the next 12 months (spot 6.83).
EUR/CNY: 10.59, 10.59 and 9.22, in 3, 6 and 12 months. GSDEER of USD/CNY: 6.87.

Motivation for Our FX View: The government has a strong desire to keep the USD/CNY exchange rate stable
because the overwhelming majority of China's trade with foreign countries is denominated in USD; hence a stable
USD/CNY is perceived to be beneficial to trade. Appreciating the currency against the USD even in light of further
weakness in the latter will be difficult, given that export growth is still in negative territory despite the significant
improvements in recent months. On the other hand, depreciating the currency is not an option either politically or
economically given the still large external imbalances.

Monetary Policy and FX Framework: The People's Bank of China (PBoC) is not independent from the central
government and has multiple targets of maintaining price stability and high growth. It does not hold regular policy
meetings and policy changes are typically released after the close of the local market without advanced notice. The
Monetary Policy Committee of the PBoC is an advisory body, which does not determine policy direction. The FX
regime has been a managed float since July 2005 after a decade-long peg to the USD.

Growth/Inflation Outlook: We believe the real economy's growth momentum remains strong. October industrial
production (IP) grew at a robust pace of 21.8%mom, annualised. This is above the 16% trend level and we believe
growth momentum will remain strong going into 2010. The sequential growth of both CPI and PPI inflation has been
in positive territory continously since July, and we expect their yoy growth to turn positive in November and
December, respectively, which would give a clear signal that deflation is over in China after nearly a year of strong
recovery in activity growth.

Monetary Policy Forecast: We expect the PBoC to keep benchmark interest rates unchanged in 2009 and hike them
once by 27bp in 2010.

Balance of Payments Situation: The trade surplus rebounded significantly in October to US$24.0bn from US$12.9bn
in September. While the trade surplus tends to rise towards the end of the year, we believe the widening surplus is a
reflection of stronger-than-expected external demand growth and weakening sequential imports growth as a result of
domestic policy tightening. We believe this trend may well continue into next year and the likelihood of a trade deficit
appearing in 1H2010 is lower than we previously thought.

Things to Watch: The government has started to tighten monetary policy quietly since July. We believe the current
pace of broad money supply growth is appropriate for the real economy judging by recent activity growth and inflation
data. If the government is able to maintain its policy stance, we believe the economy will be able to continue to
improve without generating significant inflationary pressures.

Yu Song and Helen Qiao

$/CNY % of GDP China: BBoP vs Current Account

9.40 18%

16%
8.40
14% CA BBoP
7.40 12%

10%
6.40
Spot 8%

5.40 GSDEER 6%

4%
4.40
2%
3.40 0%
90 92 94 96 98 00 02 04 06 08 10 97 98 99 00 01 02 03 04 05 06 07 08 09 10

39 December 2009