Preparing for China's Urban Billion Stefano Negri, McKinsey Global Institute RIC, 4 th annual conference New Delhi November 21, 2008 This report contains information that is confidential and proprietary to McKinsey & Company, Inc., and is solely for the use of McKinsey & Company, Inc., personnel. No part of it may be used, circulated, quoted, or reproduced for distribution outside McKinsey & Company, Inc. If you are not the intended recipient of this report, you are hereby notified that the use, circulation, quoting, or reproducing of this report is strictly prohibited and may be unlawful.

McKinsey developed an innovative, unique perspective on the booming urbanization in China Shanghai Taizhou, Zhejiang Beijing Cangnan, Zhejiang Huhehaote, Inner Mongolia Shenzhen, Guangdong Harbin, Heilongjiang Taiyuan, Shanxi Nanchong, Sichuan Changsha, Hunan Chengdu, Sichuan Xiamen, Fujian Suzhou, Anhui Xingping, Shaanxi Methodology Econometric model (22,000+ equations) – macro and demographic forecast 2007-2025 Scenario analysis – 4 alternative scenarios depicting contrasting directions for China's future urbanization, size and pattern City visits – visited 14 different cities and interviewed >100 local government officials and business leaders to complement the model findings Sources of distinctiveness Granularity – Yearly historical and forecast data at national and city level Comparability – Urban definition consistent with international standard and applied to all indicators Completeness – Time series data consistent with theory and individual city behavior, providing data and forecasts for 858 cities, including 195 "unofficial cities"

Econometric model (22,000+ equations) – macro and demographic forecast 2007-2025

Scenario analysis – 4 alternative scenarios depicting contrasting directions for China's future urbanization, size and pattern

City visits – visited 14 different cities and interviewed >100 local government officials and business leaders to complement the model findings

Granularity – Yearly historical and forecast data at national and city level

Comparability – Urban definition consistent with international standard and applied to all indicators

Completeness – Time series data consistent with theory and individual city behavior, providing data and forecasts for 858 cities, including 195 "unofficial cities"

Chinese cities are redefining urbanization scale, over the next 20 years … Source: Demographia; China-All-City model output, McKinsey Global Institute analysis 5 How many additional people will live in Chinese cities vs today? More than 350 million people , more than the population of the entire United States How many cities in China will have more than one million inhabitants? More than 200 cities ; in Europe today there are only 35 cities of that size How many new skyscrapers will be built? There will be up to 50,000 new skyscrapers , the equivalent of building ten New York cities How many new mass transit systems will be built? Up to 170 new mass transit systems ; in Europe today there are about 70 By 2025, two-thirds of China’s citizens will live in cities … … that’s nearly 1 billion people

China's urbanization could follow different paths Source: McKinsey Global Institute analysis 54 Super cities Hub and spoke A small number of very large cities emerge (>20 million), 4 of them reaching 30 - 40 million people each 11 economic clusters of large cities of 30 - 90 million people each emerge Major and very small cities decelerate, and a large number of cities from 1.5 million - 5 million emerge Many small cities (500,000 - 1.5 million) emerge, including almost 300 rural counties becoming cities Country examples Japan Korea US Germany Concentrated urbanization Dispersed urbanization Shanghai Beijing Yangtzi River Delta cities Taizhou Harbin Xingping Examples of “boosted cities” in each scenario Scenarios Distributed Growth Townization

A small number of very large cities emerge (>20 million), 4 of them reaching 30 - 40 million people each

11 economic clusters of large cities of 30 - 90 million people each emerge

Major and very small cities decelerate, and a large number of cities from 1.5 million - 5 million emerge

Many small cities (500,000 - 1.5 million) emerge, including almost 300 rural counties becoming cities

Shanghai

Beijing

Yangtzi River Delta cities

Taizhou

Harbin

Xingping

China's energy demand will more than double in all scenarios by 2025 Source: McKinsey Global Institute analysis 5,233 2005 1,920 Super cities 2,082 Hub and spoke 2,258 Distributed growth 2,140 Townization 12 68 68 60 54 139 131 142 123 +138% Urban energy intensity BTU per Renminbi Urban GDP Renminbi trillion Urban energy demand QBTUs

Mass transit requirements could vary widely depending on urban shape * Based on Chinese Government criteria, population and GDP in 2020 Source: Urban Statistical Yearbook of China; Criteria of subway/light rail development issued by Ministry of Construction Criteria* Subway City population: ≥ 3 million City GDP: ≥ RMB 100 billion Light rail City population: ≥ 1.5 million City GDP: ≥ RMB 60 billion 171 Distributed growth 131 Trend Line 130 Hub & Spoke 102 Super cities 85 Townization Qualified cities by 2025 76 In all Europe (including Russia), there are approximately 70 subway and light rail systems 150,000 to 400,000 additional rail cars needed Between 4.5 and 7 trillion RMB over the next 20 years

Subway

City population: ≥ 3 million

City GDP: ≥ RMB 100 billion

Light rail

City population: ≥ 1.5 million

City GDP: ≥ RMB 60 billion

In all Europe (including Russia), there are approximately 70 subway and light rail systems

150,000 to 400,000 additional rail cars needed

Between 4.5 and 7 trillion RMB over the next 20 years

China will build a Chicago every year * Smoothed to 5-year intervals Source: NBS; press clippings; team analysis, city visits POTENTIAL ANNUAL CONSTRUCTION OF LARGE SKYSCRAPERS* Number of buildings above 30 floors, 2005 - 2025 Hub and Spoke Distributed growth Trend line Super cities Townization Number of Skyscrapers in Chicago

Contact information http://www.mckinsey.com/mgi/ For more information and to download the full report 83 Stefano Negri, McKinsey Global Institute McKinsey & Company 17/F Platinum - 233, Tai Cang Road 200020 Shanghai - PRC Mobile: +86-15821665209 Email: stefano_negri@mckinsey.com

BACKUPS

To tell the future, we had to understand the past * Include 663 official cities and 195 additional areas that we consider as cities using various government criteria to qualify them. These criteria were discontinued in 1996 for practical reasons but, in our view, remain valid Source: McKinsey Global Institute analysis, China-All-City model output 0 21 51 254 1990 32 84 161 572 2005 Mega (10M+) Big (5 - 10M) Mid-sized (1.5 - 5.0M) Small (0.5 - 1.5M) Big town (<0.5M) 2.0 9.5 8.0 5.0 N/A 5.6 9.3 17.4 15.8 13.6 14.5 N/A Population Real GDP CAGR , 1990-2005, percent POPULATION BY CITY SIZE Millions of people We discovered that there are various ways to define Chinese cities (e.g. Chongqing) We corrected statistical distortions (e.g. hukou vs census ) We uncovered 195 “hidden cities” We established that migration is only half the story 146

We discovered that there are various ways to define Chinese cities (e.g. Chongqing)

We corrected statistical distortions (e.g. hukou vs census )

We uncovered 195 “hidden cities”

We established that migration is only half the story

The urbanization research produced a set of insights which are very relevant for businesses Source: McKinsey Global Institute analysis Urbanization is inevitable – and cities will be the clear drivers of China's economic growth City clusters will provide a new lens to assess opportunities in China Different urbanization paths could drive significantly different outcomes for China Investment growth will continue , and public spending will come along Burgeoning middle and upper middle class will take off China's &quot;growing pains&quot; will generate new markets and business opportunities 1 billion urban population >90% GDP from urban areas 11 clusters are emerging, with average population of ~60 millions and ~60% of total urban investments Variability between urbanization scenarios: 20% in GDP 15-30% of demand for natural resources 40+ trillion USD (2005 through 2025) 170+ new MT systems, 360'000+ km of new water pipe, x6 healthcare spending Middle class (household income 40k-200k RMB/yr) will make up almost 80% of total consumption Spending in key areas such as environmental protection is bound to raise (e.g., 100% SO2 scrubbers ) 1 2 3 4 5 6

1 billion urban population

>90% GDP from urban areas

11 clusters are emerging, with average population of ~60 millions and ~60% of total urban investments

Variability between urbanization scenarios:

20% in GDP

15-30% of demand for natural resources

40+ trillion USD (2005 through 2025)

170+ new MT systems, 360'000+ km of new water pipe, x6 healthcare spending

Middle class (household income 40k-200k RMB/yr) will make up almost 80% of total consumption

Spending in key areas such as environmental protection is bound to raise (e.g., 100% SO2 scrubbers )

China is moving toward an urban billion Source: McKinsey Global Institute CAC model, McKinsey Global Institute analysis POPULATION BY CITY SIZE Millions of people TREND LINE FORECASTS 120 316 926 2025 Mega cities (>10 million) Big cities (5 - 10 million) Midsized cities (1.5 - 5 million) 32 161 572 2005 Small cities (0.5 - 1.5 million) Big towns (<0.5 million) 6.9 1.1 3.4 2.2 0.3 2.4 154 1 Mega and midsized city populations will grow faster over the next 20 years An urban billion will be attained by 2030 CAGR, percent XX

Mega and midsized city populations will grow faster over the next 20 years

An urban billion will be attained by 2030

Six new megacities will emerge by 2025 Chengdu Chongqing Shanghai Wuhan Guangzhou Shenzhen Beijing Tianjin Source: McKinsey Global Institute CAC model, McKinsey Global Institute analysis Millions of people TREND LINE FORECASTS 14.7 26.8 Beijing 17.1 25.1 Shanghai 12.6 Tianjin 12.4 Shenzhen 11.9 Wuhan 10.7 Chongqing 10.3 Chengdu 10.1 Guangzhou 10.100 1 2025 2007 Beijing and Shanghai already megacities in 2007

Even with conservative assumptions, urban GDP will more than quadruple by 2025 Source: McKinsey Global Institute analysis, China-All-City model output SENSITIVITIES 68 2025 Low 2025 High 12 2005 54 +467% +350% Urban GDP RMB trillions Urban GDP/capita RMB thousand Urban GDP/ total GDP Percent 62 76 21 +195% +262% 75 90 92 21 1

Clusters of cities with average population of ~60mln provide a new lens to assess market opportunities Source: McKinsey Global Institute analysis ECONOMIC REGIONS Number of cities in the region Regional hubs Hubs 2 ` Beijing Xun River Huang River Yangtze River Guangzhou Qingdao Chengdu Dalian Xian Fuzhou Shanghai Wuhan Tianjin Xiamen Jinan Zhengzhou Changsha Shenzhen Chongqing Shenyang Beijing / Tianjin 28 Shenyang / Dalian 22 Qingdao / Jinan 35 Zhengzhou 23 Xian 8 Shanghai 58 Chengdu / Chongqing 31 Wuhan 27 Changsha 20 Xiamen / Fuzhou 14 Guangzhou / Shenzhen 23 Fixed asset investment in 11 economic regions will represent almost 60% (13 trn RMB) of total urban investment in China by 2025

Each scenario has pressures – But these appear less intense overall in concentrated urbanization Source: City visits; interviews; McKinsey Global Institute analysis Super cities Hub and spoke Distributed Growth Townization Jobs and skills Pollution Energy Water Funding Land development Congestion Pressure points Concentrated urbanization ALL URBAN CHINA 3

At local level, regardless of scenarios, it is possible to define an &quot;urban productivity agenda&quot; for Chinese cities Source: McKinsey Global Institute analysis NOT EXHAUSTIVE Examples of detailed initiatives Create strategic land development plans (combining zoning, building heights, transit plans) Develop integrated, mixed use areas Implement car traffic demand management Incentivize energy and water efficient industrial equipment Establish and enforce energy saving building codes Increase control , emission standards on pollutants Introduce productivity based performance systems on public service provision (e.g., healthcare) Increase transparency in city budgets and infrastructure spending Partner with local companies to increase internship / team work (e.g., establishing joint vocational education and training institutions) Introduce performance management systems on labor productivity and employability measures rather than, for example, enrollment rate Manage demand, not only supply of resources Improve quality and relevance of educational process Increase productivity in public services and capital expenditures Build dense cities with integrated urban planning design High-level initiatives Land Resources Economics People 6

Create strategic land development plans (combining zoning, building heights, transit plans)

Develop integrated, mixed use areas

Implement car traffic demand management

Incentivize energy and water efficient industrial equipment

Establish and enforce energy saving building codes

Increase control , emission standards on pollutants

Introduce productivity based performance systems on public service provision (e.g., healthcare)

Increase transparency in city budgets and infrastructure spending

Partner with local companies to increase internship / team work (e.g., establishing joint vocational education and training institutions)

Introduce performance management systems on labor productivity and employability measures rather than, for example, enrollment rate

The China urbanization story 83 China's urban success story will continue, with massive changes in the next 20 years China has set ambitious economic goals. Urbanization is key to make that happen – urban GDP / capita will grow five times and cities will generate more than 90% of China's GDP Urbanization will continue, but with it will be different from the urbanization China experienced in the past 15 years (e.g., migration will be the driving force) Pressure will intensify on several areas and will need to be managed, especially if China continues to follow a dispersed pattern of urbanization – land and spatial development, resources and pollution, human capital, funding There is an opportunity to shape China's future towards a more productive urbanization – with policy interventions both at national and local level Between all possible urban shapes, concentrated growth is the most efficient and beneficial way to go for China (higher GDP, more efficient use of resources, more productivity from its talent pool) &quot; City level productivity initiatives &quot; are an opportunity to reduce the cost of urbanization while increasing quality of life (China could cut its public spending needs by 2.5% of GDP, reduce SO2 and NOx emissions by upwards of 35%; halve its water pollution; and deliver private sector savings equivalent to an additional 1.7% of GDP in 2025) and opening new business opportunities

China's urban success story will continue, with massive changes in the next 20 years

China has set ambitious economic goals. Urbanization is key to make that happen – urban GDP / capita will grow five times and cities will generate more than 90% of China's GDP

Urbanization will continue, but with it will be different from the urbanization China experienced in the past 15 years (e.g., migration will be the driving force)

Pressure will intensify on several areas and will need to be managed, especially if China continues to follow a dispersed pattern of urbanization – land and spatial development, resources and pollution, human capital, funding

There is an opportunity to shape China's future towards a more productive urbanization – with policy interventions both at national and local level

Between all possible urban shapes, concentrated growth is the most efficient and beneficial way to go for China (higher GDP, more efficient use of resources, more productivity from its talent pool)

&quot; City level productivity initiatives &quot; are an opportunity to reduce the cost of urbanization while increasing quality of life (China could cut its public spending needs by 2.5% of GDP, reduce SO2 and NOx emissions by upwards of 35%; halve its water pollution; and deliver private sector savings equivalent to an additional 1.7% of GDP in 2025) and opening new business opportunities