EM Outlook 2012

Global
6 December 2011
Emerging Markets 2012 Outlook

Research Team
Survival of the Fittest Marc Balston

Global Markets Research
(+44) 20 754-71484
Robert Burgess
(+44) 20 754-71930
Gustavo Cañonero
(+1) 212 250-7530
Marcel Cassard
(+44) 20 754-55507
Drausio Giacomelli
(+1) 212 250-7355
Michael Spencer
(+852 ) 2203-8303
Special Reports
Rates in 2012: Identifying Pockets of Value
FX in 2012: The Vehicle to Trade Global Risk
Sovereign Credit in 2012: Diminished Returns; Country Selection Key
EM: Survival of the Fittest
EM Performance: The Grass is Grayer on the Other Side
Emerging Markets
EM Technicals in 2012: Structurally Sound; Cyclically Vulnerable

A Closer Look at Real-Money Positioning
IMF Financing: Possibilities and Limitations
EMEA Domestic Debt: Supply and Demand in Focus
Deutsche Bank Securities Inc.
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
MICA(P) 146/04/2011.
Key Economic Forecasts
1/
Real GDP (%) Consumer Prices (%, eop) Current Account (% GDP) Fiscal balance (% GDP)
2010F 2011F 2012F 2010F 2011F 2012F 2010F 2011F 2012F 2010F 2011F 2012F
Global 5.0 3.6 3.2 3.7 4.1 3.6 0.5 0.2 0.0 -5.1 -4.5 -3.8
US 3.0 1.8 2.3 1.6 3.3 3.2 -3.2 -3.1 -2.7 -8.8 -8.5 -6.2
Japan 4.1 -0.4 0.5 -0.7 -0.3 -0.3 3.6 2.2 1.9 -8.7 -8.8 -9.1
Euroland 1.8 1.6 -0.5 1.6 2.7 1.9 -0.5 -0.7 -0.3 -6.3 -4.2 -3.6
Germany 3.6 2.9 0.0 1.1 2.5 2.0 5.6 5.4 5.1 -4.3 -1.3 -1.4
France 1.4 1.6 -0.3 1.7 2.2 1.8 -1.8 -2.8 -2.6 -7.1 -6.0 -5.4
Italy 1.3 0.5 -1.1 1.6 2.7 2.3 -3.5 -3.8 -3.0 -4.6 -4.0 -2.5
Spain -0.1 0.6 -0.9 2.0 3.1 1.3 -4.6 -3.9 -3.3 -9.3 -6.8 -6.0
Netherlands 1.6 1.9 -0.5 0.9 2.5 2.0 6.7 7.0 8.0 -5.1 -3.4 -3.5
Belgium 2.3 1.9 -0.6 2.3 3.4 2.0 2.4 2.0 2.0 -4.1 -3.9 -5.0
Austria 2.3 2.8 -0.5 1.7 3.6 2.1 2.9 2.5 2.5 -4.4 -3.2 -3.2
Finland 3.6 2.9 0.0 1.7 3.3 2.3 3.0 2.0 2.0 -2.5 -1.5 -1.5
Greece -3.5 -5.3 -3.0 4.7 3.1 1.3 -11.8 -9.0 -7.0 -10.6 -9.5 -6.6
Portugal 1.4 -1.5 -2.9 1.4 3.6 2.5 -9.8 -8.0 -6.5 -9.8 -6.5 -6.4
Ireland -0.4 1.5 0.2 -1.6 1.2 1.5 -0.7 0.0 0.5 -31.3 -10.5 -9.1
Other Industrial Countries
United Kingdom 1.8 1.1 1.3 3.3 4.5 3.2 -2.5 -2.5 -2.4 -10.3 -8.2 -6.9
Sweden 5.4 4.1 1.3 1.3 2.7 2.0 6.3 6.5 6.0 -0.1 1.9 3.0
Denmark 1.7 1.4 1.2 2.3 2.6 1.9 5.5 5.8 5.6 -5.3 -1.6 -0.8
Norway 0.3 2.2 1.3 2.4 1.6 1.8 12.3 12.8 13.8 10.6 9.1 10.8
Switzerland 2.7 2.0 1.0 0.7 0.7 0.7 15.6 13.8 13.5 0.8 1.0 1.3
Canada 3.2 2.1 2.5 1.8 3.0 2.5 -3.1 -3.2 -3.1 -3.4 -2.1 -1.8
Australia 2.7 1.6 2.9 2.8 3.4 3.0 -2.7 -2.1 -1.6 -4.1 -3.3 -1.4
New Zealand 1.7 2.0 2.6 2.3 4.4 2.5 -3.4 -3.8
Emerging Europe, Middle East & Africa 4.4 4.4 3.3 6.5 6.3 5.8 1.2 1.6 0.7 -3.7 -1.0 -1.3
Czech Republic 2.2 1.8 0.0 2.3 2.0 3.3 -3.3 -4.0 -3.7 -4.8 -4.3 -3.8
Egypt 5.1 1.8 3.0 10.1 8.9 9.0 -2.0 -2.6 -2.4 -8.1 -9.5 -8.5
Hungary 1.2 1.4 -0.8 4.7 4.1 4.7 1.1 0.6 0.3 -4.3 1.9 -3.2
Israel 4.8 4.5 2.8 2.6 2.3 2.3 2.9 -0.4 -1.4 -3.7 -3.3 -3.5
Kazakhstan 7.3 6.6 5.5 7.8 8.0 7.0 3.1 10.4 8.4 1.5 2.0 2.5
Poland 3.9 4.2 2.3 3.1 4.0 2.4 -4.6 -4.5 -4.4 -7.8 -5.5 -4.3
Romania -1.3 1.8 1.9 8.0 3.5 3.2 -4.2 -3.6 -4.1 -6.4 -4.4 -3.1
4.0 4.5 4.6 8.8 7.1 7.0 4.8 5.9 4.1 -3.9 0.2 -0.4
Saudi Arabia 4.1 5.7 3.7 5.4 5.5 4.5 14.9 18.4 14.5 5.2 9.7 7.3
South Africa 2.8 3.1 3.2 3.5 6.4 6.0 -2.8 -3.1 -3.7 -6.6 -5.5 -5.4
Turkey 8.9 7.0 2.3 6.4 9.2 6.4 -6.6 -9.4 -8.4 -3.6 -1.5 -1.5
Ukraine 4.2 4.5 3.9 9.1 6.5 9.0 -2.0 -2.7 -3.1 -5.0 -2.5 -2.5
United Arab Emirates 3.2 3.7 3.5 1.7 1.6 2.4 8.0 10.1 10.3 3.6 8.2 7.4
Asia (ex-Japan) 9.5 7.3 6.9 5.4 4.8 3.7 3.5 2.6 1.9 -2.2 -2.9 -2.9
China 10.3 9.1 8.3 4.6 3.8 2.8 5.2 4.0 3.4 -1.7 -2.0 -2.0
Hong Kong 7.0 5.3 3.0 2.9 6.0 4.3 6.2 5.5 4.8 4.2 1.6 1.2
India 10.0 7.0 7.5 9.4 7.5 6.0 -3.1 -2.9 -3.1 -4.7 -8.1 -7.4
Indonesia 6.1 6.5 6.3 7.0 4.0 6.5 0.8 0.5 -0.2 -0.6 -1.1 -1.4
Korea 6.2 3.7 3.4 3.0 4.1 3.2 2.8 2.3 0.7 -0.2 1.6 0.3
Malaysia 7.2 5.0 4.3 2.1 3.4 2.1 11.5 11.4 9.9 -5.6 -4.2 -5.0
Philippines 7.6 3.5 3.0 3.1 4.7 4.0 4.2 4.5 3.4 -3.5 -2.9 -3.2
Singapore 14.5 5.0 3.0 4.6 5.3 1.2 22.2 19.1 18.5 5.1 8.0 6.6
Sri Lanka 8.0 8.0 7.5 6.8 4.1 7.6 -2.9 -5.6 -4.9 -8.0 -7.0 -7.0
Taiwan 10.9 4.4 3.0 1.2 1.0 0.6 9.2 8.6 7.6 -3.7 -3.2 -3.4
Thailand 7.8 1.8 3.9 3.0 4.1 3.3 4.6 0.0 -1.9 -1.1 -3.7 -4.9
Vietnam 6.8 5.9 5.6 11.7 18.6 10.8 -4.2 -3.8 -5.1 -6.5 -5.3 6.0
Latin America 6.3 4.1 3.6 8.4 8.2 8.2 -0.9 -0.9 -1.3 -2.4 -2.0 -1.8
Argentina 9.2 7.3 3.1 25.2 23.1 25.4 0.8 0.8 -0.5 -1.5 -2.3 -1.5
Brazil 7.5 3.0 3.3 5.9 6.4 5.3 -2.3 -2.2 -2.6 -2.5 -2.1 -1.6
Chile 5.2 6.0 4.2 3.0 3.7 2.9 1.9 -1.1 -1.7 -0.3 0.8 0.2
Colombia 4.3 5.5 5.0 3.2 3.7 3.4 -3.7 -3.2 -2.7 -3.9 -3.3 -3.2
Mexico 5.5 3.9 3.3 4.4 3.4 3.4 -0.6 -0.7 -1.0 -2.8 -2.1 -2.3
Peru 8.8 6.8 5.9 2.1 4.4 3.5 -1.6 -1.4 -1.7 -0.7 0.1 -0.2
Venezuela -1.4 3.9 4.0 27.2 28.0 27.0 4.6 6.9 2.5 -1.9 3.7 -3.7
Memorandum Lines: 2/
G7 2.9 1.5 1.3 1.4 2.6 2.4 -1.0 -1.3 -1.1 -7.7 -7.0 -5.6
Industrial Countries 2.7 1.5 1.2 1.5 2.7 2.3 -0.9 -1.1 -0.9 -7.3 -6.4 -5.1
Emerging Markets 7.7 6.1 5.5 6.2 5.7 5.0 2.2 1.7 1.1 -2.6 -2.3 -2.3
BRICS 9.1 7.3 7.0 6.3 5.3 4.4 2.5 2.0 1.4 -2.7 -3.0 -2.9
1/ CPI (%) forecasts for developed markets are period averages.
2/ Aggregates are PPP-weighted within the aggregate indicated. For instance, EM growth is calculated by taking the sum of each EM country's individual growth rate multiplied it
by its share in global PPP divided by the sum of EM PPP weights.
6 December 2011 EM Monthly
Table of Contents
Emerging Markets and the Global Economy in the Year Ahead
The coming year is clearly going to be a difficult one for the world economy; however, this resilience will not be uniform
across EM. Given the headwinds, 2012 may well prove to be a case of ‘survival of the fittest’. We expect the tug of war
between structural and tactical drivers of 2011 to extend into 2012 – particularly during the first months of the year,
when the future of Europe may be decided. ....................................................................................................................11
This Month’s Special Reports

EM receivers performed well after a rocky start. In our 2012 outlook, we analyze those country specific effects using a
model which integrates macro-monetary policy interactions and local curve dynamics. Under our benchmark scenario
the ‚fair‛ curves are relatively close to forward curves. .....................................................................................................22

During 2011, EMFX played the role of shock absorber with a large share of returns attributed to global drivers. External
factors should remain the main drivers of EM currencies in 2012. ....................................................................................30

Given the circumstances, 2011 has been another strong year for EM sovereign credit. We highlight how country
selection (as opposed to simple beta-management) has been a key factor in portfolio selection in 2011. With this in mind,
we devote much of this year’s outlook to a thorough examination of specific country factors (pricing, macro and
technical). ............................................................................................................................................................................37

We present a framework for assessing relative vulnerabilities across EM using external, fiscal, financial, and growth
sensitivity indicators. EMEA dominates our list of the most vulnerable countries. Other regions look safer though risk
from rapid credit growth (Asia) and commodity dependency (LatAm) bear watching.................................................. 46

We see the distribution of returns will likely continue to favor fixed income vs. growth-sensitive assets. Though returns
are diminishing, EM still seems too important a source of carry and value to drop from investors’ priority list – either in
risk-on or risk-off modes. In addition, if returns are less appealing in EM, the opportunities in global markets seem even
less so.................................................................................................................................................................................53
EM Technicals Outlook in 2012: Structurally Sound; Cyclically Vulnerable

A broad set of metrics suggest that structurally global investors are still under-allocated to EM. However, valuation, lack
of depth, and market access suggest that the pace of strategic inflows will be considerably slower going forward when
compared with 2003-2007. .................................................................................................................................................58

EM local currency funds have grown by a factor of almost 3.5x over the past four years, increasing their impact on the
behaviour of local markets. In this article we examine the rise of these funds and also introduce a new analysis of the
country positioning of such funds. ......................................................................................................................................63

We review the various options on the table for boosting the financial firepower of the IMF, concluding that an increase
in bilateral loans is the proposal most likely to fly. The need for a bigger IMF is primarily to deal with the euro crisis. We
think the IMF already has enough in its locker to deal with likely EM needs. .....................................................................71

Since Q32011, forced deleveraging has caused some foreign investors to either cut or hedge their holdings of local
currency government debt. This note presents detailed estimates of the supply/demand dynamics of each EMEA market
in 2012. We flag opportunities and threats from the perspective of technicals. ................................................................76
Theme Pieces .................................................................................................................................................................. 184
Deutsche Bank Securities Inc. Page 3

Summary Views – LatAm

Economic Outlook Main Risks Strategy Recommendation
Argentina The government seems to be Further confirmation of Remain neutral in the currency, but
Page 84 ready to combine some fiscal current policy continuity the front-end of the NDF curve
consolidation with tighter FX and could only preserve an on- offers attractive carry for those
price controls, and labor union going currency run and a willing to sustain elevated risk.
persuasion aiming at managing a severe capital flight. Lack of Continue avoiding the CER curve
soft landing to a 5% growth investment amid fiscal which offers unfavorable
pace. Nonetheless, inflation expansion, together with FX/inflation breakeven. Badlar-
stability together with FX unfriendly policies, could linked bonds are more attractive
sustainability will demand an maintain high inflation, for those seeking local peso
even weaker economy. The reinforcing fears of potential exposure. Stay neutral on external
sooner the government accepts financial stress. The current debt but be conservative on
that reality, the smoother the pace of real appreciation is duration, favor credit to Warrants
expected economic path ahead. leading to a rapid and sharp and favor global bonds (especially
A likely resistance will only deterioration of external the Global 17s) over local law
accelerate economic slowdown, accounts, while strong fiscal bonds. In addition we recommend
and short term inflation. spending is adding stretch to long basis on Global 17s vs. 5Y
difficult financing. CDS.
Brazil The government has showed that The government’s initiative to Take profits on long 1M USD/BRL
Page 88 it intends to use all possible aggressively ease monetary FVA and enter zero-cost 1M
instruments to prevent a strong policy to prevent a significant USD/BRL put spread Take profits
economic deceleration by easing economic slowdown could on Jul ’12- Jan ’17 steepener and
monetary policy aggressively, damage its credibility and enter Jan ’13- Jan15’ flattener.
revoking some ‚macro- lead to permanently higher Stay neutral on external debt and
prudential‛ measures, and inflation, especially if not continue to favor 41s and 40s (to
introducing fiscal measures to accompanied by the call) vs. 21s. In addition, we favor
stimulate consumption. promised fiscal austerity. The short basis at the 10Y sector as a
Therefore, we expect the large increase in the tactical trade.
economy to grow slightly above minimum wage and
3% in 2012 despite the bleak mounting pressure on the
global outlook. Although inflation government to increase
is poised to decelerate in the investment in infrastructure
next months due to the recent do not bode well for fiscal
economic slowdown and lower restraint in 2012. The BRL
commodity prices, it will likely remains vulnerable to lower
remain above 5% due to high commodity prices.
inertia and aggressive monetary
easing.
Chile The economy continues to Domestic demand could Maintain short EUR/CLP. Shift
Page 92 decelerate along an unbalanced adjust faster than expected from 2Y to 5Y breakeven inflation
path, with domestic demand still due to uncertainty in external and enter 2s5s CLP/CAM
growing at a higher pace than conditions. A slowdown in steepener. Underweight sovereign
supply. Nevertheless, albeit global growth and a potential credit, and buy 5Y CDS vs. Brazil
some surprises, domestic deceleration in China could as a defensive trade.
inflationary pressures are still affect copper prices. There
subdued. A weakening CLP and could be some form of
tight labor markets have so far contagion from a credit event
had little impact on inflation. The in Europe due to the links
Central Bank of Chile (BCCh) is between local and Spanish
increasingly considering easing banks.
monetary conditions to
counteract negative effects from
the external scenario.
Page 4 Deutsche Bank Securities Inc.

Summary Views – LatAm

Colombia Economic activity keeps growing Higher inflation because of Remain on the sidelines waiting for
Page 94 robustly, while inflation has risen stronger commodity prices better entry levels to get exposure to
temporarily, fueled by food and/or domestic demand COP. Close 2s3s COP/IBR steepener
prices. BanRep has begun to hike pressures. Overheating and and receive 5Y COP/IBR (or TES Jun
the policy rate again, and will bubbles prompted by a credit ’16) against 5Y USD swap. Stay
continue to do so in 2012. The boom. A relapse in the US overweight external debt and favor
fiscal accounts are improving on economy, destination of shorter-end of the curve, where we
the back of tax collection more than one third of the favor off-the-run 19s and 20s over
outperformance. country’s exports. the benchmark 21s.
Mexico Headline inflation has accelerated A relapse in US economic Take profits on long MXN/CZK and
Page 98 but core remains well behaved, activity. Higher inflation enter short CAD/MXN. Take profits
very near the medium term target. because of strong on 5Y TIIE payer and enter 2s10s
Economic activity surprised on the commodity prices and/or TIIE flattener vs. 2s10s USD swap
upside during 3Q11, and will higher pass-through from steepener. Neutral external debt.
decelerate very gradually over the depreciation. Volatility of The old 19s remain significantly
coming months. The negative political origin ahead of next rich to the curve.
output gap will not close until 2012. year’s presidential elections.
Banxico is unlikely to cut the
funding rate unless the currency
appreciates back towards pre-US
downgrade levels.
Peru GDP growth is to be near 7% this Higher inflation because of Maintain long 3M USD/PEN NDF
Page 102 year, slowing down very gradually food prices. Weaker fiscal and remain neutral on rates.
towards 6% in 2012. The inflation and external performance Increase to overweight external
spike is likely to be temporary, because of softer mining debt, take profit in the 37s to 19s
but it will prevent monetary prices, if global growth switch and now favor the long end
easing for now. Structural excess falters. of the curve.
demand for dollars is to maintain
the currency well supported.
Uruguay Economic growth is decelerating A drop in commodity prices. We favor UYU ’18 as a buy and
Page 104 gradually, converging towards A further acceleration in hold strategy due to elevated carry
trend levels, although risk of the inflation. Weaker growth in and diversification.
projections is on the upside given the country’s main trading
the pipeline of investment partners.
projects. Inflation remains well
above the ceiling of the target
range, preventing any monetary
easing for the time being.
Venezuela Economic activity is picking up Lower oil prices as a result of Increase to a small overweight,
Page 106 speed, following the contraction softer global growth or a favoring the Republic over PDVSA.
of the past two years and beating financial disruption in Europe. On Venezuela, 28s look the most
expectations. The recovery should Further acceleration in attractive. On PDVSA, we continue
continue next year on the back of inflation because of food to favor the 13s (for carry-oriented
very expansive fiscal and prices and/or pressures from investors) but also consider moving
monetary policies, ahead of the very loose fiscal policy. to the mid-end of the curve where
presidential elections. Inflation Volatility of political origin we favor the 22s. In addition, while
remains the highest across the before next year’s we continue to recommend long
EM universe. presidential elections. basis on the sovereign curve (24s
vs. 10Y being the best trade at the
moment), we also like PDVSA 22s
vs. Venezuela 10Y CDS.

Summary Views – EMEA

Czech The combination of a weak Germany is by far Czech 2s10s IRS set to
Republic labour market, ongoing fiscal Republic’s largest export partner steepen.Neutral on rates.
Page 110
austerity and an expected accounting for 22% of GDP in Neutral on EUR/CZK
recession in Euroland leaves a exports. A more protracted
significant risk of recession in recession in Germany leaves
Czech Republic. But with the significant downside risk for the
public debt/GDP ratio sub 40% Czech economy and could well
and C/A deficit financing the push the CNB into a rate cut.
most secure in the region, the
medium-term fundamentals
remain strong.
Egypt The economy is likely to gain Occasional setbacks in political Neutral EGP. Political stability
Page 114 strength in FY2011/12 with progress and delay in and resumption of talks with
political transition, base effects implementation of a IMF will hold the key.
and greater access to external comprehensive economic plan
financing. in coordination with and funding
from multi-lateral institutions
could lead to a much weaker
growth performance.
Hungary We expect Hungary to tip back Likely policy conflicts between NBH to provide ceiling in
Page 118 into recession in 2012. Fiscal the authorities and the IMF/EU EUR/HUF. Sell vega neutral
drag is set to increase in line with risks prolonged program 3m/6m straddles in EURHUF.
the government’s commitment negotiations which could mean Underweight sovereign credit.
to stick to a 2.5% of GDP fiscal continued pressure on the
deficit while rate hikes, FX currency, a larger hiking cycle
weakness and rising deleveraging and further rating downgrades.
will all severely constrain growth It could also mean a very
for some time ahead. With the difficult backdrop to meet
expected recession in Euroland external refinancing needs.
net trade will be unable to offset
the negative domestic
environment.


Israel The divergence between strong The geopolitical risk premium is Favour tactical shorts in EUR/ILS
Page 122 domestic absorption and faltering set to remain elevated given above 5.10. Receive 2Y IRS
net exports is set to dwindle, multiple sources of concern. A
pointing to a marked loss in more rapid than needed
growth momentum. Inflation is deceleration in housing prices
expected to behave benignly, may lead to financial stability
providing room for further easing risks and complicate rate
if needed, although housing outlook.
dynamics and ILS will also play an
increasingly important role. The
C/A is set to turn negative and
remain in deficit throughout the
forecast horizon, while fiscal
consolidation arrives with a delay.
Kazakhstan Growth is picking up and The key vulnerability remains in Maintaining a relative
Page 126 inflationary pressures are on the the banking sector, with preference for KZT NDFs vs
rise. negative implications for their UAH counterparts. Neutral
recovery in loan growth. on sovereign credit (CDS).
Poland A Poland’s larger and less export- Any evidence that the new We recommend a 1y EUR/PLN
Page 128 orientated economy compared government lacks commitment put, with a and strike at 4.25 for
with elsewhere in CEE should to fiscal austerity could quickly 2% of EUR notional.Receive 1Y
outperform again in 2012. While put pressure on yields and see XCCY basis as a hedge but
growth will undoubtedly slow the rating outlook revised to outright purchase of POLGBs
there is little risk of recession. The negative. The discussed will be attractive in H2 201.
pace of slowdown alongside zloty methodology changes to Overweight sovereign credit.
performance, the inflation outlook calculation of the debt rule, if
and the fiscal stance will all used as a substitute for fiscal
determine the scope for rate cuts reform, would be a big negative
in 2012. We see this as unlikely in this regard.
before Q3.
Romania A precautionary IMF/EU SBA in Fiscal slippage in the run up to Neutral FX. Overweight
Page 132 place until 2013 combined with the Q4 general election risks sovereign external debt.
the government’s intention to pushing the IMF/EU program off
increasingly tap the Eurobond track and would limit scope for
market ahead of large external further monetary easing. It
redemptions in 2013/14 should could also put pressure on the
help to ensure reform fatigue is ratings.
avoided and the structure of
growth continues to improve.
Despite a very difficult external
backdrop we see upside risks to
our growth projection from
stepped up absorption of EU
funding and reform of loss-
making SOEs.


Russia Growth accelerating on the back Recurring capital outflows and a Short NOK/RUB, for a move
Page 136 of high consumption and fixed drop in oil prices remain key back down to 51 flat. OFZs
investment growth. risks. likely to perform in 2012.
Overweight sovereign credit.
South Africa The much weaker growth base in Deteriorating global growth, Buy a 1y digital EUR/ZAR put
Page 140 Q2 and Q3 makes for negative repercussions for struck at 10 for roughly 25% of
encouraging rebound potential in terms of trade could severely EUR notional. ZAR curve set to
growth into 2012. We do not harm corporate profits. From steepen. Underweight
expect a recession locally, as we these risks stem employment sovereign credit.
estimate this probability between losses, which will offset the
10-15%. Household demand is benefit of lower commodity
expected to be the main growth prices on inflation.
driver in 2012.
Turkey Rebalancing in the economy A harder landing is on the cards Having hit the target on long
Page 144 continues with domestic demand given the large exposure to TRY/HUF, we recommend
slowing down gradually and short-term funding from playing the range in USD/TRY.
imports losing momentum. international banks, balance Buy a DnT with strikes at 1.70
Inflation will continue to rise in sheet effects of a weaker and 1.90. Add exposure to Jan-
the short term due to FX pass- currency and volatility in capital 20 bonds if the economy
through and higher food prices. inflows. responds to the ongoing
tightening. Overweight
sovereign external debt.
Ukraine Growth has been robust but is set Hryvnia weakness on the back The negative skew of risks
Page 148 to soften on the back of rising of the deteriorating balance of warrant a bearish position in
macroeconomic payments remains a risk NDFs. Underweight sovereign
external debt.

Summary Views – Asia

China For 2012, we expect the economy The two most important shocks We favor Repo swap NDIRS/IRS
Page 150 to be featured by 1) disinflation, 2) to the economy in the coming and Shibor swap 2x5 NDIRS/IRS
initial growth deceleration followed months are property FAI steepeners to express our view
by a recovery, and 3) policy easing deceleration and export that interbank liquidity will ease
in 1H followed by a more cautious slowdown. We expect property markedly in the coming 6-9
stance towards the end of the year. FAI growth to slow from the months. We retain our bullish
We maintain our 2012 GDP growth current 25 30%yoy to 15%yoy in view on the CGB cash bonds.
forecast at 8.3% (down from 9.1% the first few months of 2012. Expect a slower pace of RMB
in 2011), with a qoq trough in Q1 We expect export growth to appreciation in 2012.
(at 6.4% saar, slightly deeper than decelerate from the current
our earlier projection of 6.8%) and 15%yoy to 8-9% in 1Q 2012.
a sequential recovery from Q2. For
2013, we expect GDP growth to
recover to 8.6% largely on stronger
export growth. On policies, we
expect 2-3 more RRR cuts in the
coming 6-9 months, which should
permit average monthly RMB
lending to rebound to RMB800-
900/month in 1H, and annual
lending to reach around RMB8.4tn
in 2012. We expect the fiscal
deficit-to-GDP ratio to remain
largely unchanged at 2-2.2% in
2012. Fiscal priorities in 2012
should include public housing,
completion of on-going
infrastructure projects, SMEs,
services, and consumption.
Hong Kong Growth in Hong Kong continues to A disorderly resolution of the We see upside risk on Hibor -
Page 156 follow the lead of the US and EU sovereign debt crisis in Europe Libor basis in Q1 next year
economies. This means markedly would likely be translated into a driven by corporate liability
slower growth in 2012 but a likely deep recession in Hong Kong. hedging demands.
return to reasonably robust growth
in 2013
India Assuming no big collapse in global Worsening of twin deficits could Pay steepeners on the OIS
Page 158 financial markets, the Indian prevent inflation from moderating curve (1Y/2Y) to position for the
economy ought to grow by 7-7.5% to mid single-digit levels, which turn in the cycle. Risk to INR
in 2012, supported by rate cuts could complicate RBI’s monetary gets more digital next year, with
from RBI around mid-2012 policy decision, especially if policy intervention a key factor.
growth were to slow sharply at
about the same time
Indonesia Building on the momentum built Inflation could rise sharply on the Increase underweight as 10Y
Page 164 over the past couple of years, back of electricity and fuel price yields close in on 6%.
Indonesia steps into 2012 with adjustments, and as demand
well-anchored consumer and remains strong. Rupiah could
business confidence, which could come under pressure if global
allow the economy to grow by over liquidity crunch and risk aversion
6% at a year when global growth continue. Bond yields could rise
will likely slow sharply. for the same reason.

Summary Views – Asia

Malaysia Slower export growth will weigh on The main risks lie abroad, Vulnerability to bond market
Page 166 investment spending and especially the possibility of a outflows keeps us cautious on
consumption cushioned by deeper recession in Europe. rates (with a steepening bias)
continued easy monetary and fiscal and neutral on MYR.
policies.
Philippines Growth has slowed owing to a External demand could be Modest overweight on duration
Page 168 weakening of external demand, but weaker than expected if the into 2012. Peso to be more
domestic demand is likely to hold crisis in Europe deepens further. resilient than regional FX.
up as inflation declines, while
consumer and business sentiment
remains resilient.
Singapore Slower global growth means much Singapore is Asia’s most export- SGS has strong technicals but
Page 170 slower growth in Singapore in sensitive economy, so macro risk rich valuations. Expect the yield
2012, but sharply lower inflation as derives mainly from the US and curve to flatten in 2012. Trade
well. Europe. SGD NEER in a range.
South We see South Korea’s growth to The sovereign debt crisis in We look for further steepening
Korea follow the G2 cycle, reporting a Euroland pose serious downside on the KTB curve. Concerns
Page 172 below trend growth of 3.4% in risks to growth. about lack of reinvestment
2012, followed by a notable demand from offshore fund
rebound to 4% in 2013. investors should reduce, which
is supportive of 2Y-3Y segment.
Sri Lanka Real GDP growth likely to There is a non-trivial risk that the
Page 172 moderate to 7.5% in 2012 (from ongoing fiscal consolidation
8% in 2011), led by a negative base process suffers a setback, in the
and weak external demand. event of any external shock, that
threatens to lower growth below
7% in 2012.
Taiwan With exports at 74% of GDP, we Risks to our rates outlook remain We believe TWD interest rate
Page 178 see weak G2 growth of 1% in to the downside amid the swap curve is unlikely to break
2012, vs. 1.7% in 2011, guiding sovereign debt crisis in Euroland. its recent range in the next three
Taiwan’s growth lower to 3.0% months unless CBC surprises
from 4.4% in the same period. the market with cuts in the
policy rates. We recommend to
hold paying the belly in TWD
2x5x10 notional neutral butterfly
position.
Thailand We see GDP growth rebounding to Risks to growth remain to the Bond and swap curves to
Page 180 3.9% in 2012 from 1.8% in 2011, downside due to fragile external steepen driven by valuations,
supported by reconstruction conditions and implementation supply concerns and a more
activities. The latter and weak risks to reconstruction plans. dovish outlook on monetary
exports, however, point to a policy.
current account deficit of 1.9% of
GDP in 2012.
Vietnam We expect a modest slowdown in The banking system remains

Page 182 GDP growth, to 5.6% in 2012 from under pressure, posing downside
5.9% in 2011, as lower inflation risks to growth and the dong.
and rates counter the negative
impact of weaker external demand.

Emerging Markets and the Global Economy in the Year Ahead
 The coming year is clearly going to be a difficult one The survival of the fittest
for the world economy. Nevertheless, if, as we Lower debt tolerance was a trademark of 2011. What
expect, the US economy can continue to tick over at once seemed to be largely an EM trait has become
even a little below trend and China can avoid a hard widespread and likely to constrain the financing of many
landing, this will provide a moderately constructive DM countries, despite their much deeper credit markets.
backdrop for most of EM. We thus think that EM can Adapting to this new reality will require protracted debt
grow at about 5½% in aggregate next year. reduction and thus years of fiscal responsibility, possible
financial repression in some cases, and – as the market
 However, this resilience will not be uniform across
stress even in lower-debt economies such as Spain has
EM. Whereas we think much of Asia and Latin
shown – structural reforms to boost potential growth and
America are relatively well placed to weather the
improve debt dynamics. The possible outcomes have
current storm, public and private balance sheets are
become more binary given scarcer financing. But under
generally weaker in EMEA, which is also more
our baseline scenario of EU crisis resolution that we
directly exposed to the euro crisis through stronger
expected to start to be delineated in weeks to come, the
economic and financial linkages.
US avoiding recession, China soft-landing, and with EM’s
 Given the headwinds, 2012 may well prove to be a more vulnerable ‚periphery‛ too small to pose a
case of ‘survival of the fittest’ and with this in mind significant systemic risk for the asset class, we expect
we introduce a new framework for assessing relative growth in (the less indebted) EM to outperform by almost
vulnerabilities across countries in the EM universe. 4.5ppts the industrial economies (table).
 We expect the tug of war between structural and
Summary Growth and Inflation Forecasts
tactical drivers of 2011 to extend into 2012 – 1/
Real GDP (%) Consumer Prices (%, eop)
particularly during the first months of the year, when 2010F 2011F 2012F 2010F 2011F 2012F
the future of Europe may be decided. Valuation
Global 5.0 3.7 3.2 3.7 4.1 3.6
supports EM credit, local rates, and FX – particularly
US 3.0 1.8 2.3 1.6 3.3 3.2
under the risk of some financial repression in the
Japan 4.1 -0.4 0.5 -0.7 -0.3 -0.3
developed world. Structurally, flows should also Euroland 1.8 1.6 -0.5 1.6 2.7 1.9
continue to benefit EM, as global investors remain EEMEA 4.4 4.4 3.3 6.5 6.3 5.8
under-allocated. Russia 4.0 4.5 4.6 8.8 7.1 7.0
Asia (ex-Japan) 9.5 7.6 7.1 5.3 4.5 3.8
China 10.3 9.1 8.3 4.6 3.8 2.8
 In EMFX is most vulnerable to global risk and stands India 10.0 8.0 8.0 9.5 7.5 6.0
to benefit more from EU progress. We favor the more Latin America 6.3 4.1 3.6 8.4 8.2 8.2
‚US-centric‛ MXN in LatAm, and RUB on persistently Brazil
2/
7.5 3.0 3.3 5.9 6.4 5.3
Memorandum Lines:
high oil and inflows. Add ZAR tactically only vs. AUD G7 2.9 1.5 1.3 1.4 2.6 2.4
and HUF while EU uncertainty remains high despite Industrial Countries
Emerging Markets
2.7
7.7
1.5
6.2
1.2
5.6
1.5
6.2
2.7
5.6
2.3
5.0
underperformance. We position for further BRICS 9.1 7.5 7.2 6.4 5.3 4.4
appreciation in RMB and PHP.

1/ CP I (%) fo recasts fo r develo ped markets are perio d averages.
2/ A ggregates are P P P -weighted within the aggregate indicated. Fo r instance, EM gro wth is
calculated by taking the sum o f each EM co untry's individual gro wth rate multiplied it by its
 In rates, value is less than in FX, but fundamentals share in glo bal P P P divided by the sum o f EM P P P weights.
Source: Deutsche Bank
support receivers in Mexico, Brazil (for now),
Colombia, Israel, and bonds in Russia, Poland, and
More than a debt crisis year, however, 2011 has
modestly so in the Philippines, but underweight
highlighted that – at its very core – this is a governance
Indonesia. We favor steepeners in Chile, China,
crisis. It has been governance and thus capacity to react
Korea, and Thailand.
that has differentiated performance across the highly
 In sovereign credit we expect 2012 to be another indebted Ireland vs. its peripheral peers, the Fed vs. the
year of modest returns in which country selection ECB and the also highly indebted US vs. Europe. The
holds the key to outperformance. We recommend failure of the super-committee has recently reminded us
overweight exposure to Venezuela, Colombia, Poland, that we should not underestimate the governance issues
Russia, and Turkey; underweight exposure to the US faces either, but time is of essence and those are
Hungary, Ukraine, Chile, and South Africa. less pressing and more back-loaded than in the EU. Not
only does the US face better initial growth conditions and
demographics, more flexible markets, a less leveraged
banking sector and a population that largely supports a

compromise between the parties, but it has better control that concerted action is needed – and likely – once again.
over its monetary policy. Accordingly, despite the The coordinated action to ease dollar funding shortages
challenges faced by the US and also some emerging was a first step in this direction and there have been
economies, 2012 will be largely driven by EU political indications that more is underway. That France and
decisions. Germany endorsed greater fiscal integration is also
welcomed, but this needs to reach critical mass within the
Encouragingly, after successive attempts at building EU (we believe it will). As the risk that the EU crisis goes
backstops against contagion, we believe that the EU global has risen, G-20 economies (and Germany in
authorities’ mindset has finally evolved to what we believe particular) seem open to increasing the IMF’s firepower
is the fittest policy to resolve this crisis: More integration. via bilateral loans, although likely conditional on increased
They will face an uphill battle against numerous ECB participation. Judging by the original support
institutional constraints – both fiscal and monetary. But (EUR500bn from EFSF and EFSM, and EUR250bn from
the tolerance for muddling through is now limited and we the IMF), DB estimates that the combined IMF/EFSF pool
believe that the tone of the year will be dictated by the would have to increase by EUR425-650bn to cover up to
progress EU authorities make in the first few months of three years of funding needs for Italy, Spain, and Belgium
2012 and a more concerted action seems now underway. after discounting for commitments and bank capitalization
As governance cannot be quickly built, market pressure contingencies. Assuming the original IMF/EFSF ratio
seems to us the most credible incentive device and thus holds, this would require additional USD825bn. Given the
poised to linger. Therefore, this is unlikely to be a bright pending maturities across both banks and sovereigns this
year for growth but a year where growth prospects could concerted action is needed fast.
brighten somewhat later on as a stronger fiscal pact is
forged in the EU and political (and fiscal) uncertainty is What should we expect from the ECB? With European
resolved in the US. banks facing EUR450bn in maturities in 1H12, 2Y and 3Y
LTRO extension seem more likely now. But it is important
EU: The long and winding road to resolution that the eligibility criteria for collateral are eased. This
We expect material progress toward resolution rather could be accomplished via the reopening the facility for
than dissolution of the EU in 2012. With the crisis deeply non-euro paper that was discontinued this year.
rooted in core countries, widespread recession underway, Alternatively, the ECB could accept lower-rated paper,
and relentless market pressure, EU authorities seem now although this could face more resistance. Regardless, we
committed to tackle the region’s Achilles heel: the lack of expect the ECB to cut 25bp in December with a risk of a
fiscal framework that is consistent with monetary union. It 50bp. Most important is that it accelerates its SMP as
would be naïve to expect them to take such a task in discussed above, although we doubt it would commit to
stride as treaty changes cannot be delivered fast, but the large amounts a la Fed. In principle, given the risks to the
EC summit on December 8th-9th should present a positive transmission of monetary policy and price stability it
blueprint for action. Ideally, the EU should be able to should be ready to do so, but it will likely await for the
change national budgets in line with the euro stability, but ‚green light‛ from fiscal authorities and possibly move
DB believes that authorities will pursue a less ambitious more aggressive during 1Q when maturities peak.
proposal where judicial actions – in addition to financial
sanctions – could be used to enforce a beefed up Stability ECB balance sheet to grow further
and Growth Pact. Whether this would appease markets is 250 25
ECB government bond purchases, EURbn
questionable, as the EU would still need to deliver a crisis
resolution framework to deal with the potential offenders. 200 Weekly purchases (rhs) 20
From a timing perspective, however, it is more important
Cumulative (lhs)
in preventing the escalation of this crisis that this blueprint
150 Stage 4: 15
is enough to persuade the ECB to step up its securities
Ita/Spn
purchases1. Stage 1: Stage 2:
100 Greece Ireland 10
A concerted action from governments and monetary crisis crisis
authorities was instrumental in changing market Stage 3:
50 Portugal 5
sentiment in the post-Lehman debacle and we believe
crisis
0 0
May-10 Sep-10 Jan-11 May-11 Sep-11
1
Italy’s response has been impressive in such a short period of time, Source: Deutsche Bank
although obviously incomplete. The acceleration in pension reform and
expected correction in fiscal accounts underway should encourage the
ECB to help.

Even if significant progress is made early on it is very PMIs have decoupled most recently
unlikely that the EU could avoid a recession of a least 1ppt Index, > 50 ISM composite index of US (ls) Index
peak-to-through. Fiscal tightening is pervasive, monetary increasing Euro area PMI: composite output (rs)
policy has little room to maneuver, and – with banks 65 65
forced to increase their capital ratios – there is less

smoothing in private consumption and investment that
could offset reduced public demand. As a silver lining 55 55
when compared with post-Lehman performance, an

already depressed starting point in the cyclical and
stronger external demand could ease the fall 45 45
Correlation:
Jan'00 - Jul'07 = 0.52
Aug'07 - present = 0.91
An outright contraction in euro area GDP in 2012
35 35
GDP, % yoy 00 01 02 03 04 05 06 07 08 09 10 11
2010 2011F 2012F 2013F
Germany 3.6 2.9 0.0 1.0
France 1.4 1.6 -0.3 1.2 The outlook is brighter for consumer durables and
Italy 1.2 0.5 -1.1 0.7 business investment, although less so for the latter as it is
Spain -0.1 0.6 -0.9 0.8 already close to historical average. Altogether, our models
Netherlands 1.6 1.9 -0.5 1.2
suggest that pent-up consumer and business spending
should more than offset the 1-2% of fiscal drag we pencil
Belgium 2.3 1.9 -0.6 1.2
in for the year even under ‚current policies‛ 3 (chart).
Austria 2.3 2.8 -0.5 1.2
Obama’s American Jobs Act (AJA) could offset this drag,
Finland 3.6 2.9 0.0 1.4 but given the chasm between Democrats and
Portugal 1.4 -1.5 -2.9 0.4 Republicans we expect the latter to concede on only what
Greece -4.4 -5.3 -3.0 0.1 they believe is enough not to be blamed for a double-dip
Ireland -0.4 1.5 0.2 1.4 and this would amount to possibly extending payroll tax
EA-17 1.8 1.6 -0.5 1.0 cuts and unemployment benefits. Still, this could reduce
Source: Deutsche Bank the amount of fiscal drag next year by 1ppt of GDP (to
1%). Inflation is likely to ease a bit from levels that have
US: Avoiding recession been elevated by commodity price increases to remain
In the US, 2012 is likely to be another year of sluggish relatively subdued – excluding food and energy. But with
recovery with growth in the vicinity of 2.5% and with only US yields already about 100bp depressed vs. what recent
modest improvement in the labor market – assuming data implies and the outlook for prices far off deflation
authorities control the EU crisis. The recent data have territory, Fed actions should continue to be more effective
reinforced the view that the US can decouple from the at attenuating the transmission of EU shocks through the
likely recession in Europe, with the latest ISM near 53 – banking system and easing dollar funding shortage.
led by new orders at 57. The cyclical components of
demand remain near historical lows thus limiting
downside, but we expect real estate contribution to
growth to accelerate no earlier than in 2013. Home prices
are already nearing the bottom (we see just 4% downside
through 2014), but economic conditions indicate that the
depressed rate of household formation (about half the
historical norm), the overhang of vacant homes and the
still high pace of foreclosures (despite some retrenchment
in recent months) will remain a drag in 2012 2 . The
government’s renewed efforts to ease refinancing (HARP)
will possibly double the participants, but they will remain
marginal. A large-scale program involving principal write- 3
The CBO’s ‚current law‛ projections assume the expiration of payroll tax
downs could be a lot more effective, but this is unlikely to cuts, extended unemployment benefits, AMT patch, and ‚Doc Fix‛ in 2012
gain much political support ahead of elections. and Bush tax cuts in 2013. These account for a substantial part of the
deficit reductions under the CBO ‚current law‛ scenario with the rest
stemming from the winding down of the stimulus package. As no
meaningful tax reform is expected ahead of elections, we expect many of
the Bush tax cuts, the ‚Doc Fix‛, and the AMT patch to be extended (the
2
See ‚US Housing Dormant for 2012, Global Economic Perspectives, ‚alternative policy scenario‛), with possible extension also of the payroll
December 1st, 2011. tax reduction and unemployment benefits.

No scope for further easing for now SLO survey points to lower exposure than BIS data
110 5.5 % %
Exposure of US banks to European economies in their C&I
books
100
5.0 70 70
90
4.5 60 60
80
4.0
70 50 50
60 3.5
40 40
50
3.0
30 30
40
2.5
30 20 20
US Surprise Index
2.0
20 UST 10y (LHS) 10 10
10 1.5
0 0
03 04 05 06 07 08 09 10 11 0-5% 5-10% 10-20% 20-50% 50% - more
Source: Deutsche Bank Source: Deutsche Bank; SLO survey respondent exposure to Europe via C&I loans
Although we cannot ignore risks to our scenarios for fiscal China: Soft landing underway
policy and housing it is the EU crisis that poses the most In our assessment, the main risk to Chinese growth is
pressing and potentially most damaging threat. And since internal and related to the prospects for the property
the US is a relatively closed economy – the main risk is market. Chinese property investors have never seen a
financial contagion. From a pure trade perspective, 1ppt bear market for real estate, but they seem to be
drop in EU growth would reduce US GDP growth by only responding to lower prices by buying rather than waiting
0.1ppt, according to DB estimates. The impact estimated for even lower prices and recent transaction volumes
via simple macro models such as OECD’s is similar, but it appear to be picking up. This is important, because
would increase to 0.3ppt if we assume 10% euro developers still need to work off the overhang of unsold
depreciation in line with the 1ppt drop in EU growth – still properties stemming from hikes in transactions taxes,
far from recession territory. credit tightening, and quantity constraints on purchases
during 2011. Also encouraging, inflation is easing on
The financial linkages seem a lot more important. First, the favorable base effects and also on weaker demand (both
stock markets are highly correlated and about 15-20% of foreign and domestic) and we expect it to drop below 4%
S&P500 revenues stem from Europe. Second, consumer by the end of the month. Accordingly, the 50bp cut in
and business confidence surveys correlations have been reserve requirements should be just the beginning of a
very high over the past decade and more so since 2007 – cycle with 2 or 3 more cuts over the next 2-3 quarters. An
although we have seen a marked drop since mid-summer. easing of credit growth restrictions in a heavily bank-
The same applies to PMIs, although with an even stronger intermediated economy will likely be positive for growth
de-coupling recently. Third, and possibly most damaging, and reassures us that a "hard landing" scenario -- and that
US banks’ exposure to Europe could be high. BIS and probably means different things to different people -- is
DTCC data indicates that total claims and other next unlikely.
exposure to GIIPS amounts to USD230bn – about 40% of
the tier-1 capital of the four largest US banks. We forecast that growth will slow to 8.3% in 2012 from
9.1% in 2011, with slight downside risk to that 2012
However, DB’s US banks team believes that the actual forecast under our baseline scenario for Europe. The
exposure could be substantially less than the BIS data health of the banking system in China does raise
indicates. The Fed survey shows that almost two-thirds of concerns, especially when regulators concede that 25% -
the respondents reported 0-5% of their C&I loans booked 30% of the loans to local government financing vehicles
to Europe and less than 10% had substantial exposure (of are not being serviced by the original borrower (they don't
20% of more – see chart). say whether they are not being serviced at all or just being
covered by someone else). However, as the government
owns the banks and the borrowers the decision to declare
a loan nonperforming boils down to politics. In practice,
the government appears to have decided to absorb most
of the nonperforming local government loans, thus
transferring the losses away from banks. This said, the
post-Lehman massive credit stimulus is now viewed as a
mistake, so that policy expansion should be moderate –

especially with growth at a robust 8%+ pace. We expect Downgrades to DB growth forecasts since July
fiscal stimulus of the order of 1% of GDP or less in the Change in 2012 GDP growth forecast, ppts
form of tax cuts and increased social welfare spending. 0
EM: Policy flexibility and resilience to shocks -0.5

The coming year is clearly going to be a difficult one for
the world economy. Nevertheless, if, as we expect, the -1
US economy can continue to tick over at even a little
below trend and China can avoid a hard landing, this will -1.5
provide a moderately constructive backdrop for most of
EM. We thus think that EM can grow at about 5½% in -2
aggregate next year, well below recent peaks for sure but
substantially above the 2% growth rate registered in 2009
-2.5
during the last synchronized global recession.
US Eurozone EMEA Asia Latin
America
EM’s Favorable Public Debt Dynamics Source: Deutsche Bank
(% GDP)
225 Later in this EMM, we therefore present a new framework
205
We assume: (i) primary balances are held
constant at this projected 2012 levels; (ii) real
for assessing relative vulnerabilities with a view to
185
GDP grows at trend rates; and (iii) the
differential between real interest and real
identifying the most likely pressure points within EM over
growth rates in each country is 0 until 2015
the coming year. It suggests that EMEA is facing
165 and 1.0 thereafter.
DM something of a quadruple whammy. First, while current
145
account balances have improved in the last few years and
125
central banks have been able to build bigger buffers of
105 foreign reserves, the large stock of external debt
85 accumulated during the middle of the last decade, much
65 of it in foreign currency still leaves the region with large
EM
45 external burden. Second, sharply weaker growth in the
25 last two or three years has taken a heavy toll in the public
2006 2010 2014 2018 2022 2026 2030 finances leaving many with the ‚DM problem‛ of having
Source: Haver Analytics, IMF, Eurostat, Deutsche Bank to tighten policy into the face of a downturn. Third, the
rapid expansion of western European banks throughout
However, this resilience will not be uniform across EM. much of the region has left many countries exposed to
Whereas we think much of Asia and Latin America are deleveraging by foreign banks as they seek to meet
relatively well placed to weather the current storm, public additional capital requirements. And fourth, the region’s
and private balance sheets are generally weaker in EMEA, economies are mostly relatively small and open with high
which is also more directly exposed to the euro crisis trade and financial exposures to the euro area, leaving
through stronger economic and financial linkages. them relatively more exposed therefore to a recession in
Reflecting this, we have downgraded our forecasts for Europe even leaving aside the other vulnerabilities noted
EMEA much more aggressively than for other emerging above.
regions over the last few months (chart). Within EMEA,
the current crisis is weighing most heavily on the Not surprisingly, therefore, EMEA dominates our list of
economies of Central and Eastern Europe: we have the most vulnerable countries. Five countries (Hungary,
revised down our growth forecast for this region by an Ukraine, Romania, Poland, and Egypt) show up as highly
average of 2.5%, even more than our revision for the euro vulnerable, though for different reasons. Egypt’s
area, and we expect Hungary to fall back into recession underlying vulnerabilities, for example, are fiscal first and
next year. external second. Ukraine’s risks are mostly external.
Hungary’s vulnerability reflects a combination of risks in all
four areas. Poland’s risk rating is probably a notch too high
according to this mechanical exercise, though it does
underscore that the economy does have macro
imbalances that have yet to be fully addressed. Romania
remains vulnerable but has done a lot of the hard yards in
terms of fiscal adjustment and is poised to move to a
lower risk category.

EMEA’s high external debt levels Overall vulnerability map

180.0 2010 gross external debt,% GDP External Fiscal Financial
Current account
Overall balance
Foreign claims
160.0
Loan:deposits
Maturing debt
Credit growth
Short term
External debt
Growth beta
FX valuation
FX reserves
Credit level
Public debt
140.0 Medium and long term
FX Debt
Ove ral l
Overall
Overall
Overall
120.0 Region median
100.0
EMEA
80.0 Czech Rep
60.0 Egypt
Hungary
40.0
Israel
20.0 Kazakhstan
0.0
Poland
Romania
KOR
EGY
THA
KZT
PLN
TRY
IDN
CHN
BUL
UKR
CHL
LVA
PEN
EST
HUF
RON
INR
COL
MYS
CRO
ZAR
LTU
MEX
BRZ
RUS
ILS
TAI
ARG
CZK
Russia
South Africa
Source: Haver Analytics, BIS, Deutsche Bank
Turkey
Ukraine
In Asia, years of current account surpluses and sound Asia
fiscal policy have helped to underpin the region’s China
India
resilience. India’s large government deficits are a Indonesia
persistent worry, though this has to be placed alongside Korea
manageable debt levels (61% of GDP) funded almost Malaysia
Philippines
entirely onshore and we think the government will resume
Thailand
its consolidation efforts once global threats to growth LatAm
recede. The main pockets of concern are on the financial Argentina
side. Domestic credit expansion has been overly rapid Brazil
Chile
not only in China in 2009 but also in a many other
Colombia
economies over the past two or three years. China, Korea, Mexico
Malaysia, and Thailand have high credit/GDP ratios Risk ratings as follows: = low = medium = high
indicating significant potential debt burdens in the private
sector in a slowing growth environment. While the focus
The flexibility that countries have to respond to weaker
of investors today is, perhaps rightly, on the external risks
global growth by easing policies partly reflects these
to the region, we think domestic debt levels – and
relative vulnerabilities. Outside of EMEA, most countries
possibly falling asset prices – are a significant risk to some
should have room to at least let their automatic fiscal
Asian economies.
stabilizers operate. In EMEA, however, even this room is
constrained in most cases – Russia and Turkey being two
Latin America went through a painful and meaningful
notable exceptions. Pretty much all of Central and Eastern
external, fiscal, and financial crisis in the 90s and today´s
Europe, for example, is looking to tighten fiscal policy into
resilience cannot be understood without that reference.
a downturn.
Forced fiscal adjustments, together with some structural
reforms, and overly conservative financial regulation have
Monetary easing is in any event likely to continue to be
allowed the region to converge to a relatively safe status.
the first line of defense for much of EM. Here, we think
This has permitted growth to become vigorous and
reaction functions will continue to vary reflecting central
sustained with the helped of steady rise in commodity
banks’ differing degrees of tolerance for exchange rate
prices, the region´s comparative advantage. Lack of
weakness. At one of the spectrum is Brazil, where the
investment and increasing dependency on commodities is
central bank will likely view recent depreciation as
probably the major drawback of this experience.
correcting overvaluation and in that sense acceptable. It
Increasing complacency regarding long term fiscal
has also cut rates by 150bps since August and we
rigidities with spending concentrated in current spending
anticipate a further 150bps in easing to come. Israel is
in cases like Argentina, Brazil, Colombia, even Mexico, are
also in the middle of a mini-easing cycle and we think
probably the main yellow light. Strong growth
there is one more cut to come there. Others are more
sustainability and steady alleviation of poverty and social
constrained by the impact of FX weakness on inflation
conflicts remains the main challenge ahead.
and/or domestic balance sheets. Turkey, for example, cut
rates in August in response to global developments but
was forced to change course in late October when the lira
continued to weaken, despite significant FX intervention,

and this started feeding through into inflation (9.5% in returns would be rather diminished and lower than FX-
November). Hungary, which has the largest stock of FX hedged local debt as the UST cushion is now small.
liabilities in EM, also had to hike last month by 50bps to
prop up investor confidence and will likely have to hike A simplistic projection of EM FI asset returns under
further. Others, such as Mexico, Poland, and South Africa various scenarios of UST and S&P
are likely to stay on hold for the next few months in this Intercept UST S&P Carry*
environment. Inflationary concerns, however, would likely EMBI Global 448.3 -50.3 0.14 4.36
become secondary if a sharper than anticipated global GBI EM (Hedged) 165.3 -11.5 0.01 1.44
EMFX (spot and carry)** 70.9 1.3 0.06 3.49
slowdown threatens to push some of these countries
towards recession, and we could see a larger group of Current Bearish Neutral Bullish
countries cutting rates. Level Scenario Scenario Scenario
10Y UST Yield 2.07 1.50 2.07 3.00
S&P 1247 1000 1247 1350
Strategy: Facing a binary scenario with a Fitted Level Return Level Return Level Return
smaller cushion EMBI Global
GBI EM (Hedged)
569
174
556
175
-2.2%
0.7%
578
177
1.6%
1.7%
570
175
0.2%
1.0%
EMFX (spot and carry) 171 158 -7.7% 174 2.1% 182 6.6%
Defensive trades outperformed in 2011, boosted by the
* For EMBI/GBI-EM, a UST-weighted time drift term is used in the regression to capture carry;
drop in global rates. External debt was again the best For EMFX, a time drift term is used. (Regression is based on 2Y history)
vehicle to capture the rally in US Treasury bonds, trailing ** Proxied by the ratio of GBI-EM Unhedged and GBI-EM Hedged
UST total returns closely as shown in the table below.

Spreads did widen during the year, but EM external debt
was nevertheless supported by its higher quality (that
We expect the tug of war between structural and tactical
benefited from ‚flight to quality‛) and the overall negative
drivers of 2011 to extend into 2012 – particularly during
correlation between spreads and UST yields. Hedged local
the first months of the year, when the future of Europe is
currency debt also performed well, but the rally in local
been decided. Valuation supports EM credit, local rates,
rates was hindered by EM central banks need to rein in
and FX – particularly under the risk of some financial
inflation after three quarters of solid growth and inflation
repression in the developed world. Structurally, flows
pass-through from weaker currencies. Not surprisingly,
should also continue to benefit EM, as global investors
equities and currencies lagged on stretched valuations,
remain under-allocated and EM continued to expand the
higher risk aversion, and lower growth.
‚efficient frontier‛ during both ‚risk on‛ and ‚risk off‛
years 4 . However, EM’s still limited depth has kept it
Asset performances in the past ten years vulnerable to bouts of deleveraging as we repeatedly saw
Yea r E MBI Globa l GBI-E M (FX -Hedged) E MFX (s pot a nd c a r r y ) O t her a s s et s r et ur n
Return Vol Ret/Vol Return Vol Ret/Vol Return Vol Ret/Vol S&P UST throughout 2011 and we expect this weakness to persist
2003 25.7% 18.0% 1.4 5.5% 2.4% 2.3 10.8% 5.4% 2.0 26.4% 2.3%
2004 11.7% 6.7% 1.8 7.7% 2.9% 2.7 14.2% 6.1% 2.3 9.0% 3.5% into 2012.
2005 10.7% 2.4% 4.4 7.2% 1.9% 3.8 -0.9% 7.1% -0.1 3.5% 2.8%
2006 9.1% 4.5% 2.0 6.4% 2.6% 2.5 4.5% 7.8% 0.6 10.4% 3.1%
2007 6.1% 7.6% 0.8 4.8% 2.6% 1.8 13.7% 6.5% 2.1 3.9% 9.0% A concerted effort from policymakers a la 2008 could
2008 -10.9% 6.3% -1.7 5.4% 7.1% 0.8 -10.1% 15.5% -0.6 -38.5% 14.1%
2009 28.2% 16.6% 1.7 5.2% 4.2% 1.2 16.0% 12.1% 1.3 23.5% -3.8% bring a significant relief rally for EM currencies, equities
2010
2011
12.0%
7.2%
5.6%
5.2%
2.1
1.4
8.6%
4.3%
2.8%
3.0%
3.1
1.4
6.5%
-4.4%
6.9%
8.9%
0.9
-0.5
12.8%
-0.8%
5.8%
8.8%
and high-yielders. But as the institutional constraints are
Average 11.1% 8.1% 1.4 6.1% 3.3% 1.9 5.6% 8.5% 0.7 5.6% 5.1% more entrenched in Europe, implementation risks are
Correla- w/ S&P 58% 47% 68%
tion w/ UST 47% 40% -6% high. We thus favor trades that would perform well under
a scenario where risks become more EU-centric as more
Note: EMFX (spot and carry) is derived from GBI_EM unhedged and hedged returns.
comprehensive back-stops are built and EU gradually
Correlation with S&P and UST returns are calcuated using monthly returns.
strengthens its institutional framework. Under this
scenario, we expect LatAm and Asian currencies to
In contrast with the situation a year ago, EM equities and outperform EMEA FX, with more US-centric currencies
EM FX are now a source of value for the year ahead. As such as the MXN to outperform, and – with a soft-landing
we show in the 2012 outlook pieces for EM rates and in China and no disruption in global flows – the RUB to
currencies in this publication, there are still some benefit from high oil prices. As tail risk is contained, we
interesting pockets of value in receivers, but the see room for flatter curves and favor box trades vs. the
weakness of many currencies has already taken them into UST, while – in credit – we continue avoid central Europe
overshooting territory. As the table below shows, higher and, in RV, favor long basis in Venezuela.
prospective returns are now skewed towards unhedged
local markets exposure – obviously assuming an eventual
resolution of the crisis in Europe. External debt would
likely avoid losses under less upbeat scenarios, but 4
See ‚EM Flows: Structurally sound, tactically exposed” included in this
publication.

Rates: Concentrating on pockets of value long end) seems attractive in Mexico and Colombia (and
High interest rate differentials, some additional monetary also Israel – see chart below). Valuation is most
accommodation, and contained risk still bode for receiving compelling in Mexico’s long-end, where positioning is also
(locally-funded) rates in EM, although risk-reward is less relatively light, and US-related credit risks are lower. The
compelling than in 2011. For a good part of the year EM Turkish curve also stands out as too steep from our
monetary policy flexibility was limited by robust growth valuation perspective, and technicals are light (we favor
momentum and residual inflationary pressures stemming gradually adding to Jan20 bonds). Inflation pressures
both from the rally in commodities of 1H11 and weaker seem to be easing, but investors may want to wait for
currencies later in the year. Since then both growth and more clarity on FX policies before building positions. FX
inflation have eased, but FX pass-through risks may risk remains particularly important for Hungary, where
continue to hinder a more dovish monetary stance in more bear-flattening seems likely before IMF re-
several emerging economies, including most of LatAm engagement (or not). In contrast, the Chilean curve should
(though less so for Brazil’s CB) and also in Turkey, South continue to reflect more closely fundamentals and as such
Africa, and Hungary – to name a few. But this should not it is prone to bull-steepen, in our view5. We see room for
last long, as below potential growth settles in as rates in the 5-10Y sector in South Africa to drop during the
inflation/pass-through are peaking or close to peak. The year, but the reliance on foreign demand to absorb heavy
integrated analysis of macroeconomic prospect for the issuance renders the long-end too sensitive to risk and
region and valuation indicates that front-end receivers in thus less attractive for box trades vs. the US for now. We
Israel, Colombia, and Poland (where we expect 75bp of see better risk-reward in Mexico.
cuts in the year) stand out – although the Polish CB seems
comfortably on hold for now. Valuation is now less Barring a full-fledged credit crunch as in 2008, bank
compelling in Brazil, despite the gradual 150-200bp of deleveraging should in principle take a bigger toll on
easing we expect. EMEA markets. In Poland, adding cross-currency basis as
a hedge could mitigate such risks for long government
Short-end opportunities to receive and curve trades bonds (as we recommend). In the less EU-centric Russia,
however, the prospect of Euroclearable OFZs should
benefit these bonds while cross-currency swaps already
price a quite cautious global backdrop.
Searching for RV trades vs. UST: COP, MXN, ILS lead
3M 10s receiver carry (bp)

12
10 ILS MXN COP
8 ZAR
6
USD Carry
4 CZK
2 CLP
0 PLN HUF
-2
-4
-6
-8 TRY
-10
0 0.5 1 1.5
Z-score of 10s differentials to USD curve (6M history)
In Asia, the outlook for rates is less constructive. Curves

across the region are rich and flat. Furthermore, we may
Source: Deutsche Bank. Model estimate minus forward curve yields.
see less support from offshore investors in 2012 on less
compelling currency outlook, and better valuation in other
FX, technicals and credit risk will continue to weigh on the parts of EM. Although some reversal of the policy
shape of EM curves – particularly in EMEA, but we expect tightening we saw in Asia this year is in order, the longer
rates to reach lower levels and some term premium to be
priced out. More defensive relative value vs. the US
(where we believe risk is biased to higher yields in the

end may underperform. We look for steepening from a EMFX follows global risk
combination of some mean reversion in long end and
Cumulative Total Return in 2011
more from overshoot in the front end, particularly China,
1.1
India, Korea, and Thailand. We still favor receiving Hibor-
Libor basis. On cash bonds, underweight Indonesia,
overweight Philippines, and stay neutral on Malaysia and
Thailand.
As we discuss in more detail in the rates outlook piece, 1

technicals remain an important potential source of
LatAm
dislocation and we look for defensive trades via
EMEA
swaptions. Our search indicates that best risk-reward is
Asia
found in Turkey, ZAR, and CZK swaps (chart).
0.9
Selected defensive trades in EM swaptions Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Value has been restored, but risks remain asymmetric.

The chart below shows positioning and valuation
(indicated as deviations from long-term ‚fair‛ value
determined by. relative productivity, external prices,
openness, and NFAs) 6 . Most currencies are trailing
fundamentals and positioning is also very light. Since,
inflation targeting has secured mean-reversion in EMFX
with few exceptions (notably Argentina) and positioning is
supportive, there is room for retracement both tactically
and fundamentally. However, as EM currencies have
become a proxy for global factors and they are also
susceptible to non-residents’ hedging of their local
investments, the downside risk should the EU crisis
escalate could easily outweigh their potential to retrace.
EMFX: Repository of value, but proxy for global risk If our baseline scenario materializes and the crisis
In a year of relentless external shocks, EMFX played its becomes more EU-centric and contained, we could see a
role as a buffer and performed broadly in line with global substantial EMFX recovery in 2012. Accordingly, we favor
equities and the ebbs and flows of risk (chart). This is currencies where valuation and technicals are favorable,
unlikely to change in 2012, in our view. EM carry tended but the drivers of risk are less EU-centric and more
to be negatively correlated with spot returns and only IDR, dependent on the outlook for the US/China and
RUB, and the managed ARS delivered a positive oil/commodities such as MXN, and RUB. We expect
combination of carry and total returns. Regionally, EMEA investors to avoid high current account deficits and thus
currencies did underperform LatAm and Asia FX, but the expect the TRY to trade in a wide range despite attractive
worst performer of the year was the rand (the traditional valuation and would buy ZAR only against some
proxy for global equities and commodities instead of usual protection for EU/global risks such as AUD, and HUF. We
suspects such as CE3 FX). Accordingly, global variables also position for PLN undervaluation more defensively via
(such as equities, US yields, and commodities) have 1Y EUR/PLN 4.25 puts. We expect the BRL to benefit on
gained considerable importance in explaining EMFX relief rallies, but the combination of high inflation and the
dynamics more globally since 2008. At this critical central bank’s battle to compress carry limits its
juncture in the crisis we expect EM currencies should attractiveness. We prefer MXN (and also COP) in the
remain broadly a vehicle to trade global risk. region.
6
See the FX outlook piece in this publication for an outline of the model
and further discussion.

More value and lighter positioning Credit: Diminished returns; country selection key
Positioning (+ long USD/ - short USD)
Given the circumstances, 2011 has been another strong
year for EM sovereign credit. Although the total return has
6
not been high, there are very few asset classes which
5 PEN have produced a better performance. In hindsight, a key
MXN
COP factor behind the overall performance of the asset class
4 was the diversity of performance within it. Indeed, 2011
TRY
3 CLP was unusual in that alpha dominated beta for EM
ZAR BRL sovereign credit as the chart below illustrates7.
TWD
2
RUB
SGD
ARS Differences in yield and volatility did not explain
1 PLN
HUF IDR relative country performance in 2011
INR PHP ILS KRW
0 Explanatory factors for relative country performance,
-0.15 -0.1 -0.05 0 0.05 0.1 Rating change Yield (at start)
Valuation (+ overvaluation/- undervaluation)
R2 Volatility (prev yr) All three combined
Source: Deutsche Bank 1.0
0.9
0.8
Asia FX valuations and growth differentials are still
0.7
supportive (though less so than before), but current
0.6
accounts are likely to moderate next year, the policy cycle 0.5
is turning, and currencies such IDR remain too exposed to 0.4
bond outflows for limited upside. We expect the RMB to 0.3
continue to appreciate but at a smaller pace than in 2011, 0.2

0.1
and will feature early in the sequencing of policy easing in
0.0
China. We favor keeping a core long in RMB (via 1Y 2004 2005 2006 2007 2008 2009 2010 2011
NDFs), and remain positive on the low beta currencies YTD
with strong current account support such as PHP. We Source: Deutsche Bank
favor trading SGD NEER on a range basis, and would look

to add on dips within 100bp of the lower bound of the In this respect, we expect 2012 to bring more of the same
corridor. Intra-Asia, we like TWD as the funding currency. behavior and so our outlook for the market (discussed in
more depth in the separate special report) is geared
We search for defensive trades across EMFX by favoring toward trying to identify the potential ‘winners and losers’
high retracement (over the past 100 business days) and for 2012. Overall however, we expect EM sovereigns to
high long USD or EUR call skews via call spreads. The benefit from more upgrades than downgrades in the year
chart below highlights the best so defined risk-reward ahead.
trades: BRL, HUF, CZK, and KRW.
Selected defensive trades in EMFX options
7
Source: Deutsche Bank For each calendar year (and 2011 YTD) we regressed the annual returns
of each country against three different factors: (a) the yield of each
country at the start of the year, (b) the volatility of the country in the
previous year and (c) the net change in rating notches during the year.

We expect 2012 to be another year in which upgrades substantially. In positioning to defend against such a
dominate for EM sovereigns scenario, we would argue that it would be better to be
underweight (or short) the more vulnerable credits with
Proportion of upgrades
lower yields (e.g. Ukraine and Hungary) than the traditional
40%
highest beta credits (Argentina and Venezuela). This
30%
approach towards defending against the crisis scenario
20% results in a rough barbell approach to risk allocation.
10%
0% In terms of the overall return outlook for the asset class

10% we are not optimistic that we will see much better than
mid-single digit returns in 2012. The only scenario which
20%
could bring an upside to this would be one in which
30%
Proportion of downgrades spreads compress, but UST yields remain anchored at
40%
their current low levels. Ultimately however, we see an
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
environment in which very few asset classes offer a
Source: Deutsche Bank compelling value/risk proposition and in this environment
EM sovereign credit may well prove to be the least ugly
The main exogenous source of risk for EM sovereign sister.
credit remains the crisis in the eurozone. However, while
2011 saw the can being ‘kicked down the road’ (albeit by  For 2012, our strategic country recommendations are
progressively shorter distances), we believe that 2012 will to be overweight exposure to Venezuela, Colombia,
bring greater resolution. Muddling through is unlikely to Poland, Russia, and Turkey; underweight exposure to
be an option for much longer, suggesting a fairly binary Hungary, Ukraine, and South Africa.
set of possible outcomes with respect to asset price
performance. In the positive scenario (some form of fiscal  We also recommend buying Chile 5Y CDS vs. Brazil
union and ECB intervention) risk appetite should be as a defensive trade.
strong, benefiting EM sovereign debt. However, the likely  In terms of relative value we recommend Venezuela
continued weakness in the global economy, exacerbated 24s vs.10Y CDS, PDVSA 22s vs. Venezuela 10Y CDS.
by ongoing bank deleveraging, will mean that Argentina Global 17s vs. 10Y CDS
vulnerabilities will remain for some EM countries. The
negative scenario (the eurozone crisis deepens and fears
of a break up of the currency union and/or sovereign
defaults escalate) would be hugely disruptive for global Drausio Giacomelli, New York, +1 212 250 7355
markets and for global capital flows. In such a scenario we Robert Burgess, London, +44 20 7547 1930
would expect all vulnerable EM sovereigns to sell off Marc Balston, London, +44 20 7547 1484

 EM receivers performed well after a rocky start. EM receivers: Back-loaded returns

Country specifics have remained the dominant driver Accumulative Total Return in 2011
of returns, but the importance of global factors 200
increased in 2011.
150
 In our 2012 outlook, we analyze those country USD LatAm EMEA
specifics effects using a model which integrates 100
macro-monetary policy interactions and local curve

dynamics. We restrict our analysis to two potential 50
scenarios: the benchmark given by our country

0
forecasts and a more pessimistic alternative due to
potential events in Europe. -50
 Under our benchmark scenario the ‚fair‛ curves are

-100
relatively close to forward curves. Nevertheless, we Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
identify some interesting opportunities. The short-
dated tenors of Colombia, Poland, and the long-end
Country specifics have remained the dominant source of
of Mexico and Israel stand out as opportunities to
returns, but the share of EM rates returns that can be
receive, steepeners seem most attractive in Chile and
attributed to the performance in DM assets increased in
Poland, while Peru yields seem too low and the
2011 vs. recent years. After controlling for EMFX, weekly
Turkish curve poised to bear-flatten.
returns of long duration strategies were highly correlated
 Interestingly, while the analysis under the more with global assets such as UST, S&P500 and CRY on a
pessimistic scenario produces some changes in disaggregated level. For buy-and-hold 10Y receiver swaps
valuation, the most attractive opportunities seem to strategies, global factors account for approximately 20%
be robust to a greater slowdown in economic activity. of the weekly non-overlapping returns, compared to 14%
for the year of 2008, and 10% for the last 5 years (with
 Nevertheless, under the bearish scenario technical
PLN and ZAR the exceptions). The results above also carry
issues could pose a greater risk. In analyzing real
on to relative curve trades such as buy-and-hold 2s10s
money exposure for specific countries we find that
flatteners. As the chart above suggests, this increased
EMEA in general appears more vulnerable than
correlation probably owes to the wide swings in core
LatAm. South Africa and Hungary stand out in EMEA,
rates that seem more likely to repeat under a scenario of
while Brazil appears more vulnerable in LatAm.
more rapid resolution of the crisis in Europe
Turkey, Peru, and –to lesser extent – Colombia and
Mexico, could benefit from lean positioning.
Diminishing importance of carry
Taking Stock of Recent Performance Carry Return/Absolute Spot Variation
400%
EM receivers had a relatively good performance despite
crisis 2011 5Y
the rocky start of 2011, when US growth expectations
were revised up and UST yields sold off sharply. With the 300%
exception of HUF, cumulative returns for EM receivers

(which we compute by rolling 1M10Y forward-starting 200%
swap) turn marginally positive already in February. It still
took a few months for receivers to renter positive 100%
territory, with LatAm outperforming primarily on to closer
connection with the more accommodating Fed, while, in
0%
EMEA, CZK outperformed on its closer linkages with USD BRL MXN CLP TRY ZAR ILS CZK HUF PLN
Bunds. Overall, the initial level of yields had little to do
* Negative Carry are not shown
with total return, with low yielders benefiting from the ** Crisis Period: from Sep 2008 to Dec 2009
dramatic repricing of yields across the US and EU. Source: Deutsche Bank
In contrast with EMFX and equities, EM rates

performance remains largely driven by domestic factors,

with cross-country residuals displaying a low degree of economists’ forecasts presented in the respective country
correlation. Over the past five years, the first principal sections of this publication. The alternative, more
component of the individual returns -after controlling for pessimistic, scenario assumes a larger slowdown in
global macro drivers- is responsible for only 30% of the activity triggered by credit crunch, contagion and the
total variation, indicating a low degree of cross country co- associated reduction in inflation.8
movement. In order to assess the outlook for EM local
rates, we thus look in more depth into individual drivers of We find that under our benchmark scenario the simulated
curve valuation for hints about potential performance curves are relatively close to forward curves.
during next year. Nevertheless, we identify some interesting opportunities
across both short and long tenors.
EM rates performance mainly idiosyncratic
The short end:
100%
90%
crisis  We find little value on the front-end (1Y) of most
80%
70%
2011 curves (see chart); in particular the forward valuation
60%
5Y
in the short tenors of the local curves in Mexico,
50% Brazil, South Africa or Czech Republic are broadly
40%
consistent with our own forecasts. The market has
30%
already discounted enough monetary easing in Brazil
20%
10%
(-150bp), and it seems difficult that the Bank of
0% Mexico would engage in an aggressive monetary
USD EUR JPY GBP BRL MXN CLP TRY ZAR ILS CZK HUF PLN
* Crisis Period: from Sep 2008 to Dec 2009 easing by cutting much more than the 25bp already
discounted by the market. In EMEA, the SARB has
Source: Deutsche Bank. Percentage of co movement of first component of PCA. already signaled it will remain on hold.
 The short-dated tenors of Colombia, Poland, and to
lesser extent Israel, seem more attractive. In
Outlook for 2012 Colombia, this is consistent with our view that the
market has been too aggressive in pricing potential
The front-loaded sell-off of 2011 seems unlike to repeat in
tightening of monetary conditions. Although we
2012 unless EU authorities move fast toward fiscal
believe that the central bank will continue its recently
integration. Although we expect progress toward a
initiated hiking cycle, it should pursue a more gradual
stronger fiscal pact and crisis containment, EU authorities
path than currently discounted by the market. In
have rather moved reactively and slowly. It seems too late
Poland, the NBP is pointing to 2H cuts (75bp, in our
to avoid recession in the region and it would be naïve to
view), but these could be advanced depending on
expect major breakthroughs on US fiscal policy and
extent of the slowdown in the EU and PLN
housing overhang ahead of elections. Although progress
weakness. We are more constructive in Israel, where
seems in order with a more concerted and focal action,
the latest minutes and inflation numbers pave the
economic growth seems poised to decline. The US could
way for two more cuts.
still avoid recession, while China experiences a soft
landing, but EM will continue to decelerate. The possible  In Peru and Turkey pricing is relatively tight in short
outcomes of this crisis have become more binary, tenors, suggesting a bias to pay in these countries. In
however, and we consider an alternative scenario where the case of Peru, a managed exchange rate, local
another credit crunch materializes, China slows down pension system support and foreign sponsorship
more than expected, and EM central banks are forced to have helped the local curve to remain immune to
act more aggressively amid heightened risk aversion. increasing volatility in external markets. In Turkey, the
corridor blurred the policy rate as the instrument of
Assessing valuation in binary scenarios monetary policy and we prefer to focus on the longer
We build on a model which integrates macro-monetary end of the curve.
policy interactions and local curve dynamics. The
methodological discussion is summarized in the box at the
end of this piece and the results are presented in the
charts below. The chart shows the difference between
our estimated curves under two different scenarios for
several LatAm and EMEA countries and their respective
8
forward curves. The baseline scenario is given by our In particular, we assume a departure from our forecasts of -2% and -1%
for the output gap and inflation respectively.

Simulated curves vs. forwards
The long end: Positioning: A lingering source of risk

 We find more value at longer tenors (10Y) of some Following two years of steady inflows, EM Local Debt
curves under our benchmark scenario. The best saw significant outflows starting last September (although
opportunities appear in Mexico and Israel, where moderate as a percentage of assets under management).
premium seems to have overshot fundamentals the Still, positioning bodes for caution as it looks elevated in
most. In contrast, there are some curves which have several markets -in some cases near historical highs. The
not incorporated enough risk premia, in our view, chart below shows the latest figures and the distribution
such as in Brazil, Chile, Peru, Poland, and Czech of foreign holdings of domestic debt.
Republic. Accordingly, while steepeners appear as
attractive in Chile and Poland (swaps), and to lesser Encouragingly, the past year’s tame investor reaction to
extent, Brazil and Russia, flatteners seem most rising risk has revealed remarkable resilience to repeated
attractive in Mexico and Israel. bouts of global deleveraging. Fundamentals such as low
growth, controlled inflation, and high interest rate
Interestingly, while the analysis under the more
differentials likely played an important role, with local debt
pessimistic scenario produces some changes in valuation,
flows showing considerable more stability than EM
the most attractive opportunities seem to be robust to a
equities flows. That central banks have been ready to
greater slowdown in economic activity. The front-end of
provide plentiful liquidity should also remain reassuring for
the Colombian curve stands out in terms of offering value
local investors. Accordingly, foreigners remained
to receive under that scenario, while the Mexican and
committed even throughout the most serious episode of
Israeli curves continue to be the best options in the long
risk aversion (September), when disruptions to USD
end. Steepeners in Chile also become more attractive
funding of European banks acted as a channel of
under a sharper slowdown – in line with typically
contagion to EM. It appears that most funds chose to
aggressive central bank responses.
hedge their exposure to FX via NDFs rather than unwind
their bond positions. This should stay the norm barring a
major setback in Europe.

Inflows have been on an exponential trend (USD bn) specific country.9 In our assessment, we find that EMEA
in general appears as more vulnerable than LatAm.
Foreign Holdings of Domestic Government Debt (latest data)
45%
40% HU South Africa and Hungary stand out in EMEA as most
MY vulnerable, while Brazil more vulnerable in the LatAm. In
35% MX
ID the case of South Africa – where the curve was most
30%
obviously dependent on external factors – the local
25%
PL
ZA investor base seems to be persistently underweight when
20% KR
yields for back-end bonds fall below (8.5-9%), leaving the
TR CZ
15% role of supporting the market to foreign investors. In a
10% TH BR scenario, where foreign inflows are more timid next year,
5% RU the curve would steepen and ASW will widen.
0%
0% 5% 10% 15% 20% 25% 30% 35% 40% In the case of Hungary, we are concerned that non-
Foreign Holdings of Domestic Government Debt on 31-Aug-08 resident holdings have not adjusted enough in line with
Source: Deutsche Bank the riskier profile as it falls into economic recession in
2012 (our base case scenario). Non-resident holding are
In our view, fundamentals and the binary risks we foresee only 7% below their recent peak, despite a downgrade to
continue to support long rates and inflows into bonds at sub-investment grade by one rating agency. More
the expense of equities – the pattern of the past years negative news, such as disappointments in IMF
that we doubt will change at least while growth is negotiations could accelerate foreigner’s exit from that
depressed in the US and the EU is in recession. However, market. Brazil stands out in terms of positioning in the
local markets inflows have been sensitive to bouts to risk LatAm region and it could be contrasted with the situation
aversion (proxied by the VIX) despite the structural forces in Mexico. While appetite in Brazil should remain strong
discussed above. amid easing, the outlook could change should the
currency weaken substantially (not our baseline scenario).
The exposure z-score indicates how ‘over-/under-
weight’ funds are at present At the other end of the scale, we believe that Turkey
benefits from a high carry and low positioning, and
Exposure Z-score*
1.5 therefore an improvement in fundamentals is likely to be
Oct 11 met with strong inflows. Peru and, to lesser extent,
1.0
Prev. Mth Colombia and Mexico, could benefit from lean positions.
0.5
0.0 The buyers v sellers index gives an impression of the

-0.5
relative strength of appetite for different countries
Buyers v sellers index, 3m MA*
-1.0
+0.5
Oct 11
-1.5 +0.4
+0.3 Prev. Mth
-2.0
BR ZA MY TH KR HU MX CO RU CZ ID PL EG RO PE IL TR +0.2
+0.1
*-Avg exposure vs benchmark, relative to 12mth MA, divided by StDev of monthly
change in exposure 0
-0.1
-0.2
-0.3
In order to assess which curves seem more exposed to -0.4
short-term disruptions, we have developed an approach -0.5
that allow us to monitor these funds average exposure ZA TH RU BR KR CO CZ HU RO MX MY TR PL PE IL ID EG
relative to the country’s weight in the benchmark as well *-Number of funds actively increasing exposure minus number of funds actively
as the relative strength of these funds appetite for a decreasing exposure, divided by the total number of funds
9
For details on the methodology: please see “A Closer Look at Real-
Money Positioning”, inside this publication

Defensive trades in swaptions trade of 2s10s TIIE flattener against 2s10s USD swap
As protection for potential bouts of deleveraging we look steepener
for high payout ratios in put spreads after normalizing for
 EMEA: In Israel receive 2Y IRS. In Poland receive 1Y
the different degrees of responses during the 2008 crisis.
XCCY basis as a hedge. Receive 1Y EURPLN cross-
The chart below shows the resulting ‚normalized‛
currency basis. In Czech Republic take profit on
ranking: ZAR, CZK and TRY offer a combination of steep
2s10s
skew and significant upside move in the underlying rate
making those curves the most desirable ones to place Drausio Giacomelli, New York, +1 (212) 250 7355
defensive trades in the back end. We build these curves Mauro Roca, New York, +1 (212) 250 8609
by fixing the difference between high and low strike at Guilherme Marone, New York, +1 (212) 250 8640
25bp. The payout ratio monotonically increases with the Lamine Bougueroa, London, +44 (20) 7545 2402
volatility skew, but to make these positions we take the
2008 as the benchmark year for a shock. We thus
normalize the move in rates by the realized standard
deviation (a 5bp move in ILS would correspond to a 10 bp
move in TRY, for instance).
TRY, ZAR, and CZK stand out as defensive trades
Conclusion and recommendations:

The situation remains fluid, but while valuation is not
particularly appealing fundamentals and the risk bias
favors receivers in EM. In this piece we look at valuation
in more detail and highlight the most attractive pockets of
value. Interestingly, these opportunities seem to be
robust to our more pessimistic scenario characterized by
lower economic growth and inflation. Our top
recommendations in LatAm and EMEA are:
 LatAm: In Argentina, stay out of local curves but

favor Badlar linkers in relative terms. In Brazil, take
profits on July ’12-Jan ’17 DI steepener and enter Jan
’13-Jan ’15 flattener. Enter a 2s5s CLP/CAM
steepener in Chile. In Colombia close 2s3s IBR/COP
steepener and enter a 5Y receiver, either in IBR/COP
or TES Jun ’16, against 5Y USD swap payer. Take
profits on 5Y TIIE payer in Mexico, and enter a box

Appendix: Modeling local curves What Nelson-Siegel factors capture

To determine how the different curves could behave in
% NS LEVEL CLP/CAM 10Y, lhs
these distinct scenarios we use a dynamic model of the 8 8
term structure of interest rates based on macroeconomic
fundamentals (see “EM Rates: Modeling Curve Dynamics
7 7
under Macroeconomic Shocks,” EM Special Publication,
November 18th 2011). Our methodology can be
characterized by a series of steps. 6 6
First, we parameterize the yield curve using a Nelson-

Siegel decomposition. This approach consists in 5 5
projecting the entire yield curve on three latent factors,

which could be associated with the level, slope, and
4 4
curvature, respectively (see chart). One of the advantages Nov-06 Jul-07 Mar-08 Nov-08 Jul-09 Mar-10 Nov-10 Jul-11
of this approach is that the relationship between the
different tenors of the yield curve and these latent factors
bp CLP/CAM 2s10s, lhs NS SLOPE
has a closed form representation which can be used to
reconstruct the entire yield curve from these three factors 300 7
at any point in time.
5
200
Since we are ultimately interested in exploring the
behavior of the yield curve under different 3
macroeconomic conditions, in a second step we estimate 100
an econometric model (Vector Auto-Regression, VAR) of 1
the latent factors and some selected macroeconomic 0

-2
variables). Following a basic New Keynesian
representation we characterize the economy by a
-100 -4
measure of prices (YoY consumer price inflation), a Nov-06 Jul-07 Mar-08 Nov-08 Jul-09 Mar-10 Nov-10 Jul-11
measure of activity (the deviation of GDP or IP from its
trend), and the stance of monetary policy (the policy
bp CLP/CAM 2s5s10s NS CURVATURE
interest rate).
80 9
Finally, from the estimated relationships between the 7

variables in the VAR, we can forecast the interest rate 60
5
curves under certain assumptions regarding the future
evolution of the macroeconomic variables or determine 40 3
what would be the dynamic response of each of these 1
20
variables –or the entire term structure of interest rates- to
-1
a shock in any other variable (that is, we obtain the
0
corresponding impulse response functions). We can then -3
compare the simulated curves with forward curves to
-20 -5
assess if there is some value under our assumptions. Nov-06 Jul-07 Mar-08 Nov-08 Jul-09 Mar-10 Nov-10 Jul-11
In summary, our methodology allows analyzing the

behavior of the term structure of interest rates by
exploiting the dynamic feedback mechanism between the
latent factors, -representing the yield curve- and some key
macroeconomic variables. The latter influence the position
and shape of the curve, but the curve also influences the
evolution of the macro variables.

Appendix: Rates Strategy Summary
Country View Strategy Risks

China We believe the risk of an RRR cut before the year- We take profit on the 2Y/5Y steepeners Upside surprises on CPI which could delay
end is rising to 30% from 0% and we expect short- monetary easing
term rates to fall towards 3% over the next two
months.
Hong Kong Hibor - Libor basis to remain stable towards the Looking to receive Hibor-Libor basis position USD strengthens against EM currencies
year-end
India Concerns about further fiscal slippages to add to Neutral A very weak Q3 (calendar 2011) growth number.
issuance will keep cash bonds under pressure,
unless we see RBI easing liquidity through OMOs
or a cut in CRR. That might not come till the CB
gets more evidence of a sharp growth slowdown,
or at least an easing in inflation because of base
effects into end year. Timing is critical in receiving
the front end of OIS curve, given the steep
negative carry.
Indonesia Mostly a tail risk trade at these levels. The Stay underweight Squeeze on under allocated investors if risk tone
fundamentals of the Indonesia story have not improves, especially as supply winds down into
changed, but we don’t like the timing of the rate end year
cut by BI, or indeed that the CB has been the only
significant buyer of duration in the last couple of
months.
Malaysia The policy outlook could arguably turn more dovish Neutral. Return of appetite for EM exposure among global
in the coming months, but with a large supply investor portfolios.
calendar in 2012, the markets would need strong
appetite again from offshore investors, in the
absence of interest from local players.
Philippines Except for its traditional EM like character Modest overweight. Spike in food inflation because of spillover from the
because of shallow markets, there is little to fault Thai flood situation.
the rates backdrop in Philippines - comfortable
inflation outlook, improving fiscal picture, strong
BOP and low concentration of risk with offshore
investors.
Singapore With the MAS not having eased as aggressively as Neutral Upside surprise to economic data.
expected, richness in front end of the curve could
persist for a while on weak macro conditions.
South Korea Steepening bias on KTB curve driven by rolling over DV01 neutral 3Y/10Y KTB steepener through 3Y An early monetary easing tends to flatten the IRS
pressure from the concentration of KTB and 10Y KTB futures at 36bp with a target of 50bp. curve.
redemption in December. Modest steepening view
on KRW 2Y-5Y IRS curve.
Thailand The flood situation is likely to remain a drag on the Pay 5Y/10Y steepeners, target 60bp. BOT cuts rates sharply in response to a
supply outlook for this market. Any dovish turn in worsening flood situation.
the policy outlook could end up impacting belly of
the curve more, given the low level of yields in the
front end.
Taiwan The front-end of the IRS curve likely will remain Maintain 2Y/5Y/10Y butterfly spread paid position Deterioration in exports and growth causing CBC
anchored but 5Y/10Y has room to flatten. at -7bp to turn dovish.
Czech Czech economy to be impacted by the Eurozone Neutral at current levels A reversal in risk appetite that would hurt the
slowdown. Central bank to remain dovish Krona
Egypt Significant deterioration in the political outlook We do not favour being invested in EGP or T-bills Resumption of demonstrations asking for a faster
since the reinstatement of emergency rule. until we see more clarity on the political situation pace of reforms, leading to capital outflows
Balance of payment difficulties likely to persist
causing pressure on the level of FX reserves
Israel Disinflation trend to persist due to macro and Receive 2Y IRS. Expect curve to bull steepen Middle East political uncertainty
micro elements. BoI likely to continue monetary
easing policy
Poland Our and market expectations Cuts have been Receive 1Y XCCY basis as a hedge. Outright The negative impact of the Eurozone crisis on
pushed back to Q3 2011. Growth to decelerate but purchase of POLGBs will be attractive in H2 2012 banks operating in Poland (liquidity risk)
remain positive in 2012. Inflation to start slowing
after Q1 2012

Appendix: Rates Strategy Summary Cont’d

Russia Strong fiscal performance. Year-end inflation Neutral in rates. Bullish bias on OFZ market A sudden fall-out in global growth would have
target (7%) likely to be met, but capital outflows negative consequences for oil
maintaining rates at a high level
South Africa SARB to stay on hold for a prolonged period. Expect rates to trade in range consistent with Large scale foreign outflows from bond and
Inflation outlook dependent on ZAR 5y5y in (8.40-9%). Front-end rates are well equities, caused by global risk aversion
anchored, while the back-end is dependent on ZAR
performance. 2s10s set to steepen
Turkey CBT trying to juggle multiple goals, but with Receiver bias at the back-end Roll-over risks for local banks short term external
inflation being its top priority at this stage. De debt
facto tightening of monetary policy to help
rebalancing the economy
Argentina With real yields in low double digits CER-linked In relative terms, we continue to favour Badlar Liquidity could dry very rapidly
bonds do not offer an attractive return for foreign linkers, which benefit from nominal instability.
investors.
Brazil The market is widely expecting that BCB will We recommend taking profits on our July ’12-Jan With domestic and external activities trending
continue reducing rates aggressively during 1Q12 ’17 DI steepener recommendation and position for lower, the risks to this scenario are still biased to
(150bp to 9.5%). a setback in short-term rates with a Jan ’13- the downside due to BCB’s increasing focus on
Jan’15 DI flattener. growth.
Chile As the economy continues to decelerate, the As a consequence, we recommend shifting the 2Y The cuts could help to build up additional risk and
BCCh seems closer to ease monetary conditions. breakeven inflation position to the 5Y sector and inflation premium in the belly of the curve.
entering a 2s5s CLP/CAM steepener.
Colombia The local curve has been anticipating the on-going Closing 2s3s IBR/COP steepener and entering a 5Y Risks are biased to the downside for short-term
tightening cycle for some weeks. receiver, either in IBR/COP or TES Jun ’16, against rates, as the slowdown in global growth may drag
5Y USD swap payer . on domestic activity and reduce some inflationary
pressures.
Mexico Local rates have been following the movements in We take profits in our 5Y TIIE payer The reduction of risk appetite.
the exchange rate. recommendation and switch to a box trade of
2s10s TIIE flattener against 2s10s USD swap
steepener .
Peru The local curve, supported by favorable technicals With the curve now trading at relatively low levels, Higher than expected inflation might force the
and a stable currency, has shown extraordinary the risk/reward of the position looks less Central Bank to rise rates.
resilience to external events. attractive, even at shorter tenors.

 During 2011, EMFX played the role of shock absorber EMFX performs in line with global growth and risk
with a large share of returns attributed to global Cumulative Total Return in 2011
drivers. It ended the year as one of the worst 1.1
performer across the major global asset classes. In
line with increased risk aversion, ex-ante carry tended
to be a poor indicator of ex-post performance.
 External factors should remain the main drivers of EM
currencies in 2012. More attractive valuation will have 1
to overcome the ebbs and flows of external prices, LatAm

portfolio flows, and risk appetite. For its liquidity and EMEA
role as a shock absorber, EMFX should continue to be Asia
the preferred vehicle EM investors have to express

0.9
their views on the global economy and the prospect Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
for the EU crisis.
 Global risks could be amplified by domestic

weaknesses. Even if global risks do not escalate but In line with increased risk aversion, ex-ante carry tended
linger, the market may start to focus on EM’s to be a poor indicator of ex-post performance with
‚periphery‛. positive carry normally incurring in negative P&L as shown
in the chart below. Except for the IDR, only managed or
 In LatAm we recommend entering zero-cost 1x2 dirty floating currencies such as the RUB, ARS and PEN
USD/BRL put spreads and short CAD/MXN, while delivered positive total return and carry, with only the low
maintaining short EUR/CLP and long USD/PEN. In carry PEN posting total return in excess of carry.
EMEA, we favor shorting EUR/ILS and oil sensitive
NOK/RUB, and entering long PLN/HUF and long ZAR
Under heightened risk aversion, carry anticipated loss
versus an equally weighted basket of similarly high
betas AUD and HUF.
Taking Stock of Recent Performance

EMFX –after EM equities– ended the year as one of the
worst performer across the major global asset classes10.
In line with perceptions on global growth, EM currencies
performed reasonably well until mid-year, when the EU
crisis and worsened economic data in developed markets
prevailed (chart). In terms of leaders and laggards,
idiosyncratic currencies such as PEN and (the managed)
ARS outperformed their peers while currencies most
linked to global drivers (such as ZAR) lagged – although
country-specifics also amplified external shocks in Source: Deutsche Bank
currencies such as TRY and INR.

EMFX played the role of shock absorber and, accordingly,
a large share of the returns could be attributed to global
drivers in 2011. Cross-country did matter with heavy
positioning, stretched valuations, or lack of central bank
support associated with underperformance. But simple
regressions of spot EMFX weekly changes on the
equivalent changes in some relevant global variables (SPX,
UST and CRY) shows that ex-carry, total returns indeed
traded as a global asset in 2011. As the chart below
shows, and as we have highlighted in several reports,
10 EMFX has become more of a proxy of global risks since
See ‚EM performance: The grass is greyer on the other side‛ in this
publication. the outset of the 2008 crisis. Except for more tightly

managed RUB, the best performers were the low r-square shown) 11. PLN and HUF naturally feature among the most
currencies (ARS and PEN) while the worst performers ‚undervalued‛ after the recent correction, but we’d rather
(ZAR, TRY and MXN) were the high r-square pairs. avoid their sensitivity to EU developments. Although the
table below also points to laggards such as the ZAR and
EMFX as a proxy for global risks TRY as the pairs that have most room to catch up under
retracement, we would be long ZAR only vs. an equally-
70%
weighted basket of crisis-sensitive HUF and AUD and
crisis 2011 5Y
60% avoid currencies with large current account deficits such
as TRY.
50%
40% We favor currencies such as MXN (vs. USD or CAD), COP,

and RUB (vs. NOK) that are more exposed to US and
30%
commodities (oil) instead. Tactically we would be long
20% BRL, although – from a longer-term perspective – we find
10%
it less appealing than MXN.
0%
ARS BRL CLP COP MXN PEN CZK HUF PLN ILS RUB TRY ZAR KRW IDR INR THB TWD SGD PHP EMFX overshoots drivers, but heterogeneity matters
Outlook for 2012

External fundamentals and technicals should remain the
main drivers of EM currencies in 2012. In contrast with
rates where fundamentals and –to a lesser extent
valuation– are aligned, in the case of EMFX more
attractive valuation will have to overcome the ebbs and
flows of external prices, portfolio flows, and risk appetite.
For its liquidity and role as a shock absorber, EMFX should
continue to be the preferred vehicle EM investors have to
express their views on the global economy and the
prospect for the EU crisis. This and the fact that real
money investors have hedged their local markets
exposure at moments of stress should continue to amplify
external shocks even if speculative positioning is light.
From a tactical perspective, the most pressing issue is

whether the steps to fiscal integration to be announced
later in the week will suffice for the ECB to step up its
purchases. We believe that it will – even if backloaded to
1Q12 –and that additional firepower will be added by the
IMF– conditional on EU’s increased commitment to
resolution of the crisis.
From a strategic perspective, growth prospects and EM
Our scenario thus bodes well for near-term retracement in fundamentals in particular are most relevant and we focus
EMFX under the view that a more concerted action by on macro – rather than financial – variables to asses value.
authorities will succeed in containing the escalation of this Accordingly, we estimate ‚fair‛ value using an
crisis and hopefully render it more EU-centric. But as econometric model of real effective exchange rates vs.
many parts need to fall in place implementation risk will selected macroeconomic fundamentals such as
run high and we favor trades that could benefit from less productivity, terms of trade, net foreign assets, and trade
policy-sensitive risks as US growth and China’s soft- openness (see Appendix for further details). Although this
landing supporting commodity prices.
The degree of underperformance vs. financial drivers 11

The table shows EMFX misalignments vs. a benchmark of financial
presented in the table below provides an indication of drivers such as S&P500 (or VIX), CRY (or the more appropriate metric for
potential retracement and sensitivity to each driver (not external prices a country faces), EUR/USD and UST or credit risk. The
regressions are specified according to each currency pair

model has more of a medium to long term appeal, and devaluation we foresee. Most countries have accepted
misalignment tends to correct only gradually, the some depreciation to reflect worse fundamentals, but in
equilibrium values are more representative of EMFX’s true Peru more forceful intervention has already pushed the
value as currencies do tend to revert to this moving currency into slight overvaluation territory. The less
“mean”12. interventionist and more EU-sensitive EMEA FX naturally
concentrates the most undervalued currencies in our
The results point to some similarities across sample. From a risk perspective, the chart below shows
fundamentals- and financials-based models. This is not that the most overvalued currency in our sample (the BRL)
surprising when floating currencies trade more closely to has moved closer to fair, but the degree of undervaluation
fundamentals so that dislocations show in both types of in MXN, PLN or TRY has increased further despite already
models. But in currencies such as the BRL very high rates hovering around depressed levels.
and an elevated pace of foreign direct and portfolio
investment could set a wedge between financials and EMFX valuation: Corrections and exaggerations
fundamentals approaches. Indeed, the BRL appears
undervalued according to the short-term financial drivers
perspective, but it remains one of the most overvalued
EM currencies from a fundamentals standpoint (see chart
below). Moreover, as the level of inflation the central bank
now accepts combined with its urgency to depress carry
suggest that the BRL has become a less appealing
currency to hold strategically while policies are not
corrected. Currencies such as MXN, ZAR, PLN and TRY
appear as undervalued in both set of estimates, but MXN
poses the best BoP situation. PLN vulnerability is less
than HUF and valuation is more attractive, but we prefer
to add more cautious bullish trades via EUR/PLN put Source: Deutsche Bank
spreads.
How risky are EM currencies?
Undervaluation vs. fundamentals is becoming the Although global risks are dominant they could be
norm amplifying by domestic weaknesses. Moreover, even if
global risks do not escalate but linger, the market may
start to focus on EM’s “periphery”. The following tables
present a set of scores to gauge external and fiscal
vulnerabilities across EM countries. Not surprisingly
Hungary stands out, although Poland’s and Turkey’s wide
current account deficit also raises concerns, although
market financing seems a lot more robust than in
Hungary. In LatAm, the current account deficits are wider
in Brazil and Colombia, but the capital account is expected
to provide enough financing. Argentina is the only country
in the region where international reserves could begin to
matter, particularly if the government insists in using the
Central Bank as a financing source to service the debt.
While higher inflation is a long-term concern for the BRL

and also for TRY, it is the main concern for the Argentine
peso because of the higher rate of inflation in Argentina
(about 5 times higher than in Brazil) and lower reserves
(less than 1/7th Brazil’s). But with forwards already pricing
20-30% devaluation and FX being an important nominal
anchor for the country, this is already in excess of the
12
Inflation targets and batter balance sheets have anchored inflation and
rendered nominal EMFX mean-reverting across most emerging countries.

EMEA appears more vulnerable than LatAm EM FX Scorecard: An heterogeneous landscape

External Fiscal Financial Valuation Return Risk Technical
ST LT 3M Carry 3M Carry/Vol 3M IV/HV 3M 25D RR* Positioning**
Current account
Overall balance
Foreign claims
ARS - 2% 28.9% 1.9 4.3 1.5 1.0
Loan:deposits
Maturing debt
Credit growth
External debt
FX reserves BRL -7% 5% 7.6% 0.4 0.8 0.6 2.5
Credit level
Public debt
CLP 0% 0% 4.3% 0.2 1.0 1.1 3.5
FX Debt
Overall
Overall
Overall
COP -10% 0% 0.2% 0.0 1.4 1.3 4.0
MXN -7% -10% 2.8% 0.2 0.8 0.5 4.5
PEN 0% 6% 3.1% 0.5 1.6 1.1 5.0
EMEA CZK -1% - -0.3% 0.0 1.1 2.4 1.0
Czech Rep HUF -5% -4% 4.3% 0.3 1.0 2.0 0.5
PLN -6% -15% 3.7% 0.3 0.9 1.4 1.0
Hungary
ILS -3% 3% 0.8% 0.1 1.1 2.5 0.5
Israel RUB -2% -2% 5.4% 0.3 1.0 1.5 1.5
Poland TRY -10% -13% 7.6% 0.5 1.0 1.5 4.0
Russia ZAR -12% -14% 5.4% 0.2 0.9 1.2 2.5
KRW - 4% 2.1% 0.1 1.1 0.8 0.5
South Africa
IDR - 9% 8.9% 0.6 1.1 1.7 0.5
Turkey INR - -4% 7.2% 0.6 1.1 1.8 0.5
THB - 3% 3.4% 0.5 1.0 1.7 -
LatAm
TWD - -2% -3.0% -0.4 1.1 1.2 2.0
Argentina SGD - -4% -0.2% 0.0 0.8 0.8 1.0
Brazil PHP - -2% 1.2% 0.1 1.0 1.2 0.5
Chile ST: Short-term valuation model based on financial drivers
LT: Long-term valuation model based on macroeconomic fundamentals
Colombia
Carry/vol: Ratio of expected carry and implied volatility
Mexico IV/HV: Ratio of implied and historical volatility
25D RR: 1-year z-score of 25D risk reversal
Positioning: Latam, z-score of official data; EMEA and Asia, dbSelect Positioning Indicator
When observing positioning, valuation, and carry/risk Source: Deutsche Bank
indicators for EMFX, we find that there is ample

heterogeneity (see Table below). Some currencies like Considering all the potential risks and the heterogeneity of
ARS, BRL or TRY continue to offer relatively high carry but the asset class, it is worth asking which currencies offer
as a compensation for different types of risks. Valuation is the best defensive trades. To answer this question we
becoming attractive in several currencies, but BRL and look at those liquid pairs with higher USD call spread
PEN are clearly overvalued. Risk reversals are relatively payout ratios and which have retraced the most during the
high across EM FX, but those of BRL and MXN are last 100 days (see chart). We find that BRL, KWR and CZK
relatively low with respect with recent history. Positioning stands out.
is relatively lean across all EMFX, with PEN, MXN and TRY
standing out in terms of long USD bets. Top trade recommendations:
LatAm: Enter zero-cost 1x2 USD/BRL put spreads, and

maintain short EUR/CLP and long USD/PEN. Take profits
on long MXN/CZK and switch to short CAD/MXN.
EMEA: Short EUR/ILS and oil sensitive NOK/RUB. Enter

long ZAR versus an equally weighted basket of similarly
high betas AUD and HUF and long PLN/HUF.

Identifying defensive trades - Terms of trade. This variable captures the positive
income and wealth effects resulting from an improvement
in the relative price of exports.
- Openness, (ratio of the sum of imports and exports and

GDP). This variable not only captures the sensitivity of the
exchange rate to disequilibrium in the domestic economy
and its external sector but also is very sensitive to
structural breaks resulting from regime changes or crisis.
To estimate the model we follow a cointegration

approach, following and Granger and Engle.iv We apply it
to a panel covering more than a decade of monthly data –
from January 2000 to October 2011- for 20 EM countries.
The panel approach allows us to exploit the information in
the cross-section of countries to overcome the relative
short duration of macroeconomic time series of EM
countries. However, this forces all countries in the panel
Drausio Giacomelli, New York, +1 (212) 250 3755
to share regression coefficients, neglecting some relevant
Mauro Roca, New York, +1 (212) 250 8609
diverse characteristics. We chose a balanced approach by
Guilherme Marone, New York, +1 (212) 250 8640
estimating regional panels for LatAm, EMEA and EM Asia;
this allows us to exploit intra-regional similarities without
Appendix: Our Model of Equilibrium REER being subject to inter-regional differences. Moreover, we
We base our assessment of fundamental valuation of EM allow the coefficient of openness to be country specific as
FX in an econometric model of the real effective exchange this variable –as explained above- captures several
rates (REER). More specifically, our model can be framed idiosyncratic effects.
into the class of Behavioral Effective Exchange Rate
(BEER) models.
i
MacDonald, Ronald, 1998."What determines real exchange
Following the extensive literature on exchange rate rates?: The long and the short of it," Journal of International
valuationi, the value of the exchange rate is determined in Financial Markets, Institutions and Money, Elsevier, vol. 8(2), pp.
this model by a few relevant macroeconomic variables. 117-153, June; Obstfeld, Maurice & Rogoff, Kenneth, 1995.
We choose these variables with the aim of both capturing "Exchange Rate Dynamics Redux," Journal of Political Economy,
University of Chicago Press, vol. 103(3), pages 624-60, June;
the main determinants of exchange rate valuation and
Sebastian Edwards & Miguel A. Savastano, 1999. "Exchange
maintaining a parsimonious model for tractability Rates in Emerging Economies: What Do We Know? What Do We
purposes. In particular we use the following variables: Need to Know?," NBER Working Papers 7228, National Bureau of
Economic Research, Inc.i
ii
- Productivity differential (ratio between domestic and Bela Balassa, 1964."The Purchasing-Power Parity Doctrine: A
foreign total factor productivities). This is a proxy for Reappraisal," Journal of Political Economy, University of Chicago
Press, vol. 72, pp. 584.
relative productivities of the tradable and non-tradable iii
Philip R. Lane & Gian Maria Milesi-Ferretti, 2006."The External
sectors, capturing the well known Balassa-Samuelson
Wealth of Nations Mark II: Revised and Extended Estimates of
effect (a higher productivity differential produces a relative Foreign Assets and Liabilities,1970-2004," The Institute for
appreciation of the currency). ii International Integration Studies Discussion Paper Series 126.
iv
Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and
- Net Foreign Assets (ratio between net foreign assets Error Correction: Representation, Estimation, and Testing,"
and GDP). This variable captures the potential inter- Econometrica, Econometric Society, vol. 55(2), pp. 251-76,
March.
temporally financing of the current account with net
holdings of foreign assets. iii

Appendix: FX Strategy Summary

China Authorities have yet to signal worries of a slow Sell 1Y USD/CNY NDF with trailing stop-loss of Positioning unwind extends; authorities pushing
down in economic activity. Monetary policy 1.5%. spot higher in retaliation to US protectionists
remains focus on stabilizing inflation and measures
authorities are allowing gradual appreciation of the
RMB.
Hong Kong We do not think HKMA will change its USD peg in Neutral HKMA surprises with a policy change
the near-term. HKD has been trading in line with H-
shares, and we suggest watching signs of policy
easing in China, which would be a catalyst for a
renewed rally in H-shares and HKD.
India India runs a huge C/A deficits and is dependent on Bearish. Negative risk sentiment due to external factors or
foreign inflows to fund its deficits. Weak market domestic corporate governance issues.
sentiment limits portfolio inflows, while RBI is not
showing effort to stabilize its currency through FX
intervention.
Indonesia Recent move by the central bank to cut interest Neutral Sharp acceleration in inflation or global risk
rates, as well as hints of more cuts ahead, could aversion causing heavier bond outflows.
dampen foreign bond inflows somewhat. However
FDI and C/A inflows remain strong and should
provide support for the IDR.
Malaysia The MYR has a high beta to global sentiments. A Neutral Weak growth environment causing BNM to be
bullish mid-term view is still warranted given the more defensive on FX.
strong C/A and growing FDI inflows, though a
stabilization in risk sentiment is needed before the
MYR resumes its uptrend.
Philippines BoP underpinned by steady growth in remittances Positive, with a 3M target of 42.5 Oil / food price shocks dragging down the BoP.
and outsourcing inflows. Seasonals are turning
favourable for the peso and remittances are likely
to pick up ahead of the year-end festive period.
Singapore With SGD NEER spot and forwards still trading Neutral A sharp slowdown in economic growth leading
below the mid-band, there remains scope for SGD MAS to shift to a neutral policy
to appreciate vs. the basket. However, the beta of
SGD to external drivers is exceptionally high and
SGD is thus vulnerable to swings in the euro and
global risk.
South Korea Positive on valuations and strong C/A surplus. Neutral Heightening of geopolitical tensions, tightening of
External contagion and a tightening of USD funding USD funding and capital controls.
remains a key risk, but BoK is likely to intervene
more actively if spot attempts to break the 1200
level.
Thailand Recent severe flooding in Thailand is likely to Neutral A more severe slowdown in global demand leading
dampen economic activity and investor sentiment. to weaker demand for Thai exports.
BoT may not cut rates in the near-term, but is
likely to prevent outperformance of the THB
relative to regional currencies to provide some
support for exporters.
Taiwan The beta of Taiwan's growth to G2 demand is Prefer to use TWD as a funding currency for intra- A sharp slowdown in exports growth leading CBC
high. CBC is likely to limit TWD appreciation to Asia carry trades. to intervene more aggressively.
support exports in a weak growth environment.
Czech Few catalysts for downside in EUR/CZK. CZK has Neutral Significant slowdown in the key German export
become a cheap hedge against Euro woes - this is market and continued euro related risk aversion
unlikely to change in the short term. Sidelined for will hurt the koruna.
now.
Egypt Political stability and resumption of talks with IMF Neutral on USD/EGP. Political risk after the planned election due to end
will hold the key. in Jan '12 and swings in global risk appetite.

Appendix: FX Strategy Summary Cont’d

Israel Escalation of the ongoing conflict with Iran, Tactical sellers of EUR/ILS at levels above 5.10. Increased geo-political tensions in the Middle East
continued social unease over living costs as well and expectations for further rate cuts will
as a further deterioration in the trade balance, we undermine ILS.
do not find risk-rewards in being long ILS spot quite
as attractive anymore.
Kazakhstan Domestic backdrop improving. Neutral but should outperform neighbouring UAH Sharp correction oil prices and sustained risk
NDFs aversion.
Poland Cautiously constructive. This is based on strong Long PLN/HUF (target around 72). Long 1y vanilla Emergency hikes from NBH and the fact that PLN
economic momentum, sticky inflation and EUR/PLN put at 2% of EUR notional. has to some degree become a hostage of the
commentary towards the hawkish side from NBP Eurozone crisis.
and positive developments on the fiscal front.
Longer term valuation is attractive.
Romania Despite an improving macro backdrop, we do not Neutral. Generalised risk aversion and lower oil prices.
see meaningful catalysts for a significant sell off in
EUR/RON in a risk positive scenario. Upside in
EUR/RON should be limited by NBR intervention.
South Africa Remains default risk-on/off choice, regardless of Our preference remains to express constructive ZAR currently has one of the highest EUR/USD
fundamentals (limited gross external financing ZAR views through relative value trades. We betas, meaning it might suffer more in any risk led
requirements and attractive LT valuation). Fate of recommend long ZAR versus an equally weighted sell off.
the rand will be determined by European rather basket of similarly high betas AUD and HUF.
than domestic factors. Otherwise, buy a 1y digital EUR/ZAR put struck at
10 for 25% of EUR notional.
Turkey Is one of the worst performing EM currencies, Trade ranges, or alternatively, but a short dated Global recession fears and the consequential
having lost 19% vs USD and 21% vs EUR. Going DnT with strikes at 1.70 and 1.90. drying up of financing flows would hurt the lira.
forward, we expect the lira to stay rangebound
between 1.75-1.90.
Ukraine The three most important factors for the UAH are Bearish NDFs. One positive that could emerge is reduction in gas
gas price negotiations with Russia, risk appetite in price charged by Russia. Press reports that this
macro markets and domestic economic and could be up to 40% (i.e. to $225/mcm from
political developments. The risks to all three are $355/mcm in 3Q '11) - saving Ukraine $500m/y.
negative in our view.
Argentina The government will find it increasingly difficult to We recommend avoiding exposure to the NFD Elevated risks and low liquidity
avoid any meaningful depreciation due to the curve, but some investors may find attractive the
combination of worrisome levels of capital flight elevated carry in the front-end.
and double digit inflation.
Brazil The BRL –as other liquid EM currencies- has Positioning for potential short-term retracement Carry is expected to decrease further as the
suffered from increased volatility on the back of with zero-cost 1x2 USD/BRL put spreads. central bank continues easing monetary conditions
developments in core markets. aggressively with a focus on economic activity.
Chile During next year, the CLP will continue to be Maintain a short EUR/CLP position The main short-term risks are related to the direct
affected by the continuous revisions of and indirect effects of a potential escalation in the
expectations regarding global growth and copper European crisis.
prices.
Colombia Fundamentals keeps improving the medium-term We remain on the sidelines, waiting for better The currency could also suffer from a more
prospects for the COP. entry levels at the beginning of next year. challenging global environment.
Mexico MXN was one of the currencies which suffered Taking profits in our long MXN/CZK Swings in risk aversion originating from the
the most from recent market volatility. recommendation and switching to short external enviroment.
CAD/MXN.
Peru The successful Central Bank intervention in the FX We recommend maintaining 3M USD/PEN NDF. The risks, in our view, are biased toward
market has shielded the PEN from the recent depreciation.
volatility in global financial markets.

 Given the circumstances, 2011 has been another would expect all vulnerable EM sovereigns to sell off
strong year for EM sovereign credit. Although the substantially. In positioning to defend against such a
total return has not been high, there are very few scenario, we would argue that it would be better to be
asset classes which have produced a better underweight (or short) the more vulnerable credits with
performance. lower yields (e.g. Ukraine and Hungary) than the traditional
highest betas (Argentina and Venezuela). This approach
 In this article we highlight how country selection (as
towards defending against the crisis scenario results in a
opposed to simple beta-management) has been a key
rough barbell approach to risk allocation.
factor in portfolio selection in 2011. With this in
mind, we devote much of this year’s outlook to a
In terms of the overall return outlook for the asset class
thorough examination of specific country factors
we are not optimistic that we will see much better than
(pricing, macro and technical).
mid-single digit returns in 2012. The only scenario which
 For 2012 our strategic recommendations are to be could bring an upside to this would be one in which
overweight exposure to Venezuela, Colombia, Poland, spreads compress, but UST yields remain anchored at
Russia, and Turkey; underweight exposure to their current low levels. Ultimately however, we see an
Hungary, Ukraine, Chile and South Africa. environment in which very few asset classes offer a
compelling value/risk proposition and in this environment
EM sovereign credit may well prove to be the least ugly.
Given the circumstances, 2011 has been another strong
year for EM sovereign credit. Although the total return has
not been high, there are very few asset classes which Taking Stock of 2011
have produced a better performance. In hindsight, a key
Sovereign credit has outperformed yet again in 2011…
factor behind the overall performance of the asset class
As we discuss in EM Performance: grass is greyer on the
was the diversity of performance within it. Indeed, 2011
other side, 2011 has been another year of outperformance
was very much a year in which alpha dominated beta for
of EM assets and, in particular, sovereign credit. The total
EM sovereign credit.
return of the EMBI Global is higher than US IG (despite
EM having a lower average rating) and only slightly lower
In this respect, we expect 2012 to bring more of the same
than that of USTs (see the graph below).
behaviour and so we devote much of this outlook toward
trying to identify the potential ‘winners and losers’ for
During a year of heightened risk aversion, EM Sovereign
2012. We examine a variety of factors in determining the
Credit seems fairly close to being a ‘safe-haven’.
appropriate country selection. These factors cover market
pricing, macro fundamentals and technicals (supply,
2011 YTD performances of major asset classes
demand and positioning).
The main exogenous source of risk for EM sovereign

credit remains the crisis in the eurozone. However, while
2011 saw the can being ‘kicked down the road’ (albeit by
progressively shorter distances), we believe that 2012 will
bring greater resolution. Muddling through is unlikely to
be an option for much longer, suggesting a fairly binary
set of possible outcomes with respect to asset price
performance. In the positive scenario (some form of fiscal
union and ECB intervention) risk appetite should be
strong, benefiting EM sovereign debt. However, the likely
continued weakness in the global economy, exacerbated
by ongoing bank deleveraging, will mean that Source: Deutsche Bank
vulnerabilities will remain for some EM countries. The

negative scenario (the eurozone crisis deepens and fears …but it can’t be ignored that yet again USTs were a
of a break up of the currency union and/or sovereign significant contributor to performance
defaults escalate) would be hugely disruptive for global Clearly, EM credit once again benefited from lower US
markets and for global capital flows. In such a scenario we yields. The graphs below show the UST rally has

accounted for most of the positive total returns of DB- EM Sovereign spreads have been highly correlated
EMSI constituents. With the notable exceptions of with the US corporate credit market
Ukraine, Egypt, and Argentina, the stellar performance of
Libor spread, bp
USTs has more than offset the widening in spreads. The
450
best performers have been, not surprisingly, low-beta,
high-quality LatAm credits. Only in Venezuela were yields
400
(and carry) high enough to more than compensate for the
widening in spread seen in 2011.
350
Sovereign credit: UST more than offsets wider 300

spreads
YTD Total Return and UST Contributions 250
20% Total Return UST Contribution
200
15%
Nov-09 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Nov-11
10%
Median for US/EU corporates* EM Sovereigns
5%
0%
compare EM to the corporate market alone, since the

-5%
EC UY PE PA MX CO VE BR PH ID EM ZA CL LB RU SV HU TR PL BG UA EG AR majority of EM sovereigns do not suffer from the same
5Y CDS Total Returns, YTD pressures that have led to the re-pricing of financials
10%
8%
(excess leverage and uncertain funding costs).
6%
4%
The second reason for us to believe that EM sovereigns
2%
0% continue to offer value over and above US corporates is
-2%
because we continue to see an underlying positive rating
-4%
-6% migration in the asset class. As we discuss later, we
-8%
expect upgrades to continue to outpace downgrades by a
-10%
VE QA MX CO PE BR PH PA LV ZA IL KZ MY RU ID CZ RO HU PL TR BG UA AR HR SK significant degree during 2012. Such migration leads EM
Source: Deutsche Bank to outperform, even if the relative level of spreads at a
given rating remains constant.
However, this simple picture of a year dominated by
lower UST yields and wider credit spreads is misleading. 2011 has been a year in which ‘alpha’ has dominated
The reality was more complex. 2011 was very much a inter-country returns
year of two halves as the chart below illustrates. For the Historically, EM sovereign credit has been a market
first seven months of the year, spreads were tightly dominated by ‘beta’. During most calendar years, a large
range-bound, while USTs rallied. Then, in late July, degree of the variation in the returns of different countries
spreads dramatically broke out of that range as the can be explained simply by market ‘beta’. This beta can
combination of fiscal concerns in the US and financing be reflected in the yield and volatility of the individual
concerns in Europe both lead to a sharp increase in risk components.
aversion.
However, 2011 has been far from the norm in this respect
The chart below highlights that the level of spreads for as the chart below shows. For each calendar year (and
EM sovereigns has remained closely in-line with the level 2011 YTD) we regressed the annual returns of each
of spreads for equivalently rated US corporates for much country against three different factors: (a) the yield of
of the past two years. Does this mean that EM each country at the start of the year, (b) the volatility of
sovereigns are at fair value and hence offer little upside the country in the previous year and (c) the net change in
vs. corporate credit? We think not, for two reasons. rating notches during the year.
First, credit markets are currently pricing two fairly distinct

markets: corporates and financials, with the latter priced
significantly wider than the former, at the same rating.
While the chart above represents the blend of these two
markets, we believe that it is more appropriate to

Differences in yield and volatility did not explain We expect 2012 to be another year in which upgrades
relative country performance in 2011 dominate for EM sovereigns
2011 was again a year in which upgrades outpaced
Explanatory factors for relative country performance,
Rating change Yield (at start)
downgrades – particularly during the second quarter when
R2 Volatility (prev yr) All three combined the pace of sovereign upgrades in EM reached its highest
1.0 level in almost four years. More recently the actions have
0.9 been more balanced, with Egypt, Hungary and Venezuela
0.8 all suffering downgrades, but we remain optimistic for
0.7
2012.
0.6
0.5
0.4 Looking across the major EM sovereign credits, we
0.3 believe that upgrades could be expected for Argentina,
0.2 Brazil, Colombia, Peru, Russia, Turkey and Indonesia. On
0.1
the other hand we believe that Hungary and Ukraine are
0.0
2004 2005 2006 2007 2008 2009 2010 2011
both likely to suffer further downgrades.
YTD
Source: Deutsche Bank Most countries face higher than usual external debt
payments in 2012
It is clear that in most years the beta factors alone (yield
Since the 2008 financial crisis, external issuance by EM
and volatility) can explain a large degree of the variation in
governments and private sector entities has been
inter-country returns. However, in 2011 (just as in 2006)
extremely strong, breaking the records set pre-crisis. For
these factors have explained virtually none of the
governments, the increased issuance has been to finance
variation. On the other hand, the ratings changes which
looser fiscal positions and has arisen due to many new
have occurred explain a significant proportion of the
borrowers tapping the market for the first time. For
variation. Indeed, with the exception of the years in which
corporates the increase in bond issues as been in part to
beta dominates, ratings are a consistently significant
substitute for the contraction in bank lending as
factor in explaining the return variation.
developed market banks have reduced their balance
It may seem to be stating the obvious that changes in sheets. We expect both the factors to continue to
credit ratings can explain return variation. However, given influence issuance and hence we expect the pipeline of
the scepticism regarding the value of the ratings and issuance to remain robust.
given that the agencies certainly have a tendency to lag
the market, it is nevertheless an interesting result which An additional reason to expect issuance to remain high in
justifies examining possible rating changes for the year 2012 is that the majority of EM sovereigns are facing
ahead. higher than usual external debt payments (principal and
interest) in 2012. As the chart below shows, for some
countries the repayments in 2012 are up to 2-4 times the
average amount in the prior three years.
Upgrades have generally outpaced downgrade, but it
is clear that the agencies remain very active
Rolling 3-mth ratings changes (as a % of number of rated sovereign We expect 2012 to be another year in which upgrades
EM issuers) dominate for EM sovereigns
25%
Downgrades Proportion of upgrades
20% 40%
Upgrades
30%
15%
20%
10% 10%
5% 0%
10%
0%
20%
05 06 07 08 09 10 11 12
30%
Source: Deutsche Bank Proportion of downgrades
40%
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12

Despite the market turmoil in recent months, EM Most countries face higher than usual external debt
issuance in 2011 has been close to last year’s record payments in 2012, some as much as 2-4x higher
External debt payments in 2012 (principal and interest), USD
Gross external issuance, USD equivalent bn
8bn
Jan-Nov (Full year outcome is indicated by error bars) 2012 Payments = 3Y Avg PL BR
TR
140 2012 Payments 2x/0.5x Avg
4bn HU AR
2012 Payments 4x/0.25x Avg RU
120 Corporate MX
CO
VE
Financial 2bn SI LT LB
ZA
100 Sovereign
RO PE ID PH
1bn
CL UA
80 LK JM QA
CZ PA
500mm CS
60 HR
SK AE
KR UY
40 250mm SV IL
BH
BG EG
20 125mm MAKY DO IQ MY
VN
EC
0 PK CN
GA GH
2004 2005 2006 2007 2008 2009 2010 2011 50mm
50mm 125mm 250mm 500mm 1bn 2bn 4bn 8bn
Source: Deutsche Bank Average annual external debt payments (2009-11), USD
These payments (approx. USD60bn in total for 2012) can

be seen as both positive and negative. For the market as If all countries in the chart below were to issue the gross
a whole they should be a positive factor, as we would amounts indicated in the chart, the total amount of
expect a large proportion to be recycled. However, for issuance would be USD75-85bn (75bn based on the blue
the individual countries facing higher gross external bars, 85bn based on the grey bars)
financing needs, they are potentially a negative factor.
Those countries which have deep, flexible domestic Gross borrowing in 2012 projections vs. estimates
markets should be less susceptible to this pressure, since
based on past 3Y average
they should be able to be more flexible in the external
borrowing plans.
Ultimately, whether it is a positive or negative factor likely

comes down to the net issuance by individual countries.
We illustrate this indirectly in the chart below. The chart

shows (a) the estimated gross borrowing per country
assuming that the net issuance is the same as the
average of the past three years, and (b) our own estimates
of gross issuance. The difference between the two bars
is effectively the difference in the net issuance between
what we expect (or what has been stated by officials) and
what has been the average outcome over the past three
years.
The chart highlights that many of the larger EM borrowers

are cutting back on net issuance, while there is expected
to be a substantial increase in net issuance by the smaller
countries and less frequent borrowers.
Notable exceptions to this are Hungary, Ukraine, UAE (in

which we include both Abu Dhabi and Dubai) and Russia. * The estimated gross issuance is compiled from a variety of sources (official
For the former two the financing needs which drive the statements, budgets, comments from government officials and, in some cases
conjecture based on our assessment of needs).
issuance expectations are more pressing. If the market is Source: Deutsche Bank
not conducive to the significant amount of issuance

implied for Hungary and Ukraine then they will need to
find alternative sources or make further fiscal
adjustments.

Dedicated investors have cut exposure to the ‘high investors have been actively 15 adding/reducing exposure
betas’ to a given country. In order to do this we construct an
According to the latest data on investor positioning (end- index which represents the net proportion of funds in the
Oct), investors have cut back on exposure to the higher sample which have added exposure. This index is
yielding sovereign credits in EM. In another article in this computed for each country, for each month. The chart
report13 we introduce a new approach to analyzing data on below shows the three month moving average for each
dedicated fund exposures. In this approach we have two country.
measures to assess the potential impact of dedicated
funds: (a) Positioning (evidenced by a z-score measure of Appetite has recently been strong for core IG
the fund exposure relative to the reference benchmark, sovereign credits
and (b) An ‘appetite’ index which measures the relative B u y e r s v s e lle r s in d e x , 3 m M A *
proportion of funds in the sample which have been + 0 .4

O ct 11
actively adding to their exposure to a given country, + 0 .3
P re v . M th
versus those that have been reducing. + 0 .2
The chart below illustrates the positioning score. Note + 0 .1
that exposure to Argentina, Hungary, Ukraine and 0
-0 .1
Dedicated funds have reduced exposure to high beta
-0 .2
credits
-0 .3
E x p o s u r e Z -s c o r e * ZA : : BR : : CL : :MY : : PK : : UY : : EG : : PA : : SV : :
4 .0 RS : PL : CO : RU : PH : KR : BG : GH : UA :
O ct 11 MX TR TN VN AR PE VE HU ID
3 .0
* -N u m b e r o f f u n d s a c t iv e ly in c r e a s in g e x p o s u r e m in u s n u m b e r o f f u n d s a c t iv e ly
P re v . M th
2 .0 d e c r e a s in g e x p o s u r e , d iv id e d b y t h e t o t a l n u m b e r o f f u n d s
1 .0
0 .0
-1 .0 The chart indicates that fund managers have been adding

-2 .0
exposure to the core investment grade credits (BR, MX,
-3 .0
ZA, PL) along with Serbia (which issued a Eurobond in late
-4 .0
September). At the other end of the spectrum, funds
RS : : VN : : BG : :MX : : TR : :MY : : GH : : EG : : HU : : have been actively reducing exposure to Indonesia,
CL : PE : SV : BR : PH : UY : RU : UA : KR :
Ukraine and El Salvador.
PK PA PL CO ZA TN VE ID AR
* -A v g e x p o s u r e v s b e n c h m a r k , r e la tiv e to 1 2 m th M A , d iv id e d b y S tD e v o f m o n th ly
c h a n g e in e x p o s u r e For further detail on these exposure indicators – along
with time series of both indicators for all countries –
please see the companion article in this report.
Venezuela are all at the far right, with z-scores in the -1
to -3 range 14 , indicating that the exposure of dedicated Survival of the Fittest
funds is well below the average level of the past two The headline theme of this 2012 outlook has been
years. Meanwhile, funds have increased exposure to a ‘Survival of the Fittest’, a theme on which we elaborate in
number of the smaller, less-liquid credits. another of the special reports16 in this publication. In this
special report we introduce a set of indicators to capture
Understanding how dedicated funds are positioned with the relative vulnerability of each country to four key risks:
respect to individual countries can help to shed light on external risks, fiscal risks, financial risks and exogenous
how the bonds of those countries might react to a shock risks. Given that the avoidance of risks is central to asset
(positive of negative). If positioning is biased toward over- allocation within a credit portfolio, such indicators should
or under-weight then we would expect the response to a be very relevant for our assessment of relative country
shock to be similarly biased (overweight leading to a exposures.
negative bias and vice versa). In addition to this indicator
of current positioning, we also like to understand whether
13 15
A Closer Look at Real-Money Positioning We distinguish between active changes in exposure and passive
14 changes, the latter arising from relative price movements. See the
A z-score of 1 implies that for exposure to return to the 2Y average level
(relative to the benchmark) then the required change in exposure would be accompanying article for further discussion of this distinction.
16
1 standard deviation of the historical monthly changes. See: EM: Survival of the Fittest

Unsurprisingly, EMEA dominates the list of the most  Market-implied rating (z-score). While the ‘yield’ is a
vulnerable countries. Five countries (Hungary, Ukraine, useful static, absolute measure of the value offered
Romania, Poland, and Egypt) show up as highly by a credit, it conveys little in the way of relative
vulnerable, though for different reasons. Egypt’s value, either to other credits, or relative to itself over
underlying vulnerabilities, for example, are fiscal first and time. To address this we also look at the market-
external second. Ukraine’s risks are mostly external. implied rating of the credit (as a deviation from the
Hungary’s vulnerability reflects a combination of risks in all actual rating) and also a z-score of this market-implied
four areas. Poland’s risk rating is probably a notch too high rating deviation. For example, in the scorecard below,
according to this mechanical exercise, though it does Turkey has a market-implied rating deviation of -0.7
underscore that the economy does have macro (meaning that the market prices-in an average 0.7
imbalances that have yet to be fully addressed. Romania notch rating improvement across the three agencies).
remains vulnerable but has done a lot of the hard yards in However, the z-score of this deviation is +1.8,
terms of fiscal adjustment and is poised to move to a meaning that the current deviation represents a much
lower risk category. smaller deviation than the past 1-year average.
Macro fundamentals
Outside of EMEA, only Malaysia makes it on to our list of
countries with medium risk ratings mainly reflecting the
 Vulnerability indicators. As discussed, we present the
high level of foreign bank claims on the country (which
four vulnerability indicators which are described in the
may be overstated) and moderate concerns about the
article ‘EM: Survival of the Fittest’.
country’s public finances.
 Forecast rating changes: We present forecasts of
Forced fiscal adjustments, together with some structural likely rating changes over the coming year, based on
reforms, and overly conservative financial regulation in the expectations of our economics team. A value of
response to a severe external crisis in the 90s have one indicates a one-notch change by all three
allowed LatAm to converge to a relatively safe status. agencies. A value of 1/3 would indicate a one notch
Increasing dependency on commodities is probably the change by a single agency.
major short term vulnerability. Complacency regarding
Technicals
long term fiscal rigidities with spending concentrated in
current spending is probably the main yellow light for the  Real-money positioning and appetite. As discussed
medium term. previously, we look at two indicators based on the
exposures of dedicated real-money funds. The
Strategy Recommendations positioning indicator is a z-score of the current
average exposure deviation, versus the average
As discussed in the introduction, we expect country deviation of the past two years. The ‘appetite’
selection rather than simple beta-management to be key indicator is a measure of the net proportion of funds
to portfolio outperformance in 2012. To help identify the in the sample which have been actively adding (or
potential ‘winners and losers’ for 2012, we compare a reducing) exposure to the country.
variety of factors, based largely on the preceding
 Supply/demand (gross payments and expected net
discussion. These factors cover market pricing, macro
issuance). We show the gross payments due from
fundamentals and technicals (supply, demand and
each credit; what this amount represents as a
positioning).
multiple of the average payments from the past three
years and also the expected net issuance by the
On the following page we present a simple scorecard of
country.
the factors which influence our views. We divide these
factors into three groups: To highlight the positive and negative factors we highlight
appropriate values in the score card. For most indicators
Market Factors we highlight the top and bottom four values in each
column. For rating changes we highlight all values. For
 Yield and Spread. As discussed earlier, in most years the vulnerability indicators we highlight the values
yield differences alone can explain a large degree of corresponding to ‘medium risk’ and ‘high risk’ according
the variation in country returns. While we do not to the methodology discussed in the accompanying
expect 2012 to be such a ‘beta’ year, but report.
nevertheless yield remains an important factor in our
On the basis of these indicators, and also considering
selection.
additional subjective factors (such as political risk etc.) we
arrive at the following investment recommendations.

Strategic overweights Valuation, rating outlook and fund positioning are all
favourable and although net issuance may be
 Venezuela substantial, this would only take place in the context
Though Venezuela presents a clear case of credit of a very supportive market. 2012 is an important
deterioration and features some of the worst year for Russia with likely WTO accession and the
technical conditions due to large amount of net passage of elections. While we are not very
issuances, valuation looks extremely attractive, and in optimistic that the return of Putin to the Kremlin will
our view, has not sufficiently priced in the chance for spur reform, we believe that the market currently
a relatively peaceful transition of power to the prices an excessive risk premium.
opposition in 2012 (meaningfully large than 50% in
 Turkey
our view), which will likely lead to a significant (albeit
While we remain concerned about the direction of
gradual) shift of political and economic policy down
monetary policy and the risks of a hard landing for the
the road. The main risk is the potential volatility during
economy, from a sovereign credit perspective Turkey
the election process and doubt on whether the
looks fairly positive. Given the healthy primary
transition of power will be done peacefully. For this
surplus, moderate debt stock and low real rates, the
reason, we would keep only a small overweight in the
credit spreads on bonds of well above 300bp seems
near terms.
incongruous. Certainly some premium is warranted
 Colombia given the aforementioned risks, but Turkey’s debt
Colombia presented a prominent case of ascension in dynamics are considerably less vulnerable than in the
the credit standing in 2011, with significantly past. Relative to the EM sovereign market as a whole
improvement of the country’s political and economic Turkey credit is cheap on a historical basis.
environment over the past few years reaping benefits
 Poland
as it joined the investment grade club. It remains
On the scorecard, the picture for Poland is mixed. It
marginally more risky in comparison with its regional
is rated as high risk on the vulnerability indicators,
high grade peers according to our vulnerability
real-money investors are modestly overweight and
indicators, but the positive trend and marginally better
repayments are high. On the flip side, we expect net
valuation are keys to our strategic overweight
issuance to be negative, which would be a substantial
recommendation on Colombia in 2012.
change from prior years and, perhaps most
 Russia importantly, it has cheapened considerably in recent
On all the ‘domestic’ vulnerability indicators, Russia is months. In fact, the extent of the change in the
clearly one of the least vulnerable countries in EMEA. market-implied rating is similar to that of Ukraine,
External vulnerability is however significant, a Hungary and Argentina, which we think is wholly
consequence of its heavy reliance on oil exports. unjustified. Furthermore, as we discuss in ‘EM:
Country Scorecard
Market Factors Macro fundamentals Technicals Recommendation
DB F'cst
Yield Z-Spd Market-Implied Vulnerability Rating Chg Real-Money Funds Supply Exp.
% bp Rating Z-Score Ext. Fisc. Fin. Exo. Up Dwn Pos'n App. Pmts Net Iss.
Latin America
Argentina 11.8 1037 +3.0 +2.4 0.15 0.13 0.25 0.20 0.7 -3 -2 4.2 0.9x -4.2 Neutral Argentina
Brazil 3.5 162 -3.5 +0.0 0.15 0.38 0.25 0.58 0.7 +1 +22 5.6 1.2x -2.6 Neutral Brazil
Chile 2.3 68 -3.9 -2.5 0.15 0.00 0.50 0.70 +4 +13 0.8 3.6x -0.8 U/W Chile
Colombia 3.6 174 -3.4 -1.0 0.15 0.25 0.25 0.66 0.3 +1 +12 1.9 1.4x +0.1 O/W Colombia
Mexico 3.6 168 -3.0 -1.4 0.00 0.13 0.13 0.85 +1 +27 3.4 0.7x +0.1 Neutral Mexico
Peru 4.5 222 -1.8 -0.2 n.a. n.a. n.a. n.a. 0.3 +2 -7 1.4 1.9x +0.6 Neutral Peru
Uruguay 4.6 221 -3.2 -1.2 n.a. n.a. n.a. n.a. -0 -4 0.4 0.8x -0.4 Uruguay
Venezuela 14.0 1219 +5.4 -1.3 n.a. n.a. n.a. n.a. -1 -9 2.5 0.9x +4.0 O/W Venezuela
EMEA
Egypt 7.2 509 +0.5 +0.5 0.50 1.00 0.00 0.26 -7 0.1 0.3x +1.9 Neutral Egypt
Hungary 7.5 566 +4.5 +2.1 0.30 0.75 0.63 1.31 0.3 -2 -10 3.2 1.3x +1.8 U/W Hungary
Poland 4.3 282 +3.3 +2.4 0.60 0.63 0.38 0.62 +1 +19 6.6 2.2x -0.6 O/W Poland
Russia 4.4 260 +0.8 +0.6 0.00 0.00 0.13 1.75 1.0 -1 +4 3.8 0.7x +3.2 O/W Russia
South Africa 3.8 197 -0.2 +0.7 0.45 0.25 0.25 0.59 +0 +34 1.5 2.4x +0.5 Neutral South Africa
Turkey 5.2 340 -0.7 +1.8 0.45 0.13 0.25 1.49 0.3 +0 +13 5.3 1.0x -0.8 O/W Turkey
Ukraine 9.6 814 +2.9 +2.6 0.75 0.25 0.38 3.36 1.0 -2 -20 1.1 1.0x +1.9 U/W Ukraine
Asia
Indonesia 4.2 244 -2.7 -0.1 0.00 0.00 0.00 0.07 0.7 -2 -22 1.6 1.2x +1.7 Neutral Indonesia
Malaysia 3.3 172 -0.5 +0.6 0.15 0.25 0.50 1.22 +0 +6 0.1 0.1x -0.1 Neutral Malaysia
Philippines 4.1 209 -4.5 -0.8 0.00 0.63 0.00 0.64 +0 -1 1.7 0.5x +0.6 Neutral Philippines

Survival of the Fittest’ we feel that the vulnerability creating a non-supportive technical condition. We
indicators are overly harsh on Poland as they do not look to buy Chile CDS as a defensive trade.
take account of some key offsetting features.
Further, we note that while the scorecard as a very useful
Strategic underweights reference that influences our views, it does not capture all
the aspects we need to consider in order to make a
 Hungary
comprehensive decision on our country positioning
Hungary appears as the most vulnerable of all EM
recommendations, especially those that are qualitative in
countries on the vulnerability indicators and while
nature. We take exceptions to what the scorecard
valuation and positioning are supportive, we do not
suggests to us regarding:
believe they are sufficient to offset the risks. 2012 is
set to be particularly challenging given the
 Argentina
government’s need to raise a substantial amount on
Strategically, we recommend a neutral position on
the external bond market. If this is not forthcoming,
Argentina in 2012 even though the scorecard
then an agreement with the IMF seems critical.
suggests overweight. In our view, Argentina’s main
However, to secure such an agreement would likely
vulnerability lies in the erosion of investors’
require a radical change of approach from the
confidence (caused by the risk of medium term
government and we are not convinced that this
economic crisis in the absence of policy change)
government would be willing to stomach such a
coupled with significant capital flight. In addition, in
change.
terms of technicals, Argentina’s large negative net
 Ukraine issuance is more indicative of lack of a conventional
Unsurprisingly, Ukraine comes out poorly on the market based means of financing (for well
vulnerability indicators, but valuation and positioning documented reasons) rather than presenting good
are supportive. Our primary concern is the tightness technicals.
of financing conditions raising the risk of credit
 Indonesia and the Philippines
problems in the coming year. The treasury continues
Even though the vulnerability indicators look positive
to struggle to execute its domestic borrowing plan
for Indonesia, its underperformance in September
and is reliant on the NBU for financing. Net claims of
and October suggests that Indonesia remains very
the NBU on the central government have more than
sensitive to a weakening of risk sentiment due to the
doubled since the end of May, reaching approx.
lack of a strong local bid (unlike in the Philippines). In
USD8bn. A deal with Russia on gas prices would
our view, this lack of defensive prevents us from
certainly be positive, but we are not convinced that it
holding a strategic overweight recommendation on
would be sufficient to mitigate the risks and reverse
Indonesia, despite its solid and improving macro
sentiment.
fundamentals. In fact, we have recently been
 South Africa underweight Indonesia. However, we would now
The combination of increased gross issuance ahead, take the opportunity of Indonesia’s underperformance
coupled with the fact that dedicated investors are to cover underweight and move to neutral tactically.
already relatively overweight the credit persuades us
to be cautious. Furthermore, as our vulnerability In terms of the Philippines, while we acknowledge
indicators highlight, SA is not entirely immune to the the weakness apparent in its fiscal vulnerability
risks which characterise much of EMEA. indicators, the strong investor sponsorship for its
external debt more than compensate this shortfall.
 Chile
We hence recommend a strategically neutral
Despite its solid fundamentals, the tight credit
exposure to the Philippines.
spread, financial risk (albeit moderate) as shown in
our vulnerability indicators, and the likely lack of Marc Balston, London, 44 207 547 1484
support from the USTs in 2012 mean risk is biased Hongtao Jiang, New York, 1 212 250 2524
towards lower returns. In addition, real money
investors have been significantly overweight Chile,

Appendix: Credit Strategy Summary

Hungary Clearly one of the most vulnerable credits in CEE. Underweight cash A short position is likely to be costly in a general
External financing could be challenging in 2012 market rally, but the risk-reward still justifies the
absent a new IMF program. position.
Kazakhstan With plenty of opportunities in the Russian Neutral.
sovereign/quasi-sovereign space there is little
reason to take exposure in Kazakhstan at present
Poland Recent underperformance provides the potential Overweight. The newly re-elected government fails to deliver a
for outperformance should the new government credible fiscal adjustment.
deliver a credible fiscal plan. Poland is one of the
few EM credits with the potential to deliver a
positive catalyst.
Romania Risks to economic performance are mounting, but Overweight Renewed pressure on eurozone sovereigns.
the government’s commitment to fiscal
adjustment and its good relationship with the IMF
should stand the country in good stead to weather
potential storms ahead.
Russia Valuation, rating outlook and fund positioning are all Overweight With the budget assumption for oil now raised to
favourable and although net issuance may be $93bbl (Urals), the risk from a drop in oil prices
substantial, this would only take place in the has risen.
context of a very supportive market.
South Africa Increased gross issuance ahead, coupled with the Underweight Increase issuance, to the extent that it leads to a
fact that dedicated investors are already relatively higher benchmark weight, could limit the
overweight the credit persuades us to be cautious. downside.
Turkey Turkey sovereign credit is the cheapest it has been Overweight. Shorten duration to capitalize on the Turkey weathered the 2008-09 crisis well, but the
in three years, relative to EM. Concerns over very flat cash curve. 2015s represent the 'sweet current unconventional policy mix risks sacrificing
monetary policy have diverted attention from spot'. those gains.
strong fiscal performance.
Ukraine Sources of financing are diminishing, Little Remain underweight. A volte-face on domestic gas prices and/or some
likelihood of IMF disbursement; eurobond issuance leeway from Russia on the Gazprom contract
is hard to imagine and even domestic issuance is could ease the pressure,
proving challenging.
Argentina The external risk environment in 2012 is unlikely to Stay neutral, favor global bonds (especially the A surprise shift to market friendly policies takes
be supportive for Argentina, and we remain Global 17s) over local law bonds. Long basis on place and renders our conservative approach a
doubtful there will be any meaningful policy Global 17s vs. 5Y CDS. losing proposition.
changes. But attractive valuation looks attractive.
Brazil Though fiscal performance appears to be on track Stay neutral and continue to favor 41s and 40s (to Notional Treasury does not resume buying back
in 2011, we project it to underperform budget in call) vs. 21s. Sell basis (10Y vs. 21s). legacy bonds, causing 5Y sector to underperform;
2012. Brazil taps long end of the curve, causing further
steepening.
Chile Despite its solid fundamentals, its tight spread and Underweight and look to buy CDS as a defensive
the likely lack of support from the USTs in 2012 trade.
mean risk is biased towards lower returns.
Colombia Macro momentum remains strong and valuation is Stay overweight and favor shorter-end of the Historically, a higher beta credit than regional
still marginally more attractive valuation relative to curve peers - whether this has changed is yet to be
its LatAm low beta peers. tested
Mexico Valuation does not look attractive, but Mexico is Neutral. The old 19s remain significantly rich to the Sharper than expected slowdown in the US and
among the credits having the lowest risk on our curve. lower oil prices.
vulnerability indicators. Improving US economic
activity is also supportive.
Peru While we value Peru’s stability drawn from its Increase to overweight, take profit in the 37s to Policy risk remains given President Humala’s
fundamental strength, valuation also looks 19s switch and now favor the long end of the political background, though it will unlikely be a
marginally more attractive in comparison with curve. serious concern in the near term.
Brazil and Mexico.
Venezuela Attractive yields, high oil prices, and medium-term Increase to a small overweight, favoring Republic Volatility of political origin
prospects for political change will continue to play over PDVSA. Stay long basis on the sovereign
in Venezuela' favor relative to its high-yielding curve (24s vs. 10Y), and also long PDVSA 22s vs.
peers. Venezuela 10Y CDS.


 We present a new framework for assessing relative Downgrades to DB growth forecasts since July
vulnerabilities across EM in a systematic manner Change in 2012 GDP growth forecast, ppts
using external, fiscal, financial, and growth sensitivity 0
indicators.
-0.5
 EMEA dominates our list of the most vulnerable
countries. Five countries (Hungary, Ukraine, Romania,
-1
Poland, and Egypt) show up as highly vulnerable,
though for different reasons. Egypt’s underlying
vulnerabilities, for example, are fiscal first and external -1.5
second. Ukraine’s risks are mostly external. Hungary’s

vulnerability reflects a combination of risks in all four -2
areas.
-2.5
 Poland’s risk rating is probably a notch too high
US Eurozone EMEA Asia Latin
according to this mechanical exercise, though it does America
underscore that the economy does have macro Source: Deutsche Bank
imbalances that have yet to be fully addressed.

EM resilience is clearly being tested, though we continue
Romania remains vulnerable but has done a lot of the
to think that growth will remain well above that in DM at
hard yards in terms of fiscal adjustment and is poised
an aggregate level. EM and DM cycles have become
to move to a lower risk category.
increasingly correlated over the last 10-20 years as EM
 Outside of EMEA, only Malaysia makes it on to our economies have become more integrated with global
list of countries with medium risk ratings mainly economic and financial markets – i.e. cyclical coupling.
reflecting the high level of foreign bank claims on the Once we strip out the cycle, however, trend growth rates
country (which may be overstated) and moderate have moved firmly in favour of EM and we would expect
concerns about the country’s public finances. this positive differential to remain intact next year. This is
illustrated in the chart below – if there is one chart that we
 Forced fiscal adjustments, together with some
have got more mileage out of than any other it is this one,
structural reforms, and overly conservative financial
so we repeat it here for one last time this year.17
regulation in response to a severe external crisis in
the 90s have allowed LatAm to converge to a Cyclical coupling and trend decoupling
relatively safe status. Increasing dependency on Growth (%)
commodities is probably the major short term 6
EM ex. China
vulnerability. Complacency regarding long term fiscal trend
rigidities with spending concentrated in current 4
spending is probably the main yellow light for the DM Trend

2
medium term.
0
EM resilience faces a stern test
The coming year is going to be a difficult one for the -2
DM cycle
world economy. Much of Europe will likely be in recession
and the US will do well to grow at anywhere close to -4 EM ex. China
cycle
trend. Together, Europe and the US are now expected to
-6
grow by 0.9% in 2012 compared with our forecast of
1980 1985 1990 1995 2000 2005 2010
2.6% back in July. Reflecting this, we have downgraded
Source: IMF, Deutsche Bank
our forecasts for EM over the last few months, primarily in
EMEA, whereas we continue to think Asia and Latin The reasons for this EM resilience have been widely
America will be less severely affected. Within EMEA, the discussed elsewhere. We think a big factor has been
current crisis is weighing most heavily on the economies improved economic policies, which have in turn allowed
of central and eastern Europe: we have downgraded our
growth forecast for this region by an average of 2.5%,
even more than our revision for the euro area, and we
17
See also ‚EM: Trend Decoupling but Cyclical Coupling‛ in our July
expect Hungary to fall back into recession next year.
EMM.

many EM economies to reduce debt and accumulate  External sector: current account balance in percent
substantial foreign reserves. This is most clearly visible in of GDP, external debt in percent of GDP, exchange
the public finances (see chart below) where a combination rate valuation (REER vs HP trend), and foreign
of more prudent fiscal management and rapid growth – reserves as a percent of risk-weighted liabilities. The
helped in some cases by financial repression and very low latter is our preferred measure of reserve adequacy
domestic real interest rates – have brought government (see Reserve Adequacy in EMEA in our November
debt levels down to comfortably sustainable levels across EM Monthly for more details).
much of EM. These stronger public and private balance
 Fiscal sector: overall fiscal balance, public debt, debt
sheets should leave much of EM relatively well placed to
maturing in the next year (to capture rollover risk), and
weather the current economic storm.
foreign currency denominated debt (to capture
Simulated public debt paths exchange rate risk) – all measured in percent of GDP.
(% GDP)  Financial sector: loan-to-deposit ratios, the pace of
225
We assume: (i) primary balances are held private credit growth (average over the last two
205 constant at this projected 2012 levels; (ii) real
GDP grows at trend rates; and (iii) the years), and the level of private credit in percent of
185 differential between real interest and real
growth rates in each country is 0 until 2015 GDP. We also include a measure of foreign bank
165 and 1.0 thereafter.
claims on the economy (in percent GDP), using the
DM
145 BIS consolidated banking statistics, which includes
125 exposure through local subsidiaries. Our aim here is
105 to capture the potential risk from deleveraging by
85
stressed banks in core markets.
65  Exogenous shocks: we include our growth betas, i.e.
EM
45 the elasticity of economic growth with respect to
25 growth in the US and Europe.
2006 2010 2014 2018 2022 2026 2030
These indicators are then given a risk rating – low,
Source: Haver Analytics, IMF, Eurostat, Deutsche Bank
medium, or high – depending on whether or not they
exceed certain thresholds. Our thresholds are relative
This resilience is not uniform, however, across EM
rather than absolute insofar as they are based on the
regions or countries. Public and private balance sheets are
distribution of observations for each indicator across our
generally weaker in EMEA, for example, which is also
EM universe over the last five years. Taking external debt
more directly exposed to the euro crisis through stronger
as an example, the 60th and 80th percentiles of the
economic and financial linkages. Growth in Latin America
distribution correspond with 38.3% of GDP and 52.8% of
has remained more robust but the region remains heavily
GDP. Countries with external debt above these levels are
reliant on commodities and would suffer if commodity
assigned medium and high risk ratings respectively for
prices fell sharply in response to slower global growth.
this indicator.
Asia has for some time been the star performer within EM
and we would expect this to continue into 2012. We then aggregate the scores within each sector to come
Nonetheless, very rapid credit growth and rising property up with vulnerability ratings for each of one (i.e. external,
prices could quickly turn and present problems in a lower fiscal, financial, and exogenous). These sector ratings are
growth environment. in turn then combined to result in a single overall
vulnerability rating. In doing so, we attach a higher weight
We have highlighted each of these and other potential
(40%) to the external sector, followed by the fiscal sector
weaknesses several times in our research throughout the
(30%), financial sector (20%), and exogenous sector
year. Here we assess them in a more systematic manner
(10%) reflecting our judgment on the relative importance
with a view to identifying the most likely pressure points
of these variables in precipitating an economic crisis in an
within EM. We present a new framework for assessing
EM context.
relative vulnerabilities across EM and then draw some
conclusion for each emerging region. Below we summarize the main results, our current overall
vulnerability rankings, and the evolution of these overall
Assessing Vulnerability rankings over the last five years.
We provide a structured and objective assessment of the External vulnerabilities
underlying vulnerabilities of EM economies. Our Our external vulnerability indicators immediately point to
assessment is based on a range of measures that we relatively greater risks in EMEA, with only Israel and
think capture a country’s susceptibility to an economic Russia within the region ranking as low risk overall on this
crisis. Specifically, we look at the following indicators: metric. This is driven primarily by the region’s relatively

high external debt levels, which in some cases are higher External vulnerabilities
now than they were going into the last crisis because of C urrent a c c o unt R es erv e c o v er Ex terna l D eb t FX Va lua tio n Ov era ll
% GDP Risk % Risk % GDP Risk % Risk Risk
deep recessions and currency depreciations resulting in EMEA
an increase in the valued of foreign-currency denominated Czech

Egypt
-3.1
-2.6
Med.
Med.
132.3
92.6
Med.
High
48.2
14.9
Med.
Low
-1.4%
1.6%
Low
Med.
Med.
High
debt. Hungary 0.6 Low 163.2 Low 146.0 High -2.1% Low Med.
Israel 1.0 Low 182.0 Low 46.8 Med. -2.2% Low Low
Current account balances in EMEA have strengthened as Kazakh

Poland
8.1
-5.0
Low
High
125.1
146.8
Med.
Low
83.8
63.5
High
High
-2.6%
-3.2%
Low
Low
Med.
High
a result of import compression but remain elevated in Romania -3.7 Med. 229.3 Low 75.2 High 0.5% Low Med.
Russia 5.9 Low 221.3 Low 27.3 Low -2.0% Low Low
Poland and, especially, Turkey. Reserve cover has also South Africa -2.8 Med. 111.6 High 20.8 Low -2.5% Low Med.
improved in recent years but remains low relative to our Turkey -9.1 High 131.0 Med. 36.4 Low -10.0% Low Med.
Ukraine -2.7 Med. 97.0 High 81.1 High 0.2% Low High
preferred risk-weighted measure of liabilities in South Asia
Africa and Ukraine. Egypt’s reserves are also very low China 4.4 Low 198.0 Low 4.4 Low 0.3% Low Low
India -3.4 Med. 338.3 Low 13.7 Low -0.6% Low Low
halving more than halved since the start of the year. Egypt Indonesia 0.4 Low 189.7 Low 23.7 Low -0.3% Low Low
Korea 1.1 Low 146.7 Low 32.1 Low 5.4% High Low
is also the only county where we see hints of exchange Malaysia 9.4 Low 129.0 Med. 28.7 Low -1.1% Low Low
rate overvaluation. Philippines 4.5 Low 431.2 Low 32.2 Low -1.3% Low Low
Thailand 3.5 Low 349.4 Low 21.8 Low -1.6% Low Low
Overall, the high risk countries according to this metric are LatAm
Argentina 0.8 Low 138.2 Med. 30.9 Low -0.3% Low Low
Egypt, Poland, and Ukraine. This may perhaps overstate Brazil -2.2 Med. 243.5 Low 17.1 Low -1.7% Low Low
Chile -1.1 Low 149.1 Low 43.1 Med. -0.5% Low Low
the risks in Poland somewhat, where the current account Colombia -3.2 Med. 188.0 Low 22.4 Low -1.9% Low Low
is moderately high but comfortably financed by EU funds Mexico -0.7 Low 146.5 Low 19.8 Low -1.1% Low Low
Med. threshold -2.0 142.1 38.3 1.1%
and FDI. Similarly, the risks posed by Hungary’s extremely High threshold -3.7 120.7 52.8 3.1%
large external debt level and Turkey’s very large and Source: Haver Analytics, Deutsche Bank
largely short-term financed current account deficit are

probably not fully captured by these metrics. In Asia, the risks are highest in the Philippines reflecting
its moderately large public debt, over half of which is
Outside of EMEA, the picture is more comfortable with no denominated in foreign currency, with relatively significant
countries in LatAm or Asia rated as having high overall amount (12% of GDP) falling due in the next year. Aside
external risks. There are a few pockets of vulnerability, from Egypt, India’s fiscal deficit is the largest in EM at
such as India’s current account deficit, relatively low about 8% of GDP although this has so far been
reserve coverage in Malaysia, and a moderately high comfortably financed domestically.
external debt level in Chile and relatively large (by regional
standards) current account deficit in Colombia although In LatAm, there are a couple of amber warnings in Brazil
fully financed by FDI. Chile´s external debt is, however, given it high rollover needs and moderately large debt
largely compensated by high value of exports and one of stock, and in Colombia reflecting its moderate deficit and
the most solid fiscal fundamentals globally as we will note relatively high FX exposure. Brazil´s relatively large primary
in the following section. surplus (3.2% of GDP estimated for this year and 2.5%
projected for 2012) together with full dominance of local
Fiscal vulnerabilities market-local currency debt significantly mollifies the fiscal
Public finance risks are a little more evenly distributed risk although short term duration is still meaningful. A
across the three regions but again EMEA emerges as balanced primary result in Colombia also helps to
most vulnerable. Egypt’s chronic fiscal problems come moderate its fiscal risk but the combination of medium
out quite clearly, with its double-digit deficit, public debt, size deficit and debt makes the country the most
and rollover risks the highest in our EM universe. Despite vulnerable among the largest economies in the region
its relatively moderate deficit, Hungary is also highly from a fiscal stand point.
vulnerable because of its high debt, rollover risks, and
large FX exposure. Poland is again perhaps rate too Financial sector vulnerabilities
harshly on our metric – it is close to the edge of some of The picture in the financial sector is even more varied.
our thresholds, and we would expect it to move to a Loan-to-deposit ratios are typically higher in EMEA,
lower risk category should fiscal consolidation proceed especially in Hungary and Ukraine, reflecting the
along the lines outlined by Prime Minister Donald Tusk wholesale and external funding model of many banks in
last month. the region. Loans are typically more than fully covered by
deposits in Asia and LatAm, however, with the notable
exceptions of Korea, Chile, and Colombia.

Fiscal vulnerabilities Financial vulnerabilities:

Overall balance Public debt Maturing debt FX debt Overall Fo reig n b a nk
% GDP Risk % Risk % GDP Risk % Risk Risk Lo a n/ d ep o s it C red it g ro wth C red it Lev el c la im s Ov era ll
EMEA
% Risk % Risk % GDP Risk % GDP Risk Risk
Czech -4.3 Med. 39.9 Low 6.5 Low 6.0 Low Low
EMEA
Egypt -9.5 High 76.2 High 18.6 High 18.5 High High
Hungary -2.9 Low 75.9 High 13.7 High 32.3 High High Czech 0.81 Low 4.2 Low 73.2 Med. 105.9 High Med.
Israel -2.8 Low 71.1 High 8.6 Med. 13.8 Med. Med. Egypt 0.48 Low 3.7 Low 30.8 Low 18.3 Low Low
Kazakh 2.7 Low 12.9 Low 0.9 Low 1.0 Low Low Hungary 1.45 High -0.8 Low 78.1 Med. 101.4 Med. High
Poland -5.5 High 56.7 Med. 8.4 Med. 12.7 Med. High Israel 1.05 Low 6.1 Low 130.2 High 11.7 High Med.
Romania -4.4 Med. 34.0 Low 9.2 Med. 21.8 High Med. Kazakh 1.25 Med. 0.0 Low 47.5 Low 18.7 Low Low
Russia 0.2 Low 11.7 Low 1.1 Low 2.7 Low Low Poland 1.17 Med. 7.7 Low 51.9 Low 64.3 Low Med.
South Africa -5.5 High 36.1 Low 0.9 Low 3.3 Low Med. Romania 1.20 Med. 3.1 Low 56.3 Low 71.6 Low Med.
Turkey -1.5 Low 39.7 Low 9.5 Med. 10.7 Low Low
Russia 1.14 Med. 6.3 Low 0.0 Low 13.1 Low Low
Ukraine -2.5 Low 39.3 Low 5.1
0.0 Low
Low 26.1
0.0 High
Low Med.
South Africa 1.13 Low 3.2 Low 75.3 Med. 33.5 Med. Med.
Asia
Turkey 0.97 Low 35.3 High 41.9 Low 28.6 Low Med.
China -1.5 Low 19.6 Low 6.1 Low 0.1 Low Low
Ukraine 1.56 High 1.5 Low 62.9
0.0 Med.
Low 25.5
0.0 Med. Med.
India -8.1 High 61.2 Med. 3.2 Low 4.2 Low Med.
Indonesia -1.1 Low 26.0 Low 1.2 Low 10.9 Low Low Asia
Korea 0.0 Low 34.4 Low 2.2 Low ... Low Low China 0.77 Low 19.5 Med. 117.7 High 10.1 High Med.
Malaysia -4.9 Med. 55.2 Med. 2.9 Low 2.0 Low Med. India 0.00 Low 18.1 Med. 56.9 Low 17.5 Low Low
Philippines -2.8 Low 58.2 Med. 11.5 High 32.9 High High Indonesia 0.72 Low 17.3 Low 27.8 Low 14.7 Low Low
Thailand -3.3 Low 36.0 Low 6.5 Low 6.3 Low Low Korea 1.36 Med. 3.9 Low 121.2 High 34.7 High High
LatAm Malaysia 0.90 Low 11.9 Low 116.6 High 59.1 High High
Argentina -2.3 Low 21.8 Low 6.0 Low ... Low Low Philippines 0.61 Low 10.4 Low 33.7 Low 17.9 Low Low
Brazil -2.1 Low 56.6 Med. 16.8 High ... Low Med.
Thailand 1.03 Low 10.5 Low 102.1 High 28.0 High Med.
Chile 0.8 Low 7.4 Low 2.4 Low 2.2 Low Low
Colombia -3.3 Low 39.3 Low 3.9 Low 14.0 Med. Low LatAm
Mexico -2.1 Low 35.2 Low 8.7 Med. 9.2 Low Low Argentina 0.72 Low 29.5 High 15.2 Low 10.7 Low Med.
Med. threshold -3.4 41.5 7.4 12.0 Brazil 0.70 Low 22.2 Med. 71.8 Med. 24.1 Med. Med.
High threshold -5.5 62.2 10.3 17.7 Chile 1.41 High 3.7 Low 66.7 Med. 56.6 Med. High
Source: Haver Analytics, IMF, Bloomberg LLP, Deutsche Bank Colombia 1.70 High 14.6 Low 31.8 Low 12.6 Low Med.
Mexico 0.74 Low 6.1 Low 38.1 Low 35.8 Low Low
Med. threshold 1.1 17.8 59.4 30.3
Many emerging European economies are still recovering High threshold 1.4 25.5 94.3 56.8
Source: Haver Analytics, BIS, Deutsche Bank
from the collapse of earlier credit booms and this is reflect
in low credit growth across much of the region. Turkey is
Exogenous shocks
an exception where credit has been growing at an annual
We next assess the exposure of countries to an
average rate of 35% over the past two year, albeit from a
exogenous shock in the form of a drop in external demand
relatively low base. Credit is growing more rapidly in Asia
in developed markets. Our measure for this is the growth
and LatAm, especially in Argentina, Brazil, and China. The
elasticity of each EM economy with respect to growth in
stock of outstanding credit is also quite high in China, now
the US and Euro area. These ‚growth betas‛ are derived
at well over 100% of GDP.
as the coefficient estimates of regressions of a country’s
One particular concern right now is that European banks GDP on PPP-weighted US and Euro area GDP growth.
might look to reduce their exposures to EM as part of
Within EMEA, five countries (Ukraine, Russia, Romania,
efforts to meet capital requirements. The total risk
Turkey, and Hungary) have growth betas in excess of one,
exposure of foreign banks is about 45% of GDP on pushing for above one regional average. Worth noting, the
average in EMEA and about 26% of GDP in Asia, impact of a synchronized global slowdown could be
reflecting the relatively greater role of European bank higher than our growth betas – which capture the average
subsidiaries in central and eastern Europe. Outside of relationship over the last decade or so – would suggest.
Europe, Malaysia (inflated a little bit by the offshore During the last crisis, for example, the average drop in
banking business in Labuan), South Korea, Thailand, and output in EMEA was about 8-9%, compared with 5.4% in
Chile have moderately high ratios of international bank the Euro area and 5.0% in the US.
claims to GDP.
In Asia, not surprisingly the growth betas are highest in
Overall, this metric suggests that the biggest risks lie in the economies with the largest export sectors. So
Chile, Malaysia, Korea, and Hungary, though there are Singapore and Hong Kong – not included in this study
moderate vulnerabilities in almost all countries. One because their roles as financial centers exaggerate their
indicator that we did not include here was non-performing apparent vulnerability to financial shocks – have growth
loans because we think they way these are measured betas in excess of 1.5. Taiwan also has a beta of around
varies greatly from country to country, making 1.5. So in the chart below the economies that appear
comparisons difficult. If we had included a measure, highly sensitive in a pan-EM perspective -- namely
however, this would have bumped up our risk ratings for Malaysia, Thailand, and South Korea – are actually in the
Ukraine and, especially, Kazakhstan. Likewise, it is middle of the pack in Asia in terms of concerns about
questionable that high foreign claims make Chile imported growth shocks. Growth betas for three of the
region’s largest economies, China, India, and Indonesia,
vulnerable as long as any other economic fundamentals
are small as their large populations and relatively smaller
remain rock solid.
penetration of export sectors into the economy insulate
them to a considerable extent. We reckon these countries
are less sensitive to European growth than the US is

despite the fact that in China exports to Europe comprise high level of foreign bank claims on the country (which
about one-third of total exports. may be overstated) and moderate concerns about the
country’s public finances.
In Latin America, in addition to the well known case of
Mexico, there is also relatively high dependence on US/EU Overall vulnerability scores
growth in Chile and Colombia, as expected given their
Overall vulnerability score
openness, but also because of the importance of the 0.7
commodity complex in their economies. This
0.6 Growth Fin Fisc Ext
notwithstanding, the region is becoming increasingly
dependent on Asia flows and commodity prices. This is 0.5
High risk
today the most important channel of contamination from a threshold
0.4
global problem for Latin America. In Argentina, domestic
Medium risk
policies during the last eight years or so have allowed a 0.3 threshold
fairly independent performance of its economy relative to
0.2
the global scenario, something that is unlikely to continue
now that most of the financing buffers it initially had are 0.1
almost fully utilized.
0
RUS
ROM
MYS
HUN
ARG
CZE
CHL
POL
MEX
EGY
BRA
UKR
CHN
ZAF
PHL
COL
KOR
IND
THA
IDN
TUR
KAZ
ISR
EM Growth Betas
Betas to 1pp change in US/Eurozone growth
4.0
The graphic below summarizes these findings with a more
3.5
visual map, including every single indicator used for an
3.0
easier and comprehensive comparative analysis
2.5
Overall vulnerability map
2.0 External Fiscal Financial
Current account
1.5
Overall balance
Foreign claims
Maturing debt
Loan:deposits
Credit growth
External debt
Growth beta
FX valuation
FX reserves
Credit level
Public debt
1.0
FX Debt
Overall
Overall
Overall
Overall
0.5
EMEA
0.0 Czech Rep
Egypt
PHL
THA
CHL
CZE
POL
ARG
CHN
BRA
ZAF
COL
MYS
KAZ
IND
HUN
KOR
IDN
ROM
MEX
EGY
RUS
TUR
UKR
ISR
Hungary
Israel
Source: Deutsche Bank Kazakhstan
Poland
Romania
Overall vulnerability ratings Russia
Combining each of these sectors, and attaching relatively South Africa
Turkey
more weight to the external and fiscal sectors, we
Ukraine
construct an overall vulnerability score or rating for each Asia
country. This is shown in the chart below together with China
India
the contributions from each particular sector. Based on Indonesia
the discussion above, it will come as no surprise to find Korea
Malaysia
that EMEA dominates our list of most vulnerable
Philippines
countries. Five countries (Hungary, Ukraine, Romania, Thailand
Poland, and Egypt) show up as highly vulnerable, though LatAm
Argentina
for different reasons. Egypt’s underlying vulnerabilities, for Brazil
example, are fiscal first and external second. Ukraine’s Chile
risks are mostly external. Hungary’s vulnerability reflects a Colombia
Mexico
combination of risks in all four areas. As we noted above, Risk ratings as follows: = low = medium = high
our sense is that Poland’s risk rating is probably a notch Source: Deutsche Bank
too high according to this mechanical exercise, though it

does underscore that the economy does have macro Having constructed our vulnerability measures, we can
imbalances that have yet to be fully addressed. also track how these have evolved over time. Below we
show the evolution of the overall ratings for each sector
Outside of EMEA, only Malaysia makes it on to our list of and for the overall (cross-sector) rating from 2007-11.
countries with medium risk ratings mainly reflecting the Three things emerge clearly from this graphic:

 While EMEA is currently clearly the most vulnerable now with significant weakness across each of the areas
region, these vulnerabilities were actually even higher that we have looked at.
prior to the last crisis in most cases – i.e. it was no
First, current account balances have improved in the last
accident that many EMEA economies suffered their
few years and central banks have been able to build
own crisis in 2008-09
bigger buffers of foreign reserves. But the large stock of
 Some countries, however, have become more external debt accumulated during the middle of the last
vulnerable recently, at least in some respects. Egypt decade still leaves the region with large external burden.
is the obvious example, primarily reflecting its much Much of this borrowing took place in foreign currencies –
weaker reserve position but also some deterioration Swiss franc mortgages in Hungary (20% of GDP) being
in the current account. Fiscal risks have also become just one example – the local currency burden of which is
greater in Poland and South Africa as fiscal deficits now being inflated as those currencies come under
have widened sharply; and also in Ukraine as debt pressure. With these debts needing to be serviced on an
levels increased sharply. ongoing basis, many countries still face large external
financing needs even as their current account positions
 The relatively high financial exposure of countries in
have improved. This is particularly true of Hungary and
Asia (China, Korea, Malaysia) or LatAm (Brazil, Chile,
Ukraine, which have gross external financing needs of
Colombia) seems to have persisted over time despite
30% of GDP or above in 2012 despite a moderate current
relatively strong external and fiscal fundamentals,
account deficit in Ukraine and a small surplus in Hungary.
which should moderate the potential relative risk in
this regards. This notwithstanding, we feel domestic If the difficulties facing Hungary and Ukraine are partly a
debt levels – and possibly falling asset prices – are a reflection of past external deficits, Turkey’s external
significant risk to some economies in Asia. vulnerabilities are largely a reflection of the large current
account deficit (9% of GP) it is running now. Much of this
Evolution of vulnerability ratings (2007-2011) is financed through short term flows. Egypt’s problems
External Fiscal Financial Overall
are different again with political uncertainty precipitating a
2007
2008
2009
2010
2011
2007
2008
2009
2010
2011
2007
2008
2009
2010
2011
2007
2008
2009
2010
2011
withdrawal of capital from the country and foreign reserve

EMEA
Czech Rep
coverage to fall to the lowest level in EM.
Egypt
Hungary Three of these countries may well need to tap the IMF for
Israel financial support next year. Ukraine already has an IMF
Kazakhstan
program (of which USD 12bn or 6.5% of GDP is
Poland
Romania potentially still available) but is currently looking first to
Russia Russia for cheaper gas prices to reduce its external
South Africa
Turkey
financing needs. Hungary is seeking the reassurance of a
Ukraine precautionary IMF program although negotiation on the
Asia policy condition has not yet started and could well be
China
India
difficult. Egypt had reached agreement in principle on a
Indonesia USD 3bn (1.2% of GDP) arrangement with the IMF but
Korea
has yet to proceed with the deal for political reasons. We
Malaysia
Philippines don’t think Turkey will need to turn to the IMF but the risk
Thailand there is that a squeeze on capital inflows would
LatAm
precipitate a sharp slowdown in domestic growth and a
Argentina
Brazil weaker lira.
Chile
Colombia Second, as in many developed countries, sharply weaker
Mexico growth in the last two or three years has taken a heavy toll
Risk ratings as follows: = low = medium = high
Source: Deutsche Bank in the public finances. In some cases, such as Egypt and
Hungary, fiscal positions were relatively weak to begin
with. Elsewhere, they are almost entirely a reflection of
Conclusions
the fiscal response to the crisis. Poland and South Africa,
EMEA: facing a quadruple whammy for example, enjoyed strong budget positions going into
We have consistently highlighted the relatively greater the last crisis and were therefore able to ease fiscal policy
vulnerability of EMEA among emerging regions to a aggressively. They have, perhaps understandably, been
renewed downturn in core developed markets. Indeed the slow to unwind this easing but may now find themselves
region faces something of a quadruple whammy right having to either tighten policy into a downturn (as Poland

plans to do) or at least unable this time around to ease which has likely been eliminated with the 6% depreciation
policy to prop up growth. since September – Asia’s external vulnerabilities are
modest. Even India’s current account deficits – usually
Third, the buildup of foreign currency debt was probably
3% of GDP or less – raise only an amber warning. Once
largely a reflection of relatively high and volatile inflation in
upon a time it was considered normal for emerging
some cases, leading to a large spread between domestic
economies to import capital.
and foreign interest rates. But the availability of foreign
currency loans was also facilitated by the rapid expansion And while India’s chronic large government deficits –
of western European banks throughout much of the often more than 7% of GDP for the state and central
region. This has left many countries exposed to governments combined – are a persistent worry it has to
deleveraging by foreign banks as they seek to meet be placed alongside the manageable debt/ GDP ratio of
additional capital requirements imposed by the European about 61% of GDP funded almost entirely onshore. We
Banking Authority. These requirements are largest for don’t think policymakers are complacent, but deficit
Greek, Italian, and Spanish banks, which may be a reduction has been difficult over the past few years and
concern for Romania and Hungary (as well as Croatia, we expect that as global threats to growth recede in 2013
Serbia, and Bulgaria outside our sample) where Greek and and beyond, the government will return to its pre-global
Italian banks are most active. But other banks may also be financial crisis trend of falling deficits.
reluctant to maintain their exposures in the region.
Where this vulnerability exercise raises worries for Asia –
Germany’s Commerzbank, for example, has indicated that
concerns which we have raised before – is on the financial
it will temporarily suspend new lending outside of
side. Domestic credit expansion has been overly rapid
Germany and Poland. Austria’s central bank has also
not only in China in 2009 but also in a many other
imposed limits on new lending in CEE by the subsidiaries
economies over the past two or three years. The
of Austrian banks. And countries without strong parent-
economies of China, Korea, Malaysia, and Thailand have
subsidiary ownership linkages are also unlikely to be
high credit/GDP ratios indicating significant potential debt
immune. Turkish banks, for example, have substantially
burdens in the private sector in a slowing growth
increased their short term external borrowing in the last
environment. While the focus of investors today is,
couple of years (from foreign banks) and may face some
perhaps rightly, on the external risks to the region, we
difficulties in rolling these loans.
think domestic debt levels – and possibly falling asset
Fourth, EMEA’s economies are mostly relatively small and prices – are a significant risk to some Asian economies.
open markets with high trade and financial exposures to
LatAm: Commodity dependency remains the main risk
the euro area and US. Even leaving aside the
Latin America went through a painful and meaningful
vulnerabilities discussed above, it would leave countries
external, fiscal, and financial crisis in the 90s and today´s
such as Hungary and Czech Republic – where exports to
resilience cannot be understood without that reference.
the euro area account for about 40% of GDP - relatively
Forced fiscal adjustments, together with some structural
more exposed therefore to a recession in Europe.
reforms, and overly conservative financial regulation have
allowed the region to converge to a relatively safe status.
There are, however, some pockets of resilience within
This has permitted growth to become vigorous and
EMEA. With its current account surplus, large stock of
sustained with the helped of steady rise in commodity
reserves, and low debt levels, Russia faces few of the
prices, the region´s comparative advantage. Lack of
macro vulnerabilities of the rest of the region. Its
investment and increasing dependency on commodities is
weaknesses are largely structural in nature though, as the
probably the major drawback of this experience.
experience in 2008-09 reminds us, growth and the rouble
Increasing complacency regarding long term fiscal
would come under pressure in the event of a significant
rigidities with spending concentrated in current spending
weakening of oil prices. The same is also true of
in cases like Argentina, Brazil, Colombia, even Mexico, are
Kazakhstan, though the banking sector remains a potential
probably the main yellow light. Strong growth
source of weakness. Israel’s macroeconomic
sustainability and steady alleviation of poverty and social
fundamentals are also generally strong and the main risks
conflicts remains the main challenge ahead.
are geopolitical in nature.
Robert Burgess, London, (44) 20 7547 1930
Asia: risks from rapid credit growth bear watching
Gustavo Canonero, New York, (1) 212 250 7530
Years of current account surpluses and sound fiscal policy
Michael Spencer, Hong Kong, (852) 2203 8305
contribute to a picture of a region that is relatively less
vulnerable than EMEA for example. With the exception of
Korea’s real exchange rate – the apparent overvaluation of


 The year 2011 was marked by relentless crises in the single digits, except for EM equities, which dropped about
EU, damaged confidence, and faltering political 17%. We have highlighted in recent Monthly publications
leadership that kept the global economy flirting with that EM FX has become more of a proxy for global risks
recession for most of the year. Looking across all than EM specifics. This has weighed significantly on local
asset classes, the most growth-sensitive ones have markets performance, and it seems unlikely to change
underperformed fixed income in 2011 – a trend we soon. In contrast, credit has benefited from the rally in
expect to extend into 2012. UST, but this is unlikely to repeat. Altogether, the stage
seems set for fixed income to outperform once more – at
 EM Credit benefitted from lower US yields, but we
least in the beginning of the year, but total returns seem
believe UST is unlikely to repeat its contribution to the
poised to shrink for long-only defensive investors.
total returns in 2012.
 EM rates have benefited from easier monetary 2011 YTD performances of major asset classes
policies, but depreciation of the currencies has offset YTD returns of various asset classes
gains. So the prospect for local markets hinges on
UST
EM currencies and thus, on the resolution of the EU EMBI-G
crisis – the sooner the better. IG
GBI-EM (hedged)
 We see three main takeaways from recent history HY
GBI-EM
that are relevant for the year ahead: 1) the distribution
G10 FX Carry Basket
of returns will likely continue to favor fixed income vs. S&P
growth-sensitive assets such as equities and EMFX – EM FX (Spot & carry)
especially in Q1 or H1; 2) returns are diminishing; 3) Com'dty
FX Carry Basket
EM still seems too important a source of carry and EMFX Spot
value to drop from investors priority list – either in EM Eq
risk-on or risk-off modes. -20% -15% -10% -5% 0% 5% 10%
 That said, if returns are less appealing in EM as they Source: Deutsche Bank; MSCI EM, JPMorgan, Bloomberg Finance LP
used to be, the opportunities in global markets seem

even less so. Looking beyond bouts of deleveraging EM credit benefitted not only from lower US yields but
and flight-to-quality, developed markets may set an also from the negative correlation between spreads and
even-lower bar for EM in the years ahead. yields during a good part of 2011, which compressed total
return volatility and boosted Sharpe ratios. How much did
Taking Stock: Lessons from 2011 the rally in UST contribute to total returns? The chart
The year 2011 was marked by relentless crises in the EU, below shows that the UST rally has accounted for most of
damaged confidence, and faltering political leadership that DB-EMSI constituents’ positive total returns year-to-date.
kept the global economy flirting with recession for most With the notable exceptions of Ukraine, Egypt, and
of the year. Backward-looking performance has often Argentina, the stellar performance of the USTs have more
times been a very poor predictor of future returns, but as than offset the widening in spreads.
we write, the shocks that buffeted global markets in 2011
seem very likely to persist well into 2012. In particular, we The best performers have been, not surprisingly, low-
see three main takeaways from recent history that are beta, high-quality LatAm credits. Only in Venezuela, yields
relevant for the year ahead: 1) the distribution of returns (and carry) were high enough to more-than-compensate
will likely continue to favor fixed income vs. growth- for the widening in spread seen in 2011. Looking ahead,
sensitive assets such as equities and EMFX – especially in the good news is that spreads are higher and thus, offer
Q1 or H1; 2) returns are diminishing; 3) EM still seems too an additional buffer for shocks. The bad news is that UST
important a source of carry and value to drop from is unlikely to repeat its contribution to total returns in
investors priority list – either in risk-on or risk-off modes. 2012. All in all, it seems more likely that EM hard currency
In the sections below we shed more light on these. returns will be reduced going forward either by the limited
room for yield compression or potential re-pricing up of
The outperformance of the defensive UST as developed markets deal with their debt crises.
Not surprisingly, the chart below shows that the most
growth-sensitive assets underperformed fixed income – a
trend we expect to extend into 2012. Total returns were in

Sovereign credit: UST more than offsets wider EMFX: The major drag for local currency debt
spreads YTD Returns
YTD Total Return and UST Contributions 110 110
20% Total Return UST Contribution
105
15% 105
10%
100
100
5% 95
GBI-EM
0% 95
DBI-EM (FX-hedged) 90
-5% EMFX (Spot and Carry)

EC UY PE PA MX CO VE BR PH ID EM ZA CL LB RU SV HU TR PL BG UA EG AR 90 85
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11
5Y CDS Total Returns, YTD
10%
8% Source: Deutsche Bank
6%
4%
2% Diminished returns
0%
The performance in 2011 was driven by adverse market
-2%
-4% conditions but also by years of re-pricing of EM risk. As
-6%
the chart below suggests, double-digit returns in external
-8%
-10% debt seem now confined to post-crisis recovery years.
VE QA MX CO PE BR PH PA LV ZA IL KZ MY RU ID CZ RO HU PL TR BG UA AR HR SK
After years of re-rating, EM investment-grade sovereigns
account for half of Deutsche Bank’s external debt index.
This, relatively low spreads and real rates in the US near
EM rates have also benefited from easier monetary
zero point to lower returns ahead. In the case of local
policies, but depreciated currencies have offset gains
markets, the downtrend in total returns (FX + rates) still
(chart below). The chart above shows that hedged returns
seems less pronounced, but this is overshadowed by FX
held up well near 5%, while EMFX returns (with carry)
volatility. In fact, FX-hedged returns have been remarkably
were in line with the poor SP500, but outperformed
stable around 5% over the past decade, with fluctuations
Deutsche Bank’s global FX (dynamic) carry basket,
mildly tracking global policy rates.
commodities, and EM equities. EMFX will likely remain a
drag while the global economy flirts with recession and
EM rates are already relatively low. In fact, real rates are Asset performances of past ten years
Yea r E MBI Globa l GBI-E M (FX -Hedged) E MFX (s pot a nd c a r r y ) O t her a s s et s r et ur n
negative in Asia, near zero in EMEA, and still positive in Return Vol Ret/Vol Return Vol Ret/Vol Return Vol Ret/Vol S&P UST
LatAm – but relatively low. EM central banks are still 2003

2004
25.7%
11.7%
18.0%
6.7%
1.4
1.8
5.5%
7.7%
2.4%
2.9%
2.3 10.8%
2.7 14.2%
5.4%
6.1%
2.0
2.3
26.4%
9.0%
2.3%
3.5%
dealing with residual inflation (from FX pass-through and 2005 10.7% 2.4% 4.4 7.2% 1.9% 3.8 -0.9% 7.1% -0.1 3.5% 2.8%
2006 9.1% 4.5% 2.0 6.4% 2.6% 2.5 4.5% 7.8% 0.6 10.4% 3.1%
commodities), but the inflation outlook is brightening. Still, 2007 6.1% 7.6% 0.8 4.8% 2.6% 1.8 13.7% 6.5% 2.1 3.9% 9.0%
only in LatAm we see room for easing – though not 2008

2009
-10.9%
28.2%
6.3%
16.6%
-1.7
1.7
5.4%
5.2%
7.1%
4.2%
0.8 -10.1%
1.2 16.0%
15.5%
12.1%
-0.6
1.3
-38.5%
23.5%
14.1%
-3.8%
aggressive. Altogether, the prospect for local markets 2010 12.0% 5.6% 2.1 8.6% 2.8% 3.1 6.5% 6.9% 0.9 12.8% 5.8%
2011 7.2% 5.2% 1.4 4.3% 3.0% 1.4 -4.4% 8.9% -0.5 -0.8% 8.8%
hinges on EM currencies and thus on the resolution of the Average 11.1% 8.1% 1.4 6.1% 3.3% 1.9 5.6% 8.5% 0.7 5.6% 5.1%
EU crisis – the sooner the better. Correla- w/ S&P

tion w/ UST
58%
47%
47%
40%
68%
-6%
Note: EMFX (spot and carry) is derived from GBI_EM unhedged and hedged returns.
Correlation with S&P and UST returns are calcuated using monthly returns.
EM asset returns, past 10Y

30%
20%
10%
0%
EMBI Global
-10%
GBI-EM (FX-Hedged)
EMFX (spot and carry)
-20%
2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Deutsche Bank, Bloomberg Finance LP
FX-hedged returns have provided higher Sharpe ratios take here is very simplistic. Our aim here is to provide a
than hard currency, but total returns in external debt have simple perspective, rather than deriving precise
been almost twice as high since 2003. Returns in external quantitative implication from this exercise.
debt are matched only by unhedged local markets returns
Nevertheless, the main point is that it will be hard for
in this period, but at a cost of higher volatility. Deciding
credit to perform well without the support of USTs, and
whether to allocate more to external debt or local markets
likewise for local market without the contributions of FX
naturally depends on the prospects for US equities and
exposure.
rates. From a valuation perspective, EMFX has more to
offer as it has lagged other assets. However, with global
The grass is greyer on the other side
growth likely to pick up only in 2013, FX will more likely
Despite overall solid balance sheets and increased
weigh on returns into 2012.
investor interest18, EM performance has been hostage to
bouts of de-leveraging typical of riskier assets. This and
In order to provide some insight to the prospective and
the prospect of diminished returns cast doubt on whether
constraints to the performance of sovereign credit and
EM could still expand the investment frontier. Despite its
local markets (and the relative performances between
obvious limitations, we rely on standard portfolio
them), we run a multiple regression of the asset
optimization to shed some light on asset allocation, as it
performances on S&P and UST for last two years, and
remains the workhorse in the industry 19 . We obviously
project their returns in 2012 based on three scenarios:
avoid deriving precise quantitative implications from such
an exercise, as this would be futile under so much
 a bearish scenario under which 10Y UST yield
uncertainty and data limitations. Instead, we look at
tightens to 1.5% and S&P drops to 1000
different periods and asset sets that could help identify
 a neutral scenario where both UST and S&P remains performance patterns. A subset of our results is
around the current levels presented in the charts below and in the appendix.
 a bullish scenario under which 10Y UST yield rises to
The past decade has seen extreme bull and bear markets,
3% and S&P rises to 1350
but throughout these adverse and pro-risky markets EM
A simplistic projection of EM FI asset returns under assets have most often participated in the optimal
various scenarios of UST and S&P portfolios and in shares that tended to exceed by a large
Intercept UST S&P Carry* margin those reported by global asset allocation surveys20.
EMBI Global 448.3 -50.3 0.14 4.36 In hindsight, the main decision was not whether to have
GBI EM (Hedged) 165.3 -11.5 0.01 1.44 EM in size in the portfolio, but whether to concentrate in
EMFX (spot and carry)** 70.9 1.3 0.06 3.49
hard currency or local currency exposure – or whether to
Current Bearish Neutral Bullish position aggressively or defensively. Qualitatively, rather
Level Scenario Scenario Scenario than displaying the theoretical capital market line, global
10Y UST Yield 2.07 1.50 2.07 3.00 asset allocation seemed to span ‚clusters‛ of more
S&P 1247 1000 1247 1350
defensive assets (mainly fixed income and higher grade
Fitted Level Return Level Return Level Return
EMBI Global 569 556 -2.2% 578 1.6% 570 0.2% credit) and more bullish growth equities/EM currencies.
GBI EM (Hedged) 174 175 0.7% 177 1.7% 175 1.0%
EMFX (spot and carry) 171 158 -7.7% 174 2.1% 182 6.6%
* For EMBI/GBI-EM, a UST-weighted time drift term is used in the regression to capture carry;
For EMFX, a time drift term is used. (Regression is based on 2Y history)
** Proxied by the ratio of GBI-EM Unhedged and GBI-EM Hedged
The table above shows that both credit and FX-hedged

local markets would perform poorly under both the
bearish scenario (suffering from lower growth and higher 18
According to DB’s Institutional Investor Survey, EM ranks highest in the
risk aversion) and the bullish scenario (suffering from list of investors’ intentions to add exposure (see ‚2011 Institutional Survey,
John Haugh, DB Cross Rate Sales, Pensions")
higher rates). Not surprisingly, EMFX (spot and carry) will 19
The shortcomings range from estimating returns and their distribution
perform the best under the bullish – and even the neutral amid structural breaks and shocks, non-normality, skew, non-zero and
scenario – given that they have sold off the most and time-varying serial and cross-correlation in returns. It is important to note,
hence will have more to offer if there is a bounce in the however, that these do not necessarily bias EM’s ‚optimal‛ share
downwards (see Non-Normality of Market Returns: A Framework for Asset
market. On the flip side, given its high beta to equities, Allocation Decision Making, in The Journal of Alternative Investments,
EMFX would take a big hit if S&P sold off 20% from Winter 2010, V12, 3 for examples.
20
current level. That said, we note that the approach we See EM Technicals Outlook: Structurally sound; cyclically vulnerable
included in this publication.

Efficient frontier: EM present on both ends External debt as a defensive trade

Average weekly returns Average weekly returns (past 2Y)
14% EM Eq 10%
EMBI-G
Comdty
8% HY
12% IG
GBI-EM GBI-EM
6% UST
10% GBI-EM-H
EMBI-G SPX
4%
8% 2%
HY
8Y
6% 0% EM Eq
GBI-EM-H Comdty
IG 6Y
-2%
4% UST
4Y EMFX (spot)
-4%
SPX 2Y
2% 0% 5% 10% 15% 20% 25%
EMFX (spot) 2Y (w/o Annualized weekly return volatility(past 2Y)
0% UST) Source: Deutsche Bank
0% 5% 10% 15% 20% 25% 30%
Annualized weekly return volatility
Concluding remarks
Note: The lines represent frontiers calculated based on return data for
various historical periods to date; the dots are past 8Y returns vs. volatility.
A dim growth prospect suggests that optimal portfolios
GBI-EM-H is the fx-hedged version of the GBI-EM index. will likely remain skewed toward fixed income – at least in
the beginning of 2012. After two doses of QE, fixed
income returns are unlikely to repeat the performance of
The past eight years of data comprise more bullish years,
2011. From a portfolio perspective, ‚optimal‛ allocation
while the past four years have been mostly crisis years
weights of EM assets have been consistently above
with short-lived rebounds. Accordingly, EM played an
average holdings in global portfolios, according to
important role in expanding the frontier. As growth
institutional investors’ surveys, despite diminishing
prospects dimmed and risk aversion surged over the latter
returns – both in risky and defensive portfolios over the
years, the ‚optimal‛ set shrunk. But rather than dropping
past eight years. From a fundamentals and valuation
out of the portfolio, local markets gave way to a strong
standpoint, EM currencies seem broadly undervalued,
participation of hard currency debt. Note that the past two
sovereign and corporate balance sheets tend to be
years have seen an increase in risk-adjusted returns for
healthier than their developed markets counterparts, and
lower-risk portfolios that seem atypical. The frontier does
EM remains an important source of carry, nevertheless.
not shrink significantly once we exclude UST from the
optimization because the rally in UST continues to be
If returns are less appealing in EM as they used to be, the
captured by credit (high and low grade).
opportunities in global markets seem even less so.
History has shown that debt overhang has often times
Focusing on the past two years, which seem a more likely
been accompanied by negative real rates in many
reference for the near future, the chart below shows that
countries after World War II 21 . Financial repression
external debt appears on the portfolio frontier for higher
accounted for roughly 20% of tax revenues in the sample
risk tolerance portfolios (it takes 100% of the weight at
of countries facing debt overhang and around 2% of GDP
6.65% return volatility, the end point of the efficient
(3-4% in the US and UK, and 5-6% in Italy). Looking
frontier). The total return was boosted by the rally in UST
beyond bouts of deleveraging and flight-to-quality,
and this is unlikely to repeat – at least in the similar
developed markets may set an even lower bar for EM in
magnitude. But the rally in UST has been the main driver
the years ahead.
of returns across all the competing assets (for the more
defensive allocation cluster that we show) so that the net
Drausio Giacomelli, New York, (1) 212 250 7355
effect on portfolio is moot. Note from the chart above that
Hongtao Jiang, New York, (1) 212 250 2524
– for the more bullish ‚optimal‛ portfolio composition –
Jack Zhang, New York, (1) 212 250 0664
EM equities and local markets (unhedged) allocations
dominate US equities and commodities. From a
fundamentals and valuation standpoint, we believe EM
could still figure prominently in ‚optimal‛ portfolios for
both defensive and more bullish allocation ‚clusters‛.
21
See Reinhardt and Rogoff: Growth in a Time of Debt, 2009.
Appendix A: Asset average returns and volatility for past 8Y, 6Y, 4Y and 2Y periods
Return and Risk are based on weekly return
Asset 8Y 6Y 4Y 2Y (annualized)
Return Risk Return Risk Return Risk Return Risk
EMBI* 9.1% 10.0% 8.7% 10.9% 8.9% 13.0% 9.5% 6.6% * JPMorgan EMBI Global Total Return Index
GBI-EM ** (Unhedged) 11.7% 12.0% 10.7% 13.0% 7.8% 14.6% 6.6% 11.2% ** JPMorgan GBI-EM Global Diversified Composite
GBI-EM ** (Hedged) 6.3% 3.7% 6.0% 4.1% 5.8% 4.7% 6.2% 3.0% *** JPMorgan EM Currency Index
EMFX *** 0.8% 8.1% -0.1% 9.0% -3.0% 10.2% -3.3% 8.9%
EM Equity 13.1% 26.3% 8.8% 28.8% -3.6% 31.4% -1.2% 23.3%
US IG 5.3% 4.9% 6.1% 5.2% 6.8% 5.9% 7.5% 4.5%
Glolbal HY 7.4% 7.7% 7.6% 8.6% 7.9% 10.4% 9.0% 5.8%
CRB 5.0% 19.7% 1.0% 20.6% -0.2% 23.3% 7.8% 18.3%
SPX 3.0% 19.2% 1.2% 21.5% -2.3% 25.0% 5.6% 18.7%
US Treasury Total Return 5.3% 4.5% 6.2% 4.7% 6.2% 5.3% 6.8% 4.2%
Appendix B: Portfolio weights on efficient frontiers

8Y History 6Y History
Asset Portfolio Composition Asset Portfolio Composition
EMBI 0% 0% 0% 0% 0% EMBI 0% 0% 0% 0% 0%
GBI-EM (Unhedged) 0% 32% 61% 91% 0% GBI-EM (Unhedged) 0% 18% 45% 72% 100%
GBI-EM (Hedged) 48% 1% 0% 0% 0% GBI-EM (Hedged) 43% 0% 0% 0% 0%
EMFX 0% 0% 0% 0% 0% EMFX 0% 0% 0% 0% 0%
EM Equity 0% 0% 0% 0% 100% EM Equity 0% 0% 0% 0% 0%
US IG 0% 0% 0% 0% 0% US IG 0% 0% 0% 0% 0%
Glolbal HY 9% 17% 8% 0% 0% Glolbal HY 10% 20% 10% 1% 0%
CRB 1% 0% 0% 0% 0% CRB 1% 0% 0% 0% 0%
SPX 0% 0% 0% 0% 0% SPX 0% 0% 0% 0% 0%
US Treasury 42% 50% 31% 9% 0% US Treasury 46% 63% 45% 27% 0%
Port. Return 6.0% 7.7% 9.4% 11.1% 13.1% Port. Return 6.2% 7.3% 8.3% 9.4% 10.7%
Port. Risk 2.9% 4.9% 7.7% 10.8% 26.3% Port. Risk 3.1% 4.1% 6.3% 9.3% 13.0%
4Y History 2Y History
Asset Portfolio Composition Asset Portfolio Composition
EMBI 0% 6% 28% 51% 100% EMBI 0% 0% 14% 38% 100%
GBI-EM (Unhedged) 0% 0% 0% 0% 0% GBI-EM (Unhedged) 0% 0% 0% 0% 0%
GBI-EM (Hedged) 42% 9% 0% 0% 0% GBI-EM (Hedged) 41% 21% 0% 0% 0%
EMFX 0% 0% 0% 0% 0% EMFX 0% 0% 0% 0% 0%
EM Equity 0% 0% 0% 0% 0% EM Equity 0% 0% 0% 0% 0%
US IG 0% 0% 2% 20% 0% US IG 0% 0% 0% 0% 0%
Glolbal HY 9% 25% 27% 24% 0% Glolbal HY 8% 32% 40% 41% 0%
CRB 2% 0% 0% 0% 0% CRB 0% 0% 0% 0% 0%
SPX 0% 0% 0% 0% 0% SPX 5% 2% 0% 0% 0%
US Treasury 48% 59% 42% 4% 0% US Treasury 45% 45% 46% 21% 0%
Port. Return 6.1% 6.7% 7.4% 8.1% 8.9% Port. Return 6.7% 7.4% 8.1% 8.7% 9.5%
Port. Risk 3.5% 4.2% 6.0% 8.9% 13.0% Port. Risk 2.3% 2.6% 3.3% 4.4% 6.6%

EM Technicals in 2012: Structurally Sound; Cyclically Vulnerable
 A broad set of metrics encompassing institutional EM positions (thus pushing speculative positioning into
guidelines, relative amounts outstanding, basic light territory) to eventually capitulate on relentless market
portfolio allocation, and the structural indications from pressure. Therefore, despite light speculative positions
EPFR flows suggest that global investors are still EM FX in particular remains vulnerable to bouts of
structurally underweight EM deleveraging as we saw in 2011 should the global
economy enter recession and risk aversion surge again. In
 However, valuation, lack of depth, and market access
the following sections we shed more light into the various
suggest that the pace of strategic inflows will be
(structural and cyclical) aspects of EM technicals.
considerably slower going forward when compared
with 2003-2007.
EMFX positioning is very light
 In sovereign credit, we expect an increase in gross FX Spec. Positioning Z-scores (2Y)
5
issuance in 2012 due to higher financing need in a
Light
few countries and higher than usual principal and 4
interest payment. Venezuela will clearly present the 3
largest amount of net supplies, while Brazil, on the 2

other hand, will likely have the largest amount of net
1
redemptions.
0
 In local markets, a major pressure point will be 2-Nov-11 25-Nov-11 2-Dec-11
-1
foreign investor positioning, which remains close to ARS BRL CLP COP MXN PEN
historical highs. We see risks of outflows as highest

in Hungary and to a much lesser extent Poland.
Otherwise, Hungary stands out having the largest
financing requirement increases (from 10% to
14.5%), while Egypt features the largest absolute
financing need (30.5% of GDP).
 EM corporates have surpassed sovereigns in
issuance by a large margin and the primary market
activities have become quite resilient to the ebbs and
flows of global capital markets, thanks in part to the
higher quality and relatively low leverage amongst the
issuers.
Structural under-allocation faces capacity constraints
The strong strategic inflows of 2003-2007 have given way Are global investors still under-allocated to EM? The
to more gradual allocations that at times have been evidence indicates that – structurally – they are.
dwarfed by bouts of risk aversion. As we discuss in more Incidentally, the latest DB Institutional Survey22 indicates a
detail below, emerging economies are likely to command strong positive bias towards EM assets, both equities and
an increased share in global portfolios for several years debt – as shown in the graph below. For example,
from a structural standpoint, but the combination of less according to the anticipated allocation changes for the
appealing valuation and lingering risk aversion bodes for next 12 months, the percentage of funds looking to add
gradual inflows at best amid likely surges in deleveraging EM Debt vs. those looking to reduce is 28% vs. 3%.
in 2012. However, there is really no simple answer to the question
above given the difficulties in reliably estimating current
Tactically, after months of risk reduction EM technicals
vs. ‚optimal‛ portfolio allocations. We thus look at a
seem positive not only structurally but also from a
broad set of metrics encompassing institutional
(shorter-term) cyclical standpoint. The chart below shows
guidelines, relative market size, basic portfolio allocation
speculative FX data – a timely gauge for leveraged
benchmarks, and structural drivers for EPFR flows.
positions – hovering near historical lows. However, light
speculative positioning (be it in FX forwards or options,
and CDS or swaps) is a partial metric that ignores
22
See 2011 Institutional Survey, John Haugh, DB Cross Rate Sales,
potential unwinding of real investments in EM that have
Pensions. The report presents a survey of 101 institutional asset owners,
built over the years. In 2011 investors initially hedged core taken between Mid-July and end of August 2011.

DB survey: String bias towards EM assets grade, and US bonds, and global FX or
commodities. Although the ‚optimal‛ portfolio
shares obviously depend on risk tolerance,
(typical) moderate risk portfolios often post
‚optimal‛ EM allocations well in excess of the
weights in global portfolios discussed in the
previous paragraph. Whether this will hold is
questionable, as valuation is now less appealing.
But – from a long-term perspective – the pull
factors (such as EM’s superior carry and balance
sheets) will likely still compare favorably with
developed markets push factors such as balance
sheets, growth prospects, and possible financial
Source: Deutsche Bank 2011 Institutional Survey
repression26.
a) Benchmark indices: One common institutional
guideline takes the form of benchmark indices23. EM expands efficient frontiers
In the case of equities, anecdotal evidence points Average weekly returns
to an average allocation to EM equities just above 14% EM Eq
5% - still a fraction of the almost 14% share of
12%
EM in the MSCI. Moreover, long-term growth GBI-EM
differentials in favor of EM point to an increasing 10%
EMBI-G
share in the MSCI.
8%
In the case of fixed income, anecdotally (from our
HY
survey) we believe that EM’s share in global 6%
8Y
GBI-EM-H Comdty
portfolios is less than 3%, while the latest IMF IG 6Y
survey shows it is less than 5%24. This is still a 4% UST

4Y
small number when compared with EM’s SPX 2Y
2%
debt/GDP and it’s almost 50% share in global
EMFX (spot) 2Y (w/o
GDP (according to the latest IMF estimate, using 0% UST)
PPP exchange rates). However, while increasing 0% 5% 10% 15% 20% 25% 30%
Annualized weekly return volatility
allocations to equities faces adverse market
conditions, investing in EM fixed income is
hindered by numerous accessibility hurdles – a c) Fundamental drivers of EM flows. Since
constraint that will likely be lifted only gradually. portfolio analysis is rather static, we model EM
Accordingly, foreign investors have favored the portfolio inflows (using EPFR data since 2004;
most accessible markets such as CE3, Mexico, weekly and monthly) aggregated by local currency
and South Africa so that technicals actually look debt fund (LC), hard currency (HC), and equities.
heavy in these casesi. The results for LC and HC debt based on standard
b) Portfolio allocation: Although the standard CCAPM are presented in the tables below. Our
model is plagued by non-normality, serial, and results indicate that EM flows respond to
cross-correlation in returns, it remains the fundamentals and risk in line with intuition: 1) A
workhorse in the industry. As we show in a surge in risk aversion is associated with
separate article in this publication25, EM tends to substantial outflows; 2) Higher yield differentials
figure prominently in global ‚optimal‛ portfolios between local currency debt vs. hard currency
that also include global equities, high-yield, high- debt favors inflows into the former vs. outflows
from the latter; 3) inflation weighs on local
markets inflows, while growth differentials are
23
From a fundamentals standpoint, savings ultimately match investments, most relevant for equity inflows (not shown in the
so that assessing whether investors are under-allocated hinges on their table); 4) flows are most vulnerable to risk and risk
preferences and the relative performance characteristics of investable
assets. Since the determination of the optimal portfolio is no easy task,
investors often times resort to benchmarks. Although benchmark indices
can be a useful reference, they are rather static and detached from market
incentives. In fact, since weighs increase when assets appreciate or
indebtedness rises, index weights and prospective returns tend to be
negatively correlated.
24
See September’s Global Financial Stability Report
26
25
See EM Performance: grass is greyer on the other side See Reinhardt and Sbracia, 2011

aversion (proxied by the VIX), as we discuss in Assessing risks of reversals and EM capacity
more detail below 27. The analysis above supports continued strategic inflows,
but it also highlights the sensitivity of these flows to bouts
EM flows supported by fundamentals
Dependent Var.: LC (AUM%) Dependent Var.: HC (AUM %)
of risk aversion. One natural by-product of the dynamic
Variable Coeff. t-stat. Variable Coeff. t-stat.
modeling of these flows (on weekly data) is the impulse
C 4.72 2.4 C 12.27 5.4 response to a shock in VIX. As the chart below shows, the
Ln(VIX) -1.83 -3.7 Ln(VIX) -2.43 -6.1 response of flows to shocks is remarkably quick appearing
Yield diff 0.53 2.6 EM yield -0.42 -2.8 in the data already the week after shock. The impulse
EM inflation -0.19 -1.5 UST yield -0.53 -3.2 responses we obtain from the dynamic version of the
R-squared 59% R-sq. 64% regressions above show that they peak one week after
Adjusted R-sq 55% Adjusted R-sq. 51% the shock and then gradually revert over the following
S.E. of regr. 0.79 S.E. of regr. 0.39
months.
F-statistic 14.53 DW stat 1.71
DW stat. 1.94 The reversion is faster in hard currency (HC) than in local
Sample: 2004-2011, monthly markets (LC) and the impact of shocks to LC also tends to
Source: Deutsche Bank, EPFR
be higher than shocks to HC funds. The chart below
shows the response to 10-point increases in the VIX - the
d) Receding home bias. Missing in the portfolio- most important source of risk for flows. Although the
based approaches we use is the prevalence of sensitivity to one point deviations in variables such as
home bias in international allocation decisions 28 . growth, yield differentials, and inflation are comparable to
Home bias has been falling, however. As it seems the VIX, the potential changes in the VIX are much larger.
inversely related to GDP/capita, it has been on a Altogether, from a tactical standpoint, risk remains the
downward trend (see the graph below). Since most important driver of flows dynamics. In addition, the
financial assets are still concentrated in developed data patterns we have observed suggest that the VIX
markets, this trend should benefit EM allocations. threshold for outflows is around 30.
EM flows are quite sensitive to surges in the VIX

Home bias ratios trend down I m pact of a 10-point rise in VIX on AUM %
Home Bias Trend 0.0
LC response to VIX shock
1.0 -0.2
1.0 HC response of to VIX shock
0.9 -0.4
0.9 -0.6
0.8
-0.8
0.8
0.7 -1.0
0.7 -1.2
0.6
0.6 -1.4
0.5 -1.6
Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 weeks following surge in VIX
-1.8
Emerging Market Developed Market 1 2 3 4 5 6 7 8 9
Note: the figure plots the simple mean home bias ratios over time, with numbers taken
from Solnik and Zuo, 2011, A Global Equilibrium Asset Pricing Model with Home DB research, EPFR
Preference Source: Solnik and Zuo, 2011
Although not destabilizing, these fund outflows amplify

market pressure, highlighting that – despite the
improvement of the past decade – emerging markets
remain relatively shallow. Therefore, although EM
performance would warrant larger allocations in global
27
Although the sensitivity to VIX shown is higher for hard currency flows, portfolios, EM’s sheer lack of depth already poses
this is because of the additional variables included in the local flows
regression (such as FX vols and local yield variance) that reduce the capacity constraints. While investable EM fixed income
elasticity of local flows to VIX. The dynamics version shown below markets hovers below USD1.5trn, global mutual funds
indicates - in line with intuition and anecdotal evidence - that local markets
investments are more sensitive to surges in risk aversion.
alone amount to USD26trn – followed by similar stocks in
28
See Karen k. Lewis, International Home Bias in International Finance and pension funds and insurance companies. With Sovereign
Business Cycles, 1998. The paper suggests that domestic investors hold a Wealth Funds contributing with almost USD5trn, private
substantially larger proportion of their wealth portfolios in domestic assets wealth funds hovering above USD42trn, and alternative
than standard portfolio theory would suggest. In the absence of this home
bias, investors would optimally diversify away domestic output risk. investments possibly adding USD10trn (o.w.USD2trn in

hedge funds), a mere percentage point relocation into EM Among the countries, Venezuela is clearly the credit with
would amount to one-third of its equity capitalization or the largest amount of net supply, and the number above
about all the investable fixed income pool29. does not even include PDVSA. Ukraine and Hungary are
two issuers with pressing financing needs. They could
In sum, although fundamentals and institutional guidelines place bonds only if market conditions are conducive; so
indicate that global investors remain under-allocated to that external support (e.g. the IMF) may be required to
EM, valuation, lack of depth, and market access suggest solve the liquidity problem they are facing. For Argentina,
that the pace of strategic inflows will be considerably we pencil in $2bln of local law bonds supply (likely to be
slower going forward when compared with 2003-2007. placed with the Anses), with the remainder of financing
gap ($3.5bln) to be likely filled with the use of Central
A closer look at EM: Amortization and supply Bank reserves and loans with the Banco Nacion. The large
Having discussed tactical and structural drivers of amount of negative net supply in Argentina is a double-
technicals from EM at large, we now assess specifics for edged sword: on the one hand it suggests that investors
sovereign credit, local markets and EM corporate credit in will get large redemptions, but on the other hand it is
2012, mostly from the perspective of supply vs. demand. indicative of demand constraints and lack of market-based
means of financing. Brazil’s large amount of negative net
In sovereign credit, external issuance by EM governments supply, on the other hand, indeed represents a very
has been very strong post 2008 crisis, peaking in 2010, positive technical condition30.
but even in 2011 it has remained close to the 2010 high.
We expect issuance in 2012 to remain elevated (and most Total public borrowing requirements are little
likely above 2011) given the higher than usual external changed in 2012 from 2011 for most countries
debt payments (principal and interest, in total of 2012 Gross Financing Requirement (% of GDP)
USD60bn). We project total principal and interest 15
repayment to cover over 70% of our projected gross HU
RO
issuances across the major countries, in comparison with
the average 65% of the past three years. See the graph LU
CZ HR PL
below. This suggests an increase in total gross issuance 10 BR MX
to $80bln from the average of $70bln of the past three VE MY

LT TH
TR
years, mostly due to significant increase of issuances by IN
UA IL
Venezuela, Russia, UAE, and also due to a substantial AR SG
PH ZA
increase in net issuance by the smaller countries and less 5 CN
CO
frequent borrowers (e.g. Gabon, Ghana, and Egypt). BG
RU ID
Project net supply by major EM governments in 2012 KR

0 CL
2012 hard currency bonds net supplies
0 5 10 15
6000
2011 Gross Financing Requirement (% of GDP)
3000 Note: Data source for most countries is the IMF, with notable exception of Brazil,
Venezuela, Korea, and the Philippines, for which we get the amount of debt maturing
0 from Bloomberg.
Source: Deutsche Bank, IMF
-3000
Data on local markets amortization schedule is scarcer.
-6000
We thus look at total public borrowing requirements and
AE VE CZ UA HU ID RO RU PE PH ZA CO MX LT PL LB TR BR AR
investor positioning in selected markets for potential
Net supply = projected gross issuances - total principal and interest payments pressure points. Based on IMF projections, the total gross
(bonds only)
financing requirements will change little in 2012 compared
Argentina: repayment include estimated warrant payments (excl. public holdings)
issunce projection is $2bln local law bonds to 2011 (see the graph above). Countries that stand out
Venezuela: excludes PDVSA interest payments include Hungary, whose financing requirement increases
UAE: include both Abu Dhabi and Dubai
to 14.5% from 10%. Hungary has initiated talks with IMF
DB research
with the aim of accessing a precautionary credit line.
29 30
Note that EM pension funds and mutual funds are among those with For a more detailed discussion on the supply/demand outlook as well as
highest growth rates, thus adding an important source of demand to this other aspects of the technical conditions on Sovereign credit, please see
equation. See OECD, ICI, The City UK, and Towers Watson statistics for ‚Sovereign Credit in 2012: Diminished returns; country selection key‛ in
more information. this Monthly publication

Egypt features the largest financing need (30.5% of GDP), now local markets, but EM corporates bonds outstanding
but for scaling purposes it is not shown in the graph. already amount to about two-thirds of the HY and more
than 15% of IG.
For EMEA local markets, 2012 is likely to see a marginal
increase in net issuance, but the growth in volume is likely
to be in line with GDP and the increase is concentrated in Corporate-Sovereign supply gap likely to widen
USDbn 295.7
states that enjoy a comfortable fiscal position (Turkey, 300.00 286.5
Russia)31 250.00 Sovereign Corporate 229.5

245.3
the typically high financing needs in Brazil. 200.00 176.4

189.7
150.00
122.0
Otherwise, in local markets, a major pressure point will be 94.1 94.9
100.00 83.7
foreign investor positioning. Foreign investors have been 59.0
72.6
55.5 57.6 63.0
50.4 57.3
remarkably resilient even in markets (such as Hungary) 50.00

19.0
that have been hit hardest by the turmoil in the EU. As the 0.00
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2010YTD
YTD
chart below shows, non-residents share of local currency
government debt markets is at an all time high in Poland,
Russia, South Africa, Turkey, and Hungary. The recent
years have been a reminder that these positions can be Higher quality and relatively low leverage also played a
unwound once risk aversion surges and – despite its role in explaining this resilience. Average corporate cash /
resilience – we see foreign positioning as vulnerability for short term debt ratio is above 2x in LatAm and in
these markets. Risk is highest in Hungary and to a much CEEMEA and has been growing in the past quarters. At
lesser extent Poland. On the other hand the likely the same time, corporate net leverage has been declining
introduction of Euroclearable government bonds in Russia steadily in both LatAm and CEEMEA (see the graph
is supportive in attracting inflows. below), leaving the corporate sector in robust shape to
face a downturn in economic and financing activity.
Foreign ownership of local fixed income still high
Low leverage tames risk of reversals
Drausio Giacomelli, New York, 1 212 250 7355

Corporates: The rising of the asset class is on track Hongtao Jiang, New York, 1 212 250 2524
It is no news that corporates have surpassed sovereigns
in issuance by a large margin (chart). For EM corporate,
the significant increase in bond issues after the 2008 crisis
has been in part to substitute for the contraction in bank
lending as development market banks have reduced their
balance sheets. In addition, the past few years have
shown that corporate issuance has become quite resilient
to the ebbs and flows of global capital markets. Dedicate
mandates are still minor when compared to sovereign and
31
See ‚EMEA Local Debt Supply and Demand in Focus‛ in this Monthly
publication for more details.


 EM local currency funds have grown by a factor of Foreign holdings of several local currency markets has
almost 3.5x over the past four years. One of the mirrored the growth of global local currency funds...
implications of this rise is that such funds have an
Index of foreign holdings of domestic currency government bonds
increasing impact on the behaviour of local markets. USD-equivalent value, end 2007=100
450
 In this article we examine the rise of these funds and
the impact it has had on cross-correlation within EM 400
AUM of EM Local Brazi
Brazil
local markets. 350 Currency Bond Funds
300
 We also introduce a new analysis of fund positioning,
250
which we believe will serve as a useful tool for
200
gauging relative technicals across EM local markets. Indonesia
Mexico
150
The past few years have seen a dramatic rise in the 100
amount of funds managed according to dedicated, global
50
EM bond mandates. This rise has been particularly Malaysia
0
significant for EM local currency debt funds; the AUM of
Jan 08 Jan 09 Jan 10 Jan 11
such funds has gone from USD24bn at the end of 2007 to
Source: Haver, Bloomberg LLP, BIS, Country Sources, DB Global Markets Research
USD82bn32.
One of the consequences of the rise of the global local

Recently however, inflows to EMD funds have stalled and
currency funds is of course that foreign investors now
after over two years of consistent inflows, the past two
hold fairly substantial proportions of the outstanding stock
months have brought outflows. Within this article we
of many local currency debt markets. By comparing the
discuss some of the implications of the rise of local
data from the countries themselves on foreign holdings
currency funds. We also introduce a new approach for
with the flow data from EPFR we can build a picture of
assessing the relative position and appetite of real money
the impact of the global funds on the rise in foreign
investors with respect to individual countries within both
holdings. As the chart below shows, there is a striking
local currency and hard currency funds.
correlation in the holdings of a number of major local
markets with respect to the AUM of local currency funds.
EM Local Currency Bond Fund Flows
It is remarkable that since the end of 2007, the percentage
Inflows, USD mm AUM, USD bn increase in the stock of foreign holdings for all four
5,000 100 countries (Brazil, Mexico, Indonesia and Malaysia) and of
4,000 90 the total AUM of global local currency funds is in each
3,000 80 case in the range 200-250%.
2,000 70
1,000 60 ...and the impact of the fund growth can also be seen
0 50 in many other markets
-1,000 40
Index of foreign holdings of domestic currency government bonds
-2,000 30 USD-equivalent value, end 2007=100
-3,000 20 400
-4,000 10 350
AUM of EM Local
S. Africa
-5,000 0 300 Currency Bond Funds
Korea
Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11
250
Source: EPFR Global
200
150
100
Poland
50 Turkey
0 Hungary
Jan 08 Jan 09 Jan 10 Jan 11

32
This is according to data provided by EPFR Global which tracks primarily Source: Haver, EPFR, Bloomberg LLP, BIS, Country Sources, DB Global Markets Research
publicly listed funds. The actual number is likely substantially larger, as we
discuss later.

While not all countries have seen a percentage rise in coverage of local currency funds within the sample 33
foreign holdings comparable to that of the four shown reached a point at which we feel it is sufficiently
above, a number of others also reflect the same pattern of representative as to be able to provide meaningful
inflows. A likely reason why these particular countries insights. While widening our analysis of local currency
have seen a smaller percentage increase is that each of fund positioning, we have also enhanced the way we
these markets had significant proportions of foreign analyse the data.
investors prior to the recent rise of the global local
currency funds. We believe that there are two important factors to
consider when judging what the data on exposures tells
One of the implications of this remarkable rise of global us about the technical position for a given country:
local currency funds is that markets which were once
almost entirely independent of one another are now being  How are funds positioned relative to their respective
linked by a common factor: the behaviour of the local benchmark and how does this relative exposure
currency fund managers and in particular, the in/out flows compare with history?
that they are experiencing.
 What has the recent appetite been for the country in
question? Have funds generally been adding or
The impact of this increasingly common factor can be
reducing exposure?
seen by looking at the average of all pair-wise correlations
of the returns of individual local markets. The chart below For fund exposures we focus on how the exposure
shows the history of this cross-correlation, along with the deviation varies over time
cross-correlation of (a) the FX component of the returns of Local currency fund exposure to Hungary
each market and (b) the fixed income component of the
Weight, % Benchmark
returns. Most striking is the recent rise in the intra-FI 8.00
cross-correlation, coincident with the period of sharp 7.50
Avg Portfolio
outflows shown in the first chart of this article.
7.00
6.50
Cross-correlation among EM local currency fixed
6.00
income has recently jumped higher
5.50
Cross-correlation (60d mov.avg of 5d returns) Total USD Return
0.6 5.00
FI Return
FX Return 4.50
0.5
4.00
Jul10 Oct10 Jan11 Apr11 Jul11 Oct11
0.4
0.3
Avg Exposure vs. benchmark Avg Fund Exposure
1.00
0.2 12m MA
0.50 MA +/- 1StDev*
0.1 0.00
-0.50
0
-1.00
Jan 08 Jan 09 Jan 10 Jan 11 Jan 12
-1.50
Source: DB Global Markets Research -2.00

-2.50
As global fund flows are of greater importance in -3.00
determining the behaviour of local currency bond markets, Jul10 Oct10 Jan11 Apr11 Jul11 Oct11
the appetite of fund managers for different countries is *The standard deviation measure used for the bands is based on the monthly changes
likely to have an increasingly impact, as they represent a in the average exposure vs. benchmark.
far larger share of holdings in each market. For this Source: EPFR Global, DB Global Markets Research
reason, understanding how such funds are positioned

with respect to individual countries should be valuable.
For a number of years we have analysed such positioning
data for external debt funds, but only recently has the
33
We use data provided by EPFR Global on fund country exposures. This
data is provided on a monthly basis and at present covers USD28bn AUM
of hard currency funds and USD25bn AUM of local currency funds.

For the first question, the analysis is relatively occurred due to relative price movements, without any
straightforward. We simply take the average exposure of trading activity and (b) active – i.e. resulted from active
the funds and compare this to the appropriate trading. We then examine the whole sample of funds and
benchmark 34 weight for the asset class. Since not all see what proportion of the funds actively added exposure
funds will be benchmarked to the specific indices we use, and what proportion reduced exposure. We call the
we do not place great emphasis on the absolute difference between these two the ‘buyers v sellers index’.
difference between the exposure and the benchmark; The chart below illustrates this for Hungary and clearly
rather we focus on how that difference has evolved over shows that funds were, on balance, actively reducing in
time. Q2.
The charts above illustrate this for the exposure of local Having constructed the relative weight and the buyers v
currency funds to Hungary. The first chart shows the raw sellers index, we now have a pair of simple metrics with
data: the average exposure of the funds and the weight of which to compare fund exposure and appetite for
the country in the benchmark. The second chart shows different markets. For the positioning we take the
the difference, along with the 12-month moving average difference between the average deviation from the
of the difference. These charts highlight the relevance of benchmark and the 12-month average, divided by the
looking at the deviation over time. The average fund standard deviation of the monthly changes of the
exposure has historically been below the benchmark deviation.
weight, but the deviation has been relatively stable
between 1-2pp below. The exposure z-score indicates how ‘over-/under-
weight’ funds are at present
Notice that in the chart above, the relative rise in the fund
Exposure Z-score*
exposure which occurred in Q2 of this year was entirely 1.5
due to the reduction in the benchmark weight, not Oct 11
1.0
because funds were actively increasing exposure. This is Prev. Mth
clearly an important distinction and leads us to the second 0.5
factor we examine. 0.0
-0.5
To answer the second question, for each fund in the
sample we examine the changes in country exposures -1.0
from one month to the next and estimate the extent to -1.5
which those changes are (a) passive – i.e. would have
-2.0
BR ZA MY TH KR HU MX CO RU CZ ID PL EG RO PE IL TR
Our buyers v sellers index illustrates the appetite for a
country among benchmarked real-money investors change in exposure
Hungary - buyers v sellers index Source: EPFR Global, DB Global Markets Research
1.0
The chart clearly shows that funds are currently most
0.5
‘overweight’ with respect to Brazil and South Africa, while
Turkey is the biggest ‘underweight’.
0.0 For the comparison of recent ‘appetite’ we compare the

3-month moving average of the buyers vs. sellers index
-0.5 for each country, as shown below.
-1.0
Jan 10 Jan 11 Jan 12
* A value of +1.0 indicates that all funds in the sample added exposure during the given
month. A value of -1.0 indicates that all funds in the sample reduced exposure.
Source: EPFR Global, DB Global Markets Research
34
For the local currency funds we use JP Morgan’s GBI-EM Broad
Diversified weights from Bloomberg. For the hard currency funds we use
our own EM USD Sovereign Index (which is very similar in composition to
JP Morgan’s EMBI Global Diversified and other similar constrained market
cap indices for EM sovereign USD bonds).

The buyers v sellers index gives an impression of the foreign holdings in each market were held within global
relative strength of appetite for different countries local currency funds and if the country weights in our
sample is reflective of the overall market, then the points
Buyers v sellers index, 3m MA*
+0.5
on the chart below would all lie on a straight line, the
+0.4
Oct 11 slope of which would reflect the total AUM of the funds.
+0.3 Prev. Mth As it is, a portion of the holdings are certainly not
+0.2 managed within such funds, but this analysis nevertheless
+0.1 allows some approximation to be made for the possible
0 size of this family of funds. The chart below would
-0.1 suggest that there may be as much as USD200bn
-0.2 managed in such funds.
-0.3
-0.4
The total size of the global local fund universe may be
-0.5
ZA TH RU BR KR CO CZ HU RO MX MY TR PL PE IL ID EG as much as USD200bn
*-Number of funds actively increasing exposure minus number of funds actively Foreign Holdings of Domestic Government Debt (USD bn)
decreasing exposure, divided by the total number of funds 120
BR
100
This shows that funds have been most consistent in their 80

MX $400bn
appetite for South Africa; while there have been few
60
countries which have seen consistent selling pressure in KR PL $300bn
the past few months. The chart above also shows a sharp 40
TR $200bn
change in the appetite for Colombia, from selling to MY
HU ZA
buying. This can be seen more clearly by looking at the 20 CZ
TH
ID $100bn
EG
underlying index, as shown below: RU
0
0 5 10 15 20
Detailed country-specific charts (such as these) are Average % allocation within Global Local Currency EMD Funds
included in the Appendix Source: Haver, Bloomberg LLP, BIS, Country Sources, DB Global Markets Research
Colombia - avg exposure vs b'mark Colombia - buyers v sellers index
-5.2 1.0
-5.4
-5.6 Marc Balston, London, (44) 20 7547 1484
-5.8 0.5
-6.0
-6.2 0.0
-6.4
-6.6
-6.8 -0.5
-7.0
-7.2
-7.4 -1.0
The following pages contain charts like those shown

above for Colombia for all countries in the analysis. In
addition, we include similar analyses for the exposure of
hard currency funds. The interpretation of these is
discussed in the Sovereign Credit Outlook article within
this report.
Finally, we mentioned at the outset that the total amount

of assets managed by global EM local currency funds is
likely to be considerably larger than the USD80bn figure
indicated by EPFR. One way to gauge the order of
magnitude of the true figure is to compare the average
country weights of fund managers with the total stock of
foreign holdings in each market, as reported by the
various national sources (as shown below). If all the

Exposures of Local Currency EM Bond Funds

Brazil - avg exposure vs b'mark Brazil - buyers v sellers index South Korea - avg exposure vs b'mark South Korea - buyers v sellers index
10 1.0 2.0 1.0
1.8
8 1.6
0.5 0.5
1.4
6
1.2
0.0 0.0
1.0
4
0.8
-0.5 0.6 -0.5
2
0.4
0 -1.0 0.2 -1.0
Jan 10 Jan 11 Jan 12 Jan 10 Jan 11 Jan 12 Jan 10 Jan 11 Jan 12 Jan 10 Jan 11 Jan 12
Colombia - avg exposure vs b'mark Colombia - buyers v sellers index Mexico - avg exposure vs b'mark Mexico - buyers v sellers index
-5.2 1.0 6.0 1.0
-5.4
-5.6 5.5
-5.8 0.5 5.0 0.5
-6.0
-6.2 4.5
0.0 0.0
-6.4 4.0
-6.6
-6.8 -0.5 3.5 -0.5
-7.0 3.0
-7.2
-7.4 -1.0 2.5 -1.0
Czech Republic - avg exposure vs b'mark Czech Republic - buyers v sellers index Malaysia - avg exposure vs b'mark Malaysia - buyers v sellers index
2.0 1.0 2 1.0
1.8
1.6 0.5 0 0.5
1.4
1.2 0.0 -2 0.0
1.0
0.8 -0.5 -4 -0.5
0.6
0.4 -1.0 -6 -1.0
Egypt - avg exposure vs b'mark Egypt - buyers v sellers index Peru - avg exposure vs b'mark Peru - buyers v sellers index
1.0 1.0 1.8 1.0
1.6
0.8
0.5 1.4 0.5
0.6 1.2
1.0
0.4 0.0 0.0
0.8
0.2 0.6
-0.5 0.4 -0.5
0.0
0.2
-0.2 -1.0 0.0 -1.0
Hungary - avg exposure vs b'mark Hungary - buyers v sellers index Poland - avg exposure vs b'mark Poland - buyers v sellers index
5 1.0 2 1.0
4 1
0.5 0.5
3 0
0.0 0.0
2 -1
-0.5 -0.5
1 -2
0 -1.0 -3 -1.0
Indonesia - avg exposure vs b'mark Indonesia - buyers v sellers index Romania - avg exposure vs b'mark Romania - buyers v sellers index
3.0 1.0 1.0 1.0
2.5 0.8
0.5 0.5
2.0
0.6
1.5 0.0 0.0
0.4
1.0
-0.5 -0.5
0.5 0.2
0.0 -1.0 0.0 -1.0

Israel - avg exposure vs b'mark Israel - buyers v sellers index Russia - avg exposure vs b'mark Russia - buyers v sellers index
1.4 1.0 1.0 1.0
1.2 0.5
1.0 0.5 0.5
0.0
0.8
0.0 -0.5 0.0
0.6
-1.0
0.4 -0.5 -0.5
0.2 -1.5
0.0 -1.0 -2.0 -1.0

Exposures of Local Currency EM Bond Funds (cont...)

Thailand - avg exposure vs b'mark Thailand - buyers v sellers index
0 1.0
-1
0.5
-2
-3 0.0
-4
-0.5
-5
-6 -1.0
Turkey - avg exposure vs b'mark Turkey - buyers v sellers index

8 1.0
6 0.5
4 0.0
2 -0.5
0 -1.0
South Africa - avg exposure vs b'mark South Africa - buyers v sellers index
3 1.0
2
0.5
1
0.0
0
-0.5
-1
-2 -1.0

Exposures of Hard Currency EM Bond Funds

Argentina - avg exposure vs benchmark Argentina - buyers v sellers index Ghana - avg exposure vs benchmark Ghana - buyers v sellers index
8 1.0 0.4 1.0
6 0.5 0.2 0.5
4 0.0 0.0 0.0
2 -0.5 -0.2 -0.5
0 -1.0 -0.4 -1.0

Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12
Bulgaria - avg exposure vs benchmark Bulgaria - buyers v sellers index Hungary - avg exposure vs benchmark Hungary - buyers v sellers index
1.2 1.0 0.6 1.0
1.0 0.4
0.8 0.5 0.2 0.5
0.6 0.0
0.4 -0.2
0.0 0.0
0.2 -0.4
0.0 -0.6
-0.2 -0.5 -0.8 -0.5
-0.4 -1.0
-0.6 -1.0 -1.2 -1.0
Brazil - avg exposure vs benchmark Brazil - buyers v sellers index Indonesia - avg exposure vs benchmark Indonesia - buyers v sellers index
2 1.0 2.5 1.0
2.0
0 0.5 0.5
1.5
-2 0.0 1.0 0.0
0.5
-4 -0.5 -0.5
0.0
-6 -1.0 -0.5 -1.0
Chile - avg exposure vs benchmark Chile - buyers v sellers index South Korea - avg exposure vs benchmark South Korea - buyers v sellers index
0.4 1.0 -4 1.0
0.2
-5
0.0 0.5 0.5
-0.2 -6
-0.4 0.0 0.0
-0.6 -7
-0.8 -0.5 -0.5
-8
-1.0
-1.2 -1.0 -9 -1.0
China - avg exposure vs benchmark China - buyers v sellers index Mexico - avg exposure vs benchmark Mexico - buyers v sellers index
1 1.0 2 1.0
0
0 0.5 0.5
-2
-1 0.0 0.0
-4
-2 -0.5 -0.5
-6
-3 -1.0 -8 -1.0
Colombia - avg exposure vs benchmark Colombia - buyers v sellers index Malaysia - avg exposure vs benchmark Malaysia - buyers v sellers index
0.6 1.0 2 1.0
0.4
0.2 1
0.5 0.5
0.0
0
-0.2
0.0 0.0
-0.4
-1
-0.6
-0.8 -0.5 -0.5
-2
-1.0
-1.2 -1.0 -3 -1.0
Egypt - avg exposure vs benchmark Egypt - buyers v sellers index Panama - avg exposure vs benchmark Panama - buyers v sellers index
0.4 1.0 0.0 1.0
0.2 -0.2
0.0 0.5 -0.4 0.5
-0.6
-0.2
0.0 -0.8 0.0
-0.4
-1.0
-0.6 -0.5 -1.2 -0.5
-0.8 -1.4
-1.0 -1.0 -1.6 -1.0

Exposures of Hard Currency EM Bond Funds (cont)

Peru - avg exposure vs benchmark Peru - buyers v sellers index Tunisia - avg exposure vs benchmark Tunisia - buyers v sellers index
1.4 1.0 0.05 1.0
1.2
0.00
1.0 0.5 0.5
0.8 -0.05
0.6
0.0 -0.10 0.0
0.4
0.2 -0.15
0.0 -0.5 -0.5
-0.20
-0.2
-0.4 -1.0 -0.25 -1.0
Philippines - avg exposure vs benchmark Philippines - buyers v sellers index Turkey - avg exposure vs benchmark Turkey - buyers v sellers index
-1.0 1.0 -1 1.0
-1.5 -2
0.5 0.5
-2.0
-3
-2.5 0.0 0.0
-4
-3.0
-0.5 -0.5
-3.5 -5
-4.0 -1.0 -6 -1.0

Pakistan - avg exposure vs benchmark Pakistan - buyers v sellers index Ukraine - avg exposure vs benchmark Ukraine - buyers v sellers index
0.2 1.0 2.5 1.0
2.0
0.5 0.5
0.0
1.5
0.0 0.0
1.0
-0.2
-0.5 -0.5
0.5
-0.4 -1.0 0.0 -1.0

Poland - avg exposure vs benchmark Poland - buyers v sellers index Uruguay - avg exposure vs benchmark Uruguay - buyers v sellers index
0.2 1.0 0.8 1.0
0.0 0.6
-0.2
0.5 0.4 0.5
-0.4
-0.6 0.2
-0.8 0.0 0.0 0.0
-1.0 -0.2
-1.2
-0.5 -0.4 -0.5
-1.4
-1.6 -0.6
-1.8 -1.0 -0.8 -1.0
Serbia - avg exposure vs benchmark Serbia - buyers v sellers index Venezuela - avg exposure vs benchmark Venezuela - buyers v sellers index
0.2 1.0 3 1.0
2
0.5 0.5
0.0
1
0.0 0.0
0
-0.2
-0.5 -0.5
-1
-0.4 -1.0 -2 -1.0

Russia - avg exposure vs benchmark Russia - buyers v sellers index Vietnam - avg exposure vs benchmark Vietnam - buyers v sellers index
12 1.0 0.0 1.0
10
8 0.5 0.5
-0.2
6
0.0 0.0
4
-0.4
2 -0.5 -0.5
0
-2 -1.0 -0.6 -1.0
El Salvador - avg exposure vs benchmark El Salvador - buyers v sellers index South Africa - avg exposure vs benchmark South Africa - buyers v sellers index
0.8 1.0 0.8 1.0
0.6
0.6 0.4
0.5 0.5
0.4 0.2
0.0
0.2 0.0 -0.2 0.0
-0.4
0.0 -0.6
-0.5 -0.5
-0.2 -0.8
-1.0
-0.4 -1.0 -1.2 -1.0

 The IMF currently has EUR 285bn in its locker for new These resources have expanded significantly in response
lending. This would be enough to provide newly- to the 2008-09 crisis:
launched Precautionary and Liquidity Lines for both
Italy and Spain (up to EUR 138bn), though we have  IMF quota resources are in the process of being
doubts about whether they would qualify for this doubled to approximately EUR 575bn. This increase is
instrument. It would not be enough to cover a fund still working its way through the domestic approval
arrangement for Italy (EUR 292bn) proportionate in process among the IMF’s member countries. The aim
size to that put together for Greece is to get this done by October 2012, though there is a
risk that this date could slip, not least given the need
 Various options have been proposed for increasing
for US congressional approval the increase.
the IMF’s financial firepower, including voluntary
contributions to an IMF special structure, pooling  In the meantime, the credit lines available to the IMF
European SDR allocations, or ECB lending to the IMF. from stronger countries have been boosted to about
There are political and technical drawbacks with each EUR 428 billion. The amount available to the IMF is, in
of them. practice, rather less than this. Some creditor
countries could themselves run into balance of
 A further increase in bilateral contributions to the IMF
payments difficulties and the IMF sets aside a portion
would seem more viable, though this would rule out
of these credit arrangements to reflect this risk.
using the additional resources to buy bonds or lend to
Greece, Ireland, and Portugal, for example, participate
the EFSF. Non-European countries will also want to
in these arrangements; but their portion of these
see greater clarity regarding Europe’s financial
credit lines is effectively unavailable to the IMF. When
commitment before they go down this route.
the quota increase becomes effective, the intention is
 Were it not for the potential calls from the euro area, to scale back the borrowing arrangements
the IMF already has enough firepower to meet the correspondingly.
probable needs of emerging market countries. The
That currently gives the IMF about EUR 620bn of total
requests are most likely to come from emerging
resources, of which about EUR 590bn comes from quotas
Europe, where a toxic combination of relatively
and borrowing arrangements in roughly equal measure.
weaker fundamentals and higher exposures to the
This compares with total resources of EUR 244bn in
euro area have left several countries facing
December 2007 prior to the last crisis.
difficulties. Four countries in the region (Poland,
Romania, Serbia, and Macedonia) already have IMF
However, the amount the IMF has to lend to countries is
arrangements in place. Ukraine also has an
significantly less than this, primarily reflecting: (i) its
arrangement although this has been dormant for the
holdings of non-usable currencies (e.g. Zimbabwe dollar);
past year because Ukraine has not yet met the
(ii) the amounts it has already lent or has committed to
requisite policy conditions (e.g. raising gas tariffs).
lend (including precautionary arrangements or credit lines);
Hungary has also requested a program, though these
and (iii) a prudential balance or safety margin. Once all this
negotiations could well be difficult.
is factored in, that leaves the IMF with some EUR 285bn
The IMF’s Financial Firepower35 available for new lending.
The IMF’s resources come from two principal sources: (i)

Potential lending to Europe
the capital subscriptions (or ‚quotas‛) made available by
each member country – with the size of a country’s quota The IMF has a variety of lending facilities through which it
determined mainly by its economic size; and (ii), IMF can lend to its member countries:
borrowing, typically from its stronger member countries.
 At one end of the spectrum is the Flexible Credit Line
(FCL) designed to provide to large upfront financing
to countries with very strong fundamentals and a
35
The IMF’s financial resources and transactions are denominated in clear track record of implementing good policies.
Special Drawing Rights, the value of which are based on a basket of Critically, for those countries that qualify, there are no
currencies including the dollar, euro, yen and pound sterling. The dollar and strings attached in the sense that disbursements
euro amounts quoted in this note are based on exchange rates as of
November 22 (1 USD = SDR 0.639; 1 EUR = SDR 0.865) but might vary a
little with exchange rate movements.

under an FCL are not phased or conditional on a sizes for Italy and Spain in the table below. Were it to
country meeting certain policy understandings as is qualify for a PLL, for example, Italy would be able to
access up to EUR 91bn. The corresponding amount for
Current IMF quotas (EUR bns) Spain would be EUR 47bn. In both cases, only half of
Eu ro are a 63.8 Se l e cte d oth e rs these amounts would be available upfront. The IMF would
Austria 2.4 Brazil 4.9 be able to finance these amounts, totaling EUR 138bn,
Belgium 5.3 Canada 7.4 from within its existing EUR 285bn available for new
Cyprus 0.2 China 11.0
lending.
Estonia 0.1 Japan 18.1
Finland 1.5 Mexico 4.2 It would be more difficult for it to accommodate programs
France 12.4 Russia 6.7 significantly larger than this. If, for example, Italy were to
Germany 16.8 UK 12.4
request a ‚Greek-size‛ program (i.e. 3200% of quota), this
Greece 1.3 US 48.7
would amount to EUR 292bn, which would entirely wipe
Ireland 1.5
Italy 9.1
out the IMF’s new lending capacity. The Irish and
Luxembourg 0.5 Portuguese programs were a little smaller than this at
Malta 0.1 about 2300% of quota, which in Italy’s case would
Netherlands 6.0 amount to EUR 210bn. This is within the IMF’s new
Portugal 1.2 lending capacity but would leave it with little (EUR 75bn)
Slovakia 0.5 to meet the needs of other potential borrowers, such as
Slovenia 0.3
Spain, let alone emerging markets that are facing
Spain 4.7
difficulties in the current environment. Hungary, for
example, has already indicated its intention to seek
the case under a traditional IMF-supported program. another arrangement with the IMF.
There is no cap on the amounts made available, Illustrative IMF program sizes (EUR bns)
which are based on an assessment of a country’s
potential financing need. But we can get a sense of
Italy Spain Total
what is ‚normal‛ from the three countries that
PLL (1000% of quota) 91 47 138
currently have such arrangements, Mexico (1500% of
of which available immediately: 46 23 69
its quota), Poland (1400%), and Colombia (500%).
Traditional program (3200% of quota) 292 149 440
 Somewhere in the middle is the IMF’s new Traditional program (2300% of quota) 210 107 316
Precautionary and Liquidity Line, introduced earlier
this week.36 This is intended for countries with sound
fundamentals and policy track records, but which face
It is debatable whether Italy or Spain would qualify for the
moderate vulnerabilities and do not qualify for the
PLL. The IMF has, for example, indicated that the PLL is
FCL. Access is limited to 500% of quota up front and
intended for ‚crisis bystanders‛. The qualification criteria
up to a total of 1000% after 12 months subject to
(see box below) involve some subjective judgments. But
satisfactory progress in addressing remaining
we think that both Italy and Spain need to undertake large
vulnerabilities. There is also a short-term liquidity
macroeconomic and structural policy adjustment, which
window under which countries could access between
would appear to rule them out as PLL candidates. If that is
250% and 500% of quota. We do not think there will
the case, then they would need to seek more traditional
be much demand for this, with countries that qualify
programs with their more intrusive (and politically
for the PLL likely to prefer the longer 12-24 month
unpalatable) policy conditionality.
arrangement.
To give a sense of how much the IMF could lend to

Europe, using its existing instruments and given its
current firepower, we show some illustrative program
36
This is very similar to the Precautionary Credit Line (PCL), which it
replaces: Macedonia is currently the only country that has a PCL. Aside
from the new short-term liquidity window, the only other material change
is that a country can now request a PLL when it has an actual balance of
payments need versus potential need under the old arrangements. In
practice, however, defining whether a country faces an actual or potential
balance of payments need is not a precise exercise. We think it unlikely
that the distinction was much of a barrier to countries accessing the PCL.

IMF Precautionary and Liquidity Line Our reading of the G20 meetings a few weeks ago was
that while the BRICS and others were reluctant to lend
Qualification requires that a country: (i) has sound
directly to the EFSF, they were open to the idea of
economic fundamentals and institutional policy
providing support through the IMF, not least because the
frameworks; (ii) is implementing—and has a track record
IMF would then bear the credit risk. No firm pledges were
of implementing—sound policies; and (iii) remains made, though the table below (showing the current
committed to maintaining such sound policies in the breakdown of bilateral credit lines to the IMF through the
future. NAB) shows the amounts that countries eventually
The criteria used to assess whether a country qualifies for stumped up following the last crisis.
the PLL are: (i) external position and market access; (ii) The US seems less enthusiastic about increasing the size
fiscal policy; (iii) monetary policy; (iv) financial sector of the IMF. In his statement to G20 Finance Ministers in
soundness and supervision; and (v) data adequacy. While mid-October, for example, Secretary Geither note that,
requiring strong performance in most of these areas, the ‚The IMF has a substantial arsenal of financial resources,
PLL permits access to precautionary resources to and we would support further use of those existing
members that may still have moderate vulnerabilities in resources to supplement a comprehensive, well-designed
one or two of these areas. European strategy alongside a more substantial
commitment of European resources‛.
Countries suffering any of the following problems at
Ultimately, however, the main stumbling block was an
approval cannot access the PLL: (i) sustained inability to
unwillingness outside the euro area to commit resources
access international capital markets; (ii) the need to
to a bigger IMF while the financial commitment from
undertake large macroeconomic or structural policy
Europe was itself unresolved.
adjustment; (iii) a public debt position that is not
sustainable in the medium term with a high probability; or A number of other proposals potentially involving the IMF
(iv) widespread bank insolvencies. in providing financial support to Europe have been floated.
We go through these below and offer our views on
Source: IMF and based on the qualification criteria for the Precautionary Credit Line.
whether they are likely to work or garner much support.
Options for increasing IMF firepower Increased IMF Special Drawing Rights (SDRs).
Countries hold SDRs as part of their reserve assets and
There has already been some discussion, notably among are able, through the IMF, to exchange them for the freely
the G20 at the Cannes Summit, of further increasing the usable currencies of other IMF members (e.g. dollars or
financial firepower of the IMF. G20 Finance Ministers will euros). The IMF can create SDRs – it is (roughly) the IMF
return to these issues when they meet in the new year. equivalent of printing money. There have only ever been
Mirroring its primary sources of funds, there are two basic three such SDR allocations. The last allocation of EUR
ways in which to increase the general resources that the 186bn in 2009 was by far the largest and the first since
IMF has available to lend: 1981. Some countries converted their allocations into
usable currencies which they then spent. Ukraine, for
 A further increase in IMF quota subscriptions. This
example, used its allocation to pay Russia for gas
seems unlikely, with the last increase still winding its
supplies; and Serbia used its allocation to finance its
way through a lengthy and cumbersome approval
budget. For the most part, however, countries held on to
process. It was also not among the options
their allocations.37
mentioned by G20 leaders in their Cannes
communiqué. The problem with this as a means of providing financial
support to Europe is that SDRs are allocated in proportion
 Additional increases in IMF borrowing. There are a
to a country’s quota. So for every EUR 10bn that would
variety of ways in which this could be done. The IMF
get allocated to, say, Italy, the US would receive EUR
could, for example, borrow from the private sector
53bn because its quota is over five times the size of
although it has never done so. The IMF’s current
Italy’s. It would be technically possible to have an SDR
borrowing takes place primarily through a multilateral
allocation just for Europe, but it’s hard to see why other
agreement, the "New Arrangements to Borrow"
countries would agree to this.38
(NAB). The quickest way, however, is through
bilateral agreements with individual countries. This is
the route that was followed after the last crisis. These
bilateral commitments were then folded into an 37
Total SDR sales between the allocation in August 2009 and June 2011
expanded NAB. were only about EUR 8bn.
38
There was a special one-time allocation of EUR 25bn in which some
countries received more than their quota share. But this part of efforts to

Pooling Euro area SDRs. There has been some lend these resources to euro area countries or, potentially,
discussion of the euro area countries pooling their SDR buy bonds and/or lending to the EFSF.
allocations, which could then be used to provide capital
for the EFSF. The current SDR holdings of the euro area We think this is unlikely to happen for three reasons: (i)
are about EUR 52bn, not insubstantial but certainly no other countries will be reluctant to support a vehicle that
panacea in terms of increasing the size of the EFSF. Our is designed solely for the benefit of Europe; (ii)
understanding is also that Germany does not support the contributing countries rather than the IMF would still bear
proposal.39 the credit risk from such loans; and (iii) in contrast to the
extension of credit lines to the IMF (discussed above),
The IMF’s New Arrangements to Borrow (EUR bns) country contributions to an administered account or trust
Cou n try com m i tm e n ts : could not be included as part of the contributing country’s
Eu rozon e 108.0 EM 6 6 .4 foreign reserves.
Aust 4.1 Brazil 10.1
IMF as a conduit for ECB financing. This is essentially
Bel 9.1 Russia 10.1
Cyp 0.4 India 10.1
the same option as above but simply involving the ECB.
Fin 2.6 China 36.1 As such, it could be a way of getting round the EU treaty
Fra 21.6 restrictions that have so far precluded larger ECB bond
Ger 29.3 Oth e r EM 3 5 .1 purchases or lending to the EFSF. It would likely therefore
Gre 1.9 Chile 1.6 be subject to the same (German) objections.
Ire 2.2 Israel 0.6
Summary of options for IMF financing
Ita 15.7 Hong Kong 0.4 Lo a ns to I MF Lo a ns to a n I MF
g enera l res o urc es a d m inis tered
Lux 1.1 Korea 7.6 a c c o unt a c c o unt/ trus t SD R Allo c a tio n SD R Po o ling
Net 10.5 Kuwait 0.4 Approval IMF board decision IMF board decision IMF board decision Country decision as to
(simple majority). (simple majority). with 85% majority how to use the
Por 1.8 Malaysia 0.4 Funding from donor Funding from donor reserves (could be
country need to be country need to be national Treasury or the
Spa 7.7 Mexico 5.8 approved at the approved at the national central banks).
national level (See national level (see
Philippines 0.4 below). below).
Oth e r D M 218.1 Poland 2.9 Amount In 2009 EUR 428bn of Only a few examples In 2009 increased the The current SDR
additional funding was in the past (e.g. loan SDR allocation by holdings of the EUR
Australia 5.1 Saudi Arabia 12.9 committed initially as from Spain to EUR189bn area amount to
bilateral loans Argentina). EUR52bn
Canada 8.8 Singapore 1.5 subsequently folded
into an expended NAB
Denmark 3.7 South Africa 0.4 Conditions Usual IMF procedure. Has to be‛ consistent Country decision as to Not clear, but
Japan 76.2 Thailand 0.4 Loans will have with the purpose of the how to use the presumably could be
preferred creditor IMF‛. Could be more reserves (could be the rolled into the EFSF or
New Zealand 0.7 status flexible than IMF central bank or the have EFSF like
General Resources: i.e. fiscal authority). For procedure. ECB will
Norway 4.5 T otal 4 2 7 .6 does not need to be instance, Ukraine in need to agree to
limited to loans to IMF 2009 exchanged its exchange the SDRs
Sweden 5.1 member states nor SDR for hard currency against euros
Switzerland 12.6 does it have to enjoy via the IMF and used
preferred creditor the proceeds to pay
UK 21.6 status. Russia for gas
supplies
US 79.8 Funding In most countries it is The source could be De facto money De facto money
the national Treasury either national central printing by the IMF. In printing by the ECB
that provides the loan, banks or national accounting terms, the
but the net debt is Treasuries. May have national central banks
unchanged as there is an impact on the net have increased
IMF administered accounts or trusts. In addition to its a claim against the debt position of the reserves and against it
IMF. In the case of lender a long term liability to
general resources, the IMF has a number of administered Germany, it is the the IMF that never gets
accounts and trusts that have been established to meet Bundesbank that
provides the loan,
called unless the
country exits the IMF
specific purposes. 40 The main requirement is that such without an impact on

the net debt position of
accounts need to be consistent with the purposes of the Comments
Germany.
Non-EU countries have Have more flexibility A generalised SDR Small amount
IMF. One option would therefore be set up such an withheld their support than General Resources issuance implies that available.
pending further usage. Not clear the US would receive a
account or trust for Europe, to which others could then financial commitment however that non-EU disproportionate
from Europe. countries will agree to amount of SDR relative
contribute financial resources. The IMF could then either take directly the credit to Spain and Italy that
risk of the recipient would presumably
country. May also lead need the funds. Also,
to the loans being there is no
accounted as debt in conditionality
rebalance the IMF and address some obvious inequities, including the fact the national accounts automatically attached
that some members (those joining after 1981) had never received an SDR to the use of the SDR.
Assessment Most likely outcome. Less market friendly Unlikely and inefficient. Unlikely and too small
allocation. Can be agreed by the than administered Would need to be to matter. Not clear
39
It is also not clear how using these SDRs as capital for the EFSF would next G20 meeting in account as the IMF combined with SDR why Germany/ECB
February. Would need seniority may pooling to be material. would agree to it vs.
square with the IMF’s arrangements for ensuring that SDRs can be Bundesbank Approval complicate the return Lacks conditionality for other alternatives
converted into freely usable currencies. to market for program using the funds. Not
40 countries. clear why
Trusts (largely financed by donors) have been used to enable the IMF to Germany/ECB would
lend money to low-income countries on concessional terms or to provide agree to this vs. other
debt relief. Administered accounts have been used to enable countries to alternatives.
finance technical assistant. Spain also used an administered account to
provide financing to Argentina alongside its IMF program in 2000-01.

conditionality). But our assessment is that they are more

Implications for EM
likely to get a traditional Precautionary Standby
The current debate about increasing the financial Arrangement (like Romania and Serbia) – see also the
firepower of the IMF is largely about giving it sufficient Hungary section later in this EM Monthly for a more
resources to increase its lending operations in the euro detailed discussion of our views on this issue, including
area. Its current resources are adequate to handle the some of the potential policy sticking points in the
most likely requests for financial assistance from EM, negotiations.
though these resources would certainly be stretched if
Other countries in south eastern Europe (e.g. Croatia)
one or two larger emerging markets, particularly Brazil but
could also be candidates for IMF financial assistance in
also Turkey, were to request financial assistance (e.g. in
this environment. Outside of Europe, Egypt’s external
the form of Flexible Credit Lines or Precautionary and
position remains under significant pressure with reserves
Liquidity Lines).
more than halving since the revolution earlier this year.
The requests are most likely to come from emerging The government had reached preliminary agreement on a
Europe, where a toxic combination of relatively weaker USD 3bn Standby Arrangement with the IMF but stopped
fundamentals and higher exposures to the euro area have short of going forward with the arrangement for political
left several countries facing difficulties. Four countries in reasons.
the region (Poland, Romania, Serbia, and Macedonia)
Robert Burgess, London, (44) 20 7547 1930
already have IMF arrangements in place as a financial
safety net. Ukraine also has an arrangement although this
has been dormant for the past year because Ukraine has
been unable to meet the conditions required (e.g. higher
domestic gas tariffs) for further disbursements of financial
support.
Current IMF programs for EM

Type Amt (USD bn) % Quota
C o lo m b ia Flexible Credit Line 6.1 500
Ma c ed o nia Precautionary Credit Line 0.3 314
Mex ic o Flexible Credit Line 74.0 1304
Po la nd Flexible Credit Line 30.0 1135
R o m a nia Precautionary Standby 4.8 300
Serb ia Precautionary Standby 1.5 200
Sri La nka Standby Arrangement 2.6 400
Ukra ine Standby Arrangement 15.6 729
Hungary has announced that it is seeking a precautionary

financing package with the IMF (and EU). The government
has indicated that it would like an insurance-type
arrangement (i.e. upfront access with little or no policy

 2011 was a positive year for fiscal performance in …modest outflows despite a negative performance
most EMEA countries. In most instances fiscal
targets were exceeded and debt issuance programs
progressed without interruption. A performance that
contrasts with the situation prevailing in developed
markets and more specifically Eurozone countries.
 2012 is likely to see a marginal increase in net
issuance in our view, but the growth in volume is
likely to be in line with GDP and the increase is
concentrated in states that enjoy a comfortable fiscal
position (Turkey, Russia)
 EMEA countries have been cautious in managing
their debt issuance plan, often front-loading issuance
(Poland, Hungary), pre-funding for 2012 (Poland) and
preserving healthy cash balances (Poland, South Source: Deutsche Bank
Africa). Hungary has initiated talks with IMF with the

aim of accessing a precautionary credit line.
Foreigner positioning is at new highs in most markets
 EM local currency debt funds continued to see strong
Foreign Holdings of Domestic Government Debt (latest data)
inflows, but the momentum has been lost in the 45%
second half of the year as Eurozone worries forced a HU
40%
derisiking across financial markets. MY
35% MX
ID
 Appetite for local currency debt has seemed at times 30%
indiscriminate (Hungary) and excessive (Poland, South 25% ZA
PL
Africa). Non-residents share of local currency 20% KR
government debt markets is at an all time high in 15% TR CZ
Poland, Russia, South Africa, Turkey, Hungary TH
10% BR
 We see risks of outflows as highest in Eastern 5% RU
Europe: Hungary and to a much lesser extent Poland. 0%
On the other hand the likely introduction of 0% 5% 10% 15% 20% 25% 30% 35% 40%
Euroclearable government bonds in Russia should Foreign Holdings of Domestic Government Debt on 31-Aug-08
attract inflows Source: Deutsche Bank
 In the following note we take stock of the lessons

learned in 2011 and address the specifics of each
2011: Lessons from a volatile year
market in terms of supply/demand over 2012
A combination of factors arguably made EM Local debt
Inflows have been on an exponential trend (USD bn) appear to be the ideal asset class in which to invest in
2011. The global backdrop was characterized by low
expectations for global growth/inflation which should be
supportive for rates However, investors in DM rates
products were faced with new risks: the potential
negative impact of successive rounds of QE on the USD,
financial repression via the imposition of negative real
yields and the emerging risk of default in several Eurozone
names. As such EM, enjoyed better fiscal fundamentals,
and seemed to offer an ideal investment environment.
The asset class has for example attracted much more
inflows than EM equities.

Despite a positive start to the year, performance turned in FX positioning turned sharply since September
the third and fourth quarter as DM troubles caught up
with EM investors via the USD funding channel. The
spread of Greek crisis to other Eurozone assets made US
money market funds reluctant to fund European banks,
thereby triggering a scramble for USD funding which
penalized EM FX. The impact was severe enough to cause
fears of FX pass-through into inflation. Turkey and Russia
were forced to allow money market rates to rise. As a
result the benchmark index has delivered a negative
performance (at time of writing -3%).
Some investors would have been reassured that outflows

were relatively modest at (-2.5% of total assets) and the
trend reversed quickly, compared to EM hard currency.
However, anecdotal evidence suggests that bond Source: Deutsche Bank
investors themselves were at least partly responsible for

the weak EM FX performance in an attempt to hedge Turkey is the most underweight position
bond holdings via a more liquid instrument. The low risk of Exposure Z-score*
default and the absence of client redemptions make it 1.5
Oct 11
hard to justify the transaction costs of an outright
1.0
reduction in bond holdings. This form of ‚synthetic Prev. Mth
outflows‛ via FX hedging or even over-hedging (whereby 0.5
investors attempt to hedge both FX and duration exposure 0.0

via FX) can lead to higher rates with central banks forced
-0.5
to react to FX weakness to reduce the FX-pass through to
inflation It therefore seems to us that even in the relatively -1.0
supportive environment of 2011, weak technicals did play -1.5

a role in the negative performance for the year.
-2.0
BR ZA MY TH KR HU MX CO RU CZ ID PL EG RO PE IL TR
At the start of 2012, Turkey looks to be the largest
underweight position, while South Africa is the biggest change in exposure
overweight in EMEA.
In the following section, we analyse on a country by Hungary: an arduous 2012

country basis the supply/demand picture for 2012 and
compare this to the existing positioning. Fiscal: Our economists expect GDP growth of -0.8% for
2012 after an expected 1.4% outturn for 2011. The
Local debt performance turned in September government has penciled in 2.5% of GDP fiscal deficit in
2012, which we believe is too optimistic and expect the
Year to date total returns (%)
10 deficit to be close to 3.2%.
8
Supply: Favourable risk appetite in the first half of the year
6 allowed Hungary to issue significantly more than planned
4 at the end of 2010. Indeed, in 2011, gross issuance in
2 Hungarian bonds was approximately HUF 1.7tn versus
HUF 1.5tn planned. In 2012, DB forecasts a 3.2% deficit
0
in Hungary from a 1.9% surplus in 2011 which translates
-2 EM LC Index to an increase in net financing need by approximately HUF
-4 EM LC Index Hedged 360bn. However, we expect gross issuance next year to
increase only by HUF 220bn to HUF 1948bn as
-6
redemptions are set to fall to a low of HUF 738bn. We
01/11 04/11 07/11 10/11 assume zero net issuance in the external debt market. We
expect Hungary to look to issue EUR 4-4.5bn in external
debt in 2012, almost unchanged from 2011. This financing

is intended to cover repayment to the IMF and constitutional limit from Gross to Net, since that may
redemptions in the Eurobond market. Such issuance will herald more fiscal drift in the future.
clearly be susceptible to the external environment. If the
market is not conducive to such issuance then this could Supply: In the financing outlook for 2012, it is worth
result in higher domestic issuance to compensate highlighting the increase in redemptions in T-bonds in
2012 from PLN 101bn in 2011 to PLN 123bn in 2012. The
Demand: We were surprised by the resilience of demand deficit for 2012 is expected to remain approximately the
for HGBs despite three factors: 1/ Worsening outright and same at PLN 35bn. Hence, gross issuance in Polish T-
relative performance of Hungarian bonds since August. 2/ bonds is expected to reach PLN 123bn in 2012 versus
Deterioration of the economic prospects in the Eurozone PLN 100.5bn in 2011. Issuance in the external debt
3/ Investor unfriendly government measures that market is estimate by MinFin to remain the same at PLN
culminated in the loss of investment grade status. 24.1bn gross issuance. Overall, the issuance program
plans to increase the proportion of domestic debt
A probable explanation is that demand was supported by issuance denominated in zloty from 61% in 2011 to 70%
benchmarked investors who adopted an overall in 2012.
underweight position but not a deep underweight
considering the cost of carry. Demand: The reduction in government transfers to
pension funds and rather timid demand for banks which
The government’s cancellation of USD 4.5bln of bonds preferred to allocate their balance sheet to higher margin
held by pension funds was a one off event in 2011. loan demand, have left the treasury reliant on external
However, going forward the disappearance of yearly financing to cover the sharp increase in net issuance. We
transfers (amounting to 8 % of GDP) to those funds will are concerned that a deepening of the Eurozone crisis
imply either a further increase in non-residents take up or would cause foreigners to reduce exposure and the bond
an increase in banks share. Both instances imply higher curve to steepen further.
yields at the back-end of the curve.
Increased reliance on external funding
Foreigners compensated for pension funds forced exit
(External + foreign held PLN debt)% of state debt
60%
50%
40%
30%
20%
10%
0%
Source: Deutsche Bank Source: Deutsche Bank
Poland: Gross issuance increases, but net

issuance falls
Fiscal: We expect the current state budget which targets

sub-3% of GDP fiscal gap to be revised, since the growth
estimate at 4% does not take into account the increased
likelihood of weak economic performance in the
Eurozone. Having said that, the pre-financing already
executed in 2011 (10% of issuance needs) and MinFin’s
ample cash buffer (2.8% of GDP), reduce roll-over risks on
the domestic debt front in 2012. One source of worry is
the current talk of redefinition of the 55% debt/GDP

… has led to a widening of ASW41 This contrasts with the bullish view expressed by foreign
investors who have been more focused on the lack of
global inflationary pressures and the high yield
differentials offered by exposure to South Africa. South
Africa is currently the largest overweight for real money
investors 42 , which suggests reducing positions at times
where rates rally away from the ‚local bid‛ level and
where risks of outflows from EM local debt are high.
The share of non-resident holders is at the highs
Share of non-residents in the local bond market

35%
30%
Source: Deutsche Bank 25%
20%
South Africa: Stable issuance plan
15%
Fiscal: According to the Medium Term Budget Policy
10%
Statement (MTBPS) the Treasury sees a narrowing of the
fiscal gap from current 5.5% to 3.3% of GDP by 5%
2014/2015.
0%
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11
Supply: The borrowing requirement was revised higher by
R 9bn, R 20bn and R 27bn over the next 3 years.
However, the bond markets were not rattled by this
Turkey: Comfortable fiscal position
development as the announcement was made that cash
balances will be used to finance these additional
Fiscal: The primary surplus and overall budget deficit is
shortfalls. Consequently, this means that net issuance in
projected to be close to 2% of GDP and below 1% of
T-bonds in FY 2012 is set to be approximately R 135bn,
GDP, respectively in 2011.
the same as FY 2011. Net issuance in T-bills too is
expected to remain unchanged at R 22bn. Therefore, we
Supply: Net issuance in the domestic market in Turkey is
do not expect any immediate change to the weekly fixed-
set to significantly increase in 2012 to reach TRY 37.5bn
rate (R 2.1bn every Tuesday), and inflation-linked bonds (R
from TRY 22bn in 2011. This is despite domestic bond
800mn every Friday) auctions that are held currently.
redemption falling to TRY 81.6bn next year from TRY
However, it is likely that if the global markets recover,
97.1bn in 2011. In the FX market, the Treasury plans to
issuance at the back-end is stepped up again.
issue bonds almost at the same levels as 2011(both gross
and net), hence keeping net issuance in external market at
Demand: A striking feature of the market has been the
under TRY 1bn. The increase in net issuance in the
increase in foreigner holdings compared to pre-2007. It is
domestic market is being caused by a lower primary
clear that this was linked to the huge increase in issuance
budget balance next year (2%) from 2.5% in 2011
over the past two years and the lack of willingness/ability
of the domestic investor base to increase purchases at
Demand: Foreign investors have increased their
the same pace as supply. In the case of the PIC, the
underweight position in Turkey due to the uncertainty
largest domestic pension fund, it seems that preference
created by the complex monetary policy strategy
lies either with linkers or higher yielding Parastatal debt.
conducted by the CBT. In a scenario of a controlled
Mutual funds have also lagged in terms of demand due to
economic slowdown, that helps rebalancing the economy,
the positive performance of equities. The local domestic
Turkish paper could see a large bid from non-residents.
base continues to hold an insular view of the market that
While the main risks lie in the local banks ability to roll
states that long-term yields should settle around 8.5-9%
(inflation of 5.5-6% + real yields of 3% + term premium).
42
See 'A Closer Look at Real-Money Positioning' also in this
report.
41
The columns represent the annual 10-90% range, the dash shows the
annual median and the square is the latest value

over about USD 32 bln in short-term debt, mostly owed to The domestic debt market is growing rapidly
European banks.
y/y % growth in outstanding RUB debt
Tight TRY liquidity has cheapened bonds 70
60
50
40
30
20
10
0

Israel: Net issuance increases as fiscal backdrop
gets challenging
Russia: Likely to see a surge in foreign
participation Fiscal: In 2011, domestic the deficit continued to remain
above the seasonal path and is likely to exceed the
Fiscal: Russia seems in line to post a 0.2%/GDP fiscal
Ministry of Finance's working target of 2.9% by c0.4pp to
surplus, thanks to higher than expected oil prices. The
reach 3.3% of GDP (that is ILS 28.2bn). DB economics
overall performance for next year will be extremely
attribute this to a weakening domestic demand and
dependent on oil prices, but MinFin predicts an increase
possibility of higher spending in light of public protests. In
in the non-oil budget deficit to 11%/GDP from 10.2%
2012, growth is set to moderate and we expect the deficit
to worsen to 3.5% percent of GDP which translates to
Supply: MinFIn tends to be extremely flexible and
approximately ILS 32bn as the budget deficit. This should
opportunistic in conducting its bond issuance plan. We
increase net issuance in the Israeli government paper
expect an average of RUB 20 bln/ week supply with an
market from ILS 7.2bn in 2011 to ILS 11bn in 2012.
average maturity of 7Y.
Supply: Repayment to the market in 2012 is likely to be
Demand: Preparations for enabling Euroclearability of OFZ
ILS 46.7bn, ILS 5.1bn lower than 2011. However, an
bonds has entered its final stages. We expect this to
increase in the deficit offsets the fall in redemptions and
increase foreign demand for OFZ paper, particularly that
hence gross issuance in 2012 is projected to be only
Russia’s weight in the benchmark index has become
marginally lower at ILS 57.6bn. Net issuance consequently
significant. Based on the success of Russia’s first RUB
increases from ILS 7.2bn in 2011 to ILS 11bn in 2012, a
Eurobond earlier this year, it is possible to envisage that
52% rise.
foreigners could take up 20% of new issuance. To put
things in perspective, their share has consistently
Demand: Foreign involvement in bonds has remained low
averages below 5% in the past few years.
at 4% of the total market. We see this as a supportive
factor for adding exposure.
Lamine Bougueroua, London, (44) 20 7545 2402
The author of this report would like to thank Raj

Chatterjee, an employee of CIB Centre, a wholly owned
subsidiary of Deutsche Bank, for his contribution to this
piece

Appendix 1: Historical Monthly DV01 issuance
South Africa Turkey
USD mm USD mm
2.0 5.0
1.6 4.0
1.2 3.0
0.8 2.0
0.4 1.0
0.0 -
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11
Hungary Poland
USD mm USD mm
0.80 5
0.70
4
0.60
0.50
3
0.40
0.30 2
0.20
1
0.10
0.00 0
Jan06 Jan07 Jan08 Jan09 Jan10 Jan11 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11

Appendix 2: Expected issuance program
Expected issuance in EMEA (% of projected GDP)
16%
Gross Issuance % GDP
14%
Net Issuance % GDP ZA TR
12%
HU PL
10%
IL RU
8%
6%
4%
2%
0%
2010 2011 2012F 2010 2011 2012F 2010 2011 2012F 2010 2011 2012F 2010 2011 2012F 2010 2011 2012F
Expected issuance in EMEA (absolute amounts)
120
Gross Issuance (USD bn)

100
Net Issuance (USD bn)
TR
80
PL ZA
60
HU IL RU
40
20
0
2010 2011 2012F 2010 2011 2012F 2010 2011 2012F 2010 2011 2012F 2010 2011 2012F 2010 2011 2012F

Appendix 3: 2012 Local bonds redemption schedule
bonds (local currency bn)

2012 redemptions
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
CZ 0.0 0.0 0.0 45.3 0.0 0.0 0.0 0.0 0.0 70.3 0.0 0.0
HU 0.0 0.0 0.0 368.6 0.0 0.0 0.0 0.0 0.0 393.0 0.0 0.0
IL 4.1 6.4 0.5 16.5 2.7 2.4 5.1 7.3 0.8 4.5 0.0 8.5
PL 14.8 0.0 0.0 25.5 0.0 0.0 26.5 0.0 0.0 26.7 0.0 0.0
RU 45.0 0.0 0.0 0.0 0.0 0.0 44.0 181.0 44.0 45.0 42.1 0.0
ZA 4.4 1.3 11.6 0.0 0.0 12.2 4.4 1.3 11.7 0.0 0.0 12.3
TR 13.6 8.9 11.9 14.8 0.0 0.0 0.0 13.9 5.6 0.5 18.3 0.0
Source: Global M arkets Research

Argentina B3/B-/B
Moodys /S&P/ /Fitch
 Economic Outlook: The government seems to be production, bio-fuels and agrochemicals industry. Mr.
ready to combine some fiscal consolidation with Boudou noted that, as a consequence, government
tighter FX and price controls, and labor union spending will be reduced by ARS 3.468mn. Subsidies cuts
persuasion aiming at managing a soft landing to a 5% will also be extended on January 2012 to high income
growth pace. Nonetheless, inflation stability together homes and, according to authorities, this will represent an
with FX sustainability will demand an even weaker extra ARS1500mn saving. Additionally, Mr. De Vido
economy. The sooner the government accepts that announced the creation of a register for those consumers
reality, the smoother the expected economic path that voluntarily want to renounce to subsidies on water,
gas and electricity consumption. The cuts announced are
ahead. A likely resistance will only accelerate
still symbolic for the size of subsidies in place (at best
economic slowdown, and short term inflation.
10%-15% of an estimated total subsidy bill of 4% of
 Main Risks: Further confirmation of current policy GDP), but the government is at least recognizing that
continuity could only preserve an on-going currency subsidies cannot longer be extended or increased.
run and a severe capital flight. Lack of investment The ‚prudent‛ set of policy initiatives even included a
amid fiscal expansion, together with unfriendly number of comments asking for moderation in wage
policies, could maintain high inflation, reinforcing demands. Furthermore, President CFK explicitly rejected
fears of potential financial stress. The current pace of the convenience of a rule based distribution of corporate
real appreciation is leading to a rapid and sharp profits to the worker force to be discussed in Congress,
deterioration of external accounts, while strong fiscal as lobbied by labor unions. CFK argued that not all
spending is adding stretch to difficult financing. companies are in the same situation and such a
discussion should be a negotiation between interested
 Strategy Recommendations: Remain neutral in the parties without intervention of the Congress. For many
currency, but the front-end of the NDF curve offers these remarks were a clear warning message to labor
attractive carry for those willing to sustain elevated union leaders that seem ready to increase confrontation
risk. Continue avoiding the CER curve which offers with the government, as demonstrated in the recent
unfavorable FX/inflation breakeven. Badlar-linked conflict in the state owned airline.
bonds are more attractive for those seeking local
On the other extreme, the government further reinforced
peso exposure. Stay neutral on external debt but be
constrains on dollar buying by individuals or corporations.
conservative on duration, favor credit to Warrants and
The local newspapers still report that approvals from the
favor global bonds (especially the Global 17s) over
tax authority have remained in the 20%-30% of requests.
local law bonds. In addition we recommend long
In addition, the Central Bank and the government have
basis on Global 17s vs. 5Y CDS.
been persuading corporation and banks to postpone any
potential demand for dollars, from imports and trade
Macro view
finance, to transfers abroad in any concept. As a result the
Time for policy fine tuning CB has been able to stop the heavy drain of dollars of
On November 24th, a month after her landsliding re- previous weeks but creating a new source of capital flight:
election victory, President Cristina Fernandez de Kirchner dollar deposit withdrawals. As of November 18th the CB
(CFK) addressed businessmen at the closing of the reported the fall of some USD2.2bn of dollar deposits in
Industrial Chamber´s (UIA) Annual Conference. In this the system during the month or 15% of the total held
speech, CFK appeared setting the guidelines for her new before the last FX measures were introduced. This flow is
four year mandate that starts on December 10th, believed to have slowed down in recent days but the
acknowledging the need to improve policies fostering system is still losing an estimated USD200mn a week. All
investment while containing inflation. CFK also stated that this notwithstanding, Argentina is projected to have
her government does not like extraordinary rents from
already experienced USD24bn of foreign asset formation
business and that growth, not inflation, should be the
in the first eleven months of the year, representing more
target of a proper national policy. Nonetheless, the overall
than 5% of GDP.
pro-business tone of the speech was a welcome change
as well as the focus on inflation and investment. The inflation/FX threat
As discussed previously, we believe policy continuity
A few days earlier, Economy Minister Amado Boudou and
does face a strong challenge. In the very short term,
Planning Minister Julio de Vido announced further
capital flight is still the main threat to stability. A simple
subsidies removal to the once announced at the beginning
solution, in our minds, calls for a faster pace of currency
of the month. From December 1st, subsidies will be cut
depreciation and tighter monetary and fiscal policies. The
to big companies in the fuel sector, natural gas

faster depreciation rate seems a possibility but the stop the capital flight. More international reserve losses
authorities are revealing strong fear to float, probably seem inevitable at this stage, but stability could be regained
misled by past experiences of currency moves in the over time with clear policy signals.
country. More importantly, it is still unclear whether the Alternatively, the CB could keep the currency in the current
government will accept tight policies. Needless to say, the path, or at a much slower depreciation rate, while
absence of more conservative policies could only maintaining all controls or even tightening some of them
accelerate capital flight and economic slowdown. In the
further. This could place the authorities in a dead end,
end, a weaker economy would allow for a necessary
where reserves could be going away from the banks and
convergence between inflation and depreciation rate. The
the Central Bank, while standard policies could be
question is whether policy hesitation would push for
becoming increasingly ineffective to re-create credibility in
inflation acceleration before a recession is generated or
the short term.
smooth the slowdown process. In the medium term, the
challenge is about sustainable growth. In our view, Given all the considerations above, and relatively high
without a more-friendly policy set up for private sector international reserve levels at USD46bn, we foresee a
investment, Argentina might grow at a much slower pace gradual slide of the peso during the next few months.
than in the last few years with embedded volatility. Afterwards, the real economy will likely help to close the
The next few days might reveal some indications about gap between expected inflation and currency depreciation,
the government’s true understanding of the problems and as a recession will be the likely outcome of increased
its will to fix them. The very first reaction was not exactly control tightening. It is worth recalling, Argentina’s private
encouraging, as the authorities simply decided to move to and public sectors have very little external debt (USD128bn
much tighter capital controls as a way of moderating hard gross debt or 30% of GDP, or less than the USD180bn in
currency accumulation. This decision does not only reveal external assets held by residents), thus it only takes a small
the risk of extreme policy preferences in some key policy depreciation or a significant economic slowdown to
makers; it also made it evident that there is not a single rebalance the dollar flows of the country without triggering
individual in charge of economic policy. The President major balance sheets or real problems like in the past.
appears to be making the final calls even in technical On the positive side, La Nacion newspaper reported last
matters. We still believe that the confirmation of Minister week feedback from three European countries that are
Boudou’s leadership in fiscal and monetary policy expecting to see progress on Paris Club debt after the new
decisions would be a positive development. In this regard, Minister of Finance is named. The report suggested that a
the naming of current Secretary of Finance Lorenzino as deal could include a 4 year payment plan with a large initial
the new Minister of Finance could signal a vote of disbursement. An important caveat: officials consulted by
confidence for Minister Boudou, who is believed to favor the newspaper noted that the potential benefit in terms of
pragmatism over blind policy continuation. In the last few FDI could be very limited given increasing trade and capital
days, however, Minister Boudou´s looked more detached restrictions in Argentina. As of now, we should be very
from economic policy initiatives, while new candidates are cautious on any Paris Club deal mainly because of
emerging, like re-elected Tucuman governor Jose increased hard currency scarcity. Argentina can only avoid
Alperovich, who could be a less technical choice for the the IMF involvement by canceling the debt (even in
task but yet a successful entrepreneur. installments given some US support). Government officials
The very first recognition that subsidies will have to be argued that FDI flows would largely compensate the initial
revised represents a welcomed leap forward. disbursement but that seems rather difficult in the current
Implementation risks are huge and a real improvement circumstances. La Nacion is talking about USD6.0bn initial
will demand solid conviction to confront clear political disbursement which would add to the USD6.0bn dollar
costs. The absence of tighter monetary policy is rather financing gap Argentina will face in 2012, as discussed in
disappointing though. Private banks have started to offer detail below.
higher interest rates to preserve their clients as a stable The 2012 outlook
source of funding, but the Central Bank is still pushing In the next few months, we foresee a rapid deceleration
short term rates low, in the 10% range, or unacceptably of the economy, in line with expectations that the
low to compete with 23% inflation or any consistent government will keep tight controls on the current and the
exchange rate expectation. capital account of the balance of payments for the time
We hope the government will take advantage of the tighter being. Exchange rate flexibility is likely to be gained only
controls to let the currency move more in line with inflation after the economy is weaker and inflationary pressures
expectations (20% a year or so), which in our view is the are subsiding. Thus, we anticipate a gradual slowdown in
main reason behind the growing demand for the dollars. If the pace of economic growth towards a less than 3% YoY
accompanied by the CB validation of short-term rates in a range by the last quarter of 2012, from 6%-6.5%
similar range, we believe this could be enough to eventually currently. In addition, a weak economy, together with an

‚expensive‛ peso, would only make more evident the Central Bank that exceed money base at the current
worrisome fiscal and external dynamic, forcing reduced exchange rate.
fiscal spending and weaker imports to eventually help
equilibrate those trends. Whether the government can Balance of payment forecast (USD mn)
2010 2011 2012
avoid the temptation to try help the economy with fiscal
Current account 3,081 3,713 (2,194)
expansion is the pending question mark. Fiscal expansion % GDP 0.84% 0.85% -0.47%
with tensions in the FX market and inflation could only
Ex ternal debt amortization 47,596 50,874 56,537
exacerbate the problem, just deepening the economic Public 5,342 5,277 6,775
slowdown. In other words, risks to our 2012 growth Private 42,254 45,597 49,762
forecasts are biased to the downside. Debt new issues 54,920 55,773 56,175
Public 3,234 2,960 3,656
Thus, under a muddling through scenario, the lower Private 51,686 52,813 52,519
economic growth will allow inflation not to accelerate
BCRA (2,910) 3,500 1,500
much despite increasing pace of peso depreciation and Net FDI 5,372 6,298 7,055
Net portfolio flows (11,410) (25,650) (15,000)
tariff increases, but still remaining around 25% YoY. Errors and valuation (2,700) - -
Similarly, this will permit the trade balance to remain high
Change in Reserves 4,157 (7,240) (7,000)
enough to avoid a major deterioration in the current
Source: Economic Ministry, Central Bank, and Deutsche Bank Research
account. Furthermore, helped by different barriers to
import and transfer money abroad, the current account
After the election, there are probably no severe political or
could end up with a deficit of less than 0.5% of GDP in
institutional obstacles to the government’s continued use
2012. In this regard, it is worth looking at recent trade
of Central Bank reserves after changing the existing
numbers, where imports growth is decelerating rapidly
legislation. Nonetheless, any additional fiscal use of CB
(29%-27% YoY in September-October from around 40%
international reserves is going to directly affect the net
in previous months).
international reserve level. In the past, ample trade
Notwithstanding a relatively small external imbalance surpluses and moderated capital flight have allowed the
projected for next year, financing it could be a real CB to compensate reserve losses from fiscal financing
challenge, in particular if we continue to see some level of with true trade surplus. In the months to come, the trade
capital flight. The latter is unavoidable as stricter controls balance is unlikely to be large enough to prevent a further
will simply foster misreporting of trade transactions and decline in international reserves. Thus, this evident
the seeking of any possible loophole to transfer dollars weakening of the CB balance sheet could create another
abroad. We estimate international reserves will fall by powerful motive for capital flight to continue or even
USD7.2bn this year, mostly explained by USD25.6bn accelerate unless policy changes are implemented.
capital formation abroad, and despite increased private
Financing constrains might be biding soon (USD mn)
sector net financing for more than USD6.0bn. Based on
2010 2011 2012
current trends, reserve loss could be similar next year if
Net amortizations 4,775 4,859 4,758
capital flight were to slow from this year peak to Net interest payments 2900 3100 3338
USD15.0bn average of the last few years. The table below Warrants (exc. Public holdings) - 1,543 2,106
Total financing needs 7,675 9,502 10,202
shows the main drivers of the balance of payment
forecasts for next year. Primary surplus (exc. BCRA & ANSES profits) 139 (2,731) (1,606)
%GDP 0.0% -0.6% -0.3%
BCRA & ANSES profits 6,256 5,821 4,902
A full flavor of the potential scarcity of dollars next year is
only completed once public sector financing is added to Net financing needs 1,279 6,412 6,906
the picture. The table below summarizes this financing BCRA reserves 9,500 9,877 -
task, netting out government holdings and also multilateral BCRA advances 2,549 3,464 1,500
Banco Nacion 1,612 2,667 -
re-financing, both expected to provide a full rollover.
Thanks to Central Bank reserves and advances, the Financing gap (12,382) (9,596) 5,406
government basically had more resources than needed in Source: Economic Ministry, Central Bank, and Deutsche Bank Research
2010 and this year, fostering the accumulation of reserves

at the treasury. This could not prevent this year that As we noted repeatedly, public sector financing in
international reserves at the Central Bank are estimated to Argentina is greatly simplified by high inflation, as it
be falling by more than USD7.0bn by the end of this year. provides relatively cheap (short term!) financing sources
as long as money demands remain stable. This,
This situation becomes even more critical in 2012, as the
unfortunately, does not solve the dollar financing
Central Bank will not have excess reserves to allocate for
conundrum that demands improved policies, and/or a
government debt payments. It is worth noting that excess
weaker economy, or a weaker currency in real terms.
reserves are defined as international reserves at the
Gustavo Cañonero, New York, (1) 212 250 7530

Investment strategy Argentina: Deutsche Bank forecasts

2010 2011E 2012F 2013F
FX: Managing a difficult trade-off. The pressure on the National Income
currency continues to increase but the central bank seems Nominal GDP (USD bn) 368 439 475 491
engaged in avoiding any meaningful depreciation. Amid Population (m) 40.1 40.5 41.0 41.5
increasing volatility in global financial markets, the ARS GDP per capita (USD) 9,169 10,936 11,576 11,854
has weakened approximately 1% per month during the
last 2 months. In our view, the government will find Real GDP (YoY%) 9.2 7.3 3.1 2.9
increasingly difficult to continue with this strategy due to Priv. consumption 9.0 8.9 2.8 2.7
the combination of worrisome levels of capital flight and Gov't consumption 9.4 13.2 7.5 5.0
double digit inflation. Additionally, the bleeding of Gross capital formation 15.5 12.2 4.0 3.6
international reserves has accelerated after the Exports 14.6 5.4 7.1 6.0
implementation of the latest FX measures. The freely Imports 34.0 19.3 9.7 7.2
available reserves -those in excess of the monetary base
at the current exchange rate- have now disappeared. If the Prices, Money and Banking
government insists in using the central bank as financing CPI (YoY%) (*) 25.2 23.1 25.4 22.6
source, the pressures in the currency will continue to Broad money (M2) 28.0 33.0 28.0 22.0
mount. Nevertheless, the NFD curve is already pricing a Bank credit (YoY%) 37.8 33.4 28.0 22.0
depreciation of 30% in 12M, which might be excessive.
Due to elevated risks and low liquidity we recommend Fiscal Accounts (% of GDP)
avoiding exposure to this curve, but some investors may Budget surplus -1.5 -2.3 -2.0 -1.5
find attractive the elevated carry in the front-end (1M Gov't spending 30.0 31.6 31.3 31.1
offers 31% implied yield versus 3% depreciation). Gov't revenue 28.4 29.3 29.3 29.6
Rates: Not longer attractive. With real yields in low Primary surplus 0.0 -0.6 -0.3 0.2
double digits, a compensation for inflation which does not
reflect macroeconomic dynamics, and expected high External Accounts (USD bn)
depreciation of the currency, CER-linked bonds do not Merchandise exports 68.1 85.1 87.8 92.5
offer an attractive return for foreign investors. Additionally, Merchandise imports 56.5 75.0 83.8 89.5
the risks affecting the currency are amplified for the blue- Trade balance 11.6 10.1 4.0 3.0
chip swap. Apart from potential government measures
% of GDP 3.2 2.3 0.8 0.6
affecting this transaction, liquidity could dry very rapidly. In
Current account balance 3.1 3.7 -2.2 -1.7
% of GDP 0.8 0.8 -0.5 -0.3
relative terms, we continue to favour Badlar linkers, which
FDI (net) 5.4 4.3 3.4 2.8
benefit from nominal instability. The recent withdrawal of
FX reserves (USD bn) 52.2 44.9 37.9 33.4
deposits made evident that the central bank will find
FX rate (eop) ARS/USD 3.98 4.35 5.21 6.24
increasingly difficult to contain nominal interest rates.
Credit: Neutral. The external risk environment in 2012 is Debt Indicators (% of GDP)
unlikely to be supportive for Argentina, and we remain Government debt 23.8 21.8 22.3 23.6
doubtful there will be any meaningful policy changes. Domestic 9.8 9.0 9.2 9.8
What prevent us from being underweight are the External 13.9 12.8 13.0 13.8
attractive valuation and the risk of squeeze as reaction to a Total external debt 35.0 30.9 29.7 29.3
positive headline. We stay long Boden 12s (hold to in USD bn 128.6 135.7 141.1 143.8
maturity) for carry, and overall are conservative on Short-term (% of total) 35.5 35.9 42.0 42.0
duration. In addition, extending duration on the local law
curve (via placing bonds to Anses) will likely one of the General
main financing vehicles for the government in 2012 due to Industrial production (YoY) 8.7 4.6 3.1 2.9
declining reserves, and this will not be supportive to the (nominal)
Unemployment (%) 7.3 7.1 7.5 7.5
long end of the local law curve from a technical
perspective. We favour the Global 17s over the local law Financial Markets (EOP) Current 3M 6M 12M
bonds (switching from Boden 15s). We also recommend Overnight rate 10.3 13.5 17.0 19.5
buying basis on Global 17s vs. 5Y CDS. Finally, we remain 3-month Baibor 12.8 14.7 18.5 20.5
of the view that GDP Warrants are no more than a
ARS/USD 4.28 4.51 4.76 5.17
leverage beta pay over credit, and as such, the global Source: DB Global Markets Research, National Sources
bonds arguably offers superior risk/reward.
Mauro Roca, New York, (1) 212 250 8609
Hongtao Jiang, New York, (1) 212 250 2524

Brazil Baa2(pos)/BBB/BBB
Moody’s/S&P/Fitch
 Economic Outlook: The government has showed 2011 GDP growth forecast unchanged at 3.0%. In 2012,
that it intends to use all possible instruments to the economy will face a challenging international
prevent a strong economic deceleration by easing environment with a recession in Europe and tighter global
monetary policy aggressively, revoking some ‚macro- credit conditions. Thus, although we believe that
prudential‛ measures, and introducing fiscal additional monetary and fiscal easing and the unwinding
measures to stimulate consumption. Therefore, we of the ‚macro-prudential‛ restrictions on credit will help to
expect the economy to grow slightly above 3% in keep consumption afloat, we expect investment to
2012 despite the bleak global outlook. Although decelerate further. The recent drop in domestic
inflation is poised to decelerate in the next months production and imports of capital goods already reflects a
due to the recent economic slowdown and lower slowdown in investment. Another problem is that,
commodity prices, it will likely remain above 5% due according to our calculations, the GDP growth carryover in
to high inertia and aggressive monetary easing. 2012 will be only 0.3%, compared to 1.1% in 2011. In
other words, if GDP remains unchanged at 4Q11 levels
 Main Risks: The government’s initiative to
during the whole year, it will grow only 0.3% in 2012.
aggressively ease monetary policy to prevent a
Therefore, we expect the economy to grow 3.3% in 2012,
significant economic slowdown could damage its
which would be much less that the government’s target
credibility and lead to permanently higher inflation,
of 5.0%, but not a bad result considering the uncertain
especially if not accompanied by the promised fiscal
global scenario.
austerity. The large increase in the minimum wage
and mounting pressure on the government to Brazil: Capacity utilization and business confidence
increase investment in infrastructure do not bode well
120 % 88
for fiscal restraint in 2012. The BRL remains
vulnerable to lower commodity prices. 110
86
 Strategy Recommendations: Take profits on long 84

100
1M USD/BRL FVA and enter zero-cost 1M USD/BRL 82
put spread Take profits on Jul ’12- Jan ’17 steepener 90
and enter Jan ’13- Jan15’ flattener. Stay neutral on 80
Business confidence
external debt and continue to favor 41s and 40s (to 80
78
Capacity utilization (RHS)
call) vs. 21s. In addition, we favor short basis at the
70 76
10Y sector as a tactical trade.
Macro view
Source: FGV
We expect the Brazilian economy to grow 3.0% in
2011 and 3.3% in 2012. The economy decelerated
Although the labor market remains tight, job creation
significantly in 3Q11, reflecting tighter fiscal and monetary
has decelerated, and we expect a gradual increase in
policies, as well as contagion from Europe’s never-ending
unemployment. Brazil’s unemployment rate fell to 5.8%
debt crisis. The slowdown was particularly strong in the
in October from 6.0% in September, dropping below our
manufacturing sector, as industrial production dropped a
6.0% forecast. On a seasonally-adjusted basis, according
seasonally-adjusted 0.8% QoQ in 3Q11 even after falling
to our calculations, the unemployment rate dropped back
0.6% QoQ in 2Q11. The sector has also been hurt by an
to 5.9% (the all-time low) from 6.1%. Nevertheless, the
increase in competition from imported goods (mainly due
drop in unemployment was mainly caused by a 0.1%
to the strong BRL), and its malaise is attested by the
MoM drop in the labor force, as new jobs rose only 0.1%
steady decline in business confidence (the FGV index of
MoM. Job creation rose 1.5% YoY, the lowest year-on-
business confidence dropped 12% between December
year rate since December 2009. Furthermore, average real
2010 and November 2011) and capacity utilization (which
earnings remained unchanged in October even after
reached 83.3% in November, the lowest level in two
dropping a hefty 1.8% MoM in September. Consequently,
years). Due to weak industrial production, we estimate
real earnings fell 0.3% YoY, the first drop since January
that GDP dropped a seasonally-adjusted 0.2% in 3Q11.
2010. While the deceleration in real earnings reflects the
We expect a mild recovery in 4Q11 (+0.3% QoQ) due to
slowdown in job creation, it can also be explained by high
the incipient effect of the monetary easing and the recent
inflation, and the latest wage negotiations suggest that
measures to stimulate consumption, but are keeping our
wages could recover some ground in the following

months. However, we believe this scenario is consistent that NPLs have not peaked yet (although the fast decline
with a very gradual increase in unemployment, which we in interest rates tends to mitigate this effect). Fearing the
expect to rise to 6.4% in 2012 from 6.1% in 2011. The effect of the slowdown in credit growth on consumption,
persistence of a relatively low rate of unemployment will the government revoked some of the macro-prudential
likely provide important support for domestic measures enacted last year, reducing the capital
consumption. requirements on payroll debit-loans, car loans, and
personal loans of up to 36 months, scrapping the
Brazil: Job creation and labor force growth
minimum 20% credit card balance payment obligation
7% YoY
Labor force that was scheduled to become effective in December,
6%
Jobs and cutting the IOF tax on consumer loans to 2.5% from
5% 3.0%. Moreover, the government reduced taxes on
4% domestic appliances and low-income housing, and
3% eliminated the 2% IOF tax on foreign portfolio investment
2%
in equities to stimulate the stock market.
1% Brazil: IPCA weight revision
0% Old IPCA New IPCA
-1% Food at home 15.0% 15.0%

Tradables (ex-food) 20.4% 25.2%
Services 24.8% 22.3%
Source: IBGE Other non-tradables 10.8% 10.4%
Administered prices 29.0% 27.1%
Brazil: Credit delinquency Source: IBGE, DB Global Markets Research
9.0
We still see inflation above 5% next year despite the
8.0
changes in the IPCA methodology. The IPCA consumer
7.0
price index rose 7.0% YoY in October, confirming that 12-
6.0
month inflation peaked at 7.3% in September, as we had
5.0
Consumers expected. Although 12-month inflation remains
4.0 Corporates
significantly above the target of 4.5% and even above the
3.0
6.5% ceiling of the inflation target’s tolerance band, we
2.0
expect it to decline further in the coming months due to
1.0
the base effect, the economic slowdown and a drop in
0.0
commodity prices. We expect the IPCA to climb 6.4% this
year, just slightly below the top of the band. For 2012, we
have lowered our IPCA forecast slightly to 5.3% from
Source: BCB
5.5% due to the changes in the index weighting structure
that will take place in February 2012. This week, the
Credit growth has decelerated, prompting the official statistics agency IBGE announced a revision to the
government to revoke some of the ‚macro- IPCA methodology that will essentially reduce the weight
prudential‛ measures. Total bank loans grew 0.8% MoM of services to approximately 22% from 25%, (mainly due
in October, the slowest MoM increase since January to a surprisingly large drop in the weight of school fees,
2011. Although October’s poor performance was probably and despite a relatively small increase in the weight of
influenced by the strike of bank employees, credit housing rentals), and raise the weight of tradable goods
origination has decelerated significantly this year, (excluding food) roughly to 25% from 20% (led by a
especially in the area of consumer financing. Consumer significant increase in the relative importance of
credit origination rose a hefty 6.4% MoM in October, but automobiles). The change could be relevant because
the increase was led by expensive facilities such as service prices have been rising well above the headline
overdraft loans and credit cards, mainly due to the bank inflation (9.0% YoY in October), reflecting the strength of
strike that reduced the supply of other consumer loans, domestic demand and the tight labor market. Thus,
according to the Central Bank. However, the increase in although we remain concerned about the potential
expensive revolving credit lines might also reflect an inflationary effect of the hefty 13.6% minimum wage
increase in non-performing loans, which climbed to 7.1% increase programmed for January 2012, we estimate that
in October, the highest since February 2010. Since the new weighting structure will shave off approximately
unemployment is one of the main determinants of credit 20bps from our IPCA forecast. On the other hand, we
delinquency and we expect it to rise gradually, we believe

note that the increase in the weight of tradable goods in cost approximately BRL60bn (1.4% of GDP) next year,
the index might somewhat raise the exchange rate pass- while the latest tax cuts announced to stimulate
through to inflation. consumption could cost as much as BRL8bn. That said,
We still do not see inflation returning to 4.5% next we cannot discard the possibility of another positive
year, but continue to expect more rate cuts ahead. surprise in fiscal performance next year, which could
Europe’s sovereign debt crisis and the change in the IPCA make it easier for the Central Bank to ease monetary
methodology have contributed to stabilize inflation policy without fueling inflation.
expectations, offsetting the negative effect of the While risk of currency depreciation remains high due
surprising 50bp interest rate cut in August. The Central to global environment, we continue to assume a
Bank repeated the dosage in October and November, relatively benign scenario for the currency. We have
reducing the SELIC rate to 11.0%. The authorities also kept year-end BRL forecast at BRL1.80/USD for 2011 but
indicated that they plan to maintain the same pace of rate raised it to BRL1.80/USD from BRL1.75/USD for 2012 due
cuts for now, claiming that ‚a moderate adjustment in to the potential negative effects of the European crisis on
rates is consistent with convergence of inflation to the global growth, commodity prices, and credit supply. The
target.‛ We continue to forecast that three additional good news is that the BRL continues to benefit from a
50bp rate cuts will lower the SELIC rate to 9.5% by April slow increase in the current account deficit and huge
2012, although we believe the risk is tilted to the volume of foreign direct investment (FDI). This year’s
downside, considering our revisions to GDP growth and trade surplus has been surprisingly strong and will likely
inflation forecasts. Moreover, given the increasingly reach USD29bn, mainly due to high commodity prices.
tighter liquidity conditions produced by Europe’s crisis, Although exports will probably suffer as commodity prices
we would not be surprised if the Central Bank reduces decline, we expect imports to decelerate as well due to
reserve requirements on bank deposits. This week, the softer domestic demand. We still forecast a sizeable trade
government relaxed the rules for banks to sell their loan surplus of USD20bn for 2012, and therefore project a
portfolios, so as to help small and mid-sized banks. That modest increase in the current account deficit, from an
said, we believe interest rates will drop below their estimated USD53bn (2.2% of GDP) in 2011 to USD64bn
equilibrium level and will eventually rise again after the (USD2.6% of GDP) in 2012. In the financial account, the
global economy recovers. We expect the Central Bank to main highlight has been the massive inflow of foreign
initiate a new tightening cycle in 2Q13, raising the SELIC direct investment, which we estimate will reach USD64bn
rate back to 11.0% by the end of 2013. in 2011. We expect FDI to drop to USD52bn in 2012 due
We expect the government to meet its full primary to the bleak global outlook, and believe the risk is tilted to
fiscal surplus target of 3.15% of GDP in 2011, but the downside given that approximately 60% of the FDI
project a smaller surplus for 2012. As tax collection has this year originated from Europe. Critical risks to the BRL
risen more than expected this year (mainly due to high lie in the external credit crunch and in the existing large
inflation and a tax amnesty program), the government stock of foreign portfolio investment, especially the
raised this year’s primary fiscal surplus target by 0.25% of USD129bn in local bonds (as reported by the Central Bank
GDP (BRL10bn) to 3.15% of GDP. The Finance Minister for October), which include a large amount owned by
also pledged to meet next year’s primary surplus target of Japanese retail investors. Nevertheless, the Central Bank
3.1% of GDP without resorting to accounting adjustments has a strong incentive to intervene in the FX market to
(i.e., without deducting PAC investments from the primary avoid excessive BRL weakness. Since the authorities’
balance). Nevertheless, we project a primary surplus of main priority is to cut interest rates, a strong depreciation
2.7% of GDP for 2012. Barring the introduction of a new of the BRL could become a problem because of its
tax, government revenues could decelerate more than potential inflationary effect. This view is reinforced by the
expected due to slower GDP growth (the budget Central Bank’s intervention in September, by offering FX
assumed real GDP growth of 5.0% for 2012). Moreover, it swaps when the currency traded above BRL1.90/USD,
is not clear whether the government will be able to keep a and by the recent decision to scrap the 2% IOF tax on
lid on public spending. This year’s moderation has been foreign portfolio investments in the stock market. Since
achieved mainly by compressing public investment, which the Central Bank currently owns approximately USD350bn
is probably not sustainable in the medium term due to the in international reserves (compared with USD207bn in
growing demand for infrastructure investment and September 2008), the authorities have plenty of
projects related to the 2014 World Cup and 2016 Olympic ammunition to intervene in the spot market as well. In the
Games. Furthermore, the generous 13.6% minimum worst-case scenario, the government might even revoke
wage increase scheduled for 2012, the ‚Brasil Maior‛ the 1% IOF tax on FX derivatives.
stimulus program, and the ‚Amendment 29‛ (which aims José Carlos de Faria, São Paulo, (5511) 2113-5185
to increase mandatory spending on healthcare) could all

Investment strategy Brazil: Deutsche Bank Forecasts

2009 2010 2011F 2012F
FX: Position for short-term retracement. The BRL –as National Income
other liquid EM currencies- has suffered from increased Nominal GDP (USDbn) 1,626 2,090 2,388 2,425
volatility on the back of developments in core markets. Population (m) 191 193 195 197
This has favored our long 1M FVA position, which has GDP per capita (USD) 8,490 10,814 12,240 12,319
reached its target. The better tone in risk sentiment after
the coordinated action by main central banks, and the Real GDP (YoY%) -0.3 7.5 3.0 3.3
potential intervention of the Central Bank of Brazil (BCB) in Private consumption 4.1 7.0 4.7 4.2
the FX market, could help BRL to recover. However, Government consumption 3.7 3.3 2.1 2.8
behind the short-term overshooting, the currency is still Gross capital formation -6.7 22.0 5.5 2.6
overvalued from a more fundamental perspective. Exports -6.7 22.0 5.5 2.6
Additionally, carry is expected to decrease further as the Imports -10.3 11.5 4.0 3.0
central bank continues easing monetary conditions
aggressively with a focus on economic activity. Moreover, Prices, Money and Banking
both the trade balance and current account are expected CPI (YoY%) 4.3 5.9 6.4 5.3
to deteriorate amid a reduction in FDI flows. As a Money base (YoY%) 4.6 19.5 10.0 10.0
Broad money (YoY%) 7.0 17.0 8.0 10.0
consequence, we recommend positioning for potential
short-term retracement with zero-cost 1x2 USD/BRL put
Fiscal Accounts (% of GDP)
spreads, but maintaining a neutral stance at longer
Consolidated budget balance -3.3 -2.5 -2.1 -1.6
horizons.
Interest payments -5.3 -5.3 -5.2 -4.3
Rates: Stretched valuation in short-term receivers. The Primary balance 2.0 2.8 3.2 2.7
market is widely expecting that BCB will continue
reducing rates aggressively during 1Q12 (150bp to 9.5%). External Accounts (USDbn)
With domestic and external activities trending lower, the Merchandise exports 153.0 201.9 253.0 272.0
risks to this scenario are still biased to the downside due Merchandise imports 127.6 181.7 224.0 252.0
to BCB’s increasing focus on growth. Nevertheless, the Trade balance 25.3 20.2 29.0 20.0
risk/reward of short-term receivers is not longer attractive % of GDP 1.6 1.0 1.2 0.8
Current account balance -24.3 -47.6 -53.0 -64.0
with this stretched valuation. As a consequence we
% of GDP -1.5 -2.3 -2.2 -2.6
recommend taking profits on our July ’12-Jan ’17 DI
FDI 25.9 48.5 64.0 52.0
steepener recommendation and position for a setback in
FX reserves (USDbn) 239.1 288.6 350.6 360.6
short-term rates with a Jan ’13- Jan’15 DI flattener (entry:
FX rate (eop) BRL/USD 1.74 1.67 1.80 1.80
65bp, target: 40bp, stop: 80bp).
Credit: Stay neutral. We believe 2012 will likely be Debt Indicators (% of GDP)
another year of outperformance of high quality, low beta Government debt (gross) -9.0 -9.8 -12.4 -11.9
credits such as Brazil, but we prefer Colombia and Peru. Domestic 62.0 54.8 56.6 54.6
Though fiscal performance appears to be on track in 2011, External 58.5 51.8 52.8 50.9
we project it to underperform budget in 2012. Though not Total external debt 17.1 16.8 17.1 17.8
our baseline, risk remains that the aggressive monetary in USDbn 277.6 350.4 407.4 432.4
Short-term (% of total) 11.2 16.4 12.0 12.0
easing could damage Central Bank’s credibility and lead to
permanently higher inflation, especially if the promised
General (YoY%)
fiscal austerity does not materialize. Technical condition
Industrial production (YoY%) -7.4 10.5 0.5 2.0
looks supportive given Brazil’s $5.5bln principal and
Unemployment (%) 8.1 6.7 6.1 6.4
interest repayment in 2012 (vs. our issuance projection of
<=3.0bln), especially if Brazil’s Treasury returns to the
Financial Markets (EOP) Current 3M 6M 12M
market and resume buying its legacy bonds. In terms of 11.00 10.00 9.50 9.50
Selic overnight rate
positioning in the global curve, we believe 10s30s looks 3-month rate (%) 10.6 9.8 9.4 9.6
excessively steep (among LatAm low betas) while 5s10s BRL/USD 1.80 1.80 1.80 1.80
still looks too flat; we continue to favor the barbell
strategy of 41s and 40s to call vs. 21s. In addition, we
believe 10Y basis (vs. 21s) should continue to tighten,
especially if the recent positive market tone continues.
Mauro Roca, New York, (212) 250-8609
Hongtao Jiang, New York, (212) 250-2524

Chile Aa3/A+/A+
Moodys/S&P/Fitch
 Economic Outlook: The economy continues to contraction were oil refining, clothing and wood products,
decelerate along an unbalanced path, with domestic which jointly contributed with -1.3pp to the index. In
demand still growing at a higher pace than supply. contrast, mining increased by 2.9% YoY mainly driven by
Nevertheless, albeit some surprises, domestic higher production of copper (from 462k to 467k metric
tons) and, to a lesser extent, of gold and molybdenum.
inflationary pressures are still subdued. A weakening
Domestic demand growth also suffered some
CLP and tight labor markets have so far had little
deceleration, with retail sales increasing by 8.6% YoY, in
impact on inflation. The Central Bank of Chile (BCCh)
line with expectations but below the 9.6% observed in the
is increasingly considering easing monetary previous month. Consequently, the supply-demand
conditions to counteract negative effects from the growth imbalance continues to widen.
external scenario.
Regarding the external sector, the current account
 Main Risks: Domestic demand could adjust faster showed a deficit of USD2.9bn (4.9% of GDP) during
than expected due to uncertainty in external 3Q11, in contrast with the balanced level of 3Q10. This
conditions. A slowdown in global growth and a decline was more than compensated by important capital
potential deceleration in China could affect copper inflows of USD4.5bn. During October, there was a
prices. There could be some form of contagion from positive contribution from the trade balance, which
a credit event in Europe due to the links between increased to USD837mn The accumulated surplus has
local and Spanish banks. reached USD10.8bn during 10M11, representing a
decrease of 7.31% YoY. The recovery in the trade balance
 Strategy Recommendations: Maintain short was the result of a much larger decline in imports
EUR/CLP. Shift from 2Y to 5Y breakeven inflation and (10.75% MoM) than in exports (2.46% MoM). The
enter 2s5s CLP/CAM steepener. Underweight relatively good performance of exports was in part
sovereign credit, and buy 5Y CDS vs. Brazil as a explained by a recovery in copper exports, which
defensive trade. increased 6.86% MoM, or 24.35% YoY, to USD3.5bn.
…but the labor market remains tight…
Macro view Regardless of declining activity, the unemployment rate
Latest figures confirm the declining trend in activity… for the August-October moving quarter decreased to
Recently, the Central Bank of Chile published the quarterly 7.2% from 7.4% in the previous measuring period.
report of the national accounts. It showed that GDP Following the trend observed during the year, the decline
increased by 4.8% YoY (0.6% s.a. QoQ) during 3Q11, in the unemployment rate was explained by a larger
considerably below the 9.9% and 6.6% observed during increase in employment (3.5% YoY) than in the labor force
the first two quarters of the year (which were (3.1% YoY).
nevertheless favored by a low comparative base). As in
…and inflation surprised to the upside
the previous quarters, domestic demand continued to
The latest inflation data available showed a surprising
show important dynamism. It increased 9.4% YoY on the
increase in prices during October (0.5% MoM), which
back of growth in investment in machinery and equipment
drove the index to 3.7% YoY. Nevertheless, as the spike
(31.5%), construction (9.8%), and private consumption
could be partially attributed to a one off effect in some
(7.5%). All sectors exhibited positive performance, with
items (meat), the inflation outlook is still relatively benign.
the exception of the crucial mining sector, which
Seasonal factors should help to decrease headline
decreased by 6.5% due to a reduction of ore grades,
inflation during the last part of the year. In fact, the
strikes and the impact of adverse climate conditions. In
surprise in inflation had a muted effect on inflation
contrast, fishing was the sector showing the highest
expectations. According to the latest BCCh survey, the
dynamism, increasing 59.4% YoY due to the control of the
median monthly inflation forecast remained at 0.1% for
virus ISA that affected the production of salmon and
the month of November while expectations for annual
created a low comparative base effect.
inflation continued to be anchored at the 3% inflation
Preliminary figures for the last quarter seem to confirm target from 12 months onwards.
this trend. The Institute of National Statistics (INE)
BCCh still has room to wait
reported that, in October, industrial production and sales
At the latest monetary policy meeting, the BCCh decided
declined by 0.8% YoY (-3.2% MoM sa) and 0.6% YoY (2.2
to maintain the policy interest rate (TPM) unchanged at
MoM sa) respectively, markedly below consensus
5.25% for a fifth consecutive month. The minutes of that
expectations of 4.1% and 2%. This differs from previous
meeting showed that it also evaluated a 25bp reduction.
months, during which the mining sector was the main
The monetary authority believed that the easing of
culprit of disappointing figures, the slowdown was now
monetary conditions would have been a preventative
noticeable in several sectors. The sectors with the biggest
move against an increasingly adverse external

environment. However it acknowledged that such a Chile: Deutsche Bank forecasts

decision could have led the market to believe that it was 2010 2011F 2012F 2013F
more concerned about the external outlook. Moreover,
National income
the Board agreed that there was considerable uncertainty 204.0 224.1 230.4 242.3
Nominal GDP (USDbn)
regarding the potential effects of the worsening external 16.9 17.1 17.3 17.5
Population (m)
environment in the domestic economy. In contrast, the 12,040 13,098 13,334 13,882
GDP per capita (USD)
Board considered that the alternative of keeping the
interest rate unchanged, but conveying a dovish tone,
Real GDP (YoY%) 5.2 6.0 4.2 3.9
would give more time to evaluate those effects. It was
Priv. consumption 10.4 7.8 6.1 5.8
agreed that the risk of this alternative was to fall behind
Gov't consumption 3.3 6.2 5.6 5.5
the cycle due to the lagged effects of monetary policy.
Investment 18.8 13.8 8.2 7.4
However this risk was tempered by the elevated
Exports 1.9 6.5 4.3 4.8
dynamism of domestic demand, a closed output gap and
Imports 29.5 9.2 5.8 5.5
tighter labor market conditions. Additionally, the Board
considered that a more aggressive policy could later
compensate for a delayed implementation. Finally, the Prices, money and banking
Board hinted to an increasing probability of an imminent CPI (Dec YoY%) 3.0 3.7 2.9 3.2
cut during the next months, probably after the revised Broad money 10.9 12.6 11.2 11.8
monetary policy views have been published in the next Credit 25.3 13.5 12.8 12.5
inflation report (IPOM).
Fiscal accounts (% of GDP)
Mauro Roca, New York, (212) 250-8609 -0.3 0.8 0.2 -0.5
Consolidated budget balance
Investment strategy Government spending 22.7 21.9 21.2 21.6
Government revenues 22.4 22.7 21.4 21.1
FX: At the tone of global growth. During next year, the
CLP will continue to be affected by the continuous
revisions of expectations regarding global growth and External Accounts (USDbn)
Exports 71.0 81.5 82.0 83.0
copper prices. A soft landing of China and the finalization
Imports 55.2 71.0 72.0 74.0
of the rule-based intervention could benefit the CLP and
Trade balance 15.9 10.5 10.0 9.0
counteract the potential setback from reduction in carry
due to monetary easing. The main short-term risks are % of GDP 7.8 4.7 4.3 3.7
related to the direct and indirect effects of a potential Current account balance 3.8 -2.4 -3.9 -4.6
escalation in the European crisis. We recommend % of GDP 1.9 -1.1 -1.7 -1.9
maintaining a short EUR/CLP position (entry: 690, target: FDI 6.4 11.4 13.5 15.0
660, stop: 685) FX reserves 27.9 40.0 41.0 42.0
FX rate (eop) USD/CLP 468 505 510 525
Rates: Position for further steepening. As the economy
continues to decelerate, the BCCh seems closer to ease
monetary conditions. While enough easing is already Debt indicators (% of GDP)
priced in the short-end of the local curve (150bp during Government debt 9.1 7.4 6.9 6.5
9M11) we think the cuts will be more frontloaded. Domestic 6.9 5.6 5.2 5.0
Additionally, they could help to build up additional risk and External 2.2 1.8 1.7 1.5
inflation premium in the belly of the curve. We therefore Total external debt 42.5 43.1 40.3 39.5
recommend shifting the 2Y breakeven inflation position to in USDbn 86.7 94.0 95.0 96.0
the 5Y sector (entry: 2.8%, target: 3.1, tighten stop: 2.6%) Short-term (% of total) 22.4 22.1 22.0 21.0
and entering a 2s5s CLP/CAM steepener.
General
Credit markets: Underweight. Despite its solid
Industrial production (YoY%) 3.8 4.1 3.2 3.0
fundamentals, the tight credit spread, financial risk (albeit
Unemployment (%) 7.1 7.0 7.2 7.6
moderate) as shown in our vulnerability indicators, and the
likely lack of support from the USTs in 2012 mean risk is
Financial markets (end) Current 3M 6M 12M
biased towards lower returns. In addition, real money
period)
Overnight rate (%) 5.25 4.75 4.25 4.25
investors have been significantly overweight Chile,
6-month rate (%) 4.56 4.17 4.01 4.11
creating a non-supportive technical condition. We look to
USD/CLP 515 500 490 510
buy CDS as a defensive trade at good levels, and Source: Deutsche Bank Global Markets Research, National Source
recommend buying Chile CDS vs. Brazil as a defensive
trade with asymmetric payoff (more limited loss under a
bullish scenario vs. the large gain under a bearish
scenario).
Hongtao Jiang, New York, (212) 250 2524

Colombia Baa3 (stable)/BBB- (stable)/BBB- (stable)

Moodys/S&P/Fitch
 Economic outlook: Economic activity keeps growing mainly external, i.e. represented by a disorderly
robustly, while inflation has risen temporarily, fueled adjustment in Europe.
by food prices. BanRep has begun to hike the policy
rate again, and will continue to do so in 2012. The
fiscal accounts are improving on the back of tax Colombia: COP and policy interest rates
collection outperformance.
11 2700
 Main risks: Higher inflation because of stronger
10
commodity prices and/or domestic demand 2500
9
pressures. Overheating and bubbles prompted by a
credit boom. A relapse in the US economy, 8 2300
destination of more than one third of the country’s 7

2100
exports. 6
 Strategy recommendations: Remain on the 5 1900
sidelines waiting for better entry levels to get 4

exposure to COP. Close 2s3s COP/IBR steepener and 3
1700
receive 5Y COP/IBR (or TES Jun ’16) against 5Y USD

2 1500
swap. Stay overweight external debt and favor
shorter-end of the curve, where we favor off-the-run
19s and 20s over the benchmark 21s.
Repo rate (% pa) COP spot (rhs)
Macro view Source: Banco de la República, Deutsche Bank
BanRep hikes reference rate
On November 25, Banco de la Republica raised its target The tone of the communiqué was measured, suggesting
interest rate by 25bp to 4.75%. The decision was not a that BanRep may hike the reference rate some more
complete surprise, as market forecasts were fairly evenly although proceeding in a rather gradual fashion. We
divided between no hikes and a 25bp increase. The press indeed expect the Central Bank to proceed with caution in
release that accompanied the decision highlighted that the the coming months, hiking the target rate by some 50bp
policies implemented in Europe to deal with the debt to 75bp more during 2012, possibly pausing in between
crisis have yet to yield results, and that the emerging rate movements. Over time, we believe the Central Bank
market consensus is that the US will grow at a moderate will adjust its monetary policy stance to reach short term
pace for a protracted period. Commodity prices, however, real interest rate levels nearing 200bp. In the press
remain high and continue to benefit producers in the EM conference that followed the announcement, BanRep’s
world. The Bank also acknowledged that in Colombia, authorities hinted that the hike ‚was enough for now‛.
domestic demand continues to expand at a very robust
pace, so that the optimistic growth prospects presented Inflation on a temporary high
earlier this year continues to be valid. That is, the Bank Increases in consumer prices accelerated in September
expects the economy to grow by about 5.5% in 2011. and October, coming out above expectations and
Bank credit keeps growing at a very fast pace, especially resulting in annual inflation that is now a shade above the
consumer credit which is expanding at roughly three ceiling of the target band. BanRep has indicated that this
times the pace of nominal GDP, while housing prices are is a temporary phenomenon, associated with seasonal
at historically high levels. BanRep admitted that inflation increases in food prices, and that it remains confident that
during the past two months exceeded its expectations, in 2012 inflation will converge towards the 3% medium
leading to an upward revision in short term projections. term target again. Food and beverages are the fastest
For next year, however, the Bank remains confident that rising items of the index, having increased by 6.6% yoy
the temporary shocks to inflation will recede and that the through October, on the back of weak supply because of
annual rate will converge towards the target range. It heavy rains in agricultural areas. Meanwhile, core prices
pointed out, however, that stronger than expected continue to behave well, remaining at or below the
domestic demand pressures represent an inflationary risk medium term target. We expect annual inflation to end
for the coming months. On the growth front, the risks are the current year just below the ceiling of the band, and to
drop further in 2012, although we see the convergence

towards 3% as a significant challenge. This is so because Colombia: GDP and unemployment

Colombia will be among the fastest growing economies in
9 15
the region next year too, with a robust performance of
8
domestic demand, and with credit expanding fast. In 14
7
addition, concerns about financial developments in
6 13
industrialized countries have increased risk aversion,
5
prompting currency weakness, which if maintained over 12
time could contaminate domestic prices. 4
3 11
Colombia: Inflation rates (% yoy) 2

10
1
16 0 9
14
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
May-07
May-08
May-09
May-10
May-11
12
10
8 GDP Unemployment
Source: DANE, Deutsche Bank
6
4
2 IP and retail sales below expectations
0 The official statistics office DANE reported that industrial
-2 production rose by 5.2% yoy in September, below
expectations of a 5.9% increase according to
Bloomberg’s poll. Industrial sales expanded by 5.9%,
while employment in the industrial sector increased by
CPI CPI food
1.6%. During the first nine months of the year, industrial
output grew by 4.9% yoy. DANE also reported that retail
sales rose by 8.1% yoy in September, below expectations
Lowest unemployment rate in a decade of an 11.3 increase, and the lowest print since April 2010.
The official statistics office DANE reported that the urban Despite these softer than expected figures, we project
jobless rate (for the country’s 13 largest cities) came out that the Colombian economy will grow by more than 5%
at 10.2% in October, the same level as in the previous this year, while inflation is temporarily above the ceiling of
month and above market expectations of 9.9% as per the target band.
Bloomberg’s poll. The nationwide unemployment,
however, was 9.0%, significantly below the 9.7% Colombia: IP and retail activity (% yoy)
registered in September and the lowest since 2001. The
25
figure represents not only good economic news but also
20
another political for President Juan Manuel Santos, who
15
had set the goal of driving unemployment to the single
10
digit range during his administration. Santos indeed
5
celebrated the release and pointed out that this record is a
0
great accomplishment ‚considering the unfavorable
-5
external scenario where economies like United States,
-10
Europe and Asia have seen their unemployment rates
-15
increasing‛. According to DANE, Colombia has 2.13m
Jul-08
Jul-09
Jul-10
Jul-11
Jan-08
Jan-09
Jan-10
Jan-11
Apr-08
Apr-09
Apr-10
Apr-11
Oct-08
Oct-09
Oct-10
unemployed workers, a reduction of 129,000 people

relative to a year ago, while the occupied population is
Sales IP
now at 21.5m. So far this year, the unemployment rate
has dropped even though the participation rate has
increased, which means that job creation is outstripping
labor supply. We expect the open unemployment rate to Trade balance in September
continue dropping in 2012, with the nationwide figure The official statistics unit DANE reported a trade deficit of
reaching 9%. USD337m in September, below consensus expectations
of a USD90m deficit as per Bloomberg’s poll. The
accumulated surplus year-to-date reached USD3236m,
which represents a 131% increase vis-à-vis the same
period from previous year. During the month, total

imports increased by 29% yoy. Regarding exports, Congress this year, something that should also increase
traditional products rose by an impressive 56.3% yoy, on the chances of sovereign rating upgrades down the road.
the back of strong sales of oil and oil derivatives, while
those of non-traditional products rose by 6.3% yoy. As a Colombia: Tax outperformance in 2011
Jan-Sep 2011
result, total exports increased by 36.2% yoy. We expect
Actual Budgeted % of
the trade surplus to shrink by year-end, as demand for (COPtrn) % yoy for 2011 budget
imports is typically strong during the latter part of the
year, and to contract further in 2012, as imports are Internal 54.04 49.4 70.06 77.1
propped up by strong economic activity. Trade dynamics Income 27.74 40.6 32.00 86.7
VAT 18.37 41.1 31.69*
will be impacted by the recently approved FTA with the
Financial transactions 3.68 76.3 4.04 91.3
US, expected to become fully operational by 2013. In the
Wealth 4.13 294.2 2.33 177.4
meantime, the US Congress approved the renewal of the Stamp 0.11 -59.5 0.20 54.7
special trade preferences known as APTDEA retroactively External 11.62 35.1 3.52
to February 2011 when they had expired, and until 2013
when they will probably be rendered unnecessary by the Total 65.66 46.7 73.78 89.0
enactment of the FTA. By virtue of the agreement, more
* Domestic and external VAT receipts.
than 5,000 items of the tariff code that are currently levied
Source: DANE, GlobalSource, , Deutsche Bank
at 5% or above will face gradually decreasing tariffs,
converging to zero within the next two decades.
On Santos’ possible reelection bid
The current account balance, on the other hand, is During a conference at the London School of Economics,
expected to continue showing a relatively large deficit President Juan Manuel Santos said that ‚if he achieves
because of the unfavorable services balance. We project it most of the goals of his administration‛ during the four
to be near 3% of GDP this year and next. As it has been years of his mandate, he would prefer not to run for
the case in recent years, FDI flows are expected to be reelection. He added that in the event of a reelection bid,
larger than the current account deficit over the forecast the process should be smoother than in the previous
period, thus suggesting no urgency whatsoever on the political cycle, as no constitutional reform would be
external financing side. In addition, we are also of the idea necessary this time around. Thus, Santos did not close the
that Colombia would be in an optimal position within door to the possibility of a reelection, something that is
LatAm to gain access to multilateral financing, if so unlikely to be ruled out especially considering that his
desired, in the event of a worsening of international popular support is currently at an all time high of well over
conditions. Public external debt amortization is to remain 80%. Santos’ popularity is being supported by the good
below the USD2bn per year mark, almost half of which is economic performance of the country, especially in a
bilateral and multilateral. difficult international context, and the recent strikes on the
Fiscal performance gradually improving FARC, with several guerrilla leaders taken down.
Because of the faster than initially expected growth of Meanwhile, the local media reported that the relationship
economic activity, tax receipts are likely to come out between Santos and former President Alvaro Uribe is
above budgeted levels during the current year by about somewhat strained, and that Uribe may support former
5%. During the first nine months of the year, VAT Finance Minister Oscar Ivan Zuluaga as presidential
collection and income tax receipts rose by 41% yoy a candidate in 2014. It is, however, too early to determine
piece, while the financial transactions tax revenue what the eventual political strategies will be, but it
increased by 76% yoy. This has resulted in a reduction in appears that Santos is currently in a position of substantial
planned domestic debt sales this year, and will also lower strength and would become a very powerful candidate for
TES issuance for 2012. We project this year’s reelection if so desired – and conveying a message of
consolidated public sector deficit to be just above 3% of policy continuity to the market. Santos met with British
GDP, instead of official estimates from early this year that Prime Minister David Cameron and Foreign Affairs
put it at 4.1%, as tax outperformance is to be in the order Minister William Hague, who highlighted Colombia’s
of COP6trn (1% of GDP). This will be the case, in our continued commitment to improve security and Santos’
view, even if the authorities bring forward some expenses compromise to avoid human rights abuses. Hague also
originally slated for 2012, such as some pension outlays. indicated that the bilateral goal is to double trade volumes
For 2012, we project such deficit to drop further towards by 2015. Labor Party lawmakers, in turn, complained
3% of GDP, as tax collection and compliance continue on about Colombia’s human rights record and requested the
an upswing. Over the medium term, fiscal performance British government to prioritize the guarantees to the
should also benefit by the series of reforms approved by rights of labor union leaders in Colombia over bilateral
trade goals.
Fernando Losada, New York, (212) 250-3162

Investment strategy Colombia: Deutsche Bank Forecasts

2010 2011F 2012F 2013F
FX: Constructive on fundamentals but beware of National Income
short-term risks. Fundamentals keeps improving the Nominal GDP (USD bn) 243.3 267.4 293.4 319.7
medium-term prospects for the COP, but the usual end-of- Population (m) 45.8 49.3 50.4 50.4
year scarcity of USD in the local market create some GDP per capita (USD) 5,312 5,424 5,822 6,343
pressure on short-term points, increasing the volatility
during the next weeks. The favorable trade and fiscal Real GDP (YoY%) 4.3 5.5 5.0 5.0
performance observed during this year is expected to Priv. consumption 5.0 6.0 5.0 5.2
continue during 2012, and strong FDI flows will more than Gov't consumption 3.5 3.0 3.5 3.3
compensate a growing deficit in the current account. The Gross capital formation 6.0 11.0 10.0 11.0
latest activity and inflation data suggest that Banrep will Exports 18.0 25.0 21.0 18.0
continue to tighten monetary conditions early into next Imports 20.0 28.0 22.0 20.0
year. Together with lean positioning, the recovery in carry
could act as important short-term driver. Nevertheless, the Prices, Money and Banking
recent underperformance of the COP is an reminder that CPI (Dec YoY%) 3.2 3.7 3.4 3.2
the currency could also suffer from a more challenging Broad Money 8.1 13.5 13.0 13.0
global environment, particularly as technical factors play a Bank credit 10.0 12.0 15.0 15.0
role at the turn of the year. As a consequence, we
recommend remaining on the sidelines, waiting for better
entry levels at the beginning of next year.
Interest payments 3.3 3.3 3.2 3.1
Rates: Enough tightening priced in. The local curve has Primary Balance -0.6 0.0 0.0 0.1
been anticipating the on-going tightening cycle for some
weeks. With 75bp of additional tightening already priced External Accounts (USD bn)
in, we consider that the risks are biased to the downside Exports 39.8 55.0 63.8 75.0
for short-term rates, as the slowdown in global growth Imports 40.7 53.5 63.6 76.0
may drag on domestic activity and reduce some Trade balance -0.9 1.5 0.2 -1.0
inflationary pressures. Nevertheless, we find that the belly % of GDP -0.4 0.6 0.1 -0.3
of the curve may offer more value, particularly relative to Current account balance -8.9 -8.5 -8.0 -8.5
core rates. We recommend closing 2s3s IBR/COP % of GDP -3.7 -3.2 -2.7 -2.7
FDI 9.1 10.0 11.0 11.0
steepener and entering a 5Y receiver, either in IBR/COP or
FX reserves 28.4 34.0 40.0 44.0
TES Jun ’16, against 5Y USD swap payer (swaps, entry:
COP/USD (eop) 1908 1890 1850 1830
440bp, target: 410bp, stop: 455bp).
Credit: Stay overweight. We keep Colombia at Debt Indicators (% of GDP)

overweight on the back of its strong macro momentum, Government debt 38.5 39.3 39.4 39.4
evidenced in its robust domestic driven growth as well as Domestic 26.5 27.5 27.9 27.9
the improvement in fiscal performance and debt External 12.0 11.8 11.5 11.5
dynamics; marginally more attractive valuation relative to Total external debt 22.6 22.4 22.5 20.6
its LatAm low beta peers; and supportive technicals. in USDbn 55.0 60.0 66.0 66.0
Colombia will likely have (in a worst case) flat net issuance Short-term (% of total) 8.0 8.0 8.0 8.0
in 2012 (maximum USD2bn external issuance met with
General
almost the same amount in principal and interest
payments). On the global curve, while the bonds at the
Unemployment (%) 11.0 10.0 9.3 9.0
long end are trading almost flat to their counterparts on
peer curves, the shorter end still has room to catch up;
Financial Markets (eop) Current 3M 6M 12M
we favor the 19s and the off-the-run 20s over the 21s,
Overnight rate (%) 4.8 5.0 5.3 5.3
whose 20bp richness to the curve due to benchmark
Three-month rate (%) 5.0 5.2 5.6 5.6
premium looks somewhat excessive. 1946 1880 1870 1850
COP/USD
Source: DB Global Markets Research, National Sources


Mexico Baa1 (stable) / BBB (stable) / BBB (stable)

Moodys/S&P/Fitch
 Economic Outlook: Headline inflation has year-end, and we also expect similar levels for headline in
accelerated but core remains well behaved, very near 2012 and slightly lower core, possibly at 3%.
the medium term target. Economic activity surprised
GDP growth well above expectations
on the upside during 3Q11, and will decelerate very
The official statistics office INEGI reported that GDP
gradually over the coming months. The negative
expanded by 4.5% yoy during 3Q11, significantly above
output gap will not close until 2012. Banxico is
expectations of a 3.9% increase according to
unlikely to cut the funding rate unless the currency
Bloomberg’s poll. On a qoq seasonally adjusted basis,
appreciates back towards pre-US downgrade levels.
GDP expanded by 1.34%. The outperformance was
 Main Risks: A relapse in US economic activity. helped by a substantial 8.3% yoy, 11.8% qoq jump in
Higher inflation because of strong commodity prices agriculture. Manufacturing, in turn, rose by 4.6% yoy. The
and/or higher pass-through from depreciation. 2Q11 figure was revised slightly downwards by 10bp to
Volatility of political origin ahead of next year’s 3.2% yoy. GDP has expanded by 4.1% yoy during the first
presidential elections. nine months of the year, so that even if the growth pace
slows down in 4Q11 as we expect, the figure for the
 Strategy recommendations: Take profits on long
entire year will be at least 3.8%. Amid global financial
MXN/CZK and enter short CAD/MXN. Take profits on
turmoil and steady but slow growth in the US, we project
5Y TIIE payer and enter 2s10s TIIE flattener vs. 2s10s
that economic activity growth will be weaker in 2012,
USD swap steepener. Neutral external debt. The old
possibly just below the 3.5% mark.
19s remain significantly rich to the curve.
Mexico: Actual and expected GDP (% yoy)
Macro view
8
Inflation edging upwards towards year-end
6
November’s fortnight inflation came out above
expectations at 0.97% mom. Core inflation was higher 4
than expected at 0.27%, but non-core soared by 3.41%
2
because of high agricultural prices and adjustments to
energy prices, as the summer season fares were phased 0
out. When measured with the fortnightly index, annual
-2
inflation is now running at 3.44%, 30bp above the
previous month’s print. -4
-6
Mexico: Inflation rates (% yoy)
-8
10 2005 2006 2007 2008 2009 2010 2011F 2012F
9
8 Source: Banco de Mexico, Deutsche Bank
7
Tasa de fondeo unchanged
6
On December 2, the last monetary policy of the year,
5
Banxico left the tasa de fondeo unchanged at 4.5%, in line
4
with expectations. The Bank highlighted that the financial
3
crisis in Europe has worsened, and that the chances of a
2
recession in the area next year have increased, while the
concerns about the health of some European banks have
increased volatility in international financial markets.
Banxico also pointed out that despite some recently
CPI Core Food
released positive economic indicators in the US, structural
Source: Banco de Mexico, Deutsche Bank
problems persist, including unemployment and high
These developments, coupled with the fact that the household leverage, with the additional difficulty
currency remains extremely weak and that 3Q11 GDP generated by the lack of political agreement towards a
came out stronger than expected, prevents easing on the sustainable fiscal path. Banxico sees heightened risks for
part of Banxico for the time being. We expect headline growth in the US, something that was corroborated by the
inflation to be around 3.4% and core to near 3.2% by

Fed’s downward revision of its GDP growth forecasts for instrument, which had been used two years ago when the
2011 and 2012, and the indication that monetary policy global financial turmoil was on the rise, is geared towards
will remain very accommodative at least through 2013. providing liquidity to the fx market to reduce currency
Those subdued growth prospects suggest that volatility. It must be noted that the Bank is in a far stronger
commodity prices may weaken and that inflation in position to intervene at the present juncture than in 2008-
developed markets will soften. 09, as international reserves are twice as high as in 2007,
even before counting the IMF’s contingent financing. The
In Mexico, Banxico acknowledged that although general
announcement of the contingent dollar auctioning
economic activity continues to expand, the industrial
mechanism was made at the same time of the
sector has softened, reflecting weaker external demand.
coordinated action of the US Federal Reserve and five
Credit and labor markets still show signs of slack capacity,
other major central banks, thus resulting in a stronger
and the negative output gap will take longer to close.
impact on the peso, provided support for the peso, which
Banxico argued that the balance of risks for growth has
appreciated by some 28 centavos in the three days that
deteriorated but the balance of risk for inflation is neutral,
followed the news to MXN13.54/USD.
as inflation could fall because of weaker domestic and/or
external demand but it could increase as a consequence Mexico: Exchange rates and international reserves
of the currency depreciation and/or the movement in
some agricultural prices. In the previous monetary policy 14.4 150
meeting, Banxico had said that the balance of inflation risk 13.9
140
had improved, so the new statement can be construed as 130
13.4
marginally more hawkish. The Bank also reiterated the last 120
paragraph of the previous communiqué, pointing out that 12.9 110
depending on the impact of the global deceleration on the 12.4
100
Mexican economy and ‚in the context of great monetary 90
11.9
lassitude in developed countries‛, it may become 80
necessary to relax monetary policy in the future, but also 11.4 70
indicating that it remains vigilant of any possible impact of
the depreciation on inflation. All in all, the statement was
consistent with the 3Q11 inflation report, where Banxico
Exchange rate (MXN/USD) Reserves (USDbn, rhs)
said to expect both headline and core to remain within the
3.0%/4.0% interval over the foreseeable future, and that Source: Banco de Mexico, Deutsche Bank
the current monetary policy stance is neutral, with External accounts show comfortable situation
inflation expectations well anchored in spite of the recent Through October, the accumulated trade deficit was just
currency slide. Thus, we continue to be of the idea that in below USD1bn. Given the seasonal behavior of the trade
order for Banxico to cut rates in 1Q12, we would need to accounts, we expect the imbalance to increase through
see a stronger exchange rate, possibly trading with a 12 December, although remaining below the USD4bn mark.
handle, inflation edging downwards from current levels, The current account deficit, in turn, is also expected to
and some further signs of economic deceleration. remain subdued at no more than USD7bn. For next year,
The new old FX intervention policy we expect those imbalances to increase to USD7bn and
On November 29, the Exchange Commission announced USD10bn, respectively, on the back of lower export
the suspension of the monthly auctions to buy dollars, in growth given the weak prospects for the US. Similarly to
view of the sharp weakening of the currency observed in what has been the case in recent years, the external
previous weeks. The November 30 auction was called off. imbalance does not pose any risk for the Mexican
In addition, Banxico rekindled the daily dollar auction economy, as the current account deficit will be more than
mechanism that has been used several times in the past. covered with FDI inflows alone, which we expect to hover
The Bank will offer up to USD400m every day the around the USD20bn per year during 2011-12. Given our
currency depreciates by at least 2% overnight. This move balance of payments projections, we expect a further
confirms that Banxico is worried about the possible accumulation of international reserves next year, although
impact of the depreciation on inflation, especially since at a slower pace than in 2011.
the last two inflation releases came out above 2011 growth and inflation up in latest Banxico poll
expectations, and with preliminary evidence that prices of The latest Banxico expectations survey showed market
tradable goods are increasing faster than initially participants revising their GDP growth forecasts for the
expected. True to its tradition, Banxico will intervene in current year to 3.87%, 15bp above the previous month’s
the currency market via a transparent rule-based poll. It was the first time in the past six months that the
mechanism rather than on a discretionary basis. The growth projection is revised upwards, in what was a result

of the higher than expected figure observed during 3Q11. He went on to say that the slim victory obtained by the
For 2012, GDP is expected to expand by 3.25%. Headline PRI in the recent Michoacan State election and the early
inflation, in turn, was revised upwards to 3.36%, 6bp announcement of a coalition candidate by the leftist
above the October projection, also reflecting the recent parties suggest that the PRI also has to rally around a
acceleration in prices and possibly the weakening of the consensus leader as soon as possible. Indeed former
exchange rate, a phenomenon that is lasting more than Mexico City mayor and presidential candidate Andres
initially expected. The currency is now expected to be at Manuel Lopez Obrador had edged current mayor Marcelo
MXN13.32/USD by year-end, 36 centavos weaker than in Ebrard in a PRD party poll, with AMLO thus becoming the
the previous poll. Regarding the tasa de fondeo, the presidential candidate from the left. Peña thanked
majority of survey participants projected no change during Beltrones via Twitter, acknowledging his ‚professionalism
this year, while one third of them expect to see monetary and contribution towards PRI unity‛, and registered
easing during 1H12, and close to half of the respondent formally as a presidential candidate. Beltrones’ decision
project tightening since 2013. renders any primary election mechanism within the PRI
unnecessary, as the party will most likely line up behind
Retail sales, unemployment better than expected
Peña, who in different national polls appears to be at least
The National Institute of Statistics INEGI reported that
ten percentage points ahead of any candidate from the
retail sales increased by 4.7% yoy in September, beating
ruling PAN or the leftist PRD parties.
expectations of a 3.1% increase as per Bloomberg’s poll.
Employment in the retail sector increased by 2.8%, while Las month, Peña addressed a group of investors in New
average wages dropped by 1.5%. Wholesale activity, in York, indicating that in the event of being elected next
turn, rose by 6.3% yoy. INEGI also reported that year, his government program will have the following
unemployment was 5.0% in October, way below priorities: (i) maintenance of macroeconomic stability as a
expectations of 5.7%. On a seasonally adjusted basis, the necessary (albeit not sufficient) condition for growth; (ii)
jobless rate was 4.8%. These figures reaffirm the view fostering competition in all markets; (iii) promoting Mexico
that fears about a quick and sharp deceleration of as a regional energy powerhouse; (iv) opening up of the
economic activity were overblown. Instead, the real oil sector to private participation; (v) increase of
economy is holding up pretty well, and the deceleration investment in human capital, modernization of educational
expected for next year will proceed gradually. system; (vi) increase in bank penetration and credit
creation as a proportion of GDP; (vii) improvement in
Mexico: Industrial production and unemployment
physical infrastructure; (viii) implementation of a new
universal social security system, which will include health
130 7
coverage, unemployment insurance and pensions; (ix)
deepening of integration with the US, (x) implementation
120 6
of an integral fiscal reform; and (xi) implementation of
sector-specific promotion policies. He indicated that
110 5 economic policies geared towards accelerating growth
and reducing poverty will be the cornerstone of his
100 4 administration. His presentation was well suited for both
domestic and international investors, although he did not
90 3 provide details of implementation of each policy, as the
venue and the time constraint did not allow it. Regarding
the energy sector, he indicated that the public sector will
continue to have full ownership of the country’s natural
IP (Jan 09=100) Unemployment (%, rhs) resources, which suggests that his plan may include a
Source: INEGI, Deutsche Bank twist to the existing arrangement of incentive contracts
Peña Nieto likely PRI presidential candidate for private firms, but with no changes to the constitutional
Senator Manlio Fabio Beltrones from the opposition PRI constraints on private participation in the sector.
party announced his decision to step down from the race Regarding security, he said the decision of the
to become a presidential candidate ahead of next year’s administration of President Felipe Calderon to combat
election. Beltrones trailed former Mexico State Governor organized crime was correct, although he added that
Enrique Peña Nieto by a very large margin in all surveys, under his government he would try to increase the
but his decision definitely cleared the way to define Peña operational force of the security forces, both expanding
as the party candidate. In a press release, Beltrones the police and emphasizing intelligence activities.
indicated that his decision was ‚not a sacrifice, but rather Fernando Losada, New York, (212) 250-3162
a contribution to help the PRI secure the victory in 2012‛.

Investment strategy Mexico: Deutsche Bank Forecasts

2010 2011F 2012F 2013F
FX: Intervention may reduce volatility. MXN was one of National Income
the currencies which suffered the most from recent Nominal GDP (USD bn) 995 1041 1121 1199
market volatility. Nevertheless, the recently announced Population (m) 109 111 112 114
rule-based intervention by Banxico (will offer USD400mm GDP per capita (USD) 9,120 9,411 9,990 10,544
whenever the currency weakens by more than 2% in a
day) was successful in curbing the MXN depreciation and Real GDP (yoy%) 5.5 3.9 3.3 3.5
may help to reduce its volatility. The effectiveness of the Private consumption 4.1 4.0 3.0 3.3
intervention could be increased due to the important MXN Gov’t consumption 3.4 1.5 2.9 3.0
undervaluation and extreme short positioning MXN is Investment 4.0 4.6 4.0 5.0
clearly undervalued both from a short-term perspective Exports 25.0 21.0 11.0 12.0
based in recent evolution of financial drivers and from a Imports 24.0 19.0 10.0 12.0
much longer valuation based on macroeconomic
fundamentals. Additionally, in our view it will be difficult Prices, Money and Banking
that Banxico eases monetary conditions unless the CPI (Dec yoy%) 4.4 3.4 3.4 3.4
currency appreciates considerably. We continue to find Broad Money 13.0 11.0 12.0 10.0
attractive maintaining exposure to the peso, even when Credit 9.0 11.0 12.0 10.0
acknowledging the potential risks posed by the external
environment. We recommend taking profits in our long
MXNCZK recommendation and switching to short
Primary Balance -0.5 0.1 0.0 0.0
CADMXN (entry: 13.38, target: 13.10, stop: 13.50); this
cross still offers some positive carry while offering
External Accounts (USD bn)
protection against US risks.
Exports 297.0 341.2 362.0 395.0
Rates: Position to capture risk premium. Local rates have Imports 300.1 345.0 369.0 404.0
been following the movements in the exchange rate. As Trade balance -3.1 -3.8 -7.0 -9.0
Banxico does not seem ready to ease monetary % of GDP -0.3 -0.4 -0.6 -0.8
conditions, at least until the currency appreciates further, Current account balance -5.6 -7.0 -11.0 -14.0
the short-end of the curve offers little value. Nevertheless, % of GDP -0.6 -0.7 -1.0 -1.2
the medium and long term sectors of the curve could FDI 18.0 19.5 20.0 21.0
FX reserves 113.6 140.0 161.0 180.0
benefit from reduced exchange volatility due to Banxico’s
MXN/USD (eop) 12.34 13.00 12.80 12.80
intervention and from a potential improvement in risk
appetite. After reaching the target, we take profits in our
Debt Indicators (% of GDP)
5Y TIIE payer recommendation and switch to a box trade
Government debt 34.4 35.2 35.3 35.8
of 2s10s TIIE flattener against 2s10s USD swap steepener
Domestic 24.4 25.4 25.8 26.5
(entry: -15bp, target: 25bp, stop: -35bp). This trade could
External 10.0 9.8 9.5 9.3
benefit from the reduction in risk premia in Mexican rates 19.3 19.8 19.3 18.8
Total external debt
but also from some normalization of US rates. 192.0 206.0 216.0 225.0
in USDbn
Credit: Increase to neutral from underweight. Mexican Short-term (% of total) 20.0 20.0 19.0 19.0
external debt has performed broadly in line with its LatAm
low beta peers, but an improving US economic activity General
(especially relative to the rest of the world) in a way Industrial production (yoy%) 6.0 4.4 4.0 5.0
removes a source that might negatively impact Mexico’s Unemployment (%, avg) 5.3 5.6 5.4 5.2
debt dynamics. Valuation does not look attractive, but
Mexico is among the credits having the lowest risk on our Financial Markets (eop) Current 3M 6M 12M
vulnerability indicators (see the special piece: EM: Survival Overnight rate (%) 4.5 4.3 4.0 4.0
of the Fittest). On the UMS curve, a correction to the 3-month rate (%) 4.4 4.2 4.0 4.0
mispricing of the 8.125% 19s (19Os) has taking place but MXN/USD 13.54 12.80 12.60 12.60
it remains significantly rich to the curve and should be Source: DB Global Markets Research, National Sources
avoided; we continue to favor the 5.95% 19s (19N).


Peru Baa3 (pos)/BBB (neutral)/BBB (neutral)

Moody’s/S&P/Fitch
 Economic outlook: GDP growth is to be near 7% year, and also because of the higher risks stemming from
this year, slowing down very gradually towards 6% in the international financial turmoil. While the Bank has
2012. The inflation spike is likely to be temporary, but repeatedly indicated its concerns about a deteriorating
it will prevent monetary easing for now. Structural global environment, the inflation spike suggests that the
excess demand for dollars is to maintain the currency authorities have little to ease monetary policy at the
well supported. present juncture. We indeed expect the policy rate to
remain unchanged through 2012, as current levels
 Main risks: Higher inflation because of food prices.
represent real short term rates that are well below 1%.
Weaker fiscal and external performance because of
softer mining prices, if global growth falters. External accounts in good shape
September’s trade surplus reached USD656m, on track to
 Strategy recommendations: Maintain long 3M
reach almost USD7bn this year. The current account
USD/PEN NDF and remain neutral on rates. Increase
deficit, in turn, is to be below 1.5% of GDP. We project
to overweight external debt, take profit in the 37s to
similar figures for the next couple of years, with the
19s switch and now favor the long end of the curve.
current account imbalance remaining below 2% of GDP
Macro view and more than covered by FDI inflows. We also project a
further accumulation of reserves, albeit at a somewhat
3Q11 GDP in line with expectations smaller pace than in the past two years.
GDP expanded by 6.5% yoy during 3Q11, slightly below
expectations of a 6.6% increase according to Humala’s first 100 days – a mixed review in the polls
Bloomberg’s poll. This was the fifth consecutive quarter in After 100 days in office, President Ollanta Humala’s
which growth slows down. The Central Bank has recently approval rate is still high at 56% but it has dropped from
upgraded its 2011 GDP growth forecast to 6.8% from more than 70% when he took office, according to a poll
6.3%. In order to reach 6.8%, the economy should grow conducted by local consultant Apoyo. He lost six points in
by 4.8% yoy during 4Q11, something that looks feasible. the last month alone. Those supporting him indicated that
Although domestic spending appears to be holding up he is promoting change to improve the country, that he is
well, the authorities have announced a stimulus plan to fulfilling his campaign promises, and that he cares about
offset a possible further deterioration in external the poor. Those who disapprove of him mentioned that he
conditions. Currently, said plan stands at nearly 2% of is not sticking to his campaign agenda, that he does not
GDP, but Economy Minister Castilla hinted that it could be generate confidence, and that there is evidence of
increased if deemed necessary. We expect to see slower corruption in his government. First Lady Nadine Heredia is
growth next year, although Peru should still be among the the public figure with the highest popularity at 63%, even
strongest performers in LatAm, expanding by almost 6%. surpassing the President. Prime Minister Salomon Lerner
received only 33% backing, while Economy Minister
November inflation above expectations Miguel Castilla reached 37% and Congress Chairman
INEI reported that consumer prices rose by 0.43% mom, Daniel Abugattas got 42%. Vice Presidents Marisol
4.64% yoy, well above expectations of a 0.30% increase Espinoza and Omar Chehade (currently under investigation
as per Bloomberg’s survey. Year to date, prices increased and suspended from his post) did not fare well, with
by 4.46%. Prices of food and beverages continue to lead support of 34% and 8%, respectively. In terms of specific
the increases. The Central Bank has argued that the spike areas of government work, the Humala administration
in inflation is a temporary phenomenon that will dissipate obtained a mixed review, with good marks regarding the
next year, while core inflation remains better behaved at fight against poverty and the promotion of investment and
3.50% and inflation excluding all food and energy items is employment, while the efforts towards solving social
running at 2.50%, suggesting that there is no evidence of conflicts, fight drug trafficking and combat corruption
substantial demand pressures. The increase in inflation were disapproved.
observed since June, however, has been very significant,
which suggests that next year’s figures could also be a bit Fitch upgrade
higher than initially thought, near 3.5%. On November 10, Fitch ratings announced its decision to
upgrade Peru’s foreign currency issuer default rating (IDR)
Policy rate unchanged for now and country ceiling to BBB from BBB-. The local currency
The Central Bank left its reference rate unchanged at IDR was raised to BBB+ from BBB. The decision
4.25% in October, in line with expectations. The decision represents an implicit endorsement for President Ollanta
was made as the Bank acknowledged that aggregate Humala, as the agency indicated that the upgrade reflects
expenditure is growing at a slower pace than earlier in the

‚reduced uncertainty regarding macroeconomic policy Peru: Deutsche Bank Forecasts

continuity and changes to the fiscal contribution of the 2010 2011F 2012F 2013F
mining sector‛. Fitch said that the ratings are supported National Income
by a strong net external creditor position, high and Nominal GDP (USDbn) 146.8 168.5 176.2 188.6
increasing international reserves, and low external debt. Population (m) 29.3 29.7 30.0 30.5
The vulnerabilities are mainly the high dependence on GDP per capita (USD) 5,009 5,672 5,874 6,182
commodities and the high degree of dollarization. Fitch
highlighted the commitment of the new administration to Real GDP (YoY%) 8.8 6.8 5.9 5.5
Priv. Consumption 6.0 6.5 5.5 5.0
a conservative fiscal stance and a credible monetary
policy, and the rapid and successful negotiation to
Investment 22.4 11.0 10.0 10.0
increase the fiscal contribution of the mining industry,
Exports 2.5 24.0 10.0 10.0
which reduced regulatory uncertainty. We believe
Imports 23.8 31.0 17.0 12.0
upgrades from other rating agencies are likely next year.
Gustavo Cañonero, New York, (212) 250-7530 Prices, Money and Banking
Fernando Losada, New York, (212) 250-3162 CPI (YoY%) 2.1 4.4 3.5 3.2
Broad money 25.4 12.0 13.5 13.0
20.3 14.0 15.0 15.0
Investment strategy Credit
FX: Risks are biased toward depreciation. The Fiscal accounts, % of GDP
successful Central Bank intervention in the FX market has Balance -0.7 0.1 -0.2 -0.4
shielded the PEN from the recent volatility in global Government spending 20.0 19.9 20.5 21.0
financial markets. However, as the currency continues to Government revenue 19.3 20.0 20.3 20.6
trade close to multiyear high levels, the intervention has Primary surplus 0.6 0.8 0.4 0.3
helped to increase the currency overvaluation. While the
central bank will likely continue to intervene aggressively External accounts (USDbn)
to smooth the currency movements and capital flows may Exports 35.6 44.7 48.5 51.1
Imports 28.8 38.0 45.0 49.0
still be favorable, the risks, in our view, are biased toward
Trade balance 6.8 6.7 6.5 6.0
depreciation. Next year, the currency will receive less
% of GDP 4.6 4.0 3.7 3.2
support both from economic growth and terms of trade.
We recommend maintaining 3M USD/PEN NDF (entry:
% of GDP -1.6 -1.4 -1.7 -1.9
2.72, target: 2.80, stop: 2.68).
FDI 5.7 5.5 5.1 5.0
Rates: Remain neutral. The local curve, supported by FX reserves (USDbn) 44.1 49.0 51.0 53.0
favorable technicals and a stable currency, has shown FX rate PEN/USD (eop) 2.80 2.72 2.85 2.90
extraordinary resilience to external events. With rates
trading at relatively low levels and the central bank with Debt Indicators (% of GDP)
little room to ease monetary conditions, the curve does Government debt 24.1 22.9 23.4 23.7
not offer much value. We recommend remaining neutral Domestic 10.3 9.5 9.8 10.0
External 13.8 13.4 13.6 13.7
on local rates, waiting for better entry levels to get
Total external debt 27.9 27.1 27.7 28.1
additional exposure.
in USDbn 41.0 45.6 48.8 52.9
Credit: Increase to overweight. Fundamentals remain Short-term (% of total) 15.8 15.3 15.1 14.8
strong, anchored by robust growth, even though there is a
mild deterioration in fiscal and external accounts due to General
weaker global demand for mining exports. While we value Industrial prod (%) 8.3 6.0 6.3 6.0
Peru’s stability drawn from its fundamental strength, Unemployment (%) 7.6 7.3 7.0 6.9
valuation on the curve also looks marginally more
attractive in comparison with Brazil and Mexico. On the
global curve, the 19s/37s slope has significantly Financial Markets (eop) Current 3M 6M 12M
steepened and we hence recommend taking profit in the Policy rate (interbank o/n) 4.25 4.25 4.25 4.25
6-month rate (interbank) 4.50 4.50 4.50 4.50
37s to 19s switch. We now find better value at the long
PEN/USD 2.71 2.75 2.80 2.85
end of the curve. Source: DB Global Markets Research, National Sources

Hongtao Jiang, New York, (212) 250 2524

Uruguay Ba1 (stable)/BBB- (stable)/BB+ (stable)

Moodys/S&P/Fitch
 Economic Outlook: Economic growth is decelerating over the next couple of years, although we acknowledge
gradually, converging towards trend levels, although that the risk of the forecast is on the upside, as Uruguay
risk of the projections is on the upside given the remains a significant attractor of strategic foreign
pipeline of investment projects. Inflation remains well investment which, given the size of the economy, could
have an outsized impact on growth performance. In
above the ceiling of the target range, preventing any
addition, a recently approved public-private partnership
monetary easing for the time being.
law could also have a beneficial effect on infrastructure
 Main Risks: A drop in commodity prices. A further investment. Unemployment has averaged 6.1% so far this
acceleration in inflation. Weaker growth in the year, which compares favorably with the 6.7% of 2010
country’s main trading partners. and the 7.3% of 2009. We believe that the jobless rate
could continue dropping towards the high 5% level during
 Strategy Recommendations: We favor UYU ’18 as a the next two years.
buy and hold strategy due to elevated carry and
diversification. External sector dynamics
The current account deficit has widened this year and is
Macro View expected to surpass the 2% of GDP mark. The increase in
that imbalance will probably continue over the next couple
Inflation remains well above expectations of years. Demand for imports is strong, fueled by private
Consumer prices rose by 0.42% mom, 8.40% yoy in consumption and investment, while exports are likely to
November, above expectations of a 0.30% increase as grow at a slower pace as the real exchange rate continues
per the Central Bank’s poll. Annual inflation jumped 52bp to appreciate. The currency weakened since September
relative to October. With the exception of entertainment, 2011, in unison with most other EM currencies, and is
all item groups posted price increases during the month, likely to end the year at nearly UYU20/USD, after
led by apparel that rose by 1.47%. Prices of food and averaging UYU18.8/USD during 3Q11. The exchange rate,
beverages increased by 0.30% mom, 8.92% yoy. Inflation however, has been on a major appreciation trend since
has been fueled by high prices of commodity imports and, the beginning of 2009, on the back of stronger
in spite of the substantial monetary tightening fundamentals and robust capital inflows. Although we
implemented this year, to the tune of 150bp, it remains expect the nominal rate to trade slightly above 20 going
well above the ceiling of the official target that spans from forward, we estimate that the real effective exchange rate
4% to 6%. Producer prices are increasing at double digit is currently some 15% stronger than its average of the
pace, suggesting that both demand and supply factors are past decade. Given that inflation will probably remain
playing a role in the acceleration of consumer prices. This above the ceiling of the target band during the next two
suggests that despite any concerns about global years, chances are good that the real appreciation will not
economic growth and/or softening commodity prices in be corrected any time soon. In the event of excessive
the months ahead, the Central Bank has no room to ease short term currency volatility because of external
monetary policy at the present juncture. The next concerns, the Central Bank is in a strong position to
monetary policy meeting is scheduled for December 29. intervene successfully, as international reserves are
We expect the policy rate to remain unchanged at 8% currently above the USD10bn threshold, more than triple
through next year. the level of 2007.
Economic activity continues to expand Although the external deficit is expected to increase, we
GDP rose by 5.7% yoy during 1H11, significantly below believe that it will be more than covered by FDI inflows,
the 8.4% increase observed during 2010. We expect the which will contribute to maintaining the capital account of
slowdown to continue during 2H11, so that the annual the balance of payments in a surplus position. In May
figure is likely to come out at around 5%. This weakening 2011, a consortium of foreign firms started the
trend is also behind our expectation of no more interest construction of yet another pulp mill worth USD1.9bn, the
rate hikes in the coming months, despite the evidence of largest ever private FDI transaction in the country’s
inflation pressures. The index of leading indicators history. According to the Finance Ministry, the project
produced by local think tank Ceres continued to indicate should have a direct positive impact on GDP growth of
an expansion through September, which suggests that some 0.8% during 2011 and 2012, and 2% pa when it
economic activity will most likely grow during 2H11. becomes fully operational.
Ceres leading index has risen for 28 consecutive months.
Ceres diffusion index, in turn, is currently at 89%, which Public sector finances
indicates that most of the variables that are part of the In the 12 months to August 2011, the consolidated public
leading index continue to move forward. We project the sector primary surplus was equivalent to 1.9% of GDP. As
economy to grow at near trend levels of less than 5% pa the interest bill on public debt remained at 3% of GDP,

the overall deficit was just above 1% of GDP. We expect Uruguay: Deutsche Bank Forecasts
the imbalance to increase towards 1.5% of GDP by year- 2010 2011F 2012F 2013F
end, and to remain around those levels during 2012-13. National Income
Gross public sector debt currently stands just below 60% Nominal GDP (USD bn) 41.0 46.3 49.2 52.3
of GDP, of which 35% of GDP is external. We project Population (mn) 3.4 3.4 3.4 3.4
these ratios to fall further in 2012-13, although at a much GDP per capita (USD) 12,059 13,619 14,477 15,380
smaller pace than in recent years (gross debt/GDP was
over 100% in 2003). In July, S&P raised the country’s
Real GDP (YoY%) 8.0 5.0 4.8 5.0
foreign currency issue rating to BBB-, and Fitch did at the
Consumption 10.1 8.0 7.5 8.0
same time to BB+. The upgrades were justified by the
Gross capital formation 19.0 18.0 18.0 19.0
track record of sound policy design and implementation,
Exports 23.0 27.0 25.0 24.0
and the evidence that the fiscal and monetary policy mix
Imports 24.1 30.0 28.0 28.0
was not changing after the administration of President
Jose Mujica took over.
Prices, Money and Banking
CPI (Dec YoY%) 6.9 8.1 6.5 6.0
Fernando Losada, New York, (212) 250-3162
Broad Money 31.0 23.0 18.0 17.0
Investment Strategy
Rates: Linkers are attractive as a buy and hold proposition. -1.1 -1.1 -1.1 -1.0
Consolidated budget balance
While Uruguayan linkers suffer from reduced liquidity, the 2.8 3.0 2.9 2.8
Interest payments
attractive carry and good prospects for the carry make Primary Balance 1.7 1.9 1.8 1.8
them an attractive proposition to buy and hold. In our
view, inflation expectations will remain elevated as External Accounts (USD bn)
inflation remains above the upper band of the target. Exports 10.7 12.0 11.0 11.0
Additionally, while high inflation continues to appreciate Imports 9.9 11.7 9.8 9.8
the currency which is arguably already overvalued, the Trade balance 0.8 0.3 1.2 1.2
central bank will likely intervene to stop any sharp % of GDP 1.9 0.6 2.4 2.3
depreciation of the currency. Finally, as shown by the Current account balance -0.5 -1.0 -1.2 -1.4
recent credit rating upgrades, the credit will remain solid % of GDP -1.1 -2.2 -2.4 -2.7
on the back of sound policy design. As a consequence, FDI 2.4 2.5 2.5 2.5
we believe that short duration linkers –like the UYU ‘18s- FX reserves 7.7 10.5 11.6 13.0
could be an interesting source of carry while offering an UYU/USD 19.9 20.0 21.0 22.0
attractive diversification opportunity.
Mauro Roca, New York, (212) 250-8609 Debt Indicators (% of GDP)
Domestic 7.5 10.1 9.9 9.7
External 33.9 33.9 33.1 32.3
in USDbn 14.6 15.1 15.6 16.1
General
Unemployment (%) 6.9 6.0 5.9 5.7

Overnight rate (%) 8.0 8.0 8.0 8.0
3-month rate (%) 4.5 5.0 5.0 5.0
UYU/USD 19.8 20.0 20.5 21.0

Venezuela B2 (stable)/B+ (stable)/B+ (stable)

Moodys/S&P/Fitch
 Economic Outlook: Economic activity is picking up preventing economic activity from decelerating much. It
speed, following the contraction of the past two remains to be seen, however, whether that policy impulse
years and beating expectations. The recovery should will be sustainable over time, especially in the absence of
continue next year on the back of very expansive changes to the policy mix that could provide further
fiscal and monetary policies, ahead of the presidential stimulus to the demand for investment.
elections. Inflation remains the highest across the EM
universe. Venezuela: GDP growth is picking up (% yoy)
 Main Risks: Lower oil prices as a result of softer 12
global growth or a financial disruption in Europe. 10
Further acceleration in inflation because of food
8
prices and/or pressures from very loose fiscal policy.
6
Volatility of political origin before next year’s
4
presidential elections.
2
 Strategy Recommendations: Increase to a small 0
overweight, favoring the Republic over PDVSA. On -2
Venezuela, 28s look the most attractive. On PDVSA,
-4
we continue to favor the 13s (for carry-oriented
-6
investors) but also consider moving to the mid-end of
-8
the curve where we favor the 22s. In addition, while
we continue to recommend long basis on the
sovereign curve (24s vs. 10Y being the best trade at
the moment), we also like PDVSA 22s vs. Venezuela Source: BCV, Deutsche Bank
10Y CDS.
Highest inflation across EM
Macro View As of the end of October, annual inflation as measured by
GDP growth well above expectations the national index was running at 26.8%, while the old
GDP expanded by 4.2% yoy during 3Q11, surpassing Caracas index showed a 27.7% increase, posting the fifth
expectations of a 3.1% increases according to consecutive month of increases. Inflation has not been
Bloomberg’s survey. Earlier on, President Hugo Chavez below the 23% mark since December 2007. The
had hinted that the economy grew by 3.5% during the government established an informal target of 22% to 24%
period, but the actual number was even stronger than his for the current year, which will likely be surpassed,
initial estimate. Thus, GDP has risen by 3.8% during the especially considering that there could be additional
first nine months of the year (0.2% for the oil sector and adjustments to regulated prices while public spending
4.1% for the non-oil economy), and it is now on track to continues to grow at a fast pace. Core inflation was
expand by about 4% during 2011 – well above running at 27.7% as of October, i.e. head to head with the
expectations. Financial services led the increases with a general index, which suggests that inflationary pressures
15% increase, while the construction sector jumped by are broad based and will probably be persistent rather
10%. The communications sector increased by 7.9% and than temporary. For next year, we expect inflation to
mining by 7.6%. The oil economy expanded by 0.3% remain very high, fueled by very loose fiscal and monetary
during the quarter, a small contribution in spite of the very policies, combined with an uncertain supply reaction given
high crude prices, which according to Finance Minister the recent implementation of the new price and cost
Jorge Giordani is due to the compliance with the OPEC control norms. Year to date, M2 increased by 41%, even
quotas. Giordani added that the government will target surpassing inflation, and we expect the rapid rise in
5% GDP growth in 2012, something that we see as a very liquidity to continue at least until the November elections.
tall order, especially considering that global growth will be The bank credit portfolio, in turn, rose by 35%. According
weak and that 2011 figures will represent a higher to the Superintendency of Banks, however, the non
comparison point, making fast growth more difficult to performing remains very low at 1.8% of total.
achieve. As the administration will face a crucial
presidential election, however, chances are that fiscal and
monetary policy will take on a very expansive stance,

Venezuela: Inflation rates (% yoy) require some 40,000 inspectors nationwide, he said. Leon
highlighted the challenges such policy entails, as possible
60
delays in providing permits for companies to produce may
50 result in supply bottlenecks and eventually in inflationary
pressures – that is, it could backfire.
40
30 Oil prices provide ample external support

20
The very robust prices of the Venezuelan crude mix have
provided ample support for the country’s balance of
10 payments. During the first 11 months of the year, said
0 price averaged USD100/barrel, up 42% yoy. According to
our calculations, at current oil prices, Venezuela is to
Jan-06
Jan-11
Jul-08
Jun-06
Jun-11
Oct-09
Mar-10
Aug-10
Dec-08
Nov-06
May-09
Feb-08
Apr-07
Sep-07
generate a current account surplus equivalent to some

USD15bn this year, which should result in a notional
CPI Food increase in international reserves of around USD22bn.
Such increase, however, is not reflected in the reserves
Source: Bloomberg News, Deutsche Bank
being held by the Central Bank, as the government’s
strategy continues to be the establishment of an
New price and cost controls law enacted ‚optimal‛ reserve level and the transfer of any excess to
A new law that regulates prices across the board became other official entities, mainly the Fonden development
effective last month, allowing the government to establish fund. During the first nine months of the year, the
caps on prices of some 15,000 goods and services. A government’s exchange bureau Cadivi authorized
small group of personal hygiene products had their prices USD22.9bn worth of imports at the official exchange rate
frozen effective immediately, and going forward all firms of VEF4.30/USD, a 7.2% yoy increase. The supply of
will have to report their cost structure to the authorities in dollars was completed with what was processed via
order for ‚fair‛ prices to be calculated by the government. Sitme and what provided by the Central Bank. It must be
Companies will also have to provide information about noted that the implicit parity exchange rate that results
their domestic and foreign suppliers, as well as from the ration between M2 and reserves was over
technological transfers that affect costs. The norm does VEF14/USD in November.
not establish any methodology to determine when profits
are ‚excessive‛, although Commerce Minister Edmee
Venezuela: Nominal and real exchange rates
Betancourt hinted that 10% would be a ‚reasonable‛
6.0 110
figure. Official inspectors will work inside firms to monitor
5.8 105
production and cost. Thus, it has become evident that
5.6
President Chavez is to toughen his rhetoric against the 5.4
100
corporate world. Before announcing the new law, he 5.2 95

accused local firms of ‚behaving like big monopolies … 5.0 90
that dominate and ransack people‛. Given the high 4.8 85
ongoing inflation rate, the government’s strategy is to 4.6
80
shift its policies towards a stricter control mode to 4.4
75
prevent further price increases ahead of next year’s 4.2
election. 4.0 70
The strategy, however, is risky for the chavismo, as the

Official rate Sitme rate Real exchange rate (2000=100), rhs
implementation of a full price control strategy is
logistically difficult, and if the government toughens the Source: IIF, Deutsche Bank
rules in excess for the private sector, shortages will
probably appear, which would take a toll on economic New PDVSA issue
activity and could backfire and lower popular support for State owned oil Company PDVSA announced the issuance
the administration. Central Bank Director Armando Leon of USD2.394bn worth of dollar denominated bonds
provided a cautionary note about the law. Leon warned maturing on November 17, 2021. The bonds will pay a 9%
that exerting control over the 500,000 items traded in the semi-annual coupon and will be amortized in three equal
Venezuelan economy would be ‚absurd‛, and that the installments on November 2019, November 2020 and
new norm could represent ‚a straitjacket‛ for the November 2021. The securities are not registered in the
economy. Enforcement of the new regulation would US and are being offered outside the US only. The

company reported that USD1.256bn will be exchanged for who instead wanted to convey a message of unity and
the PDVSA bonds due 2013 currently being held by the need for regime change. The debate was praised by the
Central Bank. In addition, USD564m of the new bonds will local media as a successful democratic event in which the
be placed directly with the Central Bank. The remaining opposition rallied around the ideas of the need for
USD574m should in principle be sold to the market, but institutional change, the fight against corruption, the
the company did not provide any other specifics about the improvement of security and education, and the need to
transaction. The proceeds of the bond sale are to be used reduce poverty.
for ‚general corporate purposes and for contributions to
social projects and programs‛. A few weeks ago, Energy The debate appears to have prompted multiple reactions
Minister and PDVSA head Rafael Ramirez had denied that within the ruling chavista coalition. First, President Chavez
the company would issue new debt this year, but it could criticized the opposition leaders as elitist and hinted that
well be the case that he was referring to issuance to the he may decide ‚to stay in office for much longer, until
market. Before the company’s announcement, there had 2041‛. Later on, former education minister and chavista
been market talk about PDVSA tapping the dollar market coalition leader Aristobulo Isturiz announced a new
with some USD3bn issue, so that the smaller amount, nationwide political strategy in support of Chavez
coupled with the fact that a large portion of the securities reelection. The coalition plans to create so called
will be sold directly to the Central Bank, and then leak to ‚vanguard patrols‛ to drum up support for Chavez,
the market more gradually, provided some relief. starting in Caracas, then in Miranda and Aragua, and later
on in the western part of the country. Asturiz said the plan
Cemex reaches accord with Venezuelan is to put together, in this first stage, some 1,900 patrols in
government Caracas, Miranda, Aragua and Vargas, which would
The Venezuelan government reached an agreement with include 380,000 activists. We indeed expect the
Mexican cement company Cemex to compensate the firm government to implement a more aggressive electoral
for the nationalization of its assets in the country. The campaign since the beginning of 2012, including not only
local media reported that Cemex initially valued its a very expansive fiscal policy but also targeted criticism at
Venezuelan assets at USD1.3bn, but the accord was for the opposition candidates with the most robust showings
USD600m, of which USD240m will be paid immediately in the surveys.
and the rest in four USD90m installments in the form of
PDVSA securities. In August 2008, the government had The latest poll conducted by Alfredo Keller and Associates
seized the three plants of the company in Venezuela, and showed that President Chavez’s popular support
both parties were in the process of arbitration with the recovered from the drop observed in the early part of the
World Bank’s ICSID since 2009. Cemex reported that the year, reaching 57% versus the 37% of 2Q11, mainly
agreement was subscribed by its subsidiaries in the because of the positive reading of the population about
Netherlands and the Socialist Cement Corporation, which the Housing Mission and also because of sympathy
represented the Venezuelan government. Since 2008, the reaction prompted by Chavez’ illness. The survey was
cement industry is under full government control. It is not conducted during July, August and September among
clear whether the agreement with Cemex represents a 1,200 Venezuelans nationwide. The poll also shows that
blueprint for other agreements with companies currently the perception that the main problems of the country have
in arbitration with the Venezuelan government. If so, not been resolved still continues. 85% of the survey
future agreements could represent a marked increase in participants believe that security was worsened, while
PDVSA liabilities. 69% indicated that cost of living has increased, 68% said
drug trafficking has increased, 64% complained about
Electoral campaigns heating up corruption, and 63% argued that unemployment has risen.
Last month, the leading opposition politicians held their That is, while the poll suggests that Chavez has regained
first televised debate ahead of February 2012’s primary popular backing, it also highlights that the population
election to choose a coalition candidate to run against the wants policy changes, which leaves the door open for a
chavismo. The candidates were Miranda Governor good showing of the opposition in the October 2012
Henrique Capriles Radonski, currently at the top of the elections. In the event that Chavez cannot run for
opposition polls, former Chacao Mayor Leopoldo Lopez, reelection next year, the poll shows that Vice President
Zulia Governor Pablo Perez, former Caracas Mayor Diego Elias Jaua would be the strongest contender within the
Arria and independent legislator Maria Corina Machado. chavismo, with 34% of the preferences, followed by
Polls conducted by the local media immediately after the Barinas Governor (and the President’s brother) Adan
debate showed that Machado and Arria had the strongest Chavez and Former Interior Minister Nicolas Maduro. On
performances in the debate, although the event did not the opposition front, Capriles and Lopez are at the top of
feature any substantial crossfire among the candidates, the preferences, followed by Perez and Machado, with

Arria trailing by a very large margin. Interestingly, Venezuela: Deutsche Bank Forecasts
according this poll Chavez leads all opposition candidates 2010 2011F 2012F 2013F
by at least 17 percentage points when he faces an National Income
atomized opposition, but loses against a coalition Nominal GDP (USD bn) 328 436 522 597
candidate by 51% to 39%. Population (mn) 29 30 31 31
GDP per capita (USD) 11,312 14,640 17,103 19,573
Fernando Losada, New York, (1) 212 250-3162
Real GDP (YoY%) -1.4 3.9 4.0 3.0
Priv. consumption -1.7 3.5 3.5 3.0
Investment Strategy Gov't consumption 1.0 6.0 6.5 4.0
Credit Markets: Increase to a small overweight. Investment -6.0 1.0 1.0 1.0
Venezuela has been one of the best performers in terms Exports -12.4 13.0 8.0 6.0
of cash bond total returns and the best performer in terms Imports -4.6 10.0 11.0 6.0
of CDS total returns in EM in 2011, thanks in large part to
the hopes of a potential regime change down the road
CPI (Dec YoY%) 27.2 28.0 27.0 25.0
and high level of carry.
Broad Money 26.0 46.0 40.0 18.0
While continued deterioration of the credit quality and Credit 18.0 35.0 30.0 10.0
poor technicals due to massive amount of issuance will
undoubtedly continue to constrain spread performance of Fiscal Accounts (% of GDP)
Venezuelan assets, we believe market has been Consolidated budget balance -1.9 -2.4 -3.7 -3.2
underpricing the probability of a relatively peaceful Interest payments 2.6 3.0 3.2 3.3
transition of power to the opposition at end of 2012. This, Primary Balance 0.7 0.6 -0.5 0.1
together with attractive valuation and continued high oil
prices, form the main basis for our overweight External Accounts (USD bn)
Exports 65.8 94.0 85.0 85.0
recommendation. However, due to potential risk of
Imports 38.6 45.0 58.0 55.0
political uncertainty, we would keep the size of
Trade balance 27.2 49.0 27.0 30.0
overweight relatively small.
% of GDP 8.3 11.2 5.2 5.0
The recent PDVSA 21s issuance was done in a less Current account balance 15.0 30.0 13.0 14.0
disruptive fashion than expected. Consequently, PDVSA % of GDP 4.6 6.9 2.5 2.3
has outperformed the sovereign in recent days. At current FDI -2.0 2.0 0.0 0.0
levels, we are more in favor of the Sovereign curve, FX reserves 30.3 30.0 30.0 30.0
where 10Y sector continue to offer the best value (24s VEF/USD (eop) 4.30 4.30 5.20 6.50
being currently the cheapest). Towards the longer end,
the 28s look attractive. We continue to recommend long Debt Indicators (% of GDP)
basis at the mid section of the curve, now favoring 24s vs. Government debt 34.5 35.8 36.8 40.0
10Y CDS. We have previously favored the 26s, which Domestic 11.0 14.6 16.5 18.0
have outperformed and now look expensive to the curve. External 23.5 21.2 20.3 22.0
On PDVSA, while we continue to favor the 13s for carry- in USDbn 84.9 101.0 113.0 120.0
oriented investors as there is little credit risk before the Short-term (% of total) 22.0 22.0 22.0 22.0
maturity of this bond (the maturity of the 13s have also
been partially financed through the swap with the Central General
bank in the issuance of the 21s), we would also Industrial production (YoY%) 25.5 30.0 30.0 10.0
considering moving out to longer end of the curve where Unemployment (%) 8.5 8.3 8.0 8.1
we find the 22s attractive. Finally, we recommend PDVSA
22s vs. Venezuela 10Y CDS (notional ratio 1 x 0.85) at the Financial Markets (end Current 3M 6M 12M
period)
Overnight rate (%) 0.2 2.0 8.0 12.0
par-equivalent basis of almost -600bp, with excellent carry
3-month rate (%) 14.5 15.0 15.5 17.0
of 47bp in 3M breakeven.
VEB/USD 4.30 4.30 4.30 5.20
Hongtao Jiang, New York, (1) 212 250-2524 Source: DB Global Markets Research, National Sources

Czech Republic A1(stable)/AA-(stable)/A+(pos)

Moody’s/S&P/Fitch
 Economic Outlook: The combination of a weak case that direct banking sector linkages with the most
labour market, ongoing fiscal austerity and an stressed European countries are smaller than in Hungary
expected recession in Euroland leaves a significant or Poland and the sector-wide LTD ratio is at a
risk of recession in Czech Republic. But with the comfortable 80% so pressure on financing should also
public debt/GDP ratio sub 40% and C/A deficit have been much less.
financing the most secure in the region, the medium-
term fundamentals remain strong. The stalling in growth through Q3 came with a declining,
but still expansionary, PMI with a 53.0 average for Q3.
 Main Risks: Germany is by far Czech Republic’s
Nevertheless, this was a 3.7 point drop from Q2 and the
largest export partner accounting for 22% of GDP in
largest quarterly decline since Q1 2009 when the
exports. A more protracted recession in Germany
economy reported its largest quarterly GDP contraction on
leaves significant downside risk for the Czech
record (-3.6% QoQ). A decline in new orders was by far
economy and could well push the CNB into a rate cut.
the largest contributor to the drop in the PMI through Q3
 Strategy Recommendations: 2s10s IRS set to with declines in output, inventories and employment
steepen.Neutral on rates. Neutral on EUR/CZK being much smaller factors during recent months. The
trend continued in the October and November PMI
Macro View readings and pushed the November PMI to a 27-month
An imported recession in 2012. As the most open low of 48.6 and the first sub 50 reading since October
economy in EMEA alongside Hungary, Czech Republic 2009. On the domestic demand side the worst quarterly
faces a very difficult 2012. Growth stalled in Q3 in what reading on retail sales since Q1 2010 combined with a
was the worst growth performance in CEE, and with little drop back in the pace of credit extension versus earlier in
room for fiscal or monetary stimulus and a deteriorating the year will both have added to the negative domestic
growth outlook in Euroland the next several quarters are demand contribution through the quarter. Confidence has
also likely to report zero or negative growth. The currency also continued to decline with consumer confidence now
has also come under pressure from the stress in back close to the Q1 2009 lows.
European financial markets and the plans for a sovereign
Eurobond in H2 2011 did not materialize. But despite the Czech Republic: Consumer confidence has dropped
immediate spillover from European woes the back close to the Q1 2009 lows
fundamentals of the Czech economy remain the most
solid in the region. Needed fiscal adjustment and debt % balance (seasonally adjusted)
reduction is much less than elsewhere and the structure 30 10
of C/A financing the most secure. The medium-term 20 5
outlook remains robust. 0
10
-5
0 -10
The zero QoQ and 1.5% YoY reading (sa-wda basis) for
Q3 GDP compares with a consensus expectation of 0.2% -10 -15
QoQ and 1.6% YoY and a CNB forecast of 1.7% YoY. It is Industrial
-20
-20
also disappointing given the only 0.1% QoQ reading in confidence -25
-30 Consumer
Q2. Although full components are not yet released the confidence (rhs)
-30
CZSO press release from the flash estimate noted that a -40 -35
slowdown in domestic demand was compensated by Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11
positive developments in external demand with net trade Source: Haver Analytics, DB Global Markets Research
remaining as the only component reporting positive The January 2012 hike in the preferential VAT rate from
growth. We expect that some of the underperformance in 10% to 14% and ongoing fiscal consolidation efforts in an
Q3 GDP versus the 0.5% QoQ reading for Hungary and attempt to achieve a sub 3% fiscal deficit by 2013 point to
1.9% QoQ reading for Romania is due to the temporary further weakness in domestic demand for 2012.
boost from agriculture which benefitted these economies Combined with our expectation of three quarters of
due to the larger agriculture sectors in these countries. negative growth in Euroland (with our 2012 Euroland GDP
The level of the PMI remained the highest in CE3, trade growth forecasts recently revised down to -0.5% from
momentum held up better than elsewhere, albeit much +0.4% previously) we have now revised down our 2012
reduced from Q2, and households were not impacted by GDP forecasts for Czech Republic and also nudged down
a strong Swiss franc through the quarter. It is also the

2011 estimates due to the recent poor performance. We 86% in November 2010 and therefore leaves less of a
now expect 2011 GDP growth at 1.8% (from 2.0% buffer going into year end. On the wider general
previously) with a positive carryover and enough government deficit the government has initially targeted a
momentum through H1 to produce a reasonable growth 4.6% of GDP deficit for 2011 but has suggested this could
reading despite a poor H2. For 2012 we now expect GDP be as low as 3.7%. Assuming no overshoot on the state
growth of zero (and therefore in line with our forecast for budget this would still need a material improvement in the
Germany) versus 1.6% in our earlier forecasts with the local government budget to be realistic. We do not expect
contribution to growth from external trade now much the deficit targets to be achieved but nevertheless see
reduced and most of the growth coming in the second slow, steady consolidation.
half of the year. The latest CNB forecast stands at 1.2%
and Ministry of Finance projection at 1.0%. Our revised Czech Republic: The EC expects only a small
forecasts still see Czech Republic returning to pre-crisis improvement in the deficit in 2012
levels of output in 2012 but now in H2 (as of Q3 2011
Headline budget balance (% GDP)
output remained 0.6% below the peak compared with
0.0
5.3% in Hungary and 5.8% in Romania). Our baseline is
for a shallow recession through the first half of 2012 with -1.0
the risks to our forecasts remaining skewed to the -2.0
downside. -3.0
One complicating factor for our growth projections is the -4.0

upcoming release of the revised quarterly national -5.0
accounts data back to 1995. The annual revisions were -6.0 Autumn 2011
released in September and saw the level of nominal GDP Sprine 2011
-7.0
raised by around 4% relative to earlier estimates and 2010
real GDP growth revised up to 2.7% from 2.2% 2007 2008 2009 2010 2011F 2012F
previously. Depending on how the quarterly profile is Source: European Commission
distributed this could push up our 2011 and 2012 growth The Ministry of Finance has yet to release its Debt
projections. Nevertheless, given the weak backdrop the Management Outlook for 2012 but the Finance Minister
risks still remain skewed to the downside. has said the gross borrowing requirement would be
around CZK226bn (5.7% of GDP) and therefore up from
Fiscal deficit is narrowing slowly. The Finance Ministry the CZK219.5bn for 2011 (and based on the planned
has recently revised down its 2012 GDP growth CZK105bn state budget deficit). Czech Republic does not
assumption to 1.0% from 2.3% in its May Fiscal Outlook. face any sovereign Eurobond redemptions in 2012 but we
The earlier plans for a maximum 3.5% of GDP deficit in expect the authorities will issue the Eurobond announced
2012 and 2.9% in 2013 have however been retained with for H2 2011 with the remainder of the financing from
lower revenue estimates being offset by revisions to domestic issuance.
spending plans (the point forecast is for a 3.2% fiscal
deficit forecast for 2012). With the lower growth outlook, C/A financing likely to remain comfortable. We do not
the planned narrowing in the headline deficit requires an expect much change in the C/A dynamics in 2012 with the
average 0.7pp improvement in the structural position in income outflows from the high presence of foreign-
each of the next several years to achieve the targeted owned companies continuing to offset the trade surplus.
medium-term structural deficit of less than 1% of GDP. While we have modified our export assumption the very
high correlation between export and import growth in
The 2012 fiscal adjustment switches to the revenue side Czech Republic (reflecting the high import content of
after the spending side measures of 2011 which included exports) points to a largely neutral impact on the trade
a 10% reduction in the public sector wage bill, balance from a drop back in export demand. The C/A
reduction/cancellation of benefits and reduction in current deficit stands at an annualized 3.8% of GDP through
and investment spending. 2012 will see a rise in the September with the trade surplus at 4.0% of GDP and the
preferential VAT rate from 10% to 14% (expected to deficit on the income line at 11.1% of GDP. A weaker
result in increased revenues of CZK27bn) with revenues macro environment will likely reduce corporate profitability
intended to plug the gap created by the establishing of a and dividend outflows and potentially reduce the headline
second pillar pension system as of 2013. YTD C/A deficit. This will be offset by lower reinvested
performance looks broadly on track with data through earnings on the capital account (the main financing item of
November showing the state deficit at 93.2% of the
CZK135bn full-year target. This is however worse than the

the Czech C/A) and leave a stable structure of C/A close to the 2% target, the VAT hike should still be
financing. enough to rule out any rate cut. That inflation expectations
remain above target on both a one- (2.8%) and three-year
While the weaker export demand is expected to neutralize (2.2%) horizon also decreases any change of a rate cut.
on a BoP basis it is not neutral on economic growth. The With Janacek, Rezabek and Zamrazilova stating their
export-oriented manufacturing sector will take a hit from preference for stable rates it is also unlikely that Tomsik
weaker end demand in Germany which accounts for could gather enough support to push through a rate cut.
32.5% of total exports versus the next largest export
partners which are Slovakia at 8.8%, Poland at 6.3%, Czech Republic: One of the seven CNB Board
France at 5.4% and the UK at 4.8%. As a share of GDP members voted for a rate cut in November
exports to Euroland are the highest in CEE at 43.5% with Nov-11 Sep-11 Aug-11 Jun-11 May-11 Mar-11
exports to Germany accounting for 22.3% of GDP. Our P olic y r a t e (%) 0.75 0.75 0.75 0.75 0.75 0.75
chart below shows export ratio across CEE and Hungary
M. Singer H H H H H H
is the highest in the region but with a lower share to M. Hampl H H H H H H
Euroland (and Germany) than in Czech Republic. V. Tomsik -25 H H H H H
K. Janacek H H +25 +25 +25 -
Czech Republic: Exports to Euroland are around 43% P. Rezabek H H H H H H
E. Zamrazilova H H +25 +25 +25 +25
of GDP (versus 39.5% of GDP for Hungary)
L. Lízal H H H H H H
80 % GDP Source: CNB
US
70 The November PMI points to the possibility of rate cuts
Rest of the world
60 Japan with the CNB reducing the policy rate in the past with the
50 Euroland PMI at a higher level. The difference now is the level of
rates as at 0.75% the CNB rate is at a historic low and it is
40
debatable whether another cut could stimulate growth.
30
20 Czech Republic: PMI points to scope for rate cuts
10 65 0.4
0 60 0.2
HUF CZK LTL BGN LVL PLN RON
55
Source: Haver Analytics, DB Global Markets Research 0.0
50
Policy rate likely to remain unchanged until 2013. In -0.2
line with the deteriorating domestic and external backdrop 45
the Czech National Bank (CNB) has sounded increasingly -0.4
40 PMI (lhs)
dovish in recent policy meetings. Vice Governor Tomsik
35 change in policy rate -0.6
voted for a 25bps rate cut to 0.5% at the November 3rd
CNB Board meeting and the previously more hawkish 30 -0.8
Board members (Zamrazilova and Janacek) have recently Nov-03 Nov-05 Nov-07 Nov-09 Nov-11
voted to leave rates unchanged. Governor Singer had said
Source: Haver Analytics, DB Global Markets Research
even before the November ECB rate cut that CNB rates
could go down, as well as up, from there but we view rate As the CNB did not follow the ECB with its summer rate
cuts as unlikely in practice. October inflation was reported hikes we do expect they will follow on the way down
at a higher-than-expected 2.3% YoY versus a 2.1% CNB either. Our Euroland economists expect the ECB rate back
forecasts and a 2% target. The CZK-denominated CRB at 1% by January and to remain there until 2013. This
food index reported an average monthly increase of 1.0% would take the differential in the policy rates back to the -
through July-September after an average decline of -0.9% 25bp of mid 2010 – mid 2011 and with rate cuts from the
from March-June and given the lags through to headline CNB unlikely we expect the differential will remain at -
CPI there could be more bad news in the pipeline 25bps. Despite this negative interest rate differential the
particularly given a ~5% depreciation in the currency since solid medium-term fundamentals including a stronger
August. The CPI outlook is dominated by that January VAT public sector balance sheet than elsewhere in CEE, an
hike and will push up CPI to outside the 2% +/-1pp buffer. absence of near-term downward pressure on the
While the CNB will probably concentrate on their measure sovereign rating and less concern over deleveraging from
of monetary-policy-relevant inflation which should remain foreign parent banks given the 80% LTD ratio and the

banking systems status as a net external creditor, our bias Czech Republic: Deutsche Bank Forecasts
remains for medium-term appreciation of the koruna. 2009 2010 2011F 2012F
National Income
Caroline Grady, London, (44) 207 545 9913 Nominal GDP (USD bn) 190.4 191.9 151.9 160.6
Population (mn) 10.5 10.5 10.5 10.6
GDP per capita (USD) 18187 18266 14423 15214
Investment Strategy
FX: Over the medium term, CZK is supported by relatively Real GDP (%) -4.0 2.2 1.8 0.0
sound fundamentals, a credible central bank and the fact Priv. consumption -0.1 0.1 1.2 1.0
that real income convergence is well ahead of price Govt consumption 2.6 -0.1 -1.3 0.2
convergence (vs Germany). Given CNB's strong focus and Investment -15.6 5.4 3.1 1.5
historical track record of controlling inflation, over the Exports -11.4 17.8 6.4 5.1
longer term price convergence will continue to primarily Imports -10.5 17.6 5.8 5.8
take place through a stronger koruna (and not through
higher inflation). The shorter term outlook is less Prices, Money and Banking (eop)
CPI (YoY%) 1.0 2.3 2.0 3.3
favourable. The short point is that the koruna lacks
Broad money (M2) 4.2 3.3 4.4 5.6
meaningful catalysts and impetus to rally in the near term.
Given its location (next to the Eurozone), the CZK will,
rightly or wrongly, likely continue to be used as a 'cheap'
hedge against Eurozone worries (the market being paid
Revenue 40.1 40.5 40.6 41.1
gamma in considerable size in late summer is telling in
Spending 46.0 45.3 44.9 44.9
this context). Depressed economic activity, lack of
inflation momentum and fears of a sharp Eurozone External Accounts (USDbn)
slowdown mean that the CNB have little room to hike the Exports 98.4 118.0 134.9 137.7
already low base rate to 0.75%. Remain sidelined for the Imports 93.8 115.2 130.7 133.8
short term. Trade balance 4.6 2.8 4.2 3.9
% of GDP 2.4 1.5 2.7 2.4
Henrik Gullberg, London, (44) 20 7545 4987 Current account balance -4.8 -6.2 -6.0 -6.0
Siddharth Kapoor, London, (44) 20 7547 4241 % of GDP -2.5 -3.3 -4.0 -3.7
FDI (net) 1.9 5.1 3.5 3.9
Rates: Neutral on rates The IRS curve has steepened FX reserves (USDbn) 37.7 38.0 34.2 35.7
slightly in the 2s10s part since our recommendation (from CZK/USD (eop) 18.5 18.7 19.2 17.8
87 to 94bp). The trade was linked to expectations of a CZK/EUR (eop) 26.4 25.0 25.0 24.0
weaker CZK, causing an increase in inflation expectations.
However, we believe this trade has become consensus as Debt Indicators (% of GDP)
seen from the reduction in foreign holding of CZK bonds Government debt 34.4 37.6 40.9 43.2
and the build up of long gamma trades in EURCZK. We Domestic 23.9 24.7 27.4 29.2
prefer to close our trade recommendation, and await External 10.5 12.9 13.5 14.0
better levels. We expect monetary policy to remain Total external debt 46.9 49.7 64.5 62.3
in USD bn 89.2 95.4 98.0 100.1
accommodative throughout 2012, but the rates curve
could remain stable with very little scope for policy rates
General (% pavg)
to move either to the upside or downside.
Industrial production (% YoY) -14.6 10.2 6.2 3.5
Unemployment 8.1 9.0 8.6 8.6
Financial Markets (end Current 3M 6M 12M
period)
CNB policy rate (%) 0.75 0.75 0.75 0.75
CZK/EUR 25.3 24.8 24.5 24.0
CZK/USD 18.8 19.0 19.6 17.8
Source: Haver Analytics, CEIC, DB Global Markets Research

Egypt B1 (negative)/B+ (negative)/BB (negative)

Moody’s / S&P / Fitch
 Economic Outlook: The economy is likely to gain scene going forward (particularly the minimalist approach
strength in FY2011/12 with political transition, base to changing the electoral law – see below), alienating the
effects and greater access to external financing. liberals. In the summer the SCAF did accept the liberal’s
proposal of a preliminary blueprint of basic rights and
 Main Risks: Occasional setbacks in political progress
principals and yet it added clauses giving it a permanent
and delay in implementation of a comprehensive
political role.
economic plan in coordination with and funding from
multi-lateral institutions could lead to a much weaker
The SCAF has refused to step down and cede power to a
growth performance.
civilian government as some reformists have demanded
 Strategy Recommendations: Neutral EGP. Political and the police have responded to unrest with force as
stability and resumption of talks with IMF will hold over forty people have died. The events of the past couple
the key. of weeks seem to be a replay of that several months ago
before the ousting of President Mubarak and yet we
Macro View understand that the opinion on the ground may be split
The revolutionary spirit is back and elections are with some groups against protests viewed as being
underway… destructive during the elections. The SCAF indicated that
The revolutionary spirit has rejuvenated as again it would be willing to let a national referendum decide on
reformists have gathered at and remained in Cairo’s Tahrir whether the military regime should continue to lead the
square in thousands for several days pushing for political transition or not.
continued ‚change‛ demanding more democracy and
less military. While this could ultimately lead to more Egypt: Interest rate corridor and nominal exchange
progress towards a more democratic regime, it has
rate
resulted in bloodshed as the military regime cracked down
on the protestors with very little in the way of 14.0 % Deposit Rate (lhs) 6.1
concessions. The Supreme Council of the Armed Forces 13.0
Lending Rate (lhs)
6
(SCAF) accepted the resignation of the cabinet, promised EGP/USD (rhs)
5.9
to speed up the presidential election (to mid 2012 versus 12.0
5.8
the widely anticipated year-end previously) and indicated 11.0
their reluctance to govern once the electoral cycle is 5.7
10.0
completed. Neither the promises nor the appointment of 5.6
yet another elderly political veteran, Kamal Ganzouri, who 9.0
5.5
served under Mubarak as PM for three years, as PM to 8.0 5.4
form a national salvation government prevented the
7.0 5.3
reformists from continuing with their demonstrations.
The SCAF committed to holding parliamentary elections 6.0 5.2
as originally scheduled and the process went relatively Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11
smoothly in the first leg on November 28-29 with almost Source: Haver Analytics and Deutsche Bank Global Markets Research
no violence and strong voter participation expected to be

above 70%.
The economy is under greater pressure…
…but the reformists still have major concerns Political instability resulted in intense pressure on the
And yet it seems, and as local and international media EGP, which fell to its weakest point against the USD in six
report, the reformists are not as keen on parliamentary years. This and the downgrading of the sovereign to B+
elections being held on time as they are on ensuring free by S&P while maintaining a negative outlook prompted
elections and adopting of a fully democratic constitution the CBE to hike its policy rate by 100bps (the overnight
stripping the military of any supra-national powers. deposit rate to 9.25% from 8.25%) to shore up
Following a number of changes in the interim government confidence. The CBE’s international reserves (inclusive of
and occasional tension between the SCAF and the FX deposits at commercial banks) have more than halved
reformists, the pace of political progress seemed to have since the start of the year to $20bn leading to a
slowed down since March or so with the former significantly weaker reserve coverage of external
becoming more retrograde. The SCAF took a number of obligations (a SCAF official indicated that reserves may
steps that could allow the Moslem Brotherhood and the decline to $15bn by end-January due to external
remnants of the old regime to dominate the political obligations). Talks with the IMF for a program have been

on and off, and only a fraction of the bilateral funds While the results are difficult to project as there is no
previously pledged by some Arab nations (mainly Saudi precedent or polls, the newly adopted system is unlikely
Arabia) has been received. External and budgetary to yield a single-party majority government in the
financing are the two fundamental pressure points for the upcoming elections. And yet the Moslem Brotherhood
economy going forward and restoring growth will be (MB) is widely expected to win the largest number of
difficult in the absence of financial assistance in the seats with the remnants of the old regime, the reformist
months ahead, particularly with continued weakness in bloc and the old Wasd party being represented leading to
revenues from tourism and FDI, and limited non-resident a rather fragmented parliament. This is expected to result
interest in EGP assets. Continued instability may also in the formation of a broad national unity coalition
weigh in on confidence of locals and escalation of government, which may not be so effective for
violence could have negative implications for growth in policymaking going forward. We reiterate our view that
the same manner it did in the period preceding the Egypt is fundamentally different and there is much to
military takeover early this year when the economy was cheer about with public opinion now being important in
brought to a standstill would widespread supply political decisions. And yet progress is likely to be slow
bottlenecks. next year with a fragmented parliament, the preparation of
a new constitution and the presidential election now set
Egypt: FX reserves for mid-2012 (could be delayed in our opinion given that
formation of the government is likely to take us well into
50 CB T depo sits at the first half of the year).
45 banks
40 CB T Official reserves Egypt: Non-resident T-bill holdings
35
Non-resident's share in outstabding T-bills
30 25 %
25
20
20
15
15
10
5 10
0
Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 5
Source: Haver Analytics and Deutsche Bank Global Markets Research
0
Jan-10 Jul-10 Jan-11 Jul-11
…the expected broad coalition government may have
difficulty in delivering reforms
Source: Haver Analytics and Deutsche Bank Global Markets Research
Parliamentary elections started on November 28 in 9
provinces and the process will be finalized by early- The post election period may see rising tensions between
January with voting for the remaining states scheduled for the SCAF and MB. There are a number of contentious
mid-December and early January. The parliamentary issues including the MB’s opposition to the military's
elections are a relatively complex process. For the 498 desire to prevent civilian oversight of the military budget.
seats in the Parliament, one-third of the candidates will be Additionally splits in the MB and the conservative camp in
elected based on a single district scheme (voters select general may not be a surprise as there are several groups
candidates with no party affiliation who must win a simple with varying views on Islamic rule, and how it should
majority to be elected) and two-thirds will be elected written into the constitution. The reformists and the
according to proportional representation (voters pick revolutionaries are also likely to be unsatisfied with the
among party candidates and each party gains seats in election results, the continued strong presence of the
proportion to its share of votes). The former scheme military and slow progress towards a free and democratic
favors local strongholds of the Mubarak era and for the state. Weakness in the economy in our opinion requires
latter the competition will be fierce with several parties external assistance and the implementation of a cohesive
entering the race. And yet the system overall seems to economic plan in coordination with multi-lateral
favor well-entrenched larger parties with well-established institutions. Otherwise political backlash is likely and the
networks across the country while marginalizing the government must be able to prioritize politically painful
relatively new and small parties that have yet to have the economic reforms, which may be a difficult task given its
opportunity and the time to organize nationwide. likely fragmented make up.
Cem Akyurek, Istanbul, (90) 212 317 0138

Investment Strategy Egypt: Deutsche Bank Forecasts

2008/09 2009/10 2010/11F 2011/12F
FX: Neutral on USD/EGP. Political stability will hold the National Income
key to much of EGP's fate over the course of the next Nominal GDP (USD bn) 188.6 218.4 236.1 254.3
year. The complex electoral system means it may be Population (mn) 76.8 78.6 80.5 82.3
difficult to predict the precise breakdown of parliament GDP per capita (USD) 2456 2779 2933 3090
until the end of staggered voting on January 11. Even if
the current elections (at the time of writing) proceed Real GDP (YoY%) 4.7 5.1 1.8 3.0
smoothly, maintaining order and democracy will be key Priv. consumption 4.5 5.2 4.8 3.4
for the country and the currency. Political instability will Gov't consumption 8.4 4.5 3.8 2.2
also have implications for Egypt's sovereign rating - as Gross capital formation -9.1 6.5 -3.9 7.6
S&P downgraded Egypt's rating by one notch last week. Exports -12.8 -1.9 3.7 1.2
The domestic economy has also struggled - the budget Imports -17.7 -1.7 7.5 4.9
deficit has been widening, and foreign reserves have
continued to drop into November. Any resumption of talks Prices, Money and Banking
with the IMF for a $3bn loan would be a clear positive for CPI (YoY%) 9.9 10.1 8.94 9.0
capital flows, and therefore for the pound. Broad money (M2Y) (YoY%) 8.4 10.4 10 12
Bank credit (YoY%) 5.1 8.2 3..0 15
Henrik Gullberg, London, (44) 20 7545 9847
Siddharth Kapoor, London, (44) 20 7547 4241 Fiscal Accounts (% of GDP)
Interest Payments 4.4 5.4 5.2 5.5
Primary balance -1.8 -2.7 -4.3 -3.5

Merchandise exports 25.2 23.9 23.4 24.4
Merchandise imports 50.3 49.0 51 52.0
Trade balance -25.2 -25.1 -27.6 -27.7
% of GDP -13.3 -11.5 -11.2 -10.5
Current account balance -4.4 -4.3 6.5 -4.5
% of GDP -2.3 -2.0 -2.6 -1.7
FDI (net) 6.8 5.8 6 10.0
FX rate (eop) EGP/USD 5.59 5.70 5.95 6.20

Government debt 81.1 79.4 86 88.0
Domestic 67.4 67.4 76 76.0
External 13.7 12.0 10 12.0
In USD bn 31.5 33.7 34 36.0
General (YoY %)
Industrial production -2.0 5.0 0 7.0
Financial Markets (end) Current 3M 6M 12M

period)
CBE deposit rate 8.25 8.25 8.25 9.25
CBE lending rate 10.25 10.25 10.25 10.25
EGP/USD 6.01 6.20 6.30 6.20
EGP/EUR 8.20 8.40 8.40 8.68

This page is left blank intentionally

Hungary Ba1(neg)/BBB-(neg)/BBB-(neg)
Moodys/S&P/Fitch
 Economic Outlook: We expect Hungary to tip back and further benefit cuts will start to impact growth from
into recession in 2012. Fiscal drag is set to increase Q1. Any boost to growth from external demand is also
in line with the government’s commitment to stick to likely to be much reduced from earlier in 2011 given our
a 2.5% of GDP fiscal deficit while rate hikes, FX expectation of recession in Euroland from Q4. September
weakness and rising deleveraging will all severely trade momentum showed some pick up (the 0.8%
constrain growth for some time ahead. With the reading for exports on a 3m/3m basis was the first
expected recession in Euroland net trade will be positive reading since May) after a very weak summer but
unable to offset the negative domestic environment. it is unlikely that this will be sustained. Latest data on new
orders show a modest improvement after the negative
 Main Risks: Likely policy conflicts between the
readings during the summer but we the trend remains
authorities and the IMF/EU risks prolonged program
downward. The combination of a high growth beta with
negotiations which could mean continued pressure
Euroland and deteriorating domestic conditions point
on the currency, a larger hiking cycle and further
firmly to a Hungarian recession in 2012.
rating downgrades. It could also mean a very difficult
backdrop to meet external refinancing needs.
Hungary: Growth beta with Euroland is very high
 Strategy Recommendations: NBH to provide ceiling 20
in EUR/HUF. Sell vega neutral 3m/6m straddles in y = 1.5593x + 3.6383
EURHUF. Underweight sovereign credit. 10 R² = 0.8763
Hungary IP (SA, % YoY)
Macro View 0
Recession now unavoidable. Hungary’s November U-

-10
turn to request a precautionary assistance package from
the IMF/EU reflects the exceptionally fragile macro
-20
outlook. Moody’s has now downgraded the sovereign to
sub investment grade and S&P/Fitch could well follow in
-30
Q1 if the negotiations with the IMF/EU prove problematic.
-27 -18 -9 0 9
The policy stance is not supportive of growth with the Euroland IP (SA, % YoY)
NBH recently embarking on a hiking cycle despite the high Source: Haver Analytics, DB Global Markets Research
probability of a recession and the government’s
commitment to a 2.5% fiscal deficit target for next year The extent of the domestic demand contraction next year
implying a now much tighter structural position than will partly depend on the take-up rate on the discounted
originally expected. Accelerated deleveraging also leaves early repayment scheme and the resulting losses faced by
a substantial downside risk to the growth outlook. the banking sector. Our impression is that the banking
sector currently work with a maximum take-up
The higher-than-expected 0.5% QoQ and 1.4% YoY Q3 expectation of 20% and data released so far put this at
GDP reading was a rare piece of good news in Hungary. 8% between application and repayments. The additional
Q2 GDP was also revised upwards to 0.2% QoQ from an measures still being discussed between the banking
earlier reported zero reading and Q1 was revised up to association and the government could increase this
0.5% QoQ from 0.3% (which was previously revised baseline however as the government has indicated on
down from an initial 0.7% reading). KSH have yet to various occasions that it would like to see the early
publish the full components but said that the Q3 repayment option available to as many households as
performance was mainly due to agriculture and industrial possible. The very negative operating environment for
exports. The bumper summer harvest is likely to be only a foreign banks in Hungary after the bank levy, pension
temporary boost to growth however and it is very unlikely system reform, 3-year fix on mortgage payments and the
that the 0.5% QoQ reading will be repeated in the coming discounted early repayment scheme also leaves a risk that
quarters. Domestic demand growth is likely to turn foreign parents opt to significantly reduce exposure to
negative from Q4 during an acceleration in deleveraging Hungary. There is no evidence of this so far but it leaves
following the September announcement of the substantial downside risks to our macro projections. Any
discounted early repayment option on mortgages and IMF/EU program could be an important policy anchor for
protracted currency weakness through Q4 pushing next year and combined with implementation of the Szell
monthly mortgage repayments higher. A January VAT hike Kalman plan would be supportive for the medium-term

growth outlook. However it is unlikely to materially change Hungary: We see a precautionary SBA as the most
the growth dynamics for 2012. We do not however likely IMF program option for Hungary
expect anything similar to the very deep recession of P r ogr a m
Cr it er ia Condit iona lit y Likelihood Count r ies
2008/09 with the worst of the flow adjustment now done t y pe
No ex-post conditions and all
Very strong economic
and fundamentals undoubtedly improved. fundamentals and
resources available under the credit Poland,
FCL line can to tapped at any time, None Colombia,
institutional policy
disbursements not phased or Mexico
framework
We now expect GDP growth of -0.8% for 2012 after an conditioned on particular policies
expected 1.4% outturn for 2011. The NBH is likely to Combines pre-qualification (similar to
revise down its 0.6% projection for 2012 when the Sound fundamentals and
FCL) with more focused ex-post
conditions that aim to address
policies and good track
updated Inflation Report is released in late December PLL/PCL
record of policy
moderate vulnerabilities (actual or Very low Macedonia
while the Economy Ministry recently mention a 0.5-1% implementation

potential BoP needs). Access limited
to 500% of quota up front and
expectation versus the 1.5% published in September. For 1000% after 12 months
2013, a reduced pace of deleveraging, improvement in For countries facing

Specific conditionality with
household balance sheets from a stronger forint and a Precaution- potential (very large)
quantitative conditions and structural
measures. Regular program reviews, High
Romania,
ary SBA financing needs subject Serbia
more supportive external backdrop should all bring growth to relevant IMF policies
exceptional high access on a case-by-
back to positive territory but probably still lagging on any case basis
Source: IMF, DB Global Markets Research (likelihood reflects DB view)

regional comparisons.
The difficulty for the authorities with a precautionary

IMF/EU negotiations likely to face significant conflicts
SBA/BoP assistance programme is the likely strict
over policy. Hungary’s announcement that it is seeking a
conditionality and adjustment program that would be
precautionary financing package with the IMF/EU was a
required. Recent policies such as the discounted early
surprise to us given recent statements by the government
repayment scheme on mortgages, the abolishing of the
to the contrary. The initial announcement from the
2nd pillar pension system, the bank levy, the crisis taxes on
Hungarian authorities mentioned ‚a new type of
retail/telecoms/energy and the government’s leaning of
cooperation with the IMF‛ and subsequent comments by
the independence of the NBH, constitutional court and
Economy Minister Matolcsy suggested Hungary would
revamp of the fiscal council to leave it largely powerless
like a FCL (flexible credit line) but would probably have to
are all unlikely to sit well with the international lenders.
seek a PCL (precautionary credit line) or a precautionary
The ECB’s very negative published opinion in early
SBA (stand-by arrangement). The PCL facility was
November that the discounted mortgage repayment
replaced with the PLL (precautionary and liquidity line) on
option will weaken banking sector stability and the sectors
November 23rd so we do not yet have any example of
ability to lend, have adverse spillovers to the economy, hit
countries using the facility. Nevertheless, as the
banks capital positions at a time when ability to
qualification criteria are similar to those for an FCL and
recapitalize is much reduced, put pressure on the forint,
based on a track record of a sustainable external position,
increase country risk premia, put upward pressure on
favourable market access, sound fiscal and monetary
domestic interest rates, weaken growth and dent investor
policy, financial sector soundness and supervision with
confidence due to increased legal uncertainty is an
moderate vulnerabilities in ‚one or two‛ of these areas‛
example of this unhappiness. It is not yet clear whether
we do not think Hungary would be eligible. Hungary’s
the EC will challenge the legality of the policy although a
external and fiscal vulnerabilities are protracted in our view
spokesperson for the EC reputedly announced that
which suggests a precautionary SBA is the most likely
Hungary has until February to respond to complaints from
option similar to that currently in place in Romania and
European banks about the scheme. It is difficult to see
Serbia.
how the EC could agree to any precautionary assistance
with this law still in place and it would be politically
In terms of the potential EC component, we expect this
difficult for PM Orban to now reverse this. Some of the
would also be similar to Romania with a precautionary
temporary revenue raising measures are probably easier
deal under the BoP assistance programme available to
to reach a compromise on provided the authorities
non-Euro Area member states. Out of the EUR50bn funds
commit to phasing these out, but even this could take
allocated to this program a total of EUR13.25bn has been
time to negotiate.
disbursed to Hungary, Latvia and Romania and the
EUR1.4bn committed in precautionary assistance to
Our understanding is that Hungary had penciled in
Romania in March 2011 was the first time the EC had
EUR4bn (euro equivalent) in external issuance for 2012
been involved in providing precautionary financial
and therefore unchanged from 2011. This financing is
assistance.
intended to cover EUR3.2bn to the IMF (total principal
repayments to the IMF are EUR3.8bn but the remainder is

due from the NBH) and two Eurobonds totaling appetite and could open the door for rate cuts. In a
EUR1.4bn. The government has some buffer from scenario where the forint is trading back sub 300/EUR and
EUR1bn in its account at the NBH plus any proceeds from CDS drops back from the November highs the summer
the sale of pension assets. Without drawing down FX discussion on the timing of rate cuts, rather than hikes,
reserves Hungary cannot however avoid coming to the should come back on to the agenda.
Eurobond market. Should Fitch or S&P also cut Hungary’s
sovereign rating to sub investment grade (which would Hungary: The decision to hike by 50bps in November
become increasingly likely if IMF/EU negotiations are was unanimous
prolonged) this could also impact the ability to issue. Nov-11 Oct-11 Sep-11 Aug-11 Jul-11 Jun-11 May-11 Apr-11 Mar-11
P olic y r a t e (%) 6.5 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0
András Simor +50 H H H H H H H H

Hungary: External financing for 2012 remains fairly Júlia Király +50 +25 +25 H H H H H H
onerous Ferenc Karvalits +50 H H H H H H H H
Andrea Bártfai-Mager +50 H H H H H H H H
E U Rbn 2007 2008 2009 2010 2011F2012F János Cinkotai +50 H H H H H H H H
G r os s Fina nc ing Req. 34.4 45.1 39.3 37.4 37.3 36.3 Ferenc Gerhardt +50 H H H H H H H H
Gyorgy Koczizsky +50 H H H H H H H -
C/A (deficit = positive) 7.2 7.8 0.2 -1.1 -0.6 -0.3
Amortisation (MLT) 10.0 14.8 19.4 18.8 13.4 12.2 Source: NBH
Amortisation (ST) 17.1 22.5 19.7 19.6 24.6 24.3 Our call for the policy rate sees only another 50bps in
tightening to take the policy rate to 7%. We expect this
Fina nc ing 34.4 45.1 39.3 37.4 37.3 36.3
Non-debt creating 0.9 3.7 0.9 2.2 3.7 2.7
will be delivered in the December/January MPC meetings
FDI (net) 0.2 2.7 -0.2 0.4 1.3 1.0
with the peak in CPI to come in January following the
EU capital inflows 0.7 1.0 1.1 1.7 2.4 1.7
scheduled 2pp VAT hike. On the basis that Hungary does
Debt creating 33.6 51.4 44.1 39.4 33.7 33.6 not end up in a situation of very protracted IMF
Sovereign Eurobonds 1.2 1.8 1.0 1.4 4.0 4.0 negotiations we expect the combination of a reversal of
Multilateral financing 6.9 7.5 the recent forint weakness and confirmation of the
Foreign purchases of HGBs 4.1 0.2 -3.4 0.4 5.5 3.0 weaker growth backdrop to prompt a reversal of the
Banks + corporates 28.3 42.5 39.0 37.7 24.2 26.6 recent hikes. We see the policy rate back at 6% by late
2012.
Errors & omissions -1.6 -2.9 -0.3 -1.2 0.0 0.0
Reserves (+ = decrease) 1.5 -7.0 -5.5 -3.0 0.0 0.0 Political commitment to fiscal consolidation is an
important MT positive. The government’s commitment
G r os s Fina nc ing Req. to fiscal consolidation has been an important positive in an
% of GDP 34.1 42.4 42.3 38.0 36.0 34.1 otherwise negative environment. The government plan for
Source: DB Global Markets Research
a 2.5% of GDP fiscal deficit in 2012 could prove too
NBH could just as easily hike or cut rates. Success and optimistic in a recession environment but we do not
timing in securing even a precautionary multilateral expect that any overshoot would be large. The initial
financing packing combined with developments in Europe budget calculations were based on a 1.5% GDP growth
will both have an important bearing on the monetary assumption but with the inclusion of HUF300bn or 1% of
policy outlook. Three months of protracted currency GDP in reserves (split between a general reserve, a
weakness combined with a widening of CDS back to all reserve to cover higher interest costs and an additional
time highs prompted a 50bps rate hike from the NBH at safety reserve) to provide buffer room in a deteriorating
the November policy meeting despite acknowledgement environment. The budget is a combination of revenue and
by Governor Simor that the Bank’s 0.6% GDP growth expenditure side measures and split between 1.56% of
forecast for 2012 now looked too optimistic. The GDP (HUF455bn) from projected savings in the structural
statement said explicitly that further rate hikes may be reform plan (83% of that announced in structural reforms
necessary if inflation and risk perceptions remain earlier in the year) and another HUF656bn or 2.25% of
‚persistently unfavourable‛ which suggests that it would GDP from the recently announced balance improving
take a fairly significant turnaround in the currency and CDS measures (such as 2pp VAT hike and increase in
to prevent further hikes. The sharp turnaround in the forint employee social security contributions). While fiscal
after the coordinated announcement by the major central policy will prove to be a drag of growth in 2012 from the
banks to address pressure on global money markets direct impact of various measures progress on
could, if sustained, be enough to prevent another rate hike implementation of the structural reform plan is
but it remains to be seen whether this rally can last. The nevertheless an important medium-term positive.
policy anchor and likely improvement in confidence from a
successor IMF/EU package would likely have a positive Caroline Grady, London, (44) 207 545 9913
and probably more lasting impact on the currency and risk

Investment Strategy Hungary: Deutsche Bank Forecasts

2009 2010 2011F 2012F
FX: We have highlighted Hungary's vulnerabilities to the National Income
Eurozone through a number of channels such as the FX Nominal GDP (USD bn) 128.9 130.2 143.8 133.6
loan stock, high external debt and substantial refinancing Population (mn) 10.0 10.0 10.0 10.0
needs, (EMEA Daily Compass 2nd and 3rd Nov). After GDP per capita (USD) 12855 13008 14386 13381
NBH's 50bp hike on 29th Nov, the key question for the
HUF remains the timing and magnitude of further hikes. Real GDP (YoY%) -6.7 1.2 1.4 -0.8
The rates markets are currently pricing in 50bp of hikes by Priv. consumption -5.8 -2.0 -0.3 -0.7
Mar '12. The risk remains that the NBH may be forced to Gov’t consumption 2.2 -0.6 0.1 -0.1
take more forceful measures (similar to the 300bp hike in Gross capital formation -8.0 -5.6 1.5 -2.8
'08). Further rate hikes being currency constructive will Exports -9.6 14.1 6.2 3.9
depend on a number of factors, such as further Imports -14.6 12.0 6.0 3.5
downgrades (following the downgrade by Moody's to Ba1
on Nov 25th) and how that will impact on the huge foreign Prices, Money and Banking
CPI (YoY%) 5.6 4.7 4.1 4.7
holdings of domestic government debt. Providing some
Broad money (M3) 3.4 3.0 7.5 4.5
protection, meanwhile, is the surplus in the C/A and the
fact that state finances compare well with the Eurozone.
However, given its vulnerabilities EUR/HUF's risk beta will
ESA 95 fiscal balance -4.5 -4.3 1.9 -3.2
remain high. Expect aggressive rate hikes [if necessary] to
Revenue 46.1 44.6 51.0 43.3
limit the upside in EUR/HUF to around 320.
Expenditure 50.5 48.9 49.1 46.5
Henrik Gullberg, London, (44) 20 7545 9847 Primary balance 0.1 -0.1 5.8 0.6
Siddharth Kapoor, London, (44) 20 7547 4241
External Accounts (USDbn)
Rates: Favour HUF to rates Trading the Hungarian curve bn)
Exports 79.4 92.3 105.3 106.3
has become akin to trading a credit product, with little Imports 76.2 88.0 100.1 101.8
correlation to growth and inflation dynamics. The NBH has Trade balance 3.2 4.3 5.1 4.5
decided to counteract the impact of higher risk aversion % of GDP 2.5 3.3 3.6 3.4
with higher policy rates, with the primary aim being to Current account balance -0.3 1.4 0.9 0.4
reduce CHF/HUF volatility and maintain financial stability. % of GDP -0.2 1.1 0.6 0.3
Negotiations with the IMF have added a level of FDI (net) -0.2 0.6 1.7 1.5
complexity to the outlook. Our long held view that HUF FX reserves (USD bn) 41.1 43.1 47.3 43.0
would perform better than rates has held true, and we HUF/USD (eop) 189.0 208.2 230.8 216.8
expect this to be the case over 2012, particularly vs PLN. HUF/EUR (eop) 270.7 278.6 300.0 280.0
One risk Hungary faces is that of more accelerated
outflows from its bond market, where foreigners Debt Indicators (% of GDP)
represent 40% and local pension funds are expected to Government debt 78.4 80.2 76.3 74.6
not roll-over their assets following the end of government Domestic 42.0 42.4 40.1 41.2
External 36.4 37.8 36.2 33.4
transfers. In that scenario ever more aggressive hikes
could materialize.
in USD bn 188.9 182.1 210.0 189.7
Lamine Bougueroua, London, (44) 20 7545 2402 Short-term (% of total) 14.3 17.9 16.0 16.1
Credit: Underweight. Among the Central European

General (YoY%)
credits, Hungary remains the most vulnerable to a further
Industrial production -17.3 10.3 5.2 2.1
deterioration in the external environment. 2012 is set to Unemployment 9.8 11.1 11.1 11.3
be particularly challenging given the government’s need to
raise a substantial amount on the external bond market. If Financial Markets (eop) Current 3M 6M 12M
this is not forthcoming, then an agreement with the IMF Policy rate (2-week depo) 6.5 7.0 6.5 6.0
seems critical. However, to secure such an agreement HUF/EUR 304.7 295.0 290.0 280.0
would likely require a radical change of approach from the HUF/USD 226.7 226.9 232.0 207.4
government and we are not convinced that this Source: NBH, Haver Analytics, DB Global Markets Research. Fiscal and debt forecasts reflect the
government would be willing to stomach such a change. pension reform which will mean a one-off transfer of around 10% of GDP as of end May 2011.
Marc Balston, London, (44) 20 7547 1484

Israel A1(stable)/A+(stable)/A(stable)
Moody’s/S&P/Fitch
 Economic Outlook: The divergence between strong 5.2%QoQ (saar) while private consumption continued to
domestic absorption and faltering net exports is set soften and accounted for only 0.1pp of 0.8% quarterly
to dwindle, pointing to a marked loss in growth gain.
momentum. Inflation is expected to behave benignly,
providing room for further easing if needed, although Israel: Growth is set to moderate notably in 2012
housing dynamics and ILS will also play an pp contr. QoQ (saar)
10 6
increasingly important role. The C/A is set to turn 5
8
negative and remain in deficit throughout the forecast 4
6
horizon, while fiscal consolidation arrives with a delay. 3
4 2
 Main Risks: The geopolitical risk premium is set to
2 1
remain elevated given multiple sources of concern. A
0 0
more rapid than needed deceleration in housing
-1
prices may lead to financial stability risks and -2 GCF
-2
Govt cons.
complicate rate outlook. -4 Pvt cons. -3
F o recast
Net exports
 Strategy Recommendations: Favour tactical shorts -6 -4
Real GDP (rhs)
in EUR/ILS above 5.10. Receive 2Y IRS 04 05 06 07 08 09 10 11F 12F 13F
Source: Haver Analytics, CBS, DB GM Research
Macro View The negative contribution of net exports accelerated to -

2011 was another year of economic success. Israel has 1.1% following -0.8% seen in the previous period. Both
been one of the best performing economies in 2011 with exports and imports receded over the quarter but the
growth remaining well above the trend for the second extent of contraction in the former (-16.9%QoQ (saar)
year in a row. The labour market has improved markedly versus -7.6%) was considerably larger, reflecting impact
as unemployment reached its historical nadir (5.5%) of weak external sector. The latter is likely to be an
following an acute 2pp leapt during the course of global overhang on growth in 2012 as well given that exports
recession. 2011 also saw an unanticipated one-notch destined to US and Europe account for c25% of GDP and
upgrade by S&P (to A+) thanks to improved macro policy DB now expects a recession to the tune of -0.5% in
flexibility/credibility, a healthy banking sector, robust Euroland. The divergence between strong domestic
external performance and ongoing fiscal consolidation, absorption and faltering net exports is also set to dwindle.
confirming strong fundamentals of Israeli economy vis-à- The BoI’s latest Companies Survey revealed a fairly
vis the rest of EMEA. Event risks, however, were also on downbeat output growth expectations in most industries
the rise year-to-date. The geopolitical/security backdrop already in the final quarter of 2011 with manufacturing
deteriorated noticeably with ongoing unrest in neighboring companies specifically mentioning weakening domestic
countries, strained relations with Turkey and an elevated market as one of the causes. This insinuates growth in
possibility of military action against Iran more recently. private consumption and fixed investments will likely
Local sentiment also turned sour owing to social protests
Israel: C/A turns sour with record high trade deficit
over the high cost of living. The latter has complicated the
Merchandise trade Income
fiscal outlook but was conducive to improved inflationary Transfers Services
C/A balance
conditions in the second half of the year which prompted 10%
a timely monetary response by the Bank of Israel (BoI). % of GDP
8%
6%
Growth is set to moderate notably in 2012 although a
4%
hard landing is not in the cards. Recent economic
2%
activity data were still resilient but signals of a 0%
forthcoming shift from ‘normalization’ to ‘a general -2%
slowdown’ in headline growth have intensified. -4%
Preliminary Q3 2011 GDP growth was higher-than- -6%
expected at 3.4%QoQ (saar), following a revised down -8%
3.5% previously and 4.7% in Q1. While the headline 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F
number looks relatively resilient, composition of growth
Source: Haver Analytics, BoI, DB GM Research
insinuates a looming softening. Putting robust fixed
investments aside, stock-building was very strong at

Israel: Inflation seems to be under control… Israel: …and low FX pass-through
pp contribution YoY% Clothing T&C

Dwelling maintenance Housing
6 6 Total CPI (RHS)
F or e cast 0.07 0.12
5 5
pp contribution to headline
4 4 0.06 0.10
3 3 0.05
0.08
2 2 0.04
0.06
%
1 1 0.03
0 0 0.04
Transportation & Comm. 0.02
-1 Housing -1 0.02
0.01
Food (excl, fruit & veg.)
-2 Headline CPI (YoY%, rhs) -2
0.00 0.00
Jan-07 Mar-08 May-09 Jul-10 Sep-11 Nov-12
1 2 4 6 8
Source: Haver Analytics, CBS, DB GM Research Quarters
Note: The chart exhibits cumulative response of CPI (and its components) to a 1% depreciation in ILS
decelerate in 2012 on the back of elevated uncertainty, (against the USD) ; Source: BoI calculations, DB GM Research
dented confidence and constrained funding supply. We Inflation seems under control for now. Headline
now expect headline GDP growth to moderate by around inflation already receded below BoI’s upper band (3%) in
1.8pp to 2.8%YoY next year before converging to its trend Q3 and seems likely to remain within target rate at least
of 3.8% in 2013. Risks are tilted to the downside given until end-2012, barring any external/ geopolitical or
the forthcoming global slowdown. administrative price (such as higher electricity tariff)
It is also worth noting that current account is likely to turn shocks. Many factors are behind this favourable outlook.
negative – already by end-2011 and throughout the On top of anchored real wages and stable global
forecast horizon – for the first time since 2002. This is commodity prices, mass public protests over high cost of
mainly due to a marked acceleration in the trade deficit living seem to have paved the way for a welcome quasi-
emanating from the combined impact of export structural change in private (and to some extent public)
underperformance and strong import growth. While pricing behavior, reflected mostly in retail cuts on basic
higher commodity prices played a role behind the latter, a goods. Subsequently, market-derived 12-month inflation
46.2%YoY rise in investment good imports year-to-date expectations retreated significantly from 3.8% in February
suggests resilient domestic absorption was also an to 1.7% in mid-November. Secondly, the housing
important contributor. The expected deterioration in the component, a main driver of headline CPI since late 2008
current account is commensurate with empirical studies given its +20% weight in the basket, is expected to
showing that countries experiencing a natural resource moderate given improved supply and demand conditions.
discovery (natural gas in Israeli case) are likely to Finally, weakened FX pass-through is likely to cap any
spend/borrow more in the near term (in anticipation of upward pressure stemming from weaker ILS. According
higher future income) before the advent of initial receipts to the latest BoI calculations, a 1% rise in USD/ILS (i.e.
(probably in mid-2013 although a delay is more likely than depreciation) is envisaged to lift up housing component by
not) while surplus C/A figures are set to arrive consistently only 0.1pp in the short term versus 0.7pp estimated in the
once major fields (Tamar and Leviathan) become fully previous decade (as the share of rental contracts
denominated in USD has dropped to only 5% from over
Israel: …with better conditions in housing… 85% previously).
Months of supply (inverted, t-3, LHS) Fiscal backdrop will be under close scrutiny. The 2-year
House prices, YoY% (RHS) combined budget bill sets deficit ceilings of 3.0% (of
4 25
20
GDP) and 2.0% for 2011 and 2012, respectively. Yet, a
6
slippage in both cases seems highly likely. Although the
15
8 cumulative budget deficit (excluding net credit) in the first
10
10 ten months of 2011 stood at a somewhat manageable
5
12 ILS14.1bn (1.6% of GDP) compared to annual target set at
0
ILS25.2bn, domestic revenues were 2.7% lower than the
14
-5 seasonal path consistent with 3.0% ceiling mainly owing
16 -10 to a continued slowdown in indirect tax receipts. This
F o recast
18 -15 suggests Ministry of Finance’s working target estimated
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 at 2.9% (just below 3.0% ceiling) will likely be overshot by
Source: Haver Analytics, CBS, DB GM Research
c0.4pp. Possibility of higher spending in light of public
protests and moderating growth (4.0% penciled in budget
operational (probably by the middle of decade).
forecast against our and BoI’s estimates standing at 2.8%

Israel: Fiscal consolidation is to arrive with a delay Israel: Housing market will remain spotlight
Government debt (RHS) Corporate % in total bank credit
Fiscal deficit [excluding net credit, inverted] sector (ex-
-6 102 commerical
% of GDP real estate
-5 95 loans);
35.3% Commercial
-4 88 real estate
Total loans; 15.5%
-3 81 exposure to
real estate/
-2 74 housing
sector; Mortgages;
-1 67 43.9% 28.4%
0 60
04 05 06 07 08 09 10 11F 12F 13F
Retail sector; Public
11.8% sector; 9.0%
and 3.2%, respectively) point to high likelihood of a placed to the very end of this implicit ranking although this
consecutive slippage in budgetary balances next year;
is subject to change in 2012. Accordingly, the penultimate
although - in absolute terms - fiscal deficit will remain fairly
paragraph of BoI’s latest communiqué, which reads as
manageable compared to developed world and many
‘…lower rates, together with the recent weakening of the
other EM peers. Meanwhile, a meaningful drop in
effective exchange of ILS, are expected to help Israel’s
government debt/GDP ratio is now likely to arrive in 2013
economy deal with the difficulties confronting it’, implicitly
once revenue side resumes its strong growth with
improved economic activity (and also partially on the back signals, in our view, that further (and noticeable) ILS
of arrival of gas receipts while impact may be felt more in weakening in the coming period could be seen as an
2014-15 given grace period in place). Separately, alternative to additional rate cuts. Additionally, Governor
Netanyahu government's earlier plans to trim Fischer has cited his concern about the possibility of a
income/corporate taxes gradually by 2016 have been more rapid than needed deceleration in residential prices
shelved with approval Trajtenberg Committee’s long- and underlining the necessity to slowdown the pace of
awaited recommendations which envisaged social marketing of land for construction, particularly given that
spending of around ILS30bn over the forthcoming five banking system’s overall exposure to real estate/housing
years financed mainly through cuts in defense spending sector (accounting c44% of total loan book) is significant.
(to the tune of ILS2.5bn in 2012) and tax changes/hikes Combined altogether and given slowly-bleeding nature of
Monetary policy to remain focused on growth.The sovereign debt crisis in the Euro zone), we expect the BoI
newly formed 6-member Monetary Committee (MC) to reduce rates by another 25bps to 2.50% in early 2012
delivered its first cut in November following its inception a followed by steady rates until mid next-year. This will
month earlier. This was the second cut in the last three mean that monetary conditions remain accommodative
months as concerns over negative spillovers from a for most of 2012 but a delicate balance will be maintained
faltering global backdrop intensified. As has been the case in the housing market at the same time by not overly
throughout the hiking cycle (125bps) earlier in the year, stoking the demand side (or by letting housing prices drop
the Bank will continue to base its rate decisions on (i) precipitously). The precarious external outlook
domestic inflation (including inflation expectations); (ii) necessitates a data-dependent stance by the Bank more
growth in Israel and globally; (iii) monetary policies of than ever, hinting that rate risks are tilted to the downside.
major central banks; (iv) the trade weighted ILS; and (v) Apart from a deeper global slowdown, downward risks
housing prices while weight of these parameters will (on growth and the ILS) will again emanate from
continue to be dynamic. For now, growth concerns seem geopolitical backdrop. Although some part of noticeable
to have taken precedence given ongoing (forthcoming) ILS weakness seen in the shekel since September is due
global (domestic) slowdown, and will likely remain as the to poor risk appetite, weaker external balances, and
main driver at least in the first quarter of 2012. Policy (expectations of) lowered yield support; rising geopolitical
action by major central banks comes next in terms of risks (i.e. ongoing turmoil in Syria, regime change in
importance as any additional monetary accommodation Egypt, stalemate in peace talks with PA, strained relations
will likely be perceived as a strong signal for further with Turkey and more recently possibility of military action
downturn in global economy and also due to against Iran) also played a significant role. Geopolitical
repercussions for the shekel. This is followed by inflation strains are unlikely to soften in 2012 given elevated
dynamics (and inflationary expectations) which seems uncertainty over the end-game in Syria and the positioning
fairly tamed for now. Housing prices and ILS appear to be of any new administration in Egypt. Any direct

confrontation with Iran (which is not our main working Israel: Deutsche Bank Forecasts
assumption) will likely be accompanied by notably easier 2009 2010 2011F 2012F
monetary conditions by BoI while record-high FX reserves National Income
will provide some (limited) comfort. ILS is still expected to Nominal GDP (USD bn) 194.6 217.8 245.5 246.9
strengthen, mainly in the second half of the year, thanks Population (mn) 7.5 7.6 7.8 7.9
to unscathed macro fundamentals (i.e. credible macro GDP per capita (USD) 26004 28571 31634 31315
policy mix, healthy banking system, net external asset
position). Yet, projected C/A deficits and a lower yield Real GDP (%) 0.8 4.8 4.5 2.8
support (than expected) could put a cap on any Priv. consumption 1.4 5.3 4.4 2.7
meaningful appreciation cycle. Any adverse geopolitical Govt consumption 2.4 2.5 2.9 2.5
development has also a potential to reverse the envisaged Investment -4.1 13.6 15.3 4.0
Exports -12.6 13.4 4.6 3.6
path for the shekel.
Imports -14.0 12.6 10.6 5.2
Kubilay Ozturk, London, (44) 207 547 8806
Prices, Money and Banking (eop)
Investment Strategy CPI (YoY%) 4.0 2.6 2.3 2.3
Broad money (M2) 13.5 3.6 2.9 1.2
FX: Continuing tensions with Iran (and rising possibility of
military action), continued social unease over living costs, Fiscal Accounts (% of GDP)
the negative trade balance in October and the Budget balance (excl credit) -5.1 -3.7 -3.3 -3.5
outperformance in the ILS vs peer currencies over the Revenue (incl credit) 37.7 38.9 41.1 40.0
past 3-6 months mean we do not currently see Spending (incl credit) 42.7 42.3 43.7 42.9
risk/reward strongly favouring long ILS positions. Primary balance (incl credit) -2.1 -0.5 -0.1 -0.4
However, it is worth noting that price action in EUR/ILS
has been remarkably resilient over the last few months, External Accounts (USDbn)
with the pair largely back to pre-August levels. To put this Exports 46.3 56.1 60.3 63.3
move in perspective, EUR/ZAR has rallied by over 18% Imports 46.0 58.0 68.8 74.6
over the same period, EUR/HUF by 16% and EUR/PLN by Trade balance 0.3 -1.9 -8.5 -11.3
over 12%. This suggests that being short EUR/ILS is a % of GDP 0.2 -0.9 -3.5 -4.6
Current account balance 7.0 6.3 -1.0 -3.6
lower beta or ‘defensively bullish’ way to express a
% of GDP 3.6 2.9 -0.4 -1.4
constructive EM view. In terms of positioning, we have
FDI (net) 2.7 -2.8 2.3 1.0
seen a marked reduction in the ILS position on dbSelect -
FX reserves (USDbn) 60.6 70.9 76.5 77.5
the ILS position is, in fact, shorter than it has been for
ILS/USD (eop) 3.79 3.52 3.75 3.65
more than 12 months. We prefer to be tactical sellers of
ILS/EUR (eop) 5.42 4.72 4.88 4.93
EUR/ILS above 5.10, for an eventual move down towards
the pre-August lows at around 4.80.
Henrik Gullberg, London, (44) 20 7545 9847 Government debt 77.8 74.5 73.5 73.3
Siddharth Kapoor, London, (44) 20 7547 4241 Domestic 63.4 61.8 61.3 61.0
Foreign 14.4 12.7 12.2 12.3
Rates: Receive 2Y IRS We take comfort from the latest Total external debt 48.0 48.7 48.0 50.7
in USD bn 93.3 106.0 117.7 125.3
MPC meeting minutes and expect two further cuts. The
BoI inflation forecast of 1.6% y/y in 12m is consistent with
immediate cuts, but the BoI feels that waiting may give it General (% pavg)
Industrial production (% YoY) -5.9 8.0 2.3 2.0
a better opportunity to act effectively. The current 2s10s
slope is fair to the level of Telbor, based on historical
regression, however the 10Y is rich to one of its key
macro drivers (US economic surprise index). For this 2.75 2.50 2.50 3.00
BoI policy rate (%)
reason, we decide to take profit on our recommendation 3.79 3.80 3.72 3.65
ILS/USD (eop)
to receive 10Y IRS and instead recommend receiving 2Y 5.05 4.94 4.65 4.93
ILS/EUR (eop)
with a target of 2.4 and s/l at 2.9 (current 2.72). The Source: DB Global Markets Research, BoI
carry/roll on this trade is positive by 4bp/3m
Lamine Bougueroua, London, (44) 207545 2402

Kazakhstan Baa2(stable)/BBB+(stable)/BBB(positive)
Moody’s/S&P/Fitch
 Economic outlook: Growth is picking up and and profitability, which is coming on top of the already
inflationary pressures are on the rise. significant problems inherited by the sector from the
downturn experienced in 2007. The authorities are
 Main risks: The key vulnerability remains in the
targeting the sale of majority stakes held by Samruk-
banking sector, with negative implications for
Kazyna in BTA, Temirbank and Alliance under a debt
recovery in loan growth.
restructuring program, but in November 2011 the Head of
 Strategy outlook: Maintaining a relative preference the National Bank of Kazakhstan, Grigory Marchenko,
for KZT NDFs vs their UAH counterparts. Neutral on declared that it may take longer (beyond 2013) to sell off
sovereign credit (CDS). these banks due to the volatility in Europe’s financial
markets.
Macro outlook
On the political front, Kazakhstan is to hold snap
parliamentary elections on January 15-16 which are likely
The macroeconomic conditions in Kazakhstan remained
to result in a reduction of the monopoly of the ruling Nur
relatively favourable in 2011 despite global financial
Otan party. We do not expect to see an escalation in
volatility as evidenced in sovereign credit rating upgrades.
political risks in the near term, with the longer-term
In November 2011 S&P upgraded Kazakhstan’s sovereign
vulnerability being the uncertainty over the succession to
credit rating to BBB+ (outlook stable), citing rising exports
the 71-old leader, Nursultan Nazarbayev.
and the sustainability of high growth rates of 6% until
2014. The agency referred to the combination of a strong
current surplus, prudent fiscal policy and high FDI inflows Kazakhstan: Inflation and GDP growth
among the factors underpinning the upgrade. At the same 20
time, the agency also pointed to vulnerabilities, centering

18
16
on the country’s banks’ holdings of foreign debt, which 14
remains significant at 24% of total liabilities of the 12
financial sector. Overall, the increase in the sovereign 10
credit rating should be supportive for capital inflows and 8
the currency, though in the short term these positive 6

4
factors may be dented by lingering uncertainty and risk- 2
aversion in global financial markets. The S&P upgrade was 0
shortly followed by an upgrade from Moody’s, also in 2003 2004 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F
November 2011. Real GDP (YoY%) CPI (Dec/Dec)
One of the key strengths of the Kazakh economy is the

Source: National authorities, Deutsche Bank
attainment of high growth rates, which is projected by the
government to reach 7% in 2011 and to stay at 6-7% in In the fiscal sphere, expenditure restraint has helped to
the medium term. At the same time, the government is lower the vulnerability of the budget to a downturn in oil
targeting inflation in the range of 6-8% in each of the next prices. In 2011 Kazakhstan’s fiscal surplus could reach
five years, a target that lacks ambition on the disinflation close to 2% of GDP compared to a surplus of 1.4% of
front. It also reflects the greater predilection of the GDP in 2010. In November, the parliament adopted the
National bank of Kazakhstan to keeping the exchange rate budget plan for 2012-2014, which is based on
stable versus the dollar, with the head of the National conservative oil price assumptions and envisages a
Bank, Grigory Marchenko declaring that the monetary budget deficit of 2.6% of GDP in 2012, which is to
authorities would not allow the tenge to appreciate progressively decline to 1.5% of GDP in 2013 and 1.3% of
beyond KZY/USD145 in 2011. The continued commitment GDP in 2014. Outlays are projected to rise by 6-7% in
to exchange rate stability may harbor upside risks for nominal terms in 2012, with transfers to the budget from
inflation in a high oil price environment, with 2011 inflation the National Fund of Kazakhstan projected at KZT1.2tr. As
likely to come towards the upper end of the 6-8% range of September 2011 the assets of the National Fund
targeted by the monetary authorities. reached nearly USD40bn.
One of the main points of vulnerability in Kazakhstan’s
economy remains the banking sector, which continues to Yaroslav Lissovolik, Moscow, (7) 495 933 9247
face the challenges of slow lending dynamics and weak Ilya Piterskiy, Moscow,( 7) 495 933 92 30
asset quality. The latter is exerting pressure on margins

Investment strategy Kazakhstan: Deutsche Bank forecasts

2010 2011F 2012F 2013F
FX: Correlation patterns suggest that the main drivers for National income
KZT NDFs are the ruble, equity sentiment and oil. While it Nominal GDP (USDbn) 139.9 161.3 183.5 210.0
is difficult to be constructive on risk assets over the Population (m) 16.1 16.4 16.6 16.8
coming year, it is worth pointing out that the domestic GDP per capita (USD) 8 689 9 832 11 055 12 503
backdrop of Kazakhstan seems to be improving. Firstly,
the Fitch upgrade to 'BBB' (positive outlook) was a plus Real GDP (%) 7.3 6.6 5.5 6.0
for the currency, combined with a strong government Private consumption 11.8 6.4 6.0 6.0
GDP forecast for 2012 (to 6.9% from 7%), stabilization in Government consumption 2.7 8.6 4.6 5.1
FX reserves (to $32.6bn) and the continuing current Investment 2.0 9.0 10.0 10.0
account surplus in Q3 '11 (vs. a deficit in Q3 '10) and a Exports 1.9 12.9 2.5 11.2
gradual decline of inflation to 5.4% YoY in October (vs. Imports 0.9 25.4 5.6 -7.7
5.9% in September) bode well for the currency. Further,
the latest assets of the National Oil fund show another Prices, money and banking (eop)
increase, suggesting that we are unlikely to see sharp CPI (YoY %) 7.8 8.0 7.0 6.5
moves in the KZT. We recommend staying sidelined for Broad money (M3) 15.7 13.0 14.0 12.0
Private credit 0.0 9.0 9.0 11.0
now, but express a relative preference for KZT NDFs vs
their UAH counterparts.
Henrik Gullberg, London, (44) 20 7545 9847 State budget balance 1.5 2.0 2.5 3.1
Siddharth Kapoor, London, (44) 20 7547 4241 Revenue 25.3 26.3 26.6 27.0
Spending 23.8 24.3 24.1 23.9
Credit markets: Little has changed regarding our
fundamental view on Kazakhstan that selling sovereign External accounts
CDS protection offers a good medium-term risk-reward. (USDbn)
Exports 60.8 86.5 92.8 102.6
However, the weaker global environment and increased Imports 32.0 43.3 48.9 48.1
risks in the domestic banking sector argue that the risk- Trade balance 28.9 43.3 43.8 54.5
reward profile of such a position is currently unattractive. % of GDP 20.6 26.8 23.9 26.0
We recommend remaining on the sidelines for the time Current account balance 4.3 16.7 15.4 24.3
being. % of GDP 3.1 10.4 8.4 11.6
FDI (net) 2.8 8.0 8.0 8.0
Marc Balston, London, (44) 20 7547 1484 FX reserves (USDbn) 28.3 38.0 54.0 70.0
KZT/USD (eop) 147.4 147.0 145.0 143.0
OIL
Debt indicators (% of
GDP)
Total public debt 15.7 19.0 14.7 10.1
in USD bn 110.0 136.0 148.0 169.4
General (% pavg)
Industrial production (% 10.0 6.2 5.8 6.0
YoY)
Financial markets (eop) Current 3M 6M 12M
period)
NBK policy rate (%) 7.0 7.0 7.0 7.0
KZT/USD (eop) 147.6 147.0 146.6 146.5
Source: Official statistics, Deutsche Bank Global Markets Researc

Poland A2(stable)/A-(stable)/A-(stable)
Moodys/S&P/Fitch
 Economic Outlook: A Poland’s larger and less showed the quarterly pace of consumer spending slowing
export-orientated economy compared with elsewhere to just 0.6% from 1.0% in Q2 with the YoY rate
in CEE should outperform again in 2012. While moderating to a still-strong 3.0%. Fixed investment
growth will undoubtedly slow there is little risk of slowed as expected given the lower public investment
recession. The pace of slowdown alongside zloty spending with the quarterly pace of growth at 1.4% and
performance, the inflation outlook and the fiscal therefore the lowest since Q3 2009. On a YoY basis
stance will all determine the scope for rate cuts in growth in investment now stands at 8.5% and is the
2012. We see this as unlikely before Q3. highest in the post-crisis period but more reflective of
gains in previous quarters rather than in Q3 itself. On a
 Main Risks: Any evidence that the new government
YoY basis the contributions to growth from private
lacks commitment to fiscal austerity could quickly put
consumption and investment were reported at 1.8pp and
pressure on yields and see the rating outlook revised
1.6pp respectively which is the lowest contribution from
to negative. The discussed methodology changes to
consumer spending since Q4 2009. On the external side
calculation of the debt rule, if used as a substitute for
net trade added 1.0pp to growth, the highest contribution
fiscal reform, would be a big negative in this regard.
since Q4 2009 and the only meaningful boost to growth
 Strategy Recommendations: We recommend a 1y from net trade in recent quarters. This masks the fact that
EUR/PLN put, with a and strike at 4.25 for 2% of EUR exports reported a sluggish 0.4% QoQ gain while import
notional.Receive 1Y XCCY basis as a hedge but growth turned positive after a negative reading in Q2.
outright purchase of POLGBs will be attractive in H2
201. Overweight sovereign credit. Poland: Growth has eased back but remains strong
and the composition is robust
Macro View
% YoY
10 pp contribution 8
Still one of the strongest economies in Europe. Donald
Tusk has now been sworn in for a second term as Polish 7
5
PM leading a successor PO-PSL coalition. In his first 6
speech to Parliament Tusk set out a fairly ambitious fiscal 0 5
reform agenda which includes various changes to the 4
pension system, elimination of tax breaks, healthcare -5 3
reform and a pledge to step up deregulation. The Inventories GFCF 2
-10 Govt Cons Pvt Cons
commitment to fiscal reform comes as Poland feels the 1
Net Exports Real GDP (rhs)
impact of the financial stress in Western Europe via
-15 0
ongoing depreciation of the zloty but has otherwise been
Q3-06 Q3-07 Q3-08 Q3-09 Q3-10 Q3-11
relatively immune despite its own still-high fiscal deficit.
The government’s new four-year mandate and a better Source: Haver Analytics, DB Global Markets
economic backdrop then elsewhere in Europe to

Going forward we continue to expect the pace of GDP
implement fiscal reform suggests market tolerance
growth to moderate. Investment should continue to
towards any perceived lack of commitment in Poland is
decelerate on the back of reduced public investment and
likely to be limited.
an uncertain global backdrop while consumer spending
Poland statistics office reported a robust 1.0% QoQ will start to reflect lower wage growth in both nominal
reading for Q3 GDP (seasonally adjusted) and 4.2% YoY and real terms and deteriorating employment prospects.
(non-seasonally adjusted) versus a consensus expectation The planned fiscal consolidation will also weigh down on
of 4.0% YoY. This is down only slightly from the upwardly domestic demand components as benefits are cut further
revised 1.2% QoQ reading for Q2 (previously reported at and spending freezes are expanded while it is unlikely that
1.1%) and other than Romania’s agriculture-induced reform of retirement schemes will offset these measures
bumper 1.9% QoQ reading is comfortably the strongest in the near term. While Poland has a much smaller export
growth reading in Europe. The detailed components show sector compared with Hungary or Czech Republic, exports
a pretty robust composition of growth albeit with some will still feel the impact of further weakness across
evidence of a slowing in the domestic momentum. Western Europe which currency weakness (and therefore
Domestic demand accounted for 3.2pp out of the 4.2% competitiveness gains) will not be able to offset. A
YoY GDP reading with the contribution from restocking continued normalisation in the boost to growth from the
the lowest since Q4 2009 at 0.4pp. The components restocking cycle will also dampen growth in the coming

year. A better-than-expected Q3 GDP pushes our 2011 intended financing split between PLN146.1bn in domestic
growth estimate to 4.2% but we have nudged down our financing and PLN29.4bn in foreign financing. Poland has
2012 forecast to 2.3% versus 2.6% previously. We now already started pre-financing for 2012 on both the
expect a lower contribution from both domestic demand domestic and external side (Ministry of Finance officials
and net trade with the high base from the very solid said this was 10% by end November) and the government
performance in 2011 also making YoY comparisons now has a substantial cash buffer (EUR10.5bn) at its disposal.
more difficult. Our 2.3% forecast is lower than the 3.2%
The 2012 pre-financing also suggests comfort by the
NBP projection and the likely 2.5% Ministry of Finance
Ministry of Finance that Poland is not in danger of
forecast but still leaves Poland as easily one of the
breaching its 55% debt/GDP limit despite the recent zloty
strongest economies in Europe.
weakness. Some 27% of public debt is denominated in
Fiscal financing looks secure for 2012. The combination foreign currency (and predominantly euros) and with
of a VAT hike, introduction of a spending rule, reduction in debt/GDP at 53.7% as of Q2 (4-quarter rolling basis) on a
the contributions to the private pension funds and cuts to PLN rate of 3.99/EUR there have been increasing
various benefits are expected to produce a narrowing in concerns about breaking 55%. But with debt issuance
Poland’s general government budget deficit from -7.8% in front-loaded in H1 and the combination of a slower than
2010 to 5.5% in 2011. Data on the narrower state budget expected easing in GDP growth plus slightly higher
through October show the deficit at PLN22.5bn and inflation, we do not expect the threshold will be breached.
therefore on track to come in considerably below the Public debt data are only available through June but using
planned PLN40.2bn with outperformance on both the the recent Ministry of Finance projection of debt/GDP at
revenue and spending sides. The government continues 53.8% based on EUR/PLN at 4.35 we see the tipping
to target a sub 3% general government deficit for 2012 point at 4.75/EUR for 2011 (data will be released in May
with PLN35bn or 2.3% of GDP on the state budget. 2012).
Savings from the deficit rule for local governments, the
Recent comments that Poland may look to change the
spending rule, reduced pension contributions and
calculation method for public debt to use an annual
elimination of some early retirement options are all
average, rather than year end, exchange rate should be
assumed to achieve this. The state budget is still under
viewed with caution. That a single exchange rate point can
revision however given the earlier 4% GDP growth
have an important bearing on future fiscal policy does not
assumption for 2012 and unlike Hungary there is no
make much economic sense (triggering the 55% limit
explicit reserves buffer in the budget and there has not
would mean a 1pp temporary VAT hike and unspecified
been any real discussion of additional measures to keep
measures to ensure the fiscal deficit is on a declining path
the budget on track. Budgetary space afforded by
and the debt/GDP ratio is expected to decline). But the
outperformance on the state budget in 2011 could provide
worry will be that Poland uses a methodology change as a
some buffer but this is unlikely to be enough. A sub 3%
substitute for fiscal reform. The bigger risks in our view is
fiscal deficit by 2012 was too optimistic even in a better
the accompanying comments that Poland would also like
macro environment and we continue to expect the deficit
to see the debt definition changed to net, rather than
outturn to be in excess of 4% of GDP.
gross, debt. The EUR10.5bn in PLN and FX liquidity held
Poland: Gross borrowing requirement larger in 2012 by the Ministry of Finance as of end October is equivalent
to 2.8% of GDP and would therefore open up significant
140
PLN bn 2010 (Total: room to manoeuvre on fiscal policy before the debt limit
120 114.3 PLN 179.8bn) was reached. The ratings agencies have yet to comment
105.7 103
100 2011 (Total: on the proposals but we expect these will be viewed
PLN 144.9bn)
80
decidedly negatively.
65.4 2012 (Total:
60 47.3* PLN 175.5bn) C/A financing more vulnerable. Despite the ongoing
35.7 worries on the fiscal side, Poland’s larger vulnerabilities
40
for the coming year are on the external side in our opinion.
20 8.7 13.9 At an expected 4.5% of GDP in 2011 the C/A deficit is the
6.2
0 largest in CEE and has the weakest financing mix. NBP
Net Borrowing Repayment of Repayment of data show the deficit at EUR12.5bn through September,
Requirements domestic debt foreign debt of which EUR7.8bn stems from the trade deficit and
Source: Ministry of Finance (*state budget deficit of up to PLN35bn) EUR11.8bn from deficit on investment income line with a
partial offset from services and transfers surpluses. Both
Nevertheless, the fiscal financing outlook looks relatively
FDI and EU transfers components cover around 30% each
secure. The authorities have announced a PLN175.5bn
with the much larger source of financing coming from
(EUR39bn) gross borrowing requirement for 2012 with
inflows into debt securities. This stands at EUR8.75bn

YTD, with another EUR1.6bn in foreign inflows into equity, selling price expectations also dropped in November after
and covers 70% of the deficit YTD. The September BoP a sharp jump in October.
data reported the first (small) monthly outflow on the debt
securities component which corresponds with the start of Poland: Zloty weakness has been in tandem with
the zloty weakness. The overall BoP reported a shortfall stresses in Western Europe
for the month and a corresponding fall in reserves which 4.6 7.5
is not explained by foreign debt repayments. The
4.5 EURPLN 7.0
combined debt and equity inflow amounted to 5.6% of
4.4
GDP in 2010 versus a headline C/A deficit of 4.6% of Italy 10Y Government 6.5
GDP. This is now down to 3.7% of GDP on an annualised 4.3 Bond (%, rhs)
6.0
basis versus a C/A deficit at 4.5% of GDP. Should these 4.2
flows drop back further this could mean continued 5.5
4.1
pressure on the zloty as it is difficult to see where any 5.0
4.0
financing offset could come from. We view Poland’s
3.9 4.5
USD30bn precautionary flexible credit line arrangement as
only a tentative source of strength. The arrangement is in 3.8 4.0
place until January 2013 but Poland’s decision to treat the Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11
FCL as precautionary means this is not included in the Source: Bloomberg Finance LP
NBP’s EUR64.1bn in FX reserves. Any request to trigger
the facility would therefore be a very public sign of The NBP’s November Inflation Report saw a 0.4pp
weakness and we see this as likely only in a very worst upward revision to the Bank’s inflation projections for both
case scenario where the sovereign cannot issue. 2012 and 2013 and the GDP growth projections lowered
marginally. With CPI expected to remain above target
Rate cuts pushed out to Q3. Governor Belka recently through the entire forecast horizon the NBP are likely to
described the ongoing zloty weakness as a ‚temporary maintain their relatively hawkish stance for some time
headache‛ and the Bank, along with various other Polish ahead. Further zloty weakness will also rule out any
officials, have said the move is out of line with Poland’s change to a dovish stance and we expect the Bank will
fundamentals. As our chart opposite shows, the also want to be sure of the government commitment to
weakness has largely been in tandem with the stresses in fiscal consolidation before hinting at any easing in
Western Europe and has come in the absence of any monetary policy.
negative developments on the macro side. The NBP have
confirmed direct intervention on four occasions now with Poland: NBP now expects inflation to remain above
their public stance that they are not targeting a particular its 2.5% target through the entire forecast horizon
level of the zloty but instead acting against destabilisation Inflation forecasts (% YoY) GDP forecasts (%)
in the FX market. FX reserves have dropped by Previous Latest Change Previous Latest Change
EUR240mn since the start of intervention to stand at 2011 4.0 4.0 0.0 4.0 4.1 0.1
EUR64.15bn at end October but this is clouded by 2012 2.7 3.1 0.4 3.2 3.1 -0.1
valuation effects and public flows making it difficult to 2013 2.4 2.8 0.4 2.9 2.8 -0.1
disentangle exactly the intervention size. Nevertheless, Source: NBP
with reserves less than 100% of ST debt and one of the
lowest in EMEA as a share of GDP we reiterate our view Despite the ongoing zloty weakness and recent
that intervention is likely to be contained. announcement of tax increases on diesel and tobacco the
inflation profile will still improve from January as the 2011
With inflation currently way above the NBP’s 2.5% target VAT hike drops from annual comparisons. CPI will move
(4.3% YoY for October) pass-through from currency back within the 2.5% +/-1pp buffer by Q2 but it will not
weakness is an increasing concern. The monthly gains in drop back to the 2.5% midpoint target 2013. The
the October food and petrol price components were combination of still-strong domestic momentum and a
higher than elsewhere in CEE pointing to some immediate higher inflation profile suggests our earlier expectation for
pass-through from the zloty weakness and given the NBP to move to a rate cutting cycle from March 2012
continued depreciation through October and November now looks too soon. We now expect the NBP will remain
(albeit smaller than the 5% decline in September) upside firmly in wait-and-see mode for at least the next six
risks remain for the forthcoming inflation prints. The input months with the first rate cut unlikely before Q3.
price component of the November PMI was unchanged
from October at a five-month high which may cap some Caroline Grady, London, (44) 207 545 9913
of the concerns on pass-through while the EC survey on

Investment Strategy Poland: Deutsche Bank Forecasts

2009 2010 2011F 2012F
FX: Strong momentum in the domestic economy National Income
continued in Q3, with the GDP report showing that Nominal GDP (USD bn) 428.5 471.4 520.6 494.4
currency weakness is not entirely negative, as it makes Population (mn) 38.1 38.1 38.1 38.1
exports more competitive (net exports added 1% to Q3 GDP per capita (USD) 11243 12375 13673 12986
growth). Inflation has been sticky, and commentary from
NBP has remained hawkish, suggesting that the Real GDP (YoY%) 1.6 3.8 4.2 2.3
aggressive re-pricing of policy seen in August is unlikely to Priv. consumption 2.0 3.2 3.5 2.7
materialise. The consolidation plan following the elections Gov't consumption 2.1 3.9 0.2 1.0
was well received by OECD - who expect the government Gross capital formation -1.4 -2.2 6.2 4.0
deficit to be cut to 2.9% of GDP in '12 (previously 3.8%). Exports -6.8 10.2 7.0 6.4
Finally, valuation is attractive on our longer term valuation Imports -12.4 11.6 6.2 6.0
metric and combined with credible fiscal consolidation
and continued support from official authorities to keep Prices, Money and Banking
(eop
CPI (YoY%) 3.5 3.1 4.0 2.4
EUR/PLN contained (also to keep debt/GDP below 55%)
we are cautiously constructive. Near-term there are still Broad money (M2) 8.1 7.8 10.2 10.0
substantial risks, with the PLN hostage to the Eurozone
crisis and also taking over as the default European risk-off
ESA 95 budget balance -7.3 -7.8 -5.5 -4.3
hedge to some extent if NBH starts hiking rates. On
Revenue 37.2 37.5 39.5 39.6
balance, we recommend a 1y EUR/PLN put struck at 4.25
Expenditure 44.5 45.3 45.0 43.9
for an indicative cost of 2%.
Henrik Gullberg, London, (44) 20 7545 9847 External Accounts (USD bn)
Siddharth Kapoor, London, (44) 20 7547 4241 Exports 142.1 165.7 191.2 188.2
Rates: Receive 1Y XCCY basis as a hedge but outright Imports 149.7 177.5 208.5 203.8
purchase of POLGBs will be attractive in H2 2012 The Trade balance -7.6 -11.8 -17.3 -15.6
negative FX performance and robust economic growth % of GDP -1.8 -2.5 -3.3 -3.2
has led us to reduce our expectations for rate cuts in H1
% of GDP -4.0 -4.6 -4.5 -4.4
2012. Real money funds have been consistently
FDI (net) 8.5 3.6 2.8 2.7
underweight through the year, at least partly due to the
current stigma associated with European names. Any
PLN/USD (eop) 2.86 2.96 3.38 3.04
further negative developments could lead to a tightening
PLN/EUR (eop) 4.10 3.97 4.40 4.10
of USD funding and a rise in the interbank fixing. At
present, we see more upside in bearish positions such as Debt Indicators (% of GDP)
receiving the 1Y EURPLN cross-currency basis. In H2, as Government debt 49.9 52.9 53.0 53.2
more progress is achieved in resolving the Eurozone issue Domestic 36.8 38.4 38.6 38.5
and the inflation outlook likely moderates, we would be External 13.1 14.4 14.4 14.7
looking to increase exposure via bonds. Total external debt 65.6 66.2 63.0 67.4
in USD bn 281.1 312.2 327.8 333.3
Credit: Overweight. The next few months are a critical
period for Poland with respect to fiscal policy – likely the General (YoY%)
key determinant for relative performance of the credit in Industrial production -3.6 11.1 5.7 4.2
the near term. While we are cautious in our expectations Unemployment 11.0 12.1 12.1 12.0
of what the re-elected government will deliver, we believe
the market reflects an even more cautious view and Financial Markets (eop) Current 3M 6M 12M
hence we see the risks being skewed towards tighter Policy rate (14 day repo) 4.50 4.50 4.50 4.00
spreads. Certainly there are few credits in EMEA which PLN/EUR 4.49 4.33 4.25 4.10
have such a potential to provide a positive surprise in the PLN/USD 3.33 3.33 3.40 3.04
near term. We change our recommend to overweight Source: Haver Analytics, NBP, DB Global Markets Research.
from neutral.

Romania Baa3(stable)/BB+(stable)/BBB-(stable)
Moodys/S&P/Fitch
 Economic Outlook: A precautionary IMF/EU SBA in YoY reading in Q2 with the July 2010 austerity measures
place until 2013 combined with the government’s now out of annual comparisons. INSEE have yet to
intention to increasingly tap the Eurobond market publish the GDP components for Q3 but we expect
ahead of large external redemptions in 2013/14 agriculture provided by far the largest contribution to
should help to ensure reform fatigue is avoided and growth given the bumper harvest through the quarter. IP
the structure of growth continues to improve. growth picked up to 5.7% through Q3 following a sharp
Despite a very difficult external backdrop we see deceleration in Q2 and we expect exports will also show a
upside risks to our growth projection from stepped move up after merchandise exports (value basis) reported
up absorption of EU funding and reform of loss- a return to positive territory at 4.2% for Q3 versus Q2
making SOEs. after a -5.1% reading for Q2. On the domestic side,
monthly retail sales data suggests a still weak consumer
 Main Risks: Fiscal slippage in the run up to the Q4
with growth remaining in negative territory for almost
general election risks pushing the IMF/EU program
three years now (3mma YoY basis) albeit with the
off track and would limit scope for further monetary
September 2012 reading the strongest for a year. Credit
easing. It could also put pressure on the ratings.
growth remains weak with net new credit extension to
 Strategy Recommendations: Neutral FX. the private sector largely unchanged YTD versus a year
Overweight sovereign external debt. ago although this should be neutral, rather than negative,
for domestic demand. On a FX-adjusted basis credit
growth stands at 6% YoY as of September and positive in
Macro View real terms for three consecutive months now. The outlook
Domestic factors point to upside risks to the growth for any meaningful revival in credit growth is severely
outlook. We see Romania’s recovery as one of the most limited however given capital raising requirements faced
secure in the region for the coming year. While growth is by foreign parent banks. But with the Vienna initiative for
likely to be relatively slow after a bumper Q3 and continue Romania renewed in early 2011 we do not expect any
to be reliant on exports, the composition of growth is protracted reduction in exposure by the largest foreign-
expected to be the most balanced for many years. That owned banks in the coming year.
the IMF/EU precautionary stand-by arrangement (SBA) is
active through Q1 2013 should also help to avoid any Romania: At 1.9% QoQ in Q3 GDP Romania reported
policy slippage in the run up to the general election due by by far the strongest growth in CEE
November. Fundamentals have continued to improve,
reflected in the positive assessment by the IMF in its 4.0 Real GDP (SA, % QoQ)
recent program review which commended the authorities
3.0
for making ‚good progress in implementing program
2.0
policies in a very difficult external environment‛. That the
1.0
sharp fiscal policy adjustments are now in the past also
0.0
reduces the fiscal drag on the 2012 growth outlook
compared with the past two years. Despite our -1.0
expectation for a 2012 recession in Euroland we see the -2.0 Romania
Euroland
risks to our growth forecasts for Romania to the upside -3.0 Czech
with the potential for a sizeable step-up in absorption of -4.0 Hungary
Poland
EU funding and positive spillover from growth-enhancing -5.0
structural reforms. Romania’s smaller export share (35.8% Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11
of GDP) compared with Czech Republic (79.3%) and
Hungary (86.5%) also helps while a public debt/GDP ratio Source: Haver Analytics, DB Global Markets Research
of sub 40% also limits spillover from European debt As the boost from a strong harvest could continue to
worries. support growth through Q4 on a QoQ basis and the
bumper Q3 has now lifted the base to ensure a strong
At 1.9% QoQ and 4.4% YoY Romania’s Q3 GDP reading final quarter reading in YoY terms, our previous 0.9% GDP
was by far the strongest in CEE and is the fastest pace of expectation for 2011 now looks too low. We revise this up
quarterly growth since seasonally-adjusted data are to 1.8% while for 2012 we leave our 1.9% growth
available (Q1 2009). On a YoY basis the 4.4% reading is expectation unchanged despite our now weaker Euroland
the highest since Q3 2008 and up sharply from the 1.4%

baseline (-0.5% from +0.4% previously). We have improvement for next year is smaller than the adjustments
however adjusted the composition of GDP for next year made during the past two years which also supports our
with a lower export assumption and higher domestic view on an improvement in domestic demand for the
demand growth. Our revised forecasts see a gradual pick- coming year.
up in consumer spending with wage growth much
improved in both real and nominal terms and acceleration Modest rate cuts look likely. A moderate loosening in
in investment growth from efforts to improve absorption the monetary policy stance is also expected to provide
of allocated EU funding (the EUR6bn or 4.7% of GDP some support to growth in 2012. The NBR announced an
included in the budget for EU transfers is a record high). earlier-than-expected move to an easing cycle with a
To the extent that the fiscal dynamics allow for a further 25bps rate cut in early November. The rate cut was the
reversal of the 2010 public sector wage and pension cuts first since May 2010 and came after a significant
this would be another upside for growth in the coming improvement in headline inflation with the November CPI
year. The continuation of regular program reviews by the reading at 3.5% YoY, versus 8.4% in May, the adjusted
IMF/EU and the authorities desire to increasingly tap the CORE2 readings at 2.7% and 4.8% YoY for October and
Eurobond market ahead of large IMF repayments in 2013 May respectively (CORE2 excludes administered prices,
and 2014 should also help to ensure reform fatigue does volatile prices and tobacco and alcohol). While some of
not set in and the impressive track record of policy the improvement reflects a better base as the July 2010
implementation during the past two years continues. VAT hike has now dropped out of annual comparisons the
5.7% decline in the food price component (37.5% of the
Targeting a sub 3% fiscal deficit in 2012. The total index) between May and September was also a
government’s commitment to a sub 3% fiscal deficit for significant factor. The sharp disinflation pushed real rates
2012 (which would be the first such reading since 2007) is sharply higher and was offset only partly by a weaker leu
impressive particularly given the election calendar. The according to our monetary conditions index.
recently approved 2012 budget is based on an IMF-agreed
1.8% GDP growth assumption and sees the Romania: Further cuts in the policy rate will reverse
expenditure/GDP ratio dropping for the third consecutive some of the recent increase in real rates
year and the revenue/GDP ratio increasing. We do not see
a 3% deficit as unachievable. Romania has already passed 150 % 8
Dec dbREER (lhs)
all the necessary legislation to ensure continued fiscal 2000=100 6
consolidation (the fiscal responsibility law, the unitary Real policy rate (rhs)
140
wage law, the public finance law and the pension reform 4
law) and is committed to reduce the overall wage bill to
below 7.2% of GDP from 9.2% in 2009. The EUR6bn 130 2
assumption on EU transfers looks optimistic at first glance 0
but with the EU budget period ending in 2013 time is 120
running out to absorb the remaining funding allocation and -2
with just a 5% co-financing requirement (versus 15%
110 -4
normally) there is a large incentive to do so. The IMF/EU
focus on loss-making SOEs and clearing of arrears, if Oct-05 Oct-07 Oct-09 Oct-11
achieved, should also prove to be a support to growth and Source: Haver Analytic, DB Global Markets Research
indirectly to the budget. The authorities have also set out The NBR policy statement from November said that the
a timeline for IPOs and for new management structures at cut in the policy rate was intended to ensure adequate
the largest loss-making enterprises with the intention of real broad monetary conditions and that the NBR would
making the companies cash-flow positive. The success of maintain a prudent approach to monetary policy. The NBR
the IPO pipeline will however depend on the broader statement also mentioned a ‚gradual reduction‛ in real
macro environment with the unsuccessful sale of the broad monetary conditions going forward and highlighted
country’s largest energy company, Petrom, in July the importance of domestic savings and ‚appropriate
evidence of this. With an expected pick-up in growth next remuneration of bank deposits‛. These comments
year and continued narrowing of the headline deficit the combined with the Bank’s acknowledgement that the
structural budget deficit should also narrow again next medium-term risks to the inflation outlook are to the
year. The latest EC projections see a 2.6% of GDP upside suggest 2012 rate cuts are likely to be modest and
structural budget deficit for 2012 which would amount to we expect a total of 75bps in rate cuts through the next
a 6.5pp reduction in the structural deficit since the peak in twelve months. This would leave the policy rate at 5.25%
2009. This compares with 2.1pp for Czech Republic, and real rates around 2%. We expect the timing of rate
0.5pp for Hungary and 3.5pp for Poland. The ~1pp hikes to be fairly spread out as the NBR assesses the

impact of the recent cut in heating subsidies (estimated to External position looks comfortable, albeit with some
add up to 0.5pp to headline CPI) as well as any spillover widening in the C/A deficit. Romania’s external position
impact from the recent increase in industrial gas prices. should also continue to show improvement during the
The updated Inflation Report from November sees the 3% coming year although made difficult by a very weak
+/-1pp target being achieved for both 2011 and 2012 (the backdrop in Europe and a likely pick-up in import demand
NBR has only once met its target in the past) but with given the expected improvement in domestic demand.
three main risks around the outlook namely; a weaker Latest data on exports show a turnaround from the
external environment leading to a currency depreciation, summer lows but it is difficult to determine the extent this
possible upward pressure on public sector wages in 2012 will be sustained although data on new export orders have
due to the general election and administered price hikes. also rebounded from the summer slump. A very strong
performance at the beginning of 2011 should mean that
Romania: Liquidity operations have been stepped up annual growth in exports and imports is only marginally
in case of any funding squeeze down from the 28.5% and 20.4% of 2010 securing a
further reduction in the trade deficit to around 4.5% of
RON bn
GDP from a high of 13.7% in 2008. Recent divestments
60
50 by two of Romania’s main exporters will also hurt export
40 Net OMO growth next year although production increases by Ford
30 as well as investment announcements from other
20 multinational corporates could offset this to some extent.
10 Romania faces the problem that the only offset to the
0 trade deficit, namely the transfers surplus, could well
-10
decline further in line with fiscal austerity and recession in
-20
Italy, the main source of remittances. Nevertheless, at
-30
-40 around 5% of GDP the C/A deficit should be comfortably
financed and we do not foresee any BoP funding gap that
Nov-07 Nov-08 Nov-09 Nov-10 Nov-11
would put pressure on the RON.
Source: NBR, DB Global Markets Research (chart shows monthly aggregate)
Aside from the inflation trajectory, scope for rate cuts will Romania: External financing will increase in 2012 but
also be dependent on banking sector stability in the face looks easily manageable
of further stress in European financial markets as well as E U Rbn 2007 2008 2009 2010 2011F 2012F
RON performance. The NBR has stepped up its weekly 7- G r os s Fina nc ing Req. 36.0 45.1 39.2 31.3 35.7 38.5
day repo operations during recent months with the C/A (deficit = positive) 17.0 16.2 4.9 5.0 4.7 5.5
RON6.25bn repo tender on November 21st the largest Amortisation (MLT) 6.5 8.5 13.1 12.3 14.6 13.5
since early 2010. That commercial bank holdings of Amortisation (ST) 12.5 20.5 21.3 14.1 16.4 19.4
government securities now stand at 10.4% of GDP versus
Fina nc ing 36.0 45.1 39.2 31.3 35.7 38.5
just 1.3% of GDP in September 2008 significantly
Non-debt creating 8.1 9.9 4.2 2.5 2.2 4.2
improves bank’s access to repo liquidity as government
FDI (net) 7.3 9.3 3.6 2.2 1.6 2.2
securities are the bulk of eligible collateral. If banks facing
EU capital inflows 0.8 0.6 0.6 0.2 0.6 2.0
a liquidity squeeze do not have sufficient eligible collateral
Debt creating 32.6 33.5 35.2 31.5 33.4 34.3
to use the repo window the NBR also has an option to
Sovereign Eurobonds 0.8 1.0 1.5 3.0
extend emergency liquidity with a broader range of
Multilateral financing 10.9 6.2 2.1
collateral. The list is not made public however and would
Banks + corporates 32.6 32.7 24.3 24.3 29.9 31.3
be done on a case-by-case basis. These short-term
liquidity facilities are complemented by a deposit Errors & omissions -0.2 1.7 1.0 0.9 0.0 0.0
guarantee fund which has the power to take over
distressed banks temporarily in order to avoid any fire sale Reserves (+ = decrease) -4.5 0.0 -1.1 -3.5 0.0 0.0
until a private sector buyer can be found. Despite the high

G r os s Fina nc ing Req.
share of Greek parent banks in Romania and the move up
% of GDP 28.9 32.3 33.4 25.7 27.9 28.5
in NPLs to 14.2% as of September 2011 from 11.7% a Source: DB Global Markets Research
year earlier the banking system is nevertheless generally

Despite the expected move wider in the C/A deficit and
viewed as resilient with a 13.4% capital adequacy ratio as
slightly higher amortization than in 2011 the overall gross
of end September, adequate provisioning and all banks
external financing requirement looks manageable. The
above the 10% regulatory minimum. In addition, there has
bulk of the financing remains with the private sector but
not been any obvious pressure on deposits.
with the IMF/EU anchor remaining in place we expect

sufficient financing will be maintained. On the sovereign Romania: Deutsche Bank Forecasts
side, the government faces a total of EUR2.6bn in 2009 2010 2011F 2012F
redemptions in 2012 with EUR1.9bn in repayments to the National Income
IMF (with principal payments of EUR0.6bn, EUR0.6bn and Nominal GDP (USD bn) 162.8 163.2 177.6 174.1
EUR0.2bn due in August, November and December Population (mn) 21.4 21.4 21.4 21.4
respectively) and a EUR700mn Eurobond due in May. The GDP per capita (USD) 7602 7617 8305 8134
authorities have a EUR7bn EMTN program in place and
have announced plans to issue their first USD- Real GDP (%) -7.1 -1.3 1.8 1.9
denominated Eurobond soon. With EUR5bn due to the Priv. consumption -9.6 -1.8 2.3 4.0
IMF in 2013 and EUR4.6bn due in 2014, Romania’s Govt consumption 1.2 -3.2 1.5 3.5
presence on the Eurobond market will likely increase in Investment -25.3 -13.1 6.5 9.5
2012 in order to pre-finance for later years. We see Exports -5.0 14.3 8.9 9.2
potential for S&P to join Fitch in bringing Romania’s LT Imports -21.4 12.4 10.0 13.0
foreign currency sovereign rating back to investment
grade during the coming year provided the government Prices, Money and Banking (eop)
CPI (YoY%) 4.8 8.0 3.5 3.2
sticks with its fiscal commitments.
Broad money (M2) 8.3 6.2 5.6 5.3
Caroline Grady, London, (44) 207 545 9913

General budget balance -8.5 -6.4 -4.4 -3.1
Investment Strategy Revenue 32.1 34.4 34.6 35.1
Spending 40.6 40.8 39.0 38.2
FX: Romania's macro outlook is improving. Domestic
factors are pointing towards upside risks to growth, the
C/A deficit at around 4% does not pose a material threat External Accounts (USDbn)
to the RON and the government's sub 3% fiscal deficit Exports 40.3 51.8 61.7 64.6
target does not look unachievable. It is worth noting that Imports 49.8 60.0 69.7 73.6
with 35% of exports to Europe, Romania is not as Trade balance -9.5 -8.2 -8.0 -9.0
exposed to Europe as Czech Republic (around 80%) or % of GDP -5.8 -5.0 -4.5 -5.2
Hungary (87%). From a strategy point of view, however, Current account balance -6.8 -6.9 -6.5 -7.1
we see a lack of catalysts for RON volatility. In risk % of GDP -4.2 -4.2 -3.6 -4.1
positive scenarios we see investors preferring higher FDI (net) 4.9 3.1 2.3 2.9
yielding and more 'default' risk currencies such as the FX reserves (USDbn) 40.5 43.4 45.0 46.5
ZAR. In risk negative scenarios we do not foresee the leu RON/USD (eop) 2.95 3.20 3.31 3.07
getting hit as aggressively as for example HUF, and of RON/EUR (eop) 4.23 4.28 4.30 4.15
course of the threat of intervention from the NBH.
Henrik Gullberg, London, (44) 20 7545 4987 Government debt 30.0 37.9 39.0 39.1
Siddharth Kapoor, London, (44) 20 7547 4241 Domestic 18.4 22.7 21.8 22.0
External 11.6 15.2 17.2 17.1
Credit: Overweight. Risks to economic performance are Total external debt 69.1 75.8 75.2 80.2
mounting, but the government’s commitment to fiscal in USD bn 112.5 123.7 133.5 139.6
adjustment and its good relationship with the IMF should
stand the country in good stead to weather potential General (% pavg)
storms ahead. At 430bp, Romania 5Y CDS exaggerates Industrial production (% YoY) -6.1 5.6 8.7 8.8
the risks; we recommend an overweight exposure to the Unemployment 7.8 6.9 5.5 5.2
credit. The main risk to this position is renewed pressure
on eurozone sovereigns. Romania spreads are already Financial Markets (end Current 3M 6M 12M
20bp tighter than Italy and while this is arguably justified period)
NBR policy rate (%) 6.00 5.75 5.25 5.25
given the country’s relative debt dynamics, it will likely RON/EUR 4.36 4.26 4.23 4.15
constrain how much Romania spreads could tighten. RON/USD 3.24 3.28 3.38 3.07
Marc Balston, London, (44) 20 7547 1484 Source: NBR, DB Global Markets Research. The NBR classifies the IMF lending under
monetary authorities rather than government external debt.

Russia Baa1(stable)/BBB(stable)/BBB(positive)
Moody’s/S&P/Fitch
 Outlook: Growth accelerating on the back of high have still favoured spending on non-food goods as a way
consumption and fixed investment growth. to preserve rouble savings. The recent acceleration in
household consumption growth suggests that in 2011
 Main risks: Recurring capital outflows and a drop in growth could reach nearly 7%, which significantly
oil prices remain key risks. exceeds government projections.
 Strategy recommendations: Short NOK/RUB, for a Fixed investment growth reached 8.6% in October, which
move back down to 51 flat. OFZs likely to perform in is higher than the 8.5% and 6.5% seen in September and
2012. Overweight sovereign credit. August respectively. In January-October 2011 fixed
investment growth reached 5.3% and is on course to
Macro outlook reach or exceed the government’s 6% projection for
The outlook for 2012 is clouded by the volatility in global 2011. One of the drivers behind the acceleration in fixed
financial markets, which impacts Russia through higher investment growth is construction, which expanded by
capital outflows as well as elevated risks of a decline in oil 8.2% YoY in October after posting a 4.8% YoY increase in
prices. To some degree the scale of capital outflows may the preceding month. We continue to see construction as
moderate in 2012 with a reduction in political uncertainty one of the key potential drivers of higher fixed investment
and some of the positive developments in Russia’s in the remainder of this year as well as in 2012. Our view
investment climate, most notably the accession to the is that fixed investment growth is likely to benefit in 2012
WTO. The latter is likely to be largely sealed by Russia at from a combination of lower capital outflows, further
the WTO Council on December 15, 2011, with the recovery in construction as well as the implementation of
approval of the accession package and full-fledged large-scale infrastructure projects associated with the
accession taking place in mid-2012. preparations for APEC summit in 2012 and Sochi Winter
Olympics in 2014. Starting from next year a notable
We believe that growth has scope to accelerate further in increase in infrastructure spending is also projected for
2012 on the back of higher expansion in fixed investment. the 2018 Soccer World Cup.
At the same time there may be upside risks to inflation
due to the effects of rouble weakness in H2 2011 as well
Russia: fixed investment and household consumption
as higher fiscal spending ahead of the presidential
25
elections. Given DB’s positive oil price outlook for 2012,
20
the current account is likely to continue to exhibit a strong
15
surplus, while in the fiscal sphere a moderate deficit may 10
emerge at the federal level. The escalation in fiscal 5
commitments (most notably in the defense sector) may 0
sustain the level of the non-oil budget deficit at high -5
levels, leaving the federal budget vulnerable to declines in -10
oil prices. -15
-20
Growth outlook: investment likely to accelerate 2003 2004 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F
The key economic indicators for October reveal the Consumption growth, %, real Investment growth, %, real
persistence of high household consumption growth rates Source: Rosstat, Deutsche Bank
and emphatic acceleration in fixed investment growth. In
October household consumption (as proxied by retail According to the Ministry of Economy, the government
sales) increased by 8.8% YoY, which is only moderately could revise up its GDP growth estimate for 2011 from
lower than the 9.2% YoY reading registered in the 4.1% to 4.2-4.5%. For 2012-2014, the ministry projects
preceding month. The surge in household consumption the GDP growth would stabilize around 4% with inflation
was mostly driven by higher outlays on non-food goods – gradually decelerating to 4–5%. Overall, the ministry’s
while in January-October 2011 food retail sales increased possible GDP growth outlook is in line with our projection
by 2.5% YoY, the corresponding figure for non-food of 4.5% for 2011, given a significant acceleration in fixed
goods amounted to 10.4%. The high rate of growth in investment growth in recent months as well as the
consumption took place despite the rise in unemployment resilience of high rates of growth in household
from 6% in September to 6.4% in October and real consumption. At the same time compared to the official
disposable income rising by a moderate 0.4% YoY in forecast of less than 4% GDP growth in 2012, we are
October. The volatility in the exchange rate sphere may more optimistic in assessing the scope for growth in fixed

investment, while also expecting a relatively strong complemented by the effects of capital outflows, which
increase in household consumption on the back of the served to lower the pace of growth in M2 money supply.
pre-electoral boost to social outlays.
According to the CBR, Russia’s M2 money supply
Fiscal policy: medium-term concerns on the spending declined by 0.5% after rising by 2% in September. Since
front the beginning of the year the rise in M2 money supply
According to the Ministry of Finance, Russia’s federal amounted to 6.8%, while the 12-month growth rate
budget posted a RUR269bn surplus in October, putting decelerated to 20% by the end of October after reaching
YTD surplus at RUR1.4tr. The accelerating surplus was 31% at the end of last year. According to earlier
mainly due to higher-than-YTD average revenues statements of the Head of the CBR Sergey Ignatiev the
(RUR1,028bn in October vs. monthly average of deceleration in the money supply has been driven by the
RUR913bn in the first nine months of 2011), while sizeable budget surplus as well as the CBR’s tight
expenditures were slightly above average at RUR759bn. monetary policy. In the remainder of this year the growth
For the first ten months of 2011, the federal surplus figure in the money supply will get a boost from the end of the
stands at 3.2% of GDP, though this is likely to decline to year budget spending increase, which may persist into Q1
less than 1% of GDP by the end of the year due to a 2012 due to electoral factors. For 2012-2014 the CBR
seasonal surge in spending in December, which this year expects growth in the money supply of 13-20%. Despite
is likely to be exacerbated by electoral pressures. The the slowdown in the growth in the money supply,
Ministry of Finance estimates that Russia could post a inflationary pressures are building up in recent periods on
budget surplus of 0.2% of GDP in 2011, which is in line the back of the effects of rouble depreciation.
with our projections for this year.
Russia: Main parameters of the monetary programme
Russia: Federal budget parameters In RUBbn unless Scenario 1
Government forecast DB forecast otherwise mentioned 2011 2 012 2 013
% of GDP 2011* 2012 2013 2011 2012 2013 Monetary base 7 099 7 713 8 672
State budget balance -1.3% -1.5% -1.6% 0.2% -0.4% 0.6% Net international
495 480 462
reserves, USDbn
Revenue 19.3% 20.1% 19.6% 21.9% 20.2% 20.0%
Net domestic assets (7 991) (6 922) (5 401)
Expenditure 20.7% 21.6% 21.2% 21.7% 20.6% 19.4%
Net credit to the broad
Urals oil price, USD/bbl 100 97 101 109 112 117 (5 529) (5 202) (4 801)
government
* - most recently the government forecasted a 0.5% federal budget surplus in 2011
Source: Minfin, Deutsche Bank Net credit to banks (90) 679 1 865
Scenario 2
Despite the strong fiscal performance this year, there are
2011 2 012 2 013
mounting concerns regarding to possibility of high fiscal
Monetary base 7 099 8 058 9 137
outlays in the medium-term due to the already high social
Net international
commitments assumed by the government ahead of the reserves, USDbn
495 521 545
2011-2012 elections, the rising outlays on defense as well
as the projected increases in spending on infrastructure.
Net credit to the broad
In fact outlays as a share of GDP are projected to rise by government
(5 529) (5 698) (6 159)
the Ministry of Finance from 20.8% of GDP in 2011 to Net credit to banks (90) 250 1 092
21.1% of GDP in 2012. The rise in spending commitments
Scenario 3
will result in a further increase in the vulnerability of the
2011 2 012 2 013
budget to a downturn in oil prices – current projections of
the Ministry of Finance assume an increase in the non-oil Monetary base 7 099 8 264 9 452
budget deficit from 10.3% of GDP in 2011 to nearly 11% Net international
495 568 641
reserves, USDbn
of GDP in 2012.
Monetary policy: lower inflation prioritized Net credit to the broad (5 529) (6 589) (7 864)
One of the main achievements in the macro sphere for government
Russia in 2011 has been the attainment of the lowest Net credit to banks (90) 116 565
inflation rate since 1992, which by the end of the year Source: Deutsche Bank
may reach around 7%. Greater focus on inflation the part

of the CBR, which was accompanied by greater exchange We expect the rouble nominal rate next year to appreciate
rate flexibility, was a crucial factor in improving Russia’s versus the dollar towards Rb/USD28, given DB’s high oil
inflation track-record. Improved focus on inflation was also price forecast as well as the possibility of net capital
inflows in the second half of 2012 – in line with our and

government’s expectations. Provided the CBR continues notable decline in the popularity ratings of Vladimir Putin,
to target low inflation and allow greater exchange rate we expect Putin to secure his third presidential term in the
flexibility we believe that inflation may stabilize around 7% first round of the presidential elections with more than
in 2012, though upside risks associated with high fiscal 50% of the vote.
spending may be significant. Still, given that in 2012 we
expect both inflation and growth rates to remain close to Russia: : Putin and Medvedev approval ratings
90
2011 levels, we do not expect significant swings in policy
85
rates. During its November meeting the CBR ruled to
keep key policy rates on hold and noted in its statement 80
that the current level of interest rates is consistent with 75

balancing inflationary and growth slowdown risks. 70
BOP: breaking the streak of capital outflows 65
One of the key negative developments in 2011 was the 60

persistence of net capital outflows from Russia, which
55
largely deprived the economy of the benefits of a
favourable high oil price environment. The government 50
2007 2008 2009 2010 2011
projects net private capital outflows of 80 bn dollars in Percentage of Putin supporters, % Percentage of Medvedev supporters, %
2011, which implies that capital outflows in November - Source: Levada Centre, Deutsche Bank
December are projected to reach 16 bn dollars. According
to government estimates the scale of outflows in As regards the parliamentary elections scheduled for
November was significantly lower than in September- December 4, the popularity of the ruling United Russia
October, possibly reaching around 10 bn dollars. For 2012 party declined in November. The Levada-center poll
the government projects net outflows of 20 bn dollars, conducted at the end of November showed that support
while in 2013-2014 the Ministry of Economy expects net for United Russia tumbled 7ppt to 53%, which is an all-
inflows, with the trend towards inflows likely to emerge in time low for the two past electoral cycles (in the fall of
H2 2012 according to the Ministry. We share the view 2007, support for the party stood at nearly 70%). At the
that inflows are likely to materialize next year and believe same time, support for the communists increased from
that there is scope for net inflows in 2012 on the back of 17% to 20%, and for LDPR it grew from 11% to 12%,
improvements in the investment climate, though much with notable gains also observed for Yabloko and Justice
will continue to depend on global factors. Russia. The eventual outcome of the elections is likely to
As regards the current account, the high oil price be a simple (rather than a constitutional) majority for the
environment (as projected by DB for 2012) as well as the ruling United Russia party, with the nationalistic LDPR
moderation in the growth in imports (partly coming on the party possibly securing close to 15% of the vote, which
back of a weaker rouble) are likely to result in the may enable the Kremlin to retain the possibility of
persistence of a relatively high surplus of more than 4% of securing constitutional majority on key issues, since LDPR
GDP. In the medium-term the expansion in imports may tends to support the Kremlin in the Duma.
be given additional impetus by WTO accession as well as While the results of both parliamentary and presidential
imports of capital goods to support the efforts of the elections are predictable and do not suggest a significant
authorities to develop infrastructure. departure from the current political framework, the decline
Politics: Putin to come back as President in the popularity ratings of Putin and the ruling United
The main political event of 2012 will be the presidential Russia party may be of some concern with respect to the
elections scheduled for March 2012, though the main commitment of the new government to pursuing reforms
intrigue regarding the outcome of the elections has largely in a post-electoral setting. In particular, further declines in
been resolved after earlier this year current President the popularity of the authorities may constrain the scope
Dmitry Medvedev called for Prime Minister Putin to run for some of the more difficult reforms such as pension
for presidency. In November, support for Putin declined reform or increases in regulated tariffs. There is also a risk
remained at 67% compared to 66% in October, and of greater proclivity towards higher fiscal spending in the
Medvedev’s remained stable at 62%. The new popularity social sphere as a way to limit further declines in
rating of Putin is close to an all-time low of 60% since the popularity ratings.
start of his presidency in 2000-2001. The sizeable decline
in the popularity ratings of the ruling party and the Putin- Yaroslav Lissovolik, Moscow, (7) 495 933 9247
Medvedev tandem may be in part a pent-up demand for Ilya Piterskiy, Moscow, (7) 495 933 92 30
greater changes with respect to improvements in
governance and the reduction in red tape. Despite the

Investment strategy Russia: Deutsche Bank forecasts

2010 2011F 2012F 2013F
FX: Economic uncertainty, lack of transparency, fears of a National Income
Euro recession and political uncertainty point to outflows Nominal GDP (USD bn) 1 480 1 757 2 027 2 282
of around $80bn. Capital flight is likely to diminish going Population (m) 141.9 141.8 141.7 141.6
into the March elections and also likely to moderate in GDP per capita (USD) 10 427 12 390 14 305 16 118
response to the WTO finally approving Russian
membership after 18 years of negotiations - FinMin's Real GDP (YoY %) 4.0 4.5 4.6 4.9
latest estimate is for outflows to slow to $20bn in 2012. Priv. consumption 3.0 7.0 7.0 7.0
RUB will continue to be highly sensitive to oil prices, but Govt consumption 1.4 2.7 -0.7 -1.2
the budget plan for next year is based on crude at $95 on Investment 6.0 7.0 8.0 7.0
average (Urals), which does not seem unrealistic (DB Exports 11.1 0.2 4.0 4.0
Commodities forecasts Brent to average $115/barrel in Imports 25.4 6.1 9.0 10.0
‘12). On balance, the outlook for capital flows, WTO
membership, oil price assumptions, the fact that FX Prices, Money and Banking (eop)
remains a key tool for the CBR to counter price pressures CPI (YoY %) 8.8 7.1 7.0 6.8
as well as the fact that the RUB basket is still trading well Broad money 28.5 20.0 20.0 20.0
Credit 13.0 21.0 17.0 18.0
above not just pre-2008 crisis levels, but also 7% above
the levels prior to the Aug/Sep sell-off, imply there is
scope for RUB outperformance. Short 'oil' pair NOK/RUB,
State budget balance -3.9 0.2 -0.4 0.6
for a move down to the around 51 with s/l at 54.
Revenue 18.2 21.9 20.2 20.0
Henrik Gullberg, London, (44) 20 7545 9847 Expenditure 22.1 21.7 20.6 19.4
Siddharth Kapoor, (44) 20 7547 4241 Primary surplus -3.5 0.7 0.1 1.1
Rates: OFZs likely to perform in 2012. Despite a strong External Accounts

(USDbn)
Exports 400 505 519 541
fiscal performance, record low inflation and high oil prices,
Russia was not immune to the effects of global risk Imports 249 310 360 421
aversion. Large capital outflows caused a liquidity Trade balance 151 195 159 120
% of GDP 10.2 11.1 7.8 5.2
tightening, despite a record increase in Repo funding by
Current account balance 71.1 104.0 83.0 44.1
the CBR. Russian rates are already pricing a sufficiently
% of GDP 4.8 5.9 4.1 1.9
cautious global scenario and we prefer to take profit on
FDI (net) -10.5 10.0 12.0 12.0
our 2s5s flattener (initiated at 75bp, current 35bp). The
FX reserves (USD bn) 479 520 590 654
prospect of Euroclearability for OFZs as early as June
RUR/USD (eop) 30.5 28.2 28.0 28.4
2012 is likely to lead to inflows from foreign investors (we
estimate this at about USD 9bln), since the only RUB Debt Indicators (% of GDP)
sovereign Eurobond, issued this year, is trading close to Government debt 7.3 7.9 9.1 9.3
90bp tight to OFZ. Therefore, we expect bonds to have a Domestic 4.6 5.9 7.1 7.3
positive performance in 2012. An easing of 3M Mosprime External 2.8 2.0 2.0 2.0
levels would be a signal to receive rates Total external debt 32.6 27.3 25.2 25.0
in USD bn 483 480 510 570
General (% pavg)
Credit: Overweight. WTO accession and the passage of
Industrial production (% YoY) 8.2 5.2 5.4 5.4
elections make 2012 an important year for Russia. While
we are not very optimistic that the return of Putin to the
Kremlin will spur reform, we believe that the market
currently prices an excessive risk premium.
Policy rate (refinancing rate) 8.25 8.00 8.00 8.00
RUR/USD 30.7 28..2 28.1 28.0
Source: Official statistics, Deutsche Bank Global Markets Research

South Africa A3 (negative)/BBB+ (stable)/BBB+ (stable)

Moodys/S&P/Fitch
 Economic Outlook: The much weaker growth base This mediocre growth performance is an extension of the
in Q2 and Q3 makes for encouraging rebound soft patch that had started in Q2 (1.3% from 4.6% in Q1)
potential in growth into 2012. We do not expect a and from unsustainable growth momentum in the
recession locally, as we estimate this probability manufacturing sector late 2010. While there has been a
between 10-15%. Household demand is expected to series of one-off events (eg. strikes and production
be the main growth driver in 2012. stoppages) that weighed more heavily on the mining,
manufacturing and agriculture sectors, the weakness was
 Main Risks: Deteriorating global growth, negative
not entirely due to local factors.
repercussions for terms of trade could severely harm
corporate profits. From these risks stem employment However, we expect positive growth momentum going
losses, which will offset the benefit of lower forward, and expect household demand to become the
commodity prices on inflation. dominant growth driver next year. That said, risks to this
view are likely to increase if global growth falls below 3%
 Strategy Recommendations: Buy a 1y digital
next year. At global growth below 3%, the risks of weaker
EUR/ZAR put struck at 10 for roughly 25% of EUR
commodity prices, which trigger potentially deeper
notional. ZAR curve set to steepen. Underweight
destocking in China, will have negative ramifications for
sovereign credit.
the economy. As it stands, our export exposure to Europe
Macro View leaves us vulnerable to a more meaningful slowdown next
year. This has raised several questions over the likelihood
Risks to global economic growth are tilted to the of the economy falling into recession next year.
downside, despite global efforts to limit deeper growth
Before examining recession probabilities, below we briefly
contagion from the EU. Concerns have surfaced that the
discuss our main arguments against recession risks:
domestic economy’s significantly weaker-than-expected
growth performance this year means that we could be a Financial conditions are less stringent for consumers
lot closer to another recession. We believe these than during the crisis period: We explore the main
concerns are misplaced. We do not foresee significant financial vulnerability metrics in the Figure below. The
risk of recession in the economy next year; indeed, we heat map depicts the highest vulnerability in shades of
estimate the likelihood to be between 10-15%. Our red, with yellow and greener shades showing neutral to
reasons are outlined below. This analysis is supplemented low levels of vulnerability. On average, the household
with base and bear case scenarios for those key business vulnerability index43 in 2Q11 was close to 2006 levels, the
cycle indicators that are considered to be timely signals of midst of the previous boom period, but with the key
recession risks. In short, substantial slippages need to difference that employment, financial markets’
occur in global growth, commodity prices, and, by performance, house price growth and real disposable
extension, corporate profits, to raise the probability of income were much stronger in 2006 (one- to two standard
recession to higher levels of conviction. deviations above the long-term mean). Whereas
employment growth generally lags the economic cycle,
A weaker global economy...: Our European colleagues there has been very modest improvement in 2011, which
have cut near-term growth expectations to -0.5% from we believe could be sustained next year. The overall
0.4% for 2012, as downside risks to the sovereign debt financial position of households is also in a far healthier
crisis are developing into the baseline view. Though we state than in 2008, when most indicators were more than
acknowledge the risks, DB still remains of the view that a two standard deviations away from the long-term mean
euro break-up is not on the cards. The US is expected to (negative). Therefore, the envisaged slowdown in
grow even if the euro area contracts. Asian growth should household demand to 3.3% next year, from DBe of 4.2%
remain generally resilient, though with some momentum in 2011, is mostly a result of high base effects,
loss in the near term. We maintain a fairly robust outlook consolidating net wealth, and rising inflation. We do not
for EM growth, but remain cautious of increasing believe that any of these key consumer metrics could
downside risks. Within this context we remain cautiously deteriorate significantly, without a new negative catalyst.
optimistic on South Africa, expecting growth of 3.2% next
year from 3.1% in 2011 (revised from 3.3%).
43
Domestic growth artificially depressed in Q2 and Q3: Scores are assigned based on the indicator’s deviation from its long-
Economic growth improved in Q3 to 1.4% qoq saar but at term mean, with the highest score of 25 indicating extreme vulnerability,
and zero, low vulnerability. These scores are normalised to a total out of
a more sluggish pace than we had expected (DBe 2.5%). 100.

South Africa: Household vulnerability heat map currently nearly one-and-a-half times the size at the start
Historical 2006-2011 Average of 2008. Barring much weaker global growth,
Ave. Max Min Latest
Score Score Score
2Q11
Outlook retrenchments should be light in comparison with the
2006 2008 2010 *
Debt-serivce-income
9.4 12.7 6.9 6.9 10 21 9 5 Stable
2008 cycle, as corporates have not employed excessively
ratio (%)
GDP growth
3.1 6.7 -5.9 1.3 9 15 13 15 Positive
since then.
(qoq saar %)
Employment
(non-farm - yoy %)
2.9 13.9 -4.1 2.0 4 15 16 10 Stable
Monetary policy has room to manoeuvre: In the event
Financial assets
(yoy %)
12.5 28.7 -12.9 15.5 5 18 10 10 Stable
that recession risks do rise, the Bank has the option to cut
House price (yoy %) 7.2 16.1 -3.5 1.9 5 15 14 15 Stable
interest rates. Even in the absence of further monetary
6.2 13.2 3.5 4.6 10 21 8 10 Negative
policy relaxation, real rates are likely to decline further next
Inflation (yoy %)
Insolvencies (yoy %) 22 137 -43 -36 10 21 6 5 Stable

Net wealth-to-debt ratio
366 414 319 357 10 14 14 15 Stable
year to between -1 and -2%, which remains a tailwind for
(%)
Household debt consumer demand.
13.7 27.3 2.0 6.7 20 13 8 10 Stable
(yoy %)
Disposable income
(yoy %)
3.6 8.3 -4.9 3.8 6 18 10 10 Stable Export growth is more geared to EMs than before: A
Savings-income ratio
(%)
-0.6 -0.1 -1.3 -0.2 16 19 9 5 Stable point often missed in the context of export vulnerability is
that despite the importance of DMs in the export basket
(c. 55% of total rand exports), these economies only
Average score (total
38 69 42 40
out of 100)
*The outlook is based on the expected movement in the score relative to the current quarter.
Source: Deutsche Bank, SARB, StatsSA, I-Net Bridge
account for 30-40% of export growth, versus 80-90%
eight years ago. Though quite cyclical at times, China’s
Replacement needs exist for previously overextended portion of the EM growth share has reached more than
indebted households: We proxy pent-up demand as the 50%. We remain constructive on the Chinese economy,
trough-to peak increase in the ratio of durable goods to despite the modest momentum loss over the next few
total HCE in the first two years after a recession. On this quarters.
basis, we saw the strongest increase in the durable goods
ratio to HCE on record between 2Q09 and 2Q11. Most of South Africa: EM a strong force behind export growth
this demand probably originated from higher income 45 % contribution to exports yoy
earners supported by rising net wealth. In light of signs of
30
improving bad debt records, which we believe is mainly a
middle-to low income constraint; there is scope for more 15
replacement demand in our view. In addition, any upside
from modestly higher loan growth in the property market 0
should count as a bonus. -15

Emerging markets ex China
Several cyclical components of GDP are still -30 China
suppressed: The typical downward adjustments in Advanced economies ex Europe
-45 Europe
economic activity arise in the cyclical components of GDP
2003 2004 2005 2006 2007 2008 2009 2010 2011
– eg investment in residential property, transport- and
machinery equipment and durable and semi-durable Source: Deutsche Bank, IMF
goods, and business inventories. Of these indicators, only
spending on durable and semi-durable goods and Downside risks remain: From these arguments, we view
investment in transport has really recovered over the past downside risks to corporate profits, and commodity prices
few years. Residential and machinery and equipment are (terms of trade) – which could scupper our growth call for
still at rock bottom levels44, which mean there is very little next year should these really disappoint. We believe that
downside pressure to growth that could arise from these terms of trade gains this past year-and-a half has been an
indicators important cyclical driver of corporate profits, and do see
scope for moderation. However, as indicated below,
Strong corporate balance sheets: Robust corporate these indicators will have to fall dramatically in order to
profit growth in 2011, reaching 13.6% yoy in Q3 should materially weaken the growth dynamic. Should the global
bring gross corporate savings to the best levels in thirty economic recovery take a turn for the worse, in which
years. Corporate profits usually slow sharply ahead of a case corporates will battle to push rising costs through
recession, which is typically the reason for a dramatic the system, corporate profit margins will come under
downsizing of the workforce. But corporates are much pressure. The negative knock-on impact this will have on
leaner in this cycle. Profit per private sector worker is employment should offset the benefit of lower
commodity prices on inflation, in our opinion.
44
See EM Monthly: South Africa, 8 December 2010.

Turning to our recession probability gauge, we yield curve than what would normally be the case for
estimate a very low probability of recession next year economic downturns.
of between 10-15%. These estimates (from models 2 and
Implications for the C/A deficit: a function of savings:
3 in the Figure below) are based on the base view of
All in, we expect a modest widening in the current
slowing, but not contracting growth, barring the G7
account deficit to 3.7% in 2012, from 3.1% this year. Only
leading indicator. Using the benchmark leading indicator
part of this widening is attributed to a deteriorating trade
of the SARB (model 1) we estimate a 45% probability of
balance. This is in contrast to the string of surpluses this
recession in early 2012, if we assume the index level
year that had been supported by a widening in the savings
remains stable next year. In defence, we have to say that
investment gap, stemming from healthy operating
the SARB leading indicator has given three false signals of
surpluses and terms of trade gains. However the very
recession risks over the last three decades, and hence
modest improvement in private investment spending of
prefer models 1 and 2, which also have stronger
late, coupled with a larger fiscal deficit has begun to
forecasting capabilities (second figure below). For the
counter prospects of a sustained low C/A deficit.
leading indicator, we find firm levels of conviction at 70%
and above, which is worth monitoring closely. ... and private sector investment: While insufficient
demand and underlying political concerns, according to
South Africa: Recession probability model* inputs and the Bureau for Economic Research 4Q Manufacturing
assumptions survey, are amongst the main reasons for reduced
2011 2012 forecast assumptions
investment intentions, this sentiment is not evenly shared
YTD Base Prob. Bear Prob.
1. SARB leading indicator (yoy %) 2.9 0 45% -5.5 85%
amongst industries. An important feature from the survey
2. Model incorporating DM growth 15% 99% is that most manufactures, however, are not looking to
Real money supply growth 1.8 0 -2 invest in additional capacity, replacement investment or
Insolvencies (number) 731 450 1050
inventories over the next twelve months, which seem to
Yield curve (10yr-jibar) 2.9 2.8 4.7
G7 leading indicator (yoy %) 2.9 -1 -4
suggest that imports may not necessarily be buoyed.
3. Model incorporating corporate
10% 95%
Indeed, only retail-orientated industries seem somewhat
profits/commodities
positive in for the next year, but their contribution to total
Real money supply growth 1.8 0 -2
investment is less than 15% and they are smaller than the
Yield curve (10yr-jibar) 2.9 2.8 4.7
Real corporate profit growth (yoy %) 7.6 3.7 -1.1 larger capital-based industries. We therefore maintain our
Terms of trade (yoy %) 5.7 1.2 -4.5 view of fixed investment spending growth of c. 3% next
*Based on a binary response model using maximum likelihood techniques.
Source: Deutsche Bank, SARB, I-Net Bridge year.
Plus government dissaving: Our expectations of a fiscal

South Africa: Estimated probabilities of recession deficit of 5.4% of GDP (vs NT est. Of 5.2%) next year,
100% Est.
implies that corporate and households will have to save
more for the C/A to remain under control. We think this is
unlikely. On the public side, downside risks to the
Bear
Treasury’s existing growth forecasts of 3.4% in 2012
50% should mean that fiscal consolidation could be
challenging. These factors could be less constructive for
the bond and rand market.
Ba se With a weaker rand as the upshot: Our revised rand call
0%
1984 1989 1994 1999 2004 2009
of 8.2, 8.4 and 7.9/USD in 3m, 6m and 12m time
Probability range from recession models incorporates our view of a weaker terms of trade dynamic
Downswing
Recession probability: leading indicator as discussed in this note. Though the rand will be
Source: Deutsche Bank susceptible to risk events in either direction, our house
view of a stronger dollar in 1H12, coupled with the
The bear case scenario, which we attach a low probability potential underperformance in EM equities, implies that
to, is consistent with events linked to systemic contagion the rand should be range-bound between 7.80 and 8.60
in banking and financial markets, and a deeper downturn over this period. In times of risk on trades, the rand could
in advanced economies. The bear case scenario provides test 7.50/USD, in our view. Though balance of payments
guidance of trends that have historically been associated risks should be largely contained, South Africa’s net
with economic downturns. We tweaked the yield curve to redemptions of R9.7bn worth of foreign bonds in 2012
incorporate a bearish scenario of stagflation, in which could make the rand vulnerable during risk-off periods.
case we think the SARB could react to by cutting interest
Monetary policy held hostage: Finally, our long-held
rates by 100 basis points, thus initiating a much steeper
view of an inflation episode in 2012, which appears to

have become a consensus view, should mean lower rates South Africa: Deutsche Bank Forecasts
for longer and a slower adjustment when the need arises. 2010 2011F 2012F 2013F
We expect the onset of a 150bps cycle starting in National Income F
November next year, in three 50bps increments. Nominal GDP (USD bn) 364.6 411 404 444
Population (mn) 50.0 50.5 51.0 51.5
Danelee Masia, South Africa, (27) 11 775 7267
Investment Strategy Real GDP (YoY%) 2.8 3.1 3.2 3.8

Priv. consumption 4.4 4.3 3.3 3.7
FX: Has sold off 21% vs USD and 22% vs EUR YTD, and
is the worst performing currency in EM. It is worth
Gross capital formation -3.7 2.4 3.1 4.2
remembering that in 2009/10, ZAR was among the top Exports 4.7 1.7 -2.4 8.5
performing EMFX, and again was preceded in 2008 by Imports 9.6 5.3 0.9 6.9
being one of the worst performing. Rand remains very
much the default risk-on/off choice, regardless of solid Prices, Money and Banking
fundamentals such as very limited gross external financing CPI (YoY%, eop) 3.5 6.4 6 6.4
requirements (less than 10% of GDP) and a relatively
attractive long-term valuation. This would suggest that the Fiscal Accounts (% of GDP) (fiscal years)
fate of the rand will be determined by European rather Budget surplus -6.6 -5.5 -5.4 -5
than domestic factors. Our preference remains to express Expenditures 33.8 32.6 32.1 31.4
constructive ZAR views through RV, where the macro risk Revenues 27.2 27.1 26.7 26.4
component is reduced. More favourable geographic Primary surplus -4.3 -2.9 -2.7 -1.9
location (vs Hungary) warrants a ZAR/HUF rate closer to
the upper 1SD band away from the mean over the past 10 External Accounts (USD bn)
years, suggesting scope for a 10% move towards 31. Exports 85.4 101.1 92.4 104.3
Alternatively, buy a 1y digital EUR/ZAR put struck at 10 for Imports 81.6 98.8 94.3 105.0
roughly 25% of EUR notional - giving a risk/reward of 4:1. Trade balance 3.8 2.3 -1.9 -0.7
% of GDP 1.1 0.6 -0.5 -0.2
Henrik Gullberg, London, (44) 20 7545 9847 Current account balance -10.1 -12.7 -15.1 -16.3
Siddharth Kapoor, London, (44) 20 7547 4241 % of GDP -2.8 -3.1 -3.7 -3.7
FDI(% of GDP) 0.3 1.5 0.5 1.5
Rates: Curve set to steepen The SARB is unlikely to ease
FX reserves (USD bn) 43.8 50.5 55 58
monetary policy in the first half of the year despite the
USD/ZAR (eop) 6.6 8.0 7.9 8.3
ongoing slowdown in the global economy. At the same
EUR/ZAR (eop) 8.8 10.3 10.7 10.4
time, the reliance on continuous non-resident interest to
absorb the heavy pace of issuance means that the back-
Debt Indicators (% of GDP) (fiscal years)
end performance has become linked to the unpredictable Government debt 37.1 40.3 41.8 42.5
developments in Europe. Our analysis suggests that the Domestic debt 33.5 36.9 38.5 39.5
curve is too flat to fair value. At times of risk-aversion, the External debt 3.6 3.4 3.3 3
local bid for bonds became apparent only at levels Total external debt 22.5 20.8 22.0 22.0
corresponding to 5Y5Y higher than 9%, while the same In USDbn 83 85.5 88.7 97.6
point is unlikely to move lower than 8.40% without a
resumption of expectations for monetary easing. Financial Markets (eop) Current 3M 6M 12M
Policy rate 5.5 5.5 5.5 6
3-month rate (Jibar) 5.6 5.6 5.6 6.1
Credit: Underweight. The combination of increased 10-year rate 7.8 8.5 8.2 8.5
gross issuance ahead, coupled with the fact that EUR/ZAR 10.8 10.4 10.5 10.7
dedicated investors are already relatively overweight the USD/ZAR 8.1 8.2 8.4 7.9
credit persuades us to be cautious. Furthermore, as our
vulnerability indicators highlight, SA is not entirely immune
to the risks which characterise much of EMEA. In addition
to moving back to underweight from neutral, we also
close our recommendation to sell 5Y CDS protection, vs.
Brazil.
Marc Balston, London,( 44) 20 7547 1484

Turkey Ba2 (positive)/BB (positive)/BB+ (stable)

Moody’s / S&P / Fitch
 Economic Outlook: Rebalancing in the economy significantly over the past two years reaching a total of
continues with domestic demand slowing down $57bn in September (including FX credits received and
gradually and imports losing momentum. Inflation will deposits of international banks at local banks – showing
continue to rise in the short term due to FX pass- no signs of weakness yet). Arguably the size of this
through and higher food prices. exposure at 16% of the outstanding credit stock may be
not be extremely large, but nevertheless short term funds
 Main Risks: A harder landing is on the cards given
received from international banks have played a greater
the large exposure to short-term funding from
role in financing local credit expansion over the past two
international banks, balance sheet effects of a weaker
years. While the rise in such exposure has increased
currency and volatility in capital inflows.
rapidly, deposit growth has remained relatively flat as the
 Strategy Recommendations: Having hit the target loan to deposit ratio increased to about 100% from just
on long TRY/HUF, we recommend playing the range below 80% two years ago. Some large banks have rolled
in USD/TRY. Buy a DnT with strikes at 1.70 and 1.90. over sizable syndication borrowings in November at
Add exposure to Jan-20 bonds if the economy reasonable spreads (100bps) and yet conditions (price and
responds to the ongoing tightening. Overweight availability) are likely to deteriorate in the months ahead.
sovereign external debt. We also note that prolonged risk off sentiment is likely to
affect other sources of capital inflows. The vulnerability of
Macro View the capital account surfaced in August, as the balance
was close to zero with the current account deficit (CAD)
Revising our growth outlook given that risks are much being financed entirely by decline in reserve assets. The
closer to becoming a reality September figures showed a recovery with sizable
Since last month, conditions in Europe seem have inflows from the usual suspects, the errors and omissions
worsened and that has been reflected by the significant component, short term borrowing and drawdown of FX
downward revision of growth forecasts for the region for assets held abroad by local banks. Given that the CAD will
next year. This will impact Turkey mainly through three decline but remain elevated, its financing will continue to
channels. First, exports to the region are likely to remain be a source of vulnerability in the year ahead.
weak, a hindrance to the already weak recovery in external
demand. The share of exports to the EU have declined Turkey: Banking loans, deposits and ST external
significantly over the past four years and continued financing
weakness in the area will be a drag on export recovery 120
unless exports to other markets gain strength (see chart 100
below). The expected sharp de-levering in EU banks will
80
have implications for local banks despite the relatively
60
limited organic ties between the local and European
40
banking sectors. Local banks’ exposure to short-term
financing from international banks had increased 20
0
Turkey: Export growth and share of exports to EU -20 ST External Financing (Yo Y)
70% 60% -40 Lo ans (Yo Y)
Depo sits (Yo Y)
58% -60
50%
56% Jan-05 Feb-06 Mar-07 Apr-08 May-09 Jun-10 Jul-11
30% 54% Source: Turkey Data Monitor and DB Global Markets Research
52%
10% 50% Finally, weakening expectations is likely to have some
48% negative impact on the economy. Confidence surveys are
-10%
Expo rts Yo Y (lhs) 46% showing some weakness although with some mixed
-30%
44% results as the PMI has climbed back to over the 50-mark
Expo rts to EU as % o f
to tal (rhs)
42% in September-October. And yet CBT and TUIK surveys are
-50% 40% showing a decline in export orders, consumer confidence
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 has taken a downturn over the past three months and
Source: Turkey Data Monitor and DB Global Markets Research future demand for durable goods has declined sharply
following the strength seen during most of 2010-2011.

Looking at recent developments in the balance of FX For next year, we had emphasized the probability of a
deposits of retail at domestic banks, we can argue that harder landing compared to our original GDP growth
confidence in TRY is also not so strong. Typically retail has projection of 3.2% for some time. With risks now much
sold FX at times of pressure on the exchange rate working closer to becoming a reality and given the downward
as a stabilizer (particularly since 2007). Indeed during the revision to EU growth, we have reduced our 2012 GDP
weakening of the currency in 1H2011 (partly driven by the growth projection to 2.3%. We expect that domestic
CBT’s policy mix), locals sold over $10bn and yet they demand will slowdown significantly next year as
have hesitated to sell in the recent weakening episode (in rebalancing in the economy will continue. We project the
fact have re-built their FX deposits at times of occasional contribution of domestic and external demand to growth
limited appreciation). to be 3.1pp (9.5pp in 2011) and -0.8pp (-2.6pp in 2011),
respectively.
Turkey: Monthly balance of payments
Turkey: Interest rate corridor and benchmark bond

13000 $mn
14 ON B o rro wing ON Lending
1-Week Repo B enchmark B o nd
8000
12 ON M arket
3000 10
8
-2000
6
-7000 Current A cco unt B alance
4
Capital A cco unt B alance
-12000 2
Jul-10 Nov-10 Mar-11 Jul-11
0
Source: Turkey Data Monitor and DB Global Markets Research
May-10 Sep-10 Jan-11 May-11 Sep-11
Source: CBT, Reuters and DB Global Markets Research
Recent developments have led us to revise our growth

outlook. For the current year the pace of deceleration in
Credible policies are crucial for protection against
economic activity has been slower than our expectations. risks, and while fiscal policy continues to provide an
Industrial production (IP) had more momentum than our anchor…
projections expanding by 7.5% YoY in 3Q following the
In our opinion ultimately the severity of financial contagion
7.9% YoY 2Q number. Growth in imports of capital goods
from the eurozone and the credibility of domestic policies
declined in 3Q parallel to our expectations and yet
in maintaining investor confidence will be the key
remained robust (30% YoY) indicating continued strength determinants of the pace of growth deceleration going
in private sector investments. On the other hand, the forward. Fiscal policy remains to be Turkey’s strongest
slowdown in consumption appears to in line with our view anchor in this respect. The primary surplus and overall
based on the developments in leading indicators. We have budget deficit is projected to be close to 2% of GDP and
revised our current year GDP growth to 7% from 6% below 1% of GDP, respectively in 2011. The government
previously. has done relatively well in constraining growth in non-
Turkey: GDP and IP interest expenditure to about 10% YoY through October
while revenues have increased by a strong 18% YoY in
part due to collection of receivables (mainly tax arrears).
20 The government may revise the projections of its medium
15 term economic plan (MTP) released in October depending
10 on global developments as hinted by some authorities.
5 We reckon that the 4% GDP growth projection may be
0 reduced while noting that Deputy PM Babacan has
-5 reiterated that fiscal policy will not be used to mitigate
-10 downside risks to growth and that the budget targets will
-15 remain as is. The pace of convergence in the current
GDP Yo Y IP Yo Y account deficit (CAD) to more reasonable levels is also a
-20
key factor in bolstering investor confidence. Following a
-25
sharp recovery in September, momentum in import
Mar-05 Jun-06 Sep-07 Dec-08 Mar-10 Jun-11 growth declined in October as the YoY expansion was
Source: CBT, Reuters and DB Global Markets Research halved to 15% compared to the average 31% in the
previous three-month period. The YoY expansion in capital

goods and consumer goods fell slightly into the negative policy. Importantly, since loan rates have already
territory (in part due to base effects), which is an early increased significantly due to higher and more volatile
indication of weakening private sector investment and cost of funds, adjusting the repo rate is unlikely to tighten
growth in 4Q as well as a more rapid pace of adjustment policy further but the return to basics and a more
in CAD in the next several months. transparent policy framework will enhance credibility and
provide better protection towards continued volatility in
Turkey: CBT funding mix of banks markets.
80 Turkey: Reserve Requirements and CBT funding of
70 O/N banks
60 1-w eek repos TRY bn
70000
50
50000
40
30000 Required
30 Reserves
10000
20 CB T Funding o f
-10000 B anks
10
-30000
- Increase in
-50000 CB T funding
Oct-11 Oct-11 Oct-11 Nov-11 Nov-11 Nov-11
-70000
Source: CBT and DB Global Markets Research
-90000
Nov-10 Mar-11 Jul-11 Nov-11
…monetary policy needs to be brought back to basics
Large capital inflows driven by monetary expansion in Source: Turkey Data Monitor and DB Global Markets Research
developed economies, appreciation of the TRY (loss of

competitiveness), rapidly growing CAD and bank credit, In recent communication the CBT argued that the net
and to some extent tame inflation were the reasons effect of accomodative repo rates, contractionary liquidty
behind the CBT’s decision to lower its one-week repo and prudential measures, and neutral fiscal policy is
rate, widen the interest rate corridor (mainly by lowering disinflationary. The CBT believes that they have already
the overnight borrowing rate) and increase reserve done the necessary tightening to bring inflation down to
requirements back in December. The result was a 5% next year following the temporary rise. Governor
significant weakening of the TRY and gradual weakening Basci recently argued that tighter liquidity conditions and
in loan growth with some help from measures by the stability in the exchange rate (indicating that the 25%
banking sector authority. The conditions have reversed depreciation will have caused close 4pp pass-through)
since October and monetary policy has responded but not should facilitate the convergence in headline inflation to
by a complete reversal of the policy tools used back in the target also given that the CBT does not expect
December as the CBT logic would call for, but through the consumption tax increases next year of the kind seen in
initiation of yet another unorthodox dimension of an 2011 (on tobacco and other selected items). While
already unorthodox monetary policy mix. Overnight inflation will continue to increase in the balance of the
lending rate has been increased and reserve requirements year due to the expectation of a spike in unprocessed
have been decreased while the one-week repo rate held food prices in November and lagged FX pass-through, the
constant. Since then the CBT manages the volume of one CBT argues that CPI will start its decent in January next
week repo funding to ensure that market overnight rates year. We note that, and as acknowledged by the CBT, the
are sufficiently high (closer to the 12.5% upper band of CBT’s year-end inflation is likely to be significantly higher
the corridor) to stabilize the exchange rate. In the mean than the forecast presented in the October inflation report.
time a number of changes on reserve requirement rules In our opinion continued monetary experimentation may
(decline in TRY reserve requirements, allowing the banks lead to greater risks in an environment of rising inflation,
to hold a greater share of TRY requirements in FX and persistent troubles in the EU and volatility in capital
gold) have increased liquidity and allowed the CBT to inflows.
decrease its total funding of the banks (see chart above). Cem Akyurek, Turkey, (90) 212 317 0138
The CBT has traded exchange rate stability for interest
rate volatility as the latter has fluctuated significantly
depending on the strength, or lack thereof, pressure on
the TRY (see chart above). We believe that adding more
durability to the policy stance by raising the repo rate
would go a long way in bolstering confidence in monetary

Investment Strategy Turkey: Deutsche Bank Forecasts

2009 2010 2011F 2012F
FX: The lira is one of the worst performing currencies this National Income
year, having lost 19% vs the USD and 21% vs EUR. Nominal GDP (USD bn) 615.1 734.9 759.5 764.4
Despite the u-turn from the CBT on Oct 26th and their Population (mn) 72 73.7 74.0 74.3
subsequent attempt to beef up TRY the lira remains very GDP per capita (USD) 8,519 9,968 10,263 10,288
weak. We expect the lira to be broadly range-bound with
the upside limited at around 1.90 by CBT Real GDP (YoY%) -4.7 8.9 7.0 2.3
intervention/policy and expectations (at least as expressed Priv. consumption -2.3 6.5 7.2 2.4
by the CBT in the latest minutes) that the CA adjustment Gov't consumption 7.8 1.9 3.6 1.0
will become more visible in the coming months due to Gross capital formation -19.2 30.0 17.4 5.2
domestic demand weakening and loan growth Exports -5.4 3.7 7.2 11.1
deceleration. At the same time the downside in USD/TRY Imports -14.4 20.7 14.9 11.5
should be confined to around 1.75. Part of this stems
from the fact that downside risks to growth have Prices, Money and Banking
increased but also that any narrowing of the C/A deficit is CPI (YoY%) 6.5 6.4 9.2 6.4
likely to be gradual and from high levels. Our long Broad money (M2Y) (YoY%) 11.8 21.9 18.5 13.0
Bank credit (YoY%) 10.8 39.0 25.0 10.0
TRY/HUF (14 Oct) trade has worked well (target hit Nov
14), returning 9%. At current levels we recommend
trading the ranges in USD/TRY. Otherwise, buy a DnT with
strikes at 1.70 and 1.90 costing roughly 30% of USD
Interest Payments 4.4 4.4 4.0 4.0
notional - giving a risk reward of roughly 3:1.
Primary balance -1.1 0.8 2.5 2.5
Siddharth Kapoor, London, (44) 20 7547 4241 External Accounts (USD bn)
Rates: Add exposure to Jan-20 bonds if the economy Merchandise imports 134.5 177.2 220.9 259.3
responds to the ongoing tightening. We estimate that Trade balance -24.8 -56.4 -85.0 -91.1
Turkey is real money manager’s largest underweight. This % of GDP -4.0 -7.7 -11.2 -11.9
is explained by the complex policy mix being pursued by
% of GDP -2.3 -6.6 -9.4 -8.4
the CBT and the current rise in inflationary pressures. On
FDI (net) 6.1 7.2 9.5 13.0
the other hand, a slowdown in the global economy could
help Turkey’s rebalancing and some leading indicators of
FX rate (eop) USD/TRY 1.52 1.54 1.85 1.85
inflation have already slowed down. We expect that by
the end of Q1, some investors may be ready to increase
exposure to Turkey, particularly if longer dated bonds 45.0 42.2 40.0 39.0
Government debt
continue to trade close to 10% and if oil levels do not rise Domestic 32.9 30.1 27.9 27.0
further than current levels. External 12.1 12.1 12.1 12.0
Lamine Bougueroua, London, (44) 20 7545 2402 Total external debt 42.9 35.4 40.8 39.2
In USD bn 271.1 265.0 309.6 300.0
Credit: Overweight. While we remain concerned about Short-term (% of total) 19.2 23.4 27.5 25.1
the direction of monetary policy and the risks of a hard
landing for the economy, it is undeniable that from a General (YoY%)
sovereign credit perspective Turkey looks fairly positive. Industrial production -8.9 13.2 6.0 4.0
Given the healthy primary surplus, moderate debt stock Unemployment 13.5 11.9 9.9 9.9
and low real rates, the credit spreads on bonds of well
above 300bp seems incongruous. Certainly some Financial Markets (end) Current 3M 6M 12M
premium is warranted given the aforementioned risks, but period)
Policy rate 5.75 5.75 5.75 7.00
Turkey’s debt dynamics are considerably less vulnerable Benchmark bond rate (comp.) 10.95 10.75 10.50 11.50
than in the past. Relative to the EM sovereign market as a USD/TRY 1.8500 1.8500 1.850 1.850
whole Turkey credit is cheap on a historical basis. We Source: DB Global Markets Research, National Sources
maintain an overweight recommendation.

Ukraine B2(stable)/B+(stable)/B(stable)
Moody’s/S&P/Fitch
 Economic Outlook: Growth has been robust but is continue. Most recently IMF officials signalled that the
set to soften on the back of rising macroeconomic main outstanding conditionality item related more to the
risks. Inflation pressure should also ease. fiscal position of Ukraine and the budget for 2012 rather
than increases in gas tariffs per se. The line taken by
 Main Risks: Hryvnia weakness on the back of the
Ukraine’s government representatives is that the
deteriorating balance of payments remains a risk
necessity for increases in gas tariffs will be eliminated in
 Strategy Outlook: The negative skew of risks case Ukraine secures a gas tariff discount from Russia,
warrant a bearish position in NDFs. Underweight which would in itself be a significant factor in improving
sovereign external debt. the financial position of Naftogaz. While it is not clear
whether this creates scope for some concession to
Macro outlook Ukraine on the issue of gas tariff increases, we do see the
possibility of the IMF programme coming back on track in
In the macroeconomic sphere the key vulnerability relates
the first half of 2012, especially if a deal with Russia on
to the widening current account deficit, which in January-
lower gas prices is secured.
October 2011 reached USD 7 bn compared to USD 1.4 bn
in the same period of 2010. According to the NBU one of In this respect in November Ukraine's media reported that
the reasons for this apart from high fuel import costs is a Russia and Ukraine have agreed to reduce the gas price
USD 6 bn YoY increase in imports of capital equipment by nearly half to USD220-230/mcm from USD355/mcm in
and machinery, partly due to the development of 3Q11 and an estimated USD400/mcm in 4Q11 saving
infrastructure associated with Euro-2012. The rising capital USD500m per month for Ukraine according to PM Nikolai
outflows amid a growing current account deficit led to a Azarov. However, according to Russia’s PM
USD 0.8 bn decline in the forex reserves to USD 34.2 bn representative, the discussions were still ongoing. A
by the end of October as well as pressure on the Hryvnia. compromise on the price discount could be attained in
According to the head of the NBU Sergey Arbuzov greater exchange for preferences to Russian investments into
exchange rate volatility could emerge in 2012 in case BoP Ukraine as well as the possibility that Ukraine would also
conditions were to deteriorate further. At the same time provide access to its gas transportation system. Most
Arbuzov noted that until the end of 2011 the Hryvnia recently Gazprom’s CEO Alexey Miller declared that the
exchange rate would remain stable. At this stage we talks could be completed in 2011.
retain our projection of a stable Hryvnia exchange rate for
On the political front there are signs of renewed instability
2012, though we do note the intensification of downside
building up around the arrest of ex-PM and a prominent
risks, which will be partly also a function of the volatility in
member of the opposition Yulia Tymoshenko after the
global financial markets and competitive pressures
parliament declined to decriminalize her abuse of power
coming from the dynamics in the rouble.
offence. This put further pressure on Ukraine’s
Despite the rising external accounts risks, Ukraine’s GDP relationships with the EU, with risks that an FTA
growth accelerated towards the end of the year boosted agreement between may not be concluded in December.
by higher household spending, agricultural production and The tension with the West and the increasing domestic
fixed investment growth. According to preliminary figures opposition may further point the current administration
GDP growth accelerated to 6.6% YoY in Q3 2011 towards assistance from Russia. In this respect a possible
compared to 3.8% YoY in Q2 2011, and 5.5% YoY in the discount in the gas price for Ukraine would serve to
first 10 months of 2011. The government is projecting reduce the deficit of Naftogaz without hiking the gas
Ukraine’s GDP growth to reach 4.7% in 2011. For 2012 prices for the population. The latter would be an
the government has downgraded its projection from 5.5% unpopular measure ahead of the fall 2012 parliamentary
to 4%. We have also downgraded our projection to 3.9% elections, while the reduction of Naftogaz deficit is
for 2012 on the back of rising macroeconomic risks. essential for putting the IMF stand-by program back on
track. Overall, political risks are likely to intensify next year
The key gateway to addressing the issue of
as Ukraine approaches the 2012 parliamentary elections,
macroeconomic stability for Ukraine is the resuscitation of
which may entail economic costs in the form of elevated
the IMF stand-by programme, which is currently seen as
pressure for higher fiscal spending.
one of the key anchors for the country’s economy. One of
the key preconditions for this is the increase in regulated
Yaroslav Lissovolik, Moscow, (7) 495 933 9247
tariffs on gas for households. The October IMF mission to
Ilya Piterskiy, Moscow, (7) 495 933 92 30
Kiev failed to reach an agreement, though consultations

Investment strategy Ukraine: Deutsche Bank forecasts

2010 2011F 2012F 2013F
FX: The three most important drivers of UAH NDFs are
National income
gas price negotiations with Russia, risk appetite and
domestic developments. The risks to these three drivers Nominal GDP (USDbn) 130.8 145.6 164.9 185.2
remain negative and warrant a bearish position. Press Population (m) 45.7 45.5 45.3 45.1
reports and comments from Azarov on TV have alluded to GDP per capita (USD) 2 862 3 200 3 640 4 106
gas price reductions up to 40% (to $225/mcm from
$355/mcm in 3Q '11 - saving $500m/y). This would be a Real GDP (YoY%) 4.2 4.5 3.9 4.0
positive, but risks are skewed towards disappointment if Priv. Consumption 4.6 5.0 5.2 5.0
there is no reduction in gas prices or the reduction is not Govt Consumption 1.2 -3.2 8.1 -1.2
as high as expected. An announcement is expected by the Investment -1.0 5.6 6.8 8.0
end of 2011, and a delay ahead of elections in 2012 it Exports 9.0 9.0 9.0 9.0
adds to the negative skew of the risks. The strong Imports 10.0 11.0 10.0 10.0
correlation between Russian equities, Oil, VIX and UAH
NDFs suggests that any devaluation pressure is likely to Prices, money and banking (% YoY, eop)
stem from risk sentiment. Developments on the domestic CPI (Dec YoY%) 9.1 6.5 9.0 8.0
political front have worsened with Tymoshenko's arrest Broad Money 23.1 16.0 14.0 13.0
increasingly looking like a political decision - souring Credit 8.0 20.0 18.0 16.0
relations with the EU. Economic developments have
surprised to the downside: a worsening current account, Fiscal accounts (% of GDP)
declining reserves and GDP forecasts to 4% (5% Budget balance -5.0 -2.5 -2.5 -1.8
previously) by Ukraine's government do not bode well. Revenues 22.0 22.5 23.5 22.9
Expenditures 27.0 25.0 26.0 24.7
Siddharth Kapoor, (44) 20 7547 4241
External accounts
(USDbn)
Credit strategy: Underweight Financing conditions Exports 52.1 52.6 57.1 64.1
continue to tighten and with it the risks of credit problems Imports 60.5 61.0 66.6 66.3
in the coming year. The treasury continues to struggle to Trade balance -8.4 -8.4 -9.5 -2.2
execute its domestic borrowing plan and is reliant on the % of GDP -6.4 -5.8 -5.8 -1.2
NBU for financing. Net claims of the NBU on the central Current account balance -2.6 -4.0 -5.1 2.2
government have more than doubled since the end of % of GDP -2.0 -2.7 -3.1 1.2
May, reaching approx. USD8bn. FDI 5.7 6.5 7.0 7.0
All appears to hinge on Ukraine successfully extracting a FX reserves 34.6 32.0 38.0 42.7
reduction in the price of gas charged by Gazprom, but the UAH/USD (eop) 8.0 7.9 7.9 7.9
history of such agreements suggest that we shouldn’t be
Debt indicators (% of GDP)
too optimistic for a generous reduction. External liabilities
in 2012 (principal and interest) will amount to USD 7.5bn.
Domestic 16.5 16.0 17.2 -26.8
On top of this will come the cost of gas imports. Given
External 23.5 27.0 29.0 29.0
the pressure, and the fact that it is only a remote
possibility that they are comprehensively eased, we
in USDbn 108.5 118.0 122.0 137.0
continue to recommend an underweight exposure.
Marc Balston, London, (44) 20 7547 1484 General

Industrial production
(YoY%) 11.0 8.0 5.4 5.8
Unemployment (%) 9.2 8.5 7.8 7.4
Financial markets (eop) Current 3M 6M 12M

Short-term interest
rate(%) 7.75 7.75 7.75 7.75
UAH/USD 8.0 7.9 7.9 7.9
Source: Official statistics, DB Global Markets Research

China Aa3(Pos)/AA-/A+
Moody’s/S&P/Fitch
 Economic Outlook: For 2012, we expect the outlook for China’s export growth. The following table
economy to be featured by 1) disinflation, 2) initial produces our updated yoy and qoq (saar) GDP growth
growth deceleration followed by a recovery, and 3) forecasts for 2012. The slight change we made is to
policy easing in 1H followed by a more cautious further cut our qoq GDP growth forecast for 1Q 2012
stance towards the end of the year. We maintain our to 6.4% from the previous 6.8%, on downward revision
2012 GDP growth forecast at 8.3% (down from 9.1% of European GDP forecast in that quarter (we now expect
in 2011), with a qoq trough in Q1 (at 6.4% saar, European GDP to contract 1.6% on qoq saar basis, vs the
slightly deeper than our earlier projection of 6.8%) previous 0.4% contraction).
and a sequential recovery from Q2. For 2013, we
expect GDP growth to recover to 8.6% largely on China: yoy and qoq GDP growth forecast
yoy % qoq (saar) %
stronger export growth. On policies, we expect 2-3
more RRR cuts in the coming 6-9 months, which 2011Q1 9.7% 8.7%
should permit average monthly RMB lending to 2011Q2 9.5% 9.1%

rebound to RMB800-900/month in 1H, and annual 2011Q3 9.1% 9.5%
lending to reach around RMB8.4tn in 2012. We 2011Q4F 8.5% 7.3%
expect the fiscal deficit-to-GDP ratio to remain largely 2012Q1F 7.7% 6.4%
unchanged at 2-2.2% in 2012. Fiscal priorities in 2012Q2F 7.5% 9.0%
2012 should include public housing, completion of on- 2012Q3F 8.7% 10.0%
going infrastructure projects, SMEs, services, and
2012Q4F 8.7% 9.5%
consumption. Source: SSB and DB forecast
 Main Risks: The two most important shocks to the

economy in the coming months are property FAI Three factors are behind our projection of a sequential
deceleration and export slowdown. We expect growth trough in 1Q 2012. First, we believe that the
property FAI growth to slow from the current European economy is already in recession and its
25-30%yoy to 15%yoy in the first few months of economic contraction will like to be worst in 1Q. This
2012. We expect export growth to decelerate from implies that China’s export growth will suffer the most
the current 15%yoy to 8-9% in 1Q 2012. from European demand weakness in 1Q. Second, China’s
real estate sales have slowed sharply since September
 Strategy Recommendations: We favor Repo swap 2011, and developers will thus likely rein in their
NDIRS/IRS and Shibor swap 2x5 NDIRS/IRS construction activities. Sequential slowdown in
steepeners to express our view that interbank construction should last until Q1 next year, before
liquidity will ease markedly in the coming 6-9 months. property prices and sales may stabilize. Third, China’s
We retain our bullish view on the CGB cash bonds. monetary easing, which began only at the end of
Expect a slower pace of RMB appreciation in 2012. November (as marked by the RRR cut on November 30),
will likely become more visible in 1Q. With a one-quarter
Macro View lag, monetary easing should begin to support domestic
We maintain our 2012 GDP growth forecast at 8.3%, demand, especially investment activities, from 2Q.
but foresee a slightly deeper qoq trough in 1Q than Note that the qoq GDP growth rates before (and including)
our earlier projection. We cut our 2012 GDP growth 3Q 2011 are estimates from the National Statistical
forecast to 8.3% as early as in August 2011, and has since Bureau (NSB). Our estimates differ from theirs as we use
maintained this forecast. Despite many changes in DB’s a different seasonal adjustment methodology. The NSB
global economic forecasts and recent developments in uses its own methodology but the agency does not
China, we continue to believe our 8.3% annual forecast release its details and original data, and therefore it not
remains reasonable. possible to replicate its estimates. We believe its
DB’s European economists downgraded their 2012 estimates are problematic as their yoy and qoq growth
Eurozone GDP forecast twice in the past four months. rates appear inconsistent. In particular, the NBS estimate
The most recent revision reduced their 2012 Eurozone of a sequential acceleration of GDP growth in 3Q of 2011
GDP forecast from 0.4% to the current -0.5%. As we is contradictory to most other indicators which became
(DB’s China economics team) took a more bearish view visibly weaker in that quarter– these include the PMI,
on Europe as early as in August, the recent European monetary and loan growth rates, commodity prices, as
forecast changes only marginally worsened our annual well as qoq change in power consumption. In particular,

the PMI fell to around only 50 in 3Q and during the quarter government will likely have no choice but to increasingly
monetary conditions appeared to be the tightest in two steer its fiscal priority towards social spending.
years.
China: Macroeconomic Forecasts
Given this difference in methodologies, we ask readers to 2010 2011F 2012F 2013F
take our qoq GDP estimates as indicative (of our view of Real GDP (YoY%) 10.3 9.1 8.3 8.6
the momentum of the economy), rather than something
CPI (YoY%) ann avg 3.3 5.3 2.8 3.5
that could be verified by NBS data releases in the future.
Broad money (M2) 19.7 13.5 16.0 14.5
We expect GDP growth to accelerate to 8.6% in 2013. Bank credit (YoY%) 19.9 15.0 16.0 14.0
In this monthly note, we for the first time publish our Budget surplus (% of GDP) -1.7 -2.0 -2.2 -1.5
forecasts of 2013 economic indicators. We expect GDP FX rate (eop) CNY/USD 6.59 6.30 6.10 5.86
growth to rise to 8.6% in 2013, up from 8.3% in 2012. Fixed asset inv't (nominal) 23.8 23.0 17.0 17.0
This is largely reflecting our view that US and Eurozone
Retail sales (nominal) 18.4 16.5 14.0 15.0
GDP growth will be stronger in 2013 than 2012. The
Industrial production (real) 15.7 13.0 11.5 12.0
rationales for this forecast include: 1) the worst part of
Merch exports (USD nominal) 31.3 20.0 8.0 14.0
bank deleveraging, which causes the contraction of the
real economy, would be in 2012; 2) the fiscal contraction Merch imports (USD nominal) 38.7 24.0 9.0 16.0
(measured by the reduction in cyclically adjusted fiscal 1-year deposit rate (%) 3.50 3.50 3.50 3.50
Source: CEIC and DB forecasts
deficit/GDP ratio) was as much as 1.4ppts in 2012, but
would improve in 2013. In other words, the impact of
We expect property FAI growth to slow rapidly in the
fiscal contraction will become less of drag for the
first few months of the year. It appears that the
Eurozone economy in 2013.
weakening of property investments by developers is
Stronger US and Eurozone growth would enhance becoming the most serious challenge to the economy in
Chinese growth via stronger exports. So, for example, the coming few months, even more so than export
based on historical correlations, a 1% increase in US&EU deceleration. This is because the average property price
growth would increase Chinese export growth by about in 35 major cities has declined by about 13% in the past
6ppts. We thus forecast acceleration of China export two months according to Soufun, and sales and floor
growth from 8% in 2012 to 14% in 2013. In volume space started have both decelerated sharply. In terms of
terms, China’s export growth will likely accelerate by floor space started – a leading indicator of real estate
about 3-4ppts. This should translate to a 0.5ppt increase FAI – its growth fell from 30%yoy in Jan-Aug to only
in China’s GDP growth. However, given that monetary 10%yoy in September and -1% in October. Based on
and fiscal policies will likely become a bit more restrained, historical correlation, the deceleration in floor space
we expect GDP growth in 2013 to accelerate only by started will likely translate into a visible slowdown in real
0.3ppts to 8.6%. estate FAI (correlation at 0.5-0.6). We thus expect real
estate FAI growth to decelerate from the 28%yoy in Jan-
Other changes to the key components on the Chinese
September towards 15%yoy in 1Q next year.
economy should largely offset each other in terms of
impact on GDP. For example, we expect some modest Yoy% change in residential floor space started
deceleration in real gross capital formation (as the 250%
corporate profit margin will drop due to the long-term
structural trend of higher wage growth), but real private 200%
consumption will likely accelerate a bit on better income
150%
growth and higher government spending on social
services and welfare. 100%
On the latter point, the recent unfortunate school bus 50%

accident in Gansu province is illustrative. This accident,
which killed 21 preschool students, provoked a massive 0%
wave of public criticism (in the form of tens of thousands -50%

of Internet and press commentaries) that put pressure for
May-09
May-11
May-08
May-10
Aug-08
Aug-09
Aug-10
Nov-08
Nov-09
Nov-10
Aug-11
Feb-08
Feb-09
Feb-10
Feb-11
the government to improve safety standards. A week

later, the State Council decided to allocate additional
Source: CEIC
budgetary resources for purchasing school buses that
meet safety standards on a nationwide basis. This case Given that real estate sector’s capital formation accounts
demonstrates the significant rise in the role of public for about 10% of GDP, we estimate that a 15ppt nominal
opinions in influencing policy making in China, and that the

deceleration (or 10% real deceleration) in real estate FAI of this deceleration to be offset by the benefits of policy
could contribute to 1ppt reduction in yoy GDP growth in easing on other sectors.
Q1 next year. This deceleration trend will only be partially
CPI inflation to drop sharply to 3% in Q2 and 2.8% for
offset by a modest acceleration in infrastructure FAI.
2012 as a whole. We continue to expect CPI inflation to
Assuming that infrastructure FAI will accelerate by 7ppts
decline sharply to 4.2% in November and 3.8% yoy in
(from the current -2%yoy growth to 5%), it would reduce
December, and to 3% in 2Q next year. This reflects the
the impact of real estate FAI slowdown on GDP by
significant decline in wholesale agriculture prices in the
0.3ppts. This results in a net reduction of yoy GDP
past two months (by 7-8%) and its gradual pass-through
growth by about 0.7ppts for 1Q of 2011 (compared with
to retail food prices. Based on historical correlation, the
3Q of 2011).
food component of CPI should fall by at least 5%
Export growth will likely slow to 8%yoy in 1Q 2012. cumulatively between the peak September and the next
Our European economists are projecting the Eurozone trough. Even if the power tariffs are raised by 5% and
economy will be in recession for the current quarter and refined oil prices are raised by 10%, their boost to CPI is
first half of next year. The trough is projected in 1Q of only 0.3ppts, a small fraction of CPI reduction (by 1.5%)
2012. The driving forces for further deterioration of due to a 5% food price drop.
sequential growth in Q1 include bank deleveraging, fiscal
Based on normal seasonality, we assume a 5% rise in
contraction, as well as the negative wealth effect arising
food prices in January and February to reflect the Chinese
from weaker consumer confidence. However, over the
New Year effect. Even with this sequential rise in food
coming months, we expect some progress of the
prices, yoy CPI inflation will still likely fall to 3% in 2Q and
Eurozone towards fiscal consolidation, which will permit
the full year CPI inflation will likely be at 2.8% for 2012.
the ECB to further loosen monetary policy and support the
debt market, and to help lift market and consumer Other key assumptions we made in this CPI projection
confidence. The benefits for the real economy are include a modest decline in PPI in the coming few months,
expected to kick in from Q2 next year. with a recovery from Q2 next year. For the year as a
whole, we see PPI inflation at about 4%, significantly
Given this European growth trajectory, and a relatively
lower than the recent peak of about 8%. This projection
steady pace of US economic growth (at around 2.5%
is supported by the recent trend of declining input price
annualised rates for most quarters), we expect China’s
index in the PMI report.
qoq and yoy export growth to look like the following:
Another important contributor to disinflation is the fall in
property prices, which will over time translate to a decline
China export growth forecast, yoy and qoq% in the housing component (which includes rents and
China export (yoy) China export (qoq) EU/US GDP imputed rents) of CPI. We estimate that a 10% drop in
(qoq saar) physical property prices (soufun property price index) will
3Q 11 21% 2.5% 1.3% eventually – after about 6 months – reduce the housing
4Q 11F 15% 1.5% 0.7% component of CPI by 1%.
1Q 12F 8% 0.5% 0.3%
We expect M2 growth to accelerate to 15-16% for
2Q 12F 6% 0.7% 0.4% 2012. We expect M2 growth to accelerate marginally to
3Q 12F 6% 2.9% 1.5% 15-16% next year, up from the current 13%. Experience
4Q 12F 11% 3.5% 1.9% tells us that M2 growth is typically set at 2-3ppts above
Source: DB forecast
nominal GDP growth. This time, given the consensus
forecast of 8.5 for real GDP growth and about 3.5% for
According to our estimates, China’s qoq (sa) export CPI inflation, 14% will likely form the bottom for the
growth will slow sharply to only 0.5% in 1Q next year, discussion for next year’s M2 growth range. However,
down from 1.5% in 4Q this year. As a result, yoy export arguments for some additional monetary expansion will
growth will likely decelerate to 8% in 1Q, stay weak for likely be made in the coming months – even after the
2Q and 3Q, before recovering in 4Q 2012. For the year as National Economic Work Conference – to allow 1-2ppt
a whole, we now forecast export growth at 8% (vs additional M2 growth in order to offset the global demand
previous expectation of 10%). We also revised down our shock and the weakness in the real estate sector. Thus,
import growth forecast by 2ppts to 9%. the final outcome will likely be 15%-16% for M2 growth.
Ceteris paribus, the export deceleration will lead to a A M2 growth rate of 15% should be applicable if GDP
reduction in yoy GDP growth by about 1.3ppts in 1Q of growth is running safely above 8%, but 16% is more likely
2012 (compared with 3Q of 2011). We expect nearly half when yoy GDP growth slips below 8% for two quarters
(which is our forecast). Therefore, although the initial

target for M2 growth could be set at 15%, and eventual interest rates, credit guidance and administrative
outcome may be 16% next year. measures – for managing inflation. The inflation cycle has
turned in China, and downside risks to exports are
At this moment, we do not see strong reasons why loan
growing. While a major reversal of policy is unlikely, the
growth will be much different from M2 growth in 2012.
government is taking small steps to ease policy, which we
This implies that new RMB lending will be around
think include a slower pace of RMB appreciation early in
RMB8.4tn next year, up from this year’s estimated
the sequencing of an easing response. We retain a
RMB7.4tn.
structurally bullish view on the RMB (tied in to its long
We expect very modest fiscal easing in 2012. Despite the term plan for capital account liberalization, and the need to
official rhetoric that fiscal policy will remain pro-active, we reduce its undervaluation), but we expect a cyclical
think the reality is that there will be very limited fiscal slowdown in its appreciation path, to nearer 3% by H1
expansion in 2012 relative to 2011. Our baseline forecast 2012. USD/CNY NDFs could however squeeze higher as
is that the deficit-GDP-ratio will rise only slightly to 2.2% the Chinese economy slows in coming months. Possible
in 2012 (vs 2.0% in 2011). Specifically, we expect total overshoots in the NDFs in the coming months should be
fiscal deficit to be RMB1.1tn (including RMB300bn for seen as better opportunities to re-enter RMB longs.
local government deficit/bond financing) in 2012, vs
Linan Liu, Hong Kong, (852) 2203 8709
RMB900bn in 2011 (including RMB200bn for local
Dennis Tan, Singapore, (65) 6423 5347
government deficit/bond financing).
Within the fiscal budget for 2012, we expect some

modest tax further cuts to support SMEs, exporters,
consumption, and services. On the expenditure side, we
expect priorities be given to support public housing,
infrastructure (e.g., resumption of railway projects, repair
of reservoirs and dams), social services, and consumption
(e.g., extension of the electronics trade-in policy).
Jun Ma, Hong Kong, (852) 2203 8308
Investment Strategy
Rates. With monetary policy having shifted towards
easing and likely will accelerate in the next 2-3 quarters,
we expect net liquidity inflow to the interbank market to
help bring money market rates to 50-100bps before mid
of 2012. However, in the near-term, the relative stickiness
of the 7D repo fixing rate given the year-end seasonal
liquidity demand, and the extent of liquidity easing being
priced in on the Repo IRS curve argues for the outright
level of CNY IRS curves to be relatively range bound
(within 10-15 bps range). As such we think the risk reward
of outright receiving Repo rates is unfavorable and costly
in carry. We believe Repo swap or Shibor swap curve
steepeners are more suitable for investors sharing our
view. We recommend building Repo IRS/NDIRS or Shibor
IRS/NDIRS 2x5 steepeners at the current market.
We retain our bullish view on CGB cash bonds and 10Y

CGB can rally by 20-30bps over the next quarter. Supply
risk is low in Q1 which should provide good technical
support.
We remain cautious on the onshore credit market and will

wait till credit outlook stabilizes before considering
increasing allocation.
FX. In our opinion, China regards FX as a monetary policy

tool – part of a broader policy toolkit that includes RRR,

China: Deutsche Bank forecasts

2010 2011F 2012F 2013F
National Income
Nominal GDP (USD bn) 5879 7031 8141 9516
Population (mn) 1374 1383 1389 1395
Real GDP (YoY%)1 10.3 9.1 8.3 8.6

Private consumption 9.0 8.4 8.4 8.8
Government consumption 8.0 9.0 8.5 9.0
Gross capital formation 11.6 10.7 9.0 8.5
Export of goods & services 22.0 12.0 6.4 12.5
Import of goods & services 23.0 14.0 7.8 13.0

CPI (YoY%) eop 4.6 3.8 2.8 3.5
CPI (YoY%) ann avg 3.3 5.3 2.8 3.5
Broad money (M2) 19.7 13.5 16.0 14.5
Bank credit (YoY%) 19.9 15.0 16.0 14.0

Budget surplus -1.7 -2.0 -2.2 -1.5
Government revenue 21.3 22.7 22.5 22.5
Government expenditure 17.8 24.7 24.7 24.0
Primary surplus -1.2 -1.3 -1.5 -0.8

Merchandise imports 1395.0 1729.8 1885.5 2187.2
Trade balance 183.0 163.8 159.6 144.2
% of GDP 3.1 2.3 2.0 1.5
% of GDP 5.2 4.0 3.3 2.6
FDI (net) 124.9 100.0 70.0 50.0
FX rate (eop) CNY/USD 6.59 6.30 6.10 5.86

Government debt2 20.3 19.4 19.1 18.3
Domestic 19.7 18.8 18.6 17.8
External 0.6 0.6 0.5 0.5
in USD bn 549.0 730.0 830.0 930.0
General (YoY%)
Fixed asset inv't (nominal) 23.8 23.0 17.0 17.0
Retail sales (nominal) 18.4 16.5 14.0 15.0
Industrial production (real) 15.7 13.0 11.5 12.0
Merch exports (USD nominal) 31.3 20.0 8.0 14.0
Merch imports (USD nominal) 38.7 24.0 9.0 16.0
Financial Markets Current 3M 6M 12M

1-year deposit rate 3.50 3.50 3.50 3.50
10-year yield (%) 3.63 3.40 3.30 3.30
CNY/USD 6.35 6.30 6.20 6.13
Source: CEIC, DB Global Markets Research, National Sources
Note: (1) Growth rates of GDP components may not match overall GDP growth rates due to
inconsistency between historical data calculated from expenditure and product method. (2) Including
bank recapitalization and AMC bonds issued

This page is left blank intentionally

Hong Kong Aa1(Pos)/AAA/AA+

Moody’s/S&P/Fitch
 Economic Outlook: Growth in Hong Kong continues expect this will continue. Our analysis suggests that as
to follow the lead of the US and EU economies. This export growth slows and asset prices fall – we expect
means markedly slower growth in 2012 but a likely Hong Kong property prices could fall 20% next year –
return to reasonably robust growth in 2013. consumption growth is likely to slow significantly.
 Main Risks: A disorderly resolution of the sovereign Private consumption expenditures
debt crisis in Europe would likely be translated into a
%yoy PCE Model
deep recession in Hong Kong.
15
 Strategy Recommendations: We see upside risk on
10
Hibor - Libor basis in Q1 next year driven by corporate
liability hedging demands. 5
Macro View 0
Slower US&EU growth means slower HK growth. -5

Hong Kong’s economy eked out 0.3%QoQ(saar) growth in
-10
Q3 after contracting at a 1.4% rate in Q2. The key
message, though, is that when exports of goods and 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
services are 208% of GDP, external demand will always
Sources: CEIC and Deutsche Bank. The “model” is a regression of real PCE growth on real merchandise
be the main driver of growth. And it still seems to be that export growth, tourist arrivals, the real 3m Hibor yield and real equity price and property price inflation.
Since 1995 the model has an R2 of 0.70.
US and European demand matters more than Mainland
Chinese demand.45 As exports have stagnated over the Inflation to fall gradually in 2012, more quickly in 2013
past six months, so too has Hong Kong GDP. And having Because rental inflation only appears in the CPI index with
downgraded our growth forecast for the US and EU more than a one-year lag, falling property prices won’t
economies, we have done the same for Hong Kong, really show up in lower inflation until 2013. In the interim,
cutting our 2012 forecast from 4.4% to 3.0%. In 2013, commodity price inflation will be more important. So,
though, as growth in the ‚G2‛ economies is expected to falling food and fuel inflation will likely take inflation down
recover we see Hong Kong’s growth rebounding to 4.5%. from 6% at the end of this year to below 4% by mid-
GDP growth in Hong Kong and the G2 (US and EU) 2012. But as food and fuel prices start to rise in the
second half of next year we see inflation rising above 4%
15 % HK = 1.6 x G2 + 1.9
by year-end. But in 2013 even with higher commodity
R² = 0.68
prices we see the housing effect driving inflation below
10 1% and perhaps below zero in early 2014.
Expect modest fiscal stimulus The government’s
5
budget forecast a deficit of HKD32bn in the current fiscal
year. But in the first half of the fiscal year it has run a
0
deficit of only HKD5.4bn. Only once in the last thirteen
years has the government run a deficit during the Oct –
-5 March period. In the last three years it has run surpluses
%
averaging HKD78bn during those months. The payout of
-10 the HKD6,000 scheme will undoubtedly reduce the
-6 -4 -2 0 2 4 6 surplus, but we project a surplus of HKD31bn for the
Sources: CEIC and Deutsche Bank current fiscal year. Given our US and EU growth
forecasts, we expect only modest fiscal stimulus to be
While export growth has plummeted in recent months – applied in Hong Kong next year – perhaps a more targeted
from 15.1%yoy in Q1 to -0.4% in Q3 in real terms – cash handout scheme, increased support for those less
private consumption growth has held up surprisingly well, well off and possibly a cut in the corporate tax rate – but
slowing from 9.7%yoy in Q2 to 8.8% in Q3. But we don’t we still project a surplus of nearly HKD30bn.

45
See ‚China is a Weak Engine of Growth for Asia,‛ Global Economic
Perspectives, Sept 10, 2011.

Investment Strategy Hong Kong: Deutsche Bank Forecasts

2010 2011F 2012F 2013F
Fixed Income Strategy: The dynamic of Hibor - Libor National Income
basis likely will present interesting trading opportunities Nominal GDP (USD bn) 224.5 243.1 256.0 274.8
next year. We think there are three relevant factors: Population (mn) 7.1 7.1 7.2 7.2
a) Q1 is typically seasonally strong funding season and
we expect demand for corporate liability hedging
Real GDP (YoY%) 7.0 5.3 3.0 4.5
purpose to push Hi-Li basis higher;
b) Funding activities in the offshore RMB bond market Government consumption 2.7 1.9 1.8 1.8
by HK corporations which then have been swapped Gross fixed investment 7.8 4.3 1.2 5.5
back to HKD Libor, such flows are getting more Exports 16.8 3.2 2.1 8.8
active in recent week and will grow if USD funding Imports 17.3 3.3 2.1 9.5
market remains challenging next year.
c) The likely slowdown in RMB appreciation at least in CPI (YoY%) eop 2.9 6.0 4.3 -0.1
the next 1-2 quarters means less speculative CPI (YoY%) ann avg 2.3 5.3 4.6 2.1
positioning on the USD/HKD forwards, which will Broad money (M3) 7.6 12.2 4.3 4.4
reduce the risk of further widening in Hi-Li basis. HKD Bank credit (YoY%) -0.4 15.1 6.9 3.9

Fiscal Accounts (% of GDP)1
Fiscal balance 4.2 1.6 1.2 1.5
FX: We think that market speculation of a HKD depeg is
likely to dissipate in 2012. This is because the reflation
tide which has driven a growing debate over the relevance Primary surplus 4.3 1.7 1.3 1.5
of the USD peg in recent years is likely to fade. A cyclical
slowdown in China, a more gradual pace of RMB External Accounts (USD bn)
appreciation, falling inflation and possible property price Merchandise exports 394.0 431.6 439.5 477.0
declines in both the mainland and in the SAR are factors Merchandise imports 437.0 487.9 498.5 544.3
that will likely drive speculators to pare back their bets on Trade balance -43.0 -56.2 -58.9 -67.3
a near-term depeg.. % of GDP -19.1 -23.1 -23.0 -24.5
HK officials have also repeatedly emphasized that
% of GDP 6.2 5.5 4.8 3.8
convertibility of the Chinese currency is a critical
FDI (net) -7.2 -2.7 -2.5 -3.5
precondition for a repeg to the RMB. While Chinese
authorities are likely to take further steps to allow capital
FX rate (eop) HKD/USD 7.76 7.79 7.80 7.80
backflows from the CNH market, China is unlikely to
achieve full convertibility next year. As such the chances Debt Indicators (% of GDP)
of HKD depeg in 2012 are quite low in our view. We like Government debt1 2.2 2.5 2.9 3.2
buying the 12M USD/HKD outrights, which is trading right Domestic 1.6 2.0 2.3 2.7
very close to the bottom of its policy band. We also like External 0.6 0.6 0.5 0.5
buying 1Y risk reversals which are still trading near the Total external debt 357.9 349.7 302.8 291.1
lower end of its historical ranges. in USD bn 803.5 850.0 775.0 800.0
General
Unemployment (ann. avg, %) 4.4 3.5 3.7 3.7

Discount base rate 0.50 0.50 0.50 0.50
3-month interbank rate 0.30 0.30 0.30 0.30
10-year yield (%) 1.35 1.30 1.35 1.35
HKD/USD 7.78 7.80 7.80 7.80
Note: (1) Fiscal year data.

India Baa2/BBB-/BBB-
Moody’s/S&P/Fitch
 Economic Outlook: Assuming no big collapse in India’s economic growth : high correlation with G2
global financial markets, the Indian economy ought to %yoy %yoy
grow by 7-7.5% in 2012, supported by rate cuts from India, left G2, right
11 6
RBI around mid-2012
10 4
 Main Risks: Worsening of twin deficits could prevent
inflation from moderating to mid single-digit levels, 9 2
which could complicate RBI’s monetary policy
8 0
decision, especially if growth were to slow sharply at
about the same time 7 -2
 Strategy Recommendations: Pay steepeners on 6 -4
the OIS curve (1Y/2Y) to position for the turn in the
cycle. Risk to INR gets more digital next year, with 5 -6
policy intervention a key factor. 2005 2006 2007 2008 2009 2010 2011
Note: A quarterly data regression of India’s real growth against ppp-weighted G2 growth, for the sample
period 2006Q1 to 2011Q2, obtains a beta coefficient of 0.4, estimated with a statistical significance at
1% level and an adjusted R-squared of 0.61.
Source: CEIC, Deutsche Bank Global Market Research
Questions for 2012
With the current and challenging year almost behind us, Through the first three quarters of 2011, GDP growth in
focus now shifts to 2012: India has decelerated, averaging 7.5% as compared to
8.9% growth in the corresponding period in 2010. The
 When will the economy trough? slowdown has been concentrated in the industrial sector,
with growth averaging 4.9%, as against 10.2% in the first
 When will the RBI start reversing its current anti- nine months of 2010. Services sector slowdown in
inflationary stance? comparison has been relatively modest (8.7% vs. 9.8%),
 Will the government manage to carry out some though downside risks have increased in recent months.
degree of fiscal consolidation? Agricultural sector growth momentum has gained some
traction in 2011 over 2010 (4.9% vs. 2.9%). From the
 What is the outlook for the rupee? expenditure side GDP, we note that investment growth
 What is in the structural reform agenda? continues to be anemic, while private consumption
growth has also been trending lower. The main supportive
Growth in 2012 factor to growth has been higher public spending and,
more crucially, net exports.
For years, one of the appealing characteristics of India for
investors has been its resilient internal growth dynamic, Given the latest data, we have revised down our FY11/12
driven by domestic demand in a somewhat insulated growth estimate to 7.0% (from 8.0% earlier), as we see
economy. Our analysis shows that before 2006, the further intensification of global macro headwinds and
relationship between India’s growth and that of the US slowdown in domestic demand in the days ahead. We
and Euro Area (G2) was not statistically significant; i.e. the have also revised down our FY12/13 growth estimate to
growth dynamic appeared to be impervious of the G2 7.5% (from 8.0% earlier), which however reflects a
cycle. In this regard India used to mimic China. modest recovery relative to the likely 2011 outturn. This is
based on our view that growth momentum would likely
But as the economy has opened up, it is no longer improve from the second half of 2012, helped by (i) a
shielded from global cyclical movements. The adjoining supportive base effect; (ii) expected rate cuts from RBI
chart shows that India’s growth trajectory is not just starting from mid-2012; and (iii) a likely improvement in
mirroring capital flows, but G2 growth as well. The global market sentiments, helped by belated but
coefficient estimate on a growth regression with G2 ultimately market stabilizing resolution of the present
growth on the right hand side is statistically significant in Eurozone crisis. However, as the analysis of India’s
the post 2005 period, and the explanatory power of the growth relationship with G2 shows, our baseline growth
regression equation is considerable. forecast could face downside risks if the US/Euro area
economic growth were to slow appreciably in 2012 than
currently anticipated.

When will RBI start cutting policy rates? 7.50%), in our view. However, the inflation trajectory may
not look as benign as our base case scenario suggests if
India’s clear and present danger is inflation, which has supply shocks were to materialize. In such a scenario,
been on a trend rise over the past five years or so. inflation may stay in the 8-8.5% range in the second half
Stubbornly high inflation is a reflection of a number of dis- of 2012, instead of the 6-6.5% forecast in our base case
functionalities in the economy, which are also some of the scenario. Given that this would take place amidst a
key impediments to India’s stability and prosperity. On the slowing growth environment and heightened global
demand side, high growth rates of GDP (200bps higher in uncertainty, the RBI’s monetary management would
the past decade than any other period in India’s history) clearly become highly challenging, in such a scenario.
and real per capita income (rising by 8% annually since Recent depreciation of the rupee is yet another risk to
2001) have kept the economy operating at or above its inflation in the coming months.
potential growth rate. Case in point is the dairy industry;
despite production rising by double digit rates in recent WPI inflation forecast – two scenarios
years, milk prices have risen by an annual average of 13%
% yoy Baseline Alternate
since 2006 as demand has been outpacing supply. On the 11
back of strong growth, wages have risen sharply in the
10
past decade, adding sizeable purchasing power to millions
of Indian households. As household income has risen, 9
consumption has evolved from basic food items to more
8
protein-rich items, but the ensuing demand surge has not
been met with an adequate supply response. 7
6
CPI and WPI inflation trend
5
%yoy
WPI CPI 2010 2011 2012 2013
16
Source: CEIC, Deutsche Bank Global Market Research. Note: Alternate inflation scenario builds in a food
14 price spike (+3%mom) and a diesel price hike of 5-6%.
12
10 Could a CRR cut precede repo rate cut?
8
In recent months, money market liquidity has tightened
6 severely, with the existing deficit in the LAF (INR1.2trillion)
4 being almost twice that of what the RBI would like the
2 systemic liquidity deficit to be (1% of net demand and
0 time liabilities, which works out to about INR600bn).
Rupee liquidity conditions could tighten further, if the RBI
2005 2006 2007 2008 2009 2010 2011
were to resort to unsterilized FX intervention to prevent
further sharp depreciation of the rupee.
On the supply side, key impediments lie in the agriculture Net LAF against 1% (+/-) NDTL band, WPI inflation
sector, where production growth has been less than 1% a and cash reserve ratio rate
year in the past decade. There are also substantial
INR bn 1 % of NDTL (+) %
distributional and infrastructure inefficiencies that cause
1500 1 % of NDTL (-) 12
prices of goods to jump in a disorderly manner in the Net LAF
1000 10
event of weather or transportation related shocks. Rising CRR, rhs
8
fiscal deficit and the recent sharp depreciation of the 500
rupee are also potential threat for inflation going forward. 6
0
4
Despite these concerns, we expect WPI inflation to -500
2
moderate to 8% by Dec 2011 from the current 9.7%, -1000 0
thanks to a favorable base effect in food inflation. Barring
-1500 -2
any further food price spike or fuel price hike, WPI
inflation should be down to around 7-7.5% by March and
to 6.5% by June 2012. This should allow RBI to start
cutting interest rates from mid-2012, by a cumulative Source: CEIC, Deutsche Bank Global Market Research
100bps through the year (taking repo rate down to

While the RBI could resort to doing more and more open Expenditure on various subsidies as a % of GDP
market operations (OMO) to ease the pressure on rupee Petroleum, lhs
% of GDP % of GDP
liquidity, we note that the OMO route to improve rupee 1.8 Fertilizer,lhs 4.5
liquidity (especially in an environment where FX Food, lhs 4.0
1.5
intervention could further complicate matters) may prove Total, rhs
3.5
to be a time consuming process. A speedier way to infuse 1.2
rupee liquidity, thereby creating more flexibility for the 3.0
0.9
central bank to intervene in the FX market (if the situation 2.5
demands), would be to cut the cash reserve ratio (CRR) 0.6
2.0
rate which currently stands at 6%. Every 1% point cut in 0.3 1.5
the CRR will increase primary liquidity immediately by
0.0 1.0
about INR600bn. Indeed, this was the case in the fourth
FY05 FY07 FY09 FY11
quarter of 2008, when after the Lehman Brothers
collapse, RBI decided to cut the CRR sharply, while also Source: CEIC, Deutsche Bank Global Market Research
intervening aggressively in the FX market.
Building on the slippage of 2011, it is difficult to see
There are however two main differences with respect to much scope for substantial fiscal consolidation in
the 2008-09 period; first, the CRR was at 9%, before the 2012. The expenditure side of the budget will likely
RBI cut it by 250bps in October 2008 to 6.5% and then by remain sticky owing to welfare programs such as NREGA
another 150bps to 5.0% by January 2009. With the CRR and rising subsidy bill on account of food, fertilizer and oil
standing at 6% today, the flexibility to cut it is clearly less (unless global oil prices fall sharply, which is not our base
(although there is no guideline to stop the RBI from case scenario). Further, if the Food Security Act is
cutting it). Second, inflation continues to be near double- implemented next year then our estimates suggest that
digit with little chance of it to moderate to the RBI’s the food subsidy bill could rise by an additional INR200bn
comfort range of 5-5.5% anytime soon, as compared to from the current level.
2008/09, when inflation collapsed post 2008, led by a
sharp decline in commodity prices. The revenue side of the budget is likely be weak despite
the slated implementation of the Direct Tax Code, given
Given that inflation and inflation expectations remain high, likely persistence of weak growth momentum in the next
RBI therefore may find it difficult to cut the CRR rate few quarters. To support the revenue base, excise duties
before inflation shows a clear downward trajectory, which could be raised on certain items while the services tax net
we expect to see only from January onward. Another could be broadened, but this could affect economic
possibility could be that the RBI cuts the CRR, justifying growth adversely on the margin.
that its move is directed only towards liquidity
management, while its anti-inflationary stance remains The government would clearly like to revive its
unchanged. This again appears unlikely in the immediate disinvestment program to ease financing pressure, but
near-term, though one cannot rule out the possibility of a as the experience of 2011 shows the associated
100bps cut in CRR, sometime in the first half of 2012. difficulties; the government has been able to raise only
7% of the budgeted disinvestment target so far in the
Is there scope for fiscal consolidation? current fiscal year.
The government has not succeeded in reducing the fiscal Despite this, we think that the government will factor in
deficit since the onset of the 2008 global financial crisis. INR250-300bn proceeds from disinvestment, with an
While the fiscal stimulus put in place in 2008 helped the intention of bringing fiscal deficit down to 4.8% of GDP in
economy, spending has become stickier since then, FY12/13 (though upside risks will remain), from a likely
making normalization of fiscal policy difficult. Several 5.2-5.5% of GDP outturn in FY11/12 (as against the
social programs have been introduced in recent years, budget estimate of 4.6% of GDP). Consistent with past
particularly the rural employment guarantee program (that trend, this fiscal deficit will be financed primarily through
gives 100 days of minimum wage to the rural sizable market borrowings, which will continue to weigh
unemployed), providing substantial impulse to rural on bond market sentiments.
demand while making the fiscal position worse. The
government’s large subsidy programs for food, fuel, and
fertilizer (amounting to about 20% of total spending,
nearly 2.5% of GDP) also add to the adverse fiscal
position and inflated demand.

Fiscal deficit & market borrowing of the central govt. Clearly the exchange rate will be vulnerable as the balance
of payments is likely to remain under pressure until
% of GDP INR trn.
Gross market borrowing, rhs commodity prices correct (we forecast current account
7 5
Fiscal deficit, lhs deficit of 3.1% of GDP in 2012, with capital account
6 4 surplus just about managing to finance it). Persistent
5 3
inflation is yet another complicating factor, reducing the
competiveness of the currency through real exchange rate
4 2 appreciation. The rupee therefore has cyclical and
3 1 structural headwinds.
2 0
Rupee and external flows
USD bn (trade balance + net portfolio), lhs % ch,
INR/USD (inverted), rhs mom
Source: CEIC, Deutsche Bank Global Market Research 0 -8%
-5 -4%
Rupee correction: overdue or overdone?
India’s impressive track record with respect to growth and -10 0%
market potential has brought in foreign capital in recent
-15 4%
years, crucial to the financing of its current account deficit.
This is an important issue, as India’s domestic savings -20 8%
rate remains in the 32-33% of GDP range, whereas
2007 2008 2009 2010 2011
investment demand has been around 35% of GDP. As a
result a current account of deficit of 2-3% of GDP has Source: CEIC, Deutsche Bank Global Market Research
become the norm. It was generally regarded that given
the economy’s high potential rate of growth, there would Since a large part of the recent rupee depreciation has
be no shortage of foreign flows, and therefore financing of been due to India specific issues such as rising trade
the current account would continue unimpeded, allowing deficit and shrinking capital account surplus, an
even for reserves accumulation and some appreciation of improvement in those areas could therefore help the
the exchange rate. exchange rate stabilize. The central bank and the
government have recently announced some measures to
Current and capital accounts increase foreign capital flows into the country, which
% of GDP ought to be helpful on the margin.
Current account deficit
10
Capital account surplus  The limit for foreign institutional investor’s investment
8 in government and corporate debt was increased by
USD5bn each.
6
 External commercial borrowing norms were modified
4 to allow greater capital inflow through this route. i)
All-in-cost ceiling of 3-5 year loans were raised to
2
350bps above libor (from 300bps earlier); and ii) ECB
0 raised for rupee expenditure i.e. foreign borrowings
FY07 FY08 FY09 FY10 FY11 FY12F
for local activities as opposed to external purchases,
will be required to brought in immediately.
 Interest rates on new Non-Resident (External) Rupee
This thesis is however being challenged. Global risk (NRE) term deposits for 1-3 year maturity enhanced
sentiments have been poor since 2008, with little respite to libor + 275bps (from libor +175bps earlier) while
in sight. India’s current account deficit has steadily interest rate of fresh FCNR (B) deposits of all
worsened, primarily owing to high cost of commodity maturities enhanced to libor + 125bps (from libor
imports, and financing difficulties were experienced in +100bps earlier).
2008/09 and again this year. The rupee has come under
pressure lately as the oil import bill has mounted and
portfolio flows have weakened.

The recent spate of capital liberalization measures Structural agenda

however is unlikely to have an immediate positive impact
on the rupee, especially as global risk aversion and USD With economic momentum having slowed appreciably in
strength continues. The RBI, which has been virtually 2011, the pressure on the government has risen to
absent from the foreign exchange rate market in the last implement growth-critical reforms. We provide a list
two years (marking a change in long-standing strategy), below of some of the important agenda of the
could however play a bigger role. Recent statements of government in the next year, aimed at strengthening the
key RBI officials indicate unwillingness on the part of the structural dynamic of the Indian economy.
central bank to intervene, but we believe that if markets
were to become disorderly, the RBI would take action,  National Food Security Bill: The Bill proposes free
and indeed, it has a few operational tools to intervene food grain for the very vulnerable sections of the
effectively and credibly. society, and food grain at subsidized rates for
households categorized as 'priority' and 'general'
RBI intervention in FX market vs. USD/INR under the targeted public distribution system. While
Net purchase (+)/ sale (-) of USD this will likely increase the food subsidy bill by an
USD bn
54 by RBI, rhs 15 additional INR200bn, thereby straining the fiscal
USD/INR, lhs position, it is also expected to have a positive effect
10
50 by supporting private consumption.
5
0
 Tax reforms: The Direct Tax Code (DTC) is slated to
46 be implemented from FY12/13 onward. This would
-5
broaden the tax base, while improving incentives for
42 -10 tax compliance. The Goods and Services Tax (GST) is
-15 unlikely to be fully implemented next year, but some
38 -20 initial steps toward bringing retail taxes across states
2001 2003 2005 2007 2009 2011
under one common market system will be taken.
 Land Acquisition and Rehabilitation Bill: As this bill
Source: CEIC, RBI, Deutsche Bank Global Market Research
becomes an Act next year, land acquisition for
We stress that some of the correction of rupee seen in industrial purposes will likely become relatively easy
the past three months was warranted, and further stress and less controversial, though it could increase the
in the global markets could add renewed pressures. But overall cost. The benefits are however likely to
we are not worried about India seeing some sort of a outweigh the costs, giving much needed boost to
balance of payments crisis. Reserves are ample, imports industrialization and urbanization.
cannot remain high if exports are slowing, and external  Capital account liberalization: Further liberalization
financing markets are functioning better than in 2008. of the capital account could be expected as the
government is keen to attract capital flows to support
India’s reserves are ample to prevent a balance of the orderly financing of the current account deficit.
payments crisis FDI in the aviation sector could be allowed, external
commercial borrowing guidelines could be further
450
400 modified, and FII limit for investment in government
350 Adequate and corporate debt could be enhanced further.
300 c overage
250
 Infrastructure investment: To meet its ambitious
200 goal of investing USD1trillion on infrastructure
150 between 2012 and 2017, the government would very
100 likely announce supportive measures (tax benefits,
50 deregulation, and privatization) that seek to attract
0
and enhance private investment in the sector.
Taimur Baig, Singapore, (65) 6423 8681

Kaushik Das, Mumbai, (91) 22 6658 4909
Source: CEIC, Deutsche Bank. Risk weighted liabilities include short term external debt, current account
balance, broad money, portfolio investment, and exports.

Investment Strategy India: Deutsche Bank Forecasts

2010 2011F 2012F 2013F
2012 should present interesting opportunities in India National Income
as RBI starts to unwind part of its liquidity and rates Nominal GDP (USD bn) 1643 1877 2054 2458
tightening from the last couple of years, and as INR Population (mn) 1175 1200 1218 1236
likely displays a high beta character to global risk. We GDP per capita (USD) 1399 1564 1686 1988
remain of the view that it will be a slow grind on the FY10/11 FY11/12 FY12/13 FY13/14
former, with the central bank likely to ease its grip in Real GDP (YoY %), FY 8.6 7.0 7.5 8.0
liquidity before it starts to cut interest rates. The start of Real GDP (YoY %), CY 9.9 7.3 7.3 8.0
open market operations last week we see as a signal for Private consumption 8.4 6.5 6.5 7.1
the same, and we believe the process would be Government consumption 5.1 4.1 5.0 5.0
Gross fixed investment 12.2 2.5 7.4 8.5
supplemented and/or expedited via CRR cuts at some
Exports 13.9 23.2 16.3 16.2
stage possibly in Q1 2012. While the market has started
Imports 11.5 14.1 13.0 14.3
to price in a turn in the cycle, the actual overnight fixing is
likely to lag till such time as the liquidity deficit gets Prices, Money and Banking
overturned. As such, the carry and timing of a long rates WPI (YoY%) eop 9.4 7.5 6.0 7.5
position is very important. We have thus preferred to WPI (YoY%) avg 9.6 9.4 6.3 6.9
position via 1Y/2Y NDOIS steepeners (and short dated Broad money (M3) eop 16.5 16.3 19.0 18.3
bonds), with minimal bleed, and with some (arguably less Bank credit (YoY%) eop 23.2 15.7 18.7 18.9
than optimal) exposure to the likely eventual collapse of
yields in the front end of the curve. We initiated this trade Fiscal Accounts (% of GDP)1
on 18 November at -55bp mid (current: -44), and believe Central government balance -4.7 -5.5 -4.8 -4.5
the spread will eventually revert towards parity. Government revenue 10.5 9.5 10.1 10.5
Central primary balance -1.7 -2.5 -1.8 -1.5
INR has been the worst performer in Asia this year, and
Consolidated deficit -7.6 -8.1 -7.4 -7.0
among the worst in EMFX as a whole. As the only
significant economy suffering from twin deficits in the External Accounts (USD bn)
region, it is not surprising that the currency has been Merchandise exports 225.7 268.2 303.0 348.5
under pressure; though inelasticity of commodity imports Merchandise imports 357.9 418.8 473.2 544.2
(gold and oil), and a sense of policy paralysis in Trade balance -132.2 -150.6 -170.2 -195.7
government affairs (which has impacted FDI) has % of GDP -8.0 -8.0 -8.3 -8.0
worsened the situation by opening up a gap on the Current account balance -51.7 -54.6 -63.5 -78.2
financing of the current account. From a valuation % of GDP -3.1 -2.9 -3.1 -3.2
perspective, we would note that the drawdown in real FDI (net) 10.0 25.0 32.5 35.0
terms on INR (both on bilateral basis vs. USD and in terms FX reserves (USD bn) 296.5 286.9 292.9 302.7
of a broader REER) is still short of the experience in 2008- FX rate (eop) INR/USD 44.8 51.5 48.0 47.0
44.8 51.5 48.0 47.0
09, given India’s high inflation; and that on this metric, an
overshoot in USD/INR to 57-59 levels under conditions of
further global stress is not impossible.
Domestic 61.4 59.0 58.8 58.7
External 3.6 3.2 2.9 2.7
In the short run, we think INR is oversold. The threat of Total external debt 15.0 14.1 14.6 13.0
systemic stability given the sharp recent move in the in USD bn 247.0 265.0 300.0 320.0
currency has forced the authorities into action with policy Short-term (% of total) 17.0 17.0 18.0 18.0
measures, which should have a near term positive impact.
However, whether it can sustainably reverse its direction General
will depend to a large extent on the state of global risk, Industrial production (YoY %) 8.1 0.7 8.5 6.5
and the ability of policymakers to show consistent
progress on issues which impact business and
Repo rate 8.50 8.50 8.50 7.50
investment sentiment. We suspect INR will have
3-month treasury bill 8.73 8.00 7.80 7.00
significant digital risk in 2012, and to that effect will need
10-year yield (%) 8.71 9.00 8.50 8.00
more active policy intervention.
INR/USD 51.3 50.5 49.5 48.0
Sameer Goel, Singapore, (65) 6423 6973 Note: (1) Fiscal year ending March of following year, consolidated deficit includes state and central
government finances, as well as bonds issued as payments to oil and fertilizer companies on account of
the losses incurred from the provision of subsidies..

Indonesia Ba1/BB+(Pos)/BB+(Pos)
Moody’s/S&P/Fitch
 Economic Outlook: Building on the momentum built expectations in core prices in check. Inflation could be 4%
over the past couple of years, Indonesia steps into or less at the beginning of 2012.
2012 with well-anchored consumer and business
confidence, which could allow the economy to grow We however don’t see this trend persisting for long.
by over 6% at a year when global growth will likely Capacities are stretched, wage pressure has risen, and
slow sharply. demand is likely outpacing supply. Against this backdrop,
the government’s policy to keep interest rates ultra-low
 Main Risks: Inflation could rise sharply on the back of
encourages a bank lending boom (much of it will likely go
electricity and fuel price adjustments, and as demand
toward financing consumption). The practice of leaving
remains strong. Rupiah could come under pressure if
administrative prices unadjusted is bound to fuel demand-
global liquidity crunch and risk aversion continue.
push inflation. Also, we understand that some electricity
Bond yields could rise for the same reason.
tariff adjustment and fuel price hike are on the cards,
 Strategy Recommendations: Increase underweight which could unleash an unfavourable inflation dynamic.
as 10Y yields close in on 6%. Our forecasts see inflation heading above 6% next year.
Sustained growth in a more challenging Bank Indonesia has been unambiguously dovish through
environment the course of the year and will likely remain so in the first
half of 2012. Our official call is for no further rate cuts, but
It has been a landmark year for Indonesia, characterized
if inflation surprises on the downside and global
by strong growth, robust investor sentiments, and below
conditions deteriorate, the central bank will not hesitate to
trend inflation. Aided by a buoyant commodity market that
cut rates, given its track record.
saw earnings from exports rise sharply, Indonesia’s
economic performance in 2011 has been particularly
This approach toward supporting growth as first
striking as it has taken place when growth momentum
default could be problematic for the medium term.
worldwide has been waning.
The dovish approach to monetary policy pre-supposes
limited feedback from interest rate policy to inflation and
Growth will face some headwinds in 2012 if the
inflation expectations. We don’t subscribe to this idea,
commodity markets weaken, but we believe that the
and believe that inflation expectations could readily get
economy could continue to motor ahead, keeping most of
adjusted upward if rate cuts continue while growth
its growth momentum intact, as a virtuous cycle of strong
remains relatively strong.
sentiments fuelling consumption and investment, which in
turn creates employment and income that further
The policy framework of the central bank is also an
supports sentiments appears to be in place for the time
important determinant of the exchange rate and bond
being. We, therefore, expect growth to exceed 6% in the
yields. This should be a moment for the rupiah and
coming year, helped by private and public consumption
Indonesia bonds to readily outperform the region, given
and investment. Net exports contribution to growth will
the economy’s comfortable external financing position. A
likely decline, but that should not constitute more than
highly interventionist policy, however, has undermined
0.5% downside to GDP growth, in our view. On the
external investor sentiment by strenuously moderating the
investment side, we expect continued activities in mining,
moves in the exchange rate and bond yields.
transportation, infrastructure, and retail sectors. If land and
labor laws become more transparent and effective, there
We expect much of the external financial market
would be upside to our investment forecast.
difficulties of 2011 to spill over to 2012. This means
periods of heightened risk aversion and dollar funding
Inflation has been remarkably benign through the course
shortage cannot be ruled out. The authorities would likely
of 2011 due to (i) about 20% of CPI has been kept fixed as
need to intervene periodically to ensure that asset price
there have been no upward adjustment in administrative
overshooting does not happen (in either direction) and
prices of electricity, fuel, toll road usage, and
payments and settlements take place in an orderly
transportation, (ii) food prices have been mostly flat or
manner. But the interventions need to be market based,
declining owing to favorable weather and well executed
transparent, and constructive. Some progress in this
public procurement and disbursement programs, and (iii)
direction would ensure financial market stability for years
the stability of food and fuel prices have kept inflation
to come, in our view.

Investment Strategy Indonesia: Deutsche Bank forecasts

2010 2011F 2012F 2013F
Indonesia offers little value at these levels, particularly National Income
on vol adjusted basis, and we stay defensive in our Nominal GDP (USD bn) 707.8 837.0 907.7 1040.8
exposure. But given the breakeven costs, and active Population (mn) 240.8 243.7 246.6 249.6
intervention by authorities (both in spot and bond markets), GDP per capita (USD) 2939 3435 3680 4170
it is also tough to carry anything more than a small
underweight position in this market. We see it therefore Real GDP (YoY%) 6.1 6.5 6.3 6.5
more as a tail risk trade on both rates and FX, with the Private consumption 4.6 4.7 5.0 5.0
possibility of gapping out in the event global conditions Government consumption 0.3 3.0 4.4 4.5
worsen significantly, and/or policy errors get magnified. Gross fixed investment 8.5 8.3 8.0 8.7
Exports 14.9 13.9 8.5 8.5
Let’s have a look at the positives to start with, though – Imports 17.3 12.8 7.9 7.9
the biggest one being the resilience of the economy’s
growth momentum as highlighted in the section above. Prices, Money and Banking
We would also count in this list a disciplined fiscal CPI (YoY%) eop 7.0 4.0 6.5 6.6
strategy (though arguably more a reflection of lack of CPI (YoY%) ann avg 5.1 5.4 5.7 6.5
spending); a strong cash position for the MOF (which Core CPI (YoY%) 4.3 4.5 5.5 6.0
forms a part of the bond stabilization framework); Broad money (M2) 15.4 16.0 15.0 15.0
improved credit metrics; and a strong probability of Bank credit (YoY%) 13.0 22.0 20.0 22.0
upgrade for sovereign ratings to investment grade by one
or possibly two agencies in 2012. Fiscal Accounts (% of GDP)
Budget surplus -0.6 -1.1 -1.4 -1.9
But with 10Y yields moving again towards 6%, and IDR Government revenue 15.8 15.4 15.8 16.0
hugging 9000, the risk reward is hardly compelling. What Government expenditure 16.4 16.5 17.3 18.0
we don’t like in particular is, 1) the timing and quantum of Primary surplus 1.4 0.9 0.6 0.1
recent rate cuts by Bank Indonesia, given the backdrop of
a cyclically insensitive economy and possible increase in External Accounts (USD bn)
inflationary risks again next year; 2) the concentration of Merchandise exports 158.1 199.6 216.0 226.9
offshore ownership in the bond markets, and possible lack Merchandise imports 127.4 164.5 184.9 199.8
of a similar level of sponsorship as in previous years; 3) Trade balance 30.6 36.7 31.1 27.1
the dominance of BI as the main buyer of duration in this % of GDP 4.3 4.4 3.4 2.6
market in the last couple of months; and 4) the failure of Current account balance 5.6 4.0 -1.5 -5.1
BI’s spot intervention in calming market nerves. % of GDP 0.8 0.5 -0.2 -0.5
FDI (net) 10.7 9.1 9.6 12.0
Foreign investors own $24bn of government bonds, FX reserves (USD bn) 95.0 116.8 123.7 123.0
equivalent to 30% of outstanding (and arguably double FX rate (eop) IDR/USD 8991 9100 8950 8700
the proportion of ‘floating stock’), and in the first eight
months of this year, had bought 82% of all net issuance. Debt Indicators (% of GDP)
They have in the last three months offloaded $3.6bn of Government debt 27.0 26.0 24.9 24.5
their holdings, 90% of which was picked up by Bank Domestic 14.7 15.0 14.1 13.5
Indonesia (which now carries a portfolio of $7.2bn). Local External 12.3 11.0 10.8 11.0
banks picked up another $2.5bn, while other domestic Total external debt 25.4 23.9 24.2 23.1
real money (insurers, pension funds, mutual funds) have in USD bn 180.0 200.0 220.0 240.0
all been net sellers. With the pressure of issuance starting Short term (% of total) 18.6 18.5 20.5 20.8
again in January, the extent of offshore support for this
market will get severely tested again. General
Inspite of a rapid build up in its reserves since 2008, we Unemployment (%) 7.1 7.0 6.8 6.5
note that Indonesia’s BOP sensitivity to stress situations
has not necessarily gotten any better. This is because Financial Markets Current 3M 6M 12M
most of these reserves have been built on the back of a BI rate 6.00 6.00 6.00 6.50
growing concentration of offshore ownership of 10-year yield (%) 6.25 6.50 6.70 7.00
Indonesia’s capital markets. See our Asia FX Strategy IDR/USD 9100 9050 9010 8950
Notes from 27th October for details. Source: CEIC, DB Global Markets Research, National Sources
Sameer Goel, Singapore, (65) 6423 6973

Malaysia A3/A-/A-
Moody’s/S&P/Fitch
 Economic outlook: Slower export growth will weigh 5%. With US and EU combined growth rising to about
on investment spending and consumption cushioned 2% in 2012 from about 1% in 2012 we see Malaysia’s
by continued easy monetary and fiscal policies. economy growing significantly faster in 2013.
 Main risks: The main risks lie abroad, especially the Policies to remain supportive but not very stimulative
possibility of a deeper recession in Europe. In the October budget, the government announced a
mildly contractionary policy – forecasting a deficit next
 Strategy recommendations: Vulnerability to bond
year of 4.7% of GDP versus 5.4% this year. While there
market outflows keeps us cautious on rates (with a
were lots of measures aimed at boosting demand, the
steepening bias) and neutral on MYR.
overall target for government expenditures is slightly
Macro view lower than the expected outcome this year. Our forecast
is for expenditures to come in slightly above target,
Surprising strength in Q3, but GDP growth will slow. resulting in a deficit mildly higher than what was budgeted
We estimate that GDP expanded 3.8%QoQ(saar) in Q3 up but more importantly higher than this year’s forecast
from 2.4% in Q2. Compared to a year ago, growth rose deficit. So in that sense we think fiscal policy will be
to 5.8% from 4.3% in Q2. We estimate that exports fell slightly expansionary in 2012 but not aggressively so. We
3.8%QoQ(saar) in the quarter, but this was offset by think the government is committed to reducing its debt
surprising growth in private and government consumption burden in the medium term.
and in investment. Broadly, our expectation is that as
On the monetary side, while the risks are increasingly
exports continue to decline over the next few months,
weighted in the direction of rate cuts as inflation falls, we
domestic demand growth will suffer. While we are far
don’t at this point think the central bank will cut rates. The
from forecasting a return to the extreme contractions of
real policy rate is still negative today but we expect that
2001 or 2008/09 we think export growth will start 2012 in
with subsidy cuts likely deferred to the second half of next
negative YoY territory and with a gradual recovery
year inflation will fall to about 2% by mid-2012 from 3.4%
thereafter the likelihood is that growth will be slightly
currently (3.3% excluding price-controlled items). Rate
negative for the year as a whole. In such an environment,
cuts become possible, in our view, once real interest rates
we expect consumption growth – which has been running
turn significantly positive but our forecast is that by then
well above long-run average recently – to slow down next
growth will have bottomed out obviating the need for rate
year. Private capital expenditures have historically been
cuts. Clearly, some combination of slower growth and/or
heavily influenced by export growth will almost certainly
lower inflation relative to our forecasts could change the
slow down in 2012.
interest rate outlook.
Domestic and external demand in GDP
Inflation and interest rate forecasts
25 %yoy Dom demand Exports
% CPI o/n policy rate
20
10
15
8
10
6
5
0 4
-5 2
-10 0
-15 -2
-20 -4
00 01 02 03 04 05 06 07 08 09 10 11 06 07 08 09 10 11 12
Sources: CEIC and Deutsche Bank
Still, our forecast of 4.3% growth seems to us to be a

relatively positive one. Note that a backward-looking Michael Spencer, Hong Kong, (852) 2203 8305
estimate of Malaysia’s potential growth rate would put it
at about 4% although Bank Negara’s estimate is about

Investment strategy Malaysia: Deutsche Bank forecasts

2010 2011F 2012F 2013F
Rates: In FY12, we expect gross and net issuance of National Income
bonds (MGS/GII) to be MYR89bn and MYR43.5bn Nominal GDP (USD bn) 238.4 275.9 285.9 310.6
respectively. This is marginally lower compared to FY11. Population (mn) 28.3 28.6 29.0 29.4
We continue to be cautious in the MGS market due to its GDP per capita (USD) 8438 9643 9863 10580
vulnerability to capital outflows. As of end September,
foreigners had bought over 230% YTD of the net issuance Real GDP (YoY%) 7.2 5.0 4.3 5.5
of MGS on the back of continuous inflows into EM local Private consumption 6.5 7.0 5.5 6.3
currency debt funds. Even though our base case remains Government consumption 0.5 12.5 4.9 6.3
that offshore inflows will continue to support the market Gross fixed investment 9.8 4.9 1.3 6.1
in 2012, systemic risks from Europe could result in these Exports 9.9 2.8 -0.2 5.2
inflows turning weaker. Given that net supply is roughly Imports 15.1 4.1 -0.9 6.2
the same next year; the onus will be on local players to
pick up the slack. At such rich levels, locals have not Prices, Money and Banking
shown a strong appetite for bonds despite ample liquidity CPI (YoY%) eop 2.1 3.4 2.1 2.6
onshore and growing AUM of pension funds. CPI (YoY%) ann avg 1.7 3.2 2.4 2.3
Broad money (M3) 8.3 10.8 11.1 9.3
Bank credit (YoY%) 10.7 10.6 9.7 8.6
The upside risks to yield is mitigated by the dovish outlook
on monetary policy and weak growth prospects, which
could result in the domestic players allocating more
Federal government surplus -5.6 -4.2 -5.0 -5.0
towards bonds compared to risky assets. Therefore, we
think sustained and sharp spike in back end yields are
unlikely even though curves could continue to steepen on Primary fed. gov't fiscal -3.6 -2.0 -2.8 -2.7
underperformance of the long end of the curve. surplus
FX: We see the MYR as one of the more vulnerable External Accounts (USD bn)
currencies to a deepening of the European crisis. First, the Merchandise exports 199.4 226.2 237.9 261.7
ringgit is trading as a high beta currency to global risk Merchandise imports 157.7 180.5 196.8 218.4
Trade balance 41.8 45.7 41.2 43.3
sentiment and the broad USD, in part because the central
% of GDP 17.5 16.6 14.4 14.0
bank is less active in smoothing FX volatility. Second, FX-
implied USD funding costs in the local market are at
% of GDP 11.5 11.4 9.9 9.3
exceptionally high levels, as asset swapping activities by
FDI (net) -4.4 -4.0 -3.0 -3.0
MYR bond issuers and investment outflows by locals have
picked up at a time when USD funding has tightened
FX rate (eop) MYR/USD 3.13 3.15 3.10 3.07
globally. Third, foreign bond holdings remain at high
levels, and a pickup in EM fund redemptions could drive Debt Indicators (% of GDP)
further fixed income outflows from Malaysia. Government debt 53.1 52.2 54.0 55.1
Domestic 51.0 50.3 52.3 53.6
That said, we note quite a couple of positive factors for External 2.2 1.9 1.7 1.5
the MYR. Malaysia has one of the largest current account Total external debt 29.5 27.6 24.3 22.4
surpluses in the region. Currency valuations are not in USD bn 73.4 74.0 70.0 69.8
stretched, and the MYR REER is trading furthest below Short-term (% of total) 35.1 40.5 40.0 43.0
the pre-97 crisis peaks. Exports are likely to slow as
external demand weakens, but the drag to growth from General
exports would also be partly offset by the government’s Industrial production (YoY%) 8.9 1.7 0.6 3.1
initiatives to kick start a few mega projects domestically. Unemployment (%) 3.3 3.2 3.3 3.3
Nominal rates differentials should remain in favour of MYR
assets, as BNM does appear to be in a hurry to ease Financial Markets Current 3M 6M 12M
policy. In sum, our preference is to stay neutral the MYR Overnight call rate 3.00 3.00 3.00 3.00
until external headwinds subside. 3-month interbank rate 3.2 3.2 3.2 3.2
10-year yield (%) 3.75 3.80 3.80 3.90
MYR/USD 3.13 3.15 3.13 3.10
Arjun Shetty, Singapore, (65) 6423 5925
Dennis Tan, Singapore, (65) 6423 5347 Source: CEIC, DB Global Markets Research, National Sources

Philippines Ba2/BB/BB+
Moody’s/S&P/Fitch
 Economic Outlook: Growth has slowed owing to a traction, the outlook for domestic demand is considerably
weakening of external demand, but domestic demand better than was the case in 2008/09.
is likely to hold up as inflation declines, while
consumer and business sentiment remains resilient. Our growth forecasts for 2011 and 2012 (3.5% and 3%,
respectively) would have been at least 100bps lower if we
 Main Risks: External demand could be weaker than
did not take solace from the resiliency of domestic
expected if the crisis in Europe deepens further.
demand, driven by the factors discussed above. We also
 Strategy Recommendations: Modest overweight think that public spending would be more supportive
on duration into 2012. Peso to be more resilient than next year as public-private infrastructure spending picks
regional FX. up and the central bank takes monetary policy easing
measures (at least 50bps in rate cuts in Q1 2012, in our
More resilient to face external view). BSP will be comfortable with the money and credit
headwinds situation in the economy due to ample liquidity, and hence
is unlikely to pursue policy measures aggressively.
As expected, the ongoing global slowdown is pulling
down the Philippine economy. The key question is if the
We also expect inflation to ease next year as commodity
economy could head toward near-zero growth in 2012
prices flatten out and growth falls below the potential
due to the drag from the Euro area, and possibly from
rate. We see considerable base-effect led disinflation in
China, or if it would display a more resilient outcome. We
Q1 2012, which could take inflation down by 100bps
think that short of a severe exacerbation of the global
during the quarter. BSP’s 3-5% inflation target is
economy and markets, the Philippines should come
comfortably achievable, in our view.
across as more resilient in 2012 relative to 2008.
We expect remittances to be impacted only mildly in
The recently published third-quarter national accounts data
2012, growing perhaps by 3-4%. Demand for overseas
could be an apt illustration of the economy’s
Filipinos remains strong worldwide, and the 2008 crisis
vulnerabilities and strengths. Reflecting a sharp
showed that deployment of workers was not particularly
contraction in trade and poor weather, the economy grew
pro-cyclical. The marginal demand for overseas Filipinos
by 3.2%yoy in Q3 (3.1% in Q2), in line with our forecast
come from Asia and the Middle-East, where growth
(3.3%). The authorities have estimated that poor weather
would slow much less than in the industrial countries,
subtracted 0.3% from growth in Q3 (agriculture sector
which would likely help.
growth moderated to 1.8%yoy in Q3 vs. 8.2% in Q2). The
biggest drag was from the external sector, with exports
The peso should be well supported. At a time when
(which represent over 50% of GDP) declining by
rising risk aversion has caused a tightness in USD liquidity
13.1%yoy, a sharp deterioration from growth of 1.4% in
worldwide, squeezing systems of payments and
the previous quarter. With a view to 2012, the outlook will
settlements, the Philippines is an outlier, with an
remain grim for exports, with the Euro area expected to
exceptionally flush dollar liquidity position (thanks to
undergo a recession and China’s domestic economy
steady and sizeable remittance flows). Reserves are
slowing.
ample to the extent of making the Philippines a net
creditor nation, so the currency is among the least
On the bright side, industrial production appears to have
vulnerable in Asia, in our view.
stabilized owing to strong domestic demand. More
corroboration is found in the expenditure side data, which
We think that there are risks to the upside with
show consumption rising by 7.1%yoy, up from 5.5% in
respect to our growth forecasts. If agriculture rebounds,
Q2. Investment rebounded strongly during the quarter,
domestic consumption and investment sentiments remain
rising by 24.5%yoy (vs. -7.7% in Q2). Within the segment,
stable, and public spending gains traction, growth could
growth in durable equipment rose sharply by 9.9% (up
well surprise on the upside. By focusing on fiscal
from 1.0% in Q2) and the pace of decline in construction
consolidation, pursuing prudent monetary policy, the
investment eased to 10.6% in Q3 vs.-21.0% in Q2. With
Philippine authorities have established a strong macro
remittances remaining resilient, the outsourcing sector
framework to deal with adverse economic shocks, and
gaining momentum, domestic money and credit
2012 may well be a year when the economy’s improved
conditions highly comfortable, and the government’s
resiliency catches investor attention.
public infrastructure spending program beginning to take

Investment Strategy Philippines: Deutsche Bank Forecasts

2010 2011F 2012F 2013F
Rates: The key differentiating factor this year for the National Income
Philippines was the improvement in fiscal performance. Nominal GDP (USD bn) 199.5 226.9 245.9 274.3
While we would expect some payback to what was at Population (mn) 92.5 94.8 97.1 99.6
least in part a result of postponement of spending, we GDP per capita (USD) 2158 2394 2531 2755
should nonetheless see a gradual reduction in the fiscal
risk premium priced into the interest rate curve. Except for Real GDP (YoY%) 7.6 3.5 3.0 4.5
its legacy EM-like nature, characterized mostly by the lack
of depth in the bond market which makes it vulnerable to
global risk sell offs, there is little else to fault in the rates
Exports 21.0 -2.0 2.0 9.0
backdrop for the Philippines as we head into 2012. The Imports 22.5 1.4 4.5 10.8
inflation outlook is comfortably benign; with BSP itself
forecasting average CPI in mid to low 3% range for the Prices, Money and Banking
next couple of years (food prices arguably are the biggest CPI (YoY%) eop 3.1 4.7 4.0 4.0
risk to this outlook). BSP will likely be early within the CPI (YoY%) ann avg 3.8 4.8 3.8 4.0
region to cut rates, while the currency remains less Core CPI (YoY%) 3.7 4.2 3.5 4.0
Broad money (M3) 9.8 9.0 9.5 10.0
sensitive to interest rate differentials, and more a function
Bank credit1 (YoY%) 8.9 13.9 12.5 13.0
of current account surpluses. The financing picture is
robust – ample domestic liquidity, tapped this year in part Fiscal Accounts (% of GDP)
also by two very successful retail issuances. We project National government surplus -3.5 -2.9 -3.2 -3.2
net issuance of FXTBs and retail bonds to in fact dip by Government revenue 13.4 14.4 14.3 14.5
close to 20% year-on-year, with larger redemptions in the Government expenditure 16.9 17.3 17.5 17.7
pipeline. And very importantly, there is little immediate Primary surplus -0.2 0.6 0.1 0.3
vulnerability to the volatility in capital flows, except in the
case of GPNs. We think yields will grind lower towards
5.5% eventually, with the possibility of an overshoot in Merchandise imports 61.1 67.7 69.1 76.0
response to BSP rate cuts. We suggest being positioned Trade balance -10.4 -15.5 -17.6 -19.9
modestly overweight on this market going into next year. % of GDP -5.2 -6.8 -7.2 -7.2
FX: The Philippine peso has weathered this year’s market
% of GDP 4.2 4.5 3.4 3.3
turmoil better than most Asian currencies – it is one of
FDI (net) 1.2 1.3 0.1 0.5
only two Asian currencies which are trading up against the
USD year to date (the other being the RMB). Reasons for FX rate (eop) PHP/USD 43.9 43.5 42.5 41.5
the peso’s outperformance include stable growth in
remittances and outsourcing sector inflows, as well as Debt Indicators (% of GDP)
relatively more resilient portfolio inflows. We think these Government debt2 57.6 56.4 55.2 54.0
factors should help the peso outperform in 2012 as well, Domestic 30.4 30.0 30.1 29.8
particularly if the Europe-related volatility continues. Our External 27.3 26.4 25.2 24.2
recent BoP stress test reveals that the peso is one of the
in USD bn 70.0 72.0 76.0 80.0
least vulnerable currencies should market conditions turn
more adverse. We also see chances of a pick up in FDI if
the government manages to kick start the Public-Private General
Partnership (PPP) infrastructure, given strong interests in Industrial production (YoY%) 15.6 3.0 6.0 6.0
the scheme by foreign investors. Should capital inflows Unemployment (ILO) (%) 8.1 7.9 7.7 7.7
pick up next year, the BSP may face constrains in FX
intervention, not least because of flush domestic liquidity.
BSP o/n repo 6.50 6.00 6.00 6.00
Note that the BSP is the only Asian central bank talking
BSP o/n reverse repo 4.50 4.00 4.00 4.00
about relaxing outflows measures and tightening control 3-month treasury bill 2.89 3.50 4.00 4.55
measures on inflows at this point. The main risk to this 10-year yield (%) 5.88 5.70 5.50 5.50
view is if supply constraints cause commodity prices to PHP/USD 43.8 43.4 43.1 42.5
start heading higher again. Source: CEIC, DB Global Markets Research, National Sources
Note: (1) Deposit money bank credit to the private sector. (2) Incl. guarantees on SOE debt.
Sameer Goel, Singapore, (65) 6423 6973

Singapore Aaa/AAA/AAA
Moody’s/S&P/Fitch
 Economic Outlook: Slower global growth means Europe. So, with Euroland in recession and the US
much slower growth in Singapore in 2012, but growing at a stable 2.0% - 2.5% rate we expect to see
sharply lower inflation as well. slower export growth next year compared with this year
and therefore slower GDP growth. But similarly, the
 Main Risks: Singapore is Asia’s most export-
recovery in Euroland and possibly faster US growth in
sensitive economy, so macro risk derives mainly from
2013 should see the Singapore economy bounce back
the US and Europe.
sharply.
 Strategy Recommendations: SGS has strong
Inflation to fall rapidly in 2012/13 With slower global
technicals but rich valuations. Expect the yield curve
growth will come lower inflation. Indeed, the inflation
to flatten in 2012. Trade SGD NEER in a range.
impulse has already weakened. The 3m/3m seasonally
Macro View adjusted rate of change in the CPI is 1.2% versus a YoY
rate of inflation of 5.4%. Global wholesale food prices
Asia’s highest-‚beta‛ economy. As export volumes have broadly been in decline since April – the YoY change
have stagnated in recent months so too has the economy. in the IMF’s food price index has fallen from 33.4% to
We estimate that exports of goods and services fell 1.4% over the past six months. Similarly, crude oil prices
4.5%QoQ(saar) in Q3 after falling 5.3% in Q2 – more than have essentially been stable for the past seven months,
enough to offsetting the previous two quarters’ growth. taking the YoY rate of change down from above 50% in
So, not surprising given that exports are more than double July to about 30% currently. If, as we expect, oil prices
the size of GDP, GDP growth has essentially stalled as remain stable for the next six months then of course oil
well. While GDP did expand at a 1.9% annualized rate in price inflation will vanish.
Q3, this followed a 6.4% rate of decline in Q2. Given the
We are confident that we’ve seen the worst of property
volatility of economic data in Singapore even quarterly
price inflation and that prices may actually decline next
forecasts are difficult but we can with great confidence
year. However, that won’t necessarily translate into the
say that the economy will simply follow where exports
CPI. We think the CPI lags market prices by at least six
lead. Over the past 15 years the correlation between
months, but when property prices fell 24%yoy in mid-
growth in (gross) exports and goods and services and
2009 the accommodation component of the CPI for 2009
GDP has been 0.87.
recorded at most a 3%yoy fall. So, we assume the CPI
Exports of goods and services and GDP measure of accommodation costs stops rising after mid-
30
2012 but doesn’t decline.
%yoy GDP Exports
25 Inflation and interest rates
20
% Inflation 3m SGD Sibor
15
8
10
5 6
0
-5 4
-10
2
-15
-20
0
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Sources: CEIC and Deutsche Bank -2
06 07 08 09 10 11 12
So the key question for Singapore is: what drives
exports? As we argued recently1 it does not appear that Sources: CEIC and Deutsche Bank
China is yet an important source of final demand for

Singapore’s exports – at least compared with the US and Still, as inflation falls – and the risks to our forecast are,
we think, to the downside – real interest rates will rise
sharply, adding further downward momentum to GDP.
1
See ‚China is a weak engine of growth for Asia,‛ in Global Economic
Perspectives, September 10, 2011.

Investment Strategy Singapore: Deutsche Bank Forecasts

2009 2010 2011F 2012F
Rates: For 2012, we estimate a gross issuance of National Income
SGD24.7bn for SGS and 1Y T-bills. Accounting for the Nominal GDP (USD bn) 222.7 257.2 265.4 291.6
maturities of SGD20.4bn; we expect the net issuance to Population (mn) 5.2 5.3 5.4 5.5
be SGD4.3bn which is more or less in line with previous GDP per capita (USD) 43007 48800 49602 53436
years. The technicals in this market are very healthy
however valuations do appear rich. Any sustained Real GDP (YoY%) 14.5 5.0 2.5 4.8
improvement in risk sentiment could cause a significant Private consumption 4.2 5.9 4.7 5.4
back up in yields from current levels. However, we still Government consumption 11.0 3.4 6.7 4.1
think that there are factors which lend some degree of Gross fixed investment 5.1 0.7 -7.1 -0.1
comfort on this front. 1) With over EUR600bn of Exports 19.2 1.4 0.0 6.4
refinancing needs for Italy and Spain in 2012, and ECB Imports 16.6 1.4 -0.9 6.2
reluctant to finance state deficits, systemic risks from
Europe will continue to dampen risk sentiments and keep Prices, Money and Banking
a bid on save haven assets 2) Most of the foreign holdings CPI (YoY%) eop 4.6 5.3 1.2 1.0
CPI (YoY%) ann avg 2.8 5.2 2.6 0.9
in SGS are concentrated at the front end of the curve
Broad money (M2) 8.5 10.4 10.6 9.8
which means that FX exposure dominates duration
Bank credit (YoY%) 9.6 24.7 10.9 1.6
exposure. With SGD NEER close to the bottom of the
band, downside on the currency is ultimately capped by
MAS. 3) Liquidity ratio of banks is close to all time lows
Fiscal balance 5.1 8.0 6.6 7.3
which mean that despite the rich yield levels, banks are
likely to continue buying SGS/T-bills. The risk to this view Government expenditure 16.0 16.6 15.6 13.7
could come from a strong rebound in growth in US and/or
a change in stance by ECB on financing state deficits. External Accounts (USD bn)
Arjun Shetty, Singapore, (65) 6423 5925 Merchandise exports 358.5 415.9 442.5 495.6
Trade balance 46.8 50.8 51.8 57.1
FX: The SGD was the top currency pick for the macro
% of GDP 21.0 19.7 19.5 19.6
community earlier this year, but it has fallen from grace to
become the worst performing Asian currency after the
% of GDP 22.2 19.1 18.5 20.3
INR lately. We think there are a few reasons for SGD’s
FDI (net) 19.1 19.8 10.0 8.0
underperformance: 1) investors paring back bullish bets
on policy expectations, 2) impact of deleveraging by
FX rate (eop) SGD/USD 1.31 1.30 1.25 1.20
European banks, and 3) less active MAS intervention
within a relatively wide band (+/-3% around mid-point). Debt Indicators (% of GDP)
While the initial weakness in the SGD can be explained by Government debt 105.8 107.2 110.4 113.3
a washout of speculative positions in late September, we Domestic 105.8 107.2 110.4 113.3
suspect that deleveraging by European banks have started External 0.0 0.0 0.0 1.0
to impact the SGD more significantly, given Singapore’s Total external debt 169.1 233.2 218.5 188.6
in USD bn 513.6 600.0 580.0 550.0
status as a financial centre. Currencies of countries with a
higher exposure to European banks (i.e. SGD, KRW, PHP,
IDR and MYR) have underperformed this month, while
General
currencies of countries with a lower exposure (CNY, TWD,
THB) have been more insulated from the European
Unemployment (%) (eop) 2.2 2.1 2.6 2.8
contagion. This could limit SGD's recent bounce, even
though it is still trading in the lower half of the policy band Financial Markets Current 3M 6M 12M
(about 1.5% above the bottom band). A slowdown in 3-month interbank rate 0.4 0.4 0.4 0.4
global growth and inflation would also increase the 10-year yield (%) 1.70 1.75 1.80 1.90
chances of another round of policy easing by MAS in SGD/USD 1.28 1.28 1.27 1.25
April. We favor a more range-trading approach to SGD Source: CEIC, DB Global Markets Research, National Sources
NEER (within the lower band). Note: includes external liabilities of ACU banks.

South Korea A1/A/A+

Moody’s/S&P/Fitch
 Economic Outlook: We see South Korea’s growth to growth in 2012, vs. 1.3% in 2011. Meanwhile, we expect
follow the G2 cycle, reporting a below trend growth recovery in construction to guide overall investment
of 3.4% in 2012, followed by a notable rebound to higher, expanding 2.8% in 2012, after contracting 1.3% in
4% in 2013. 2011. As a result, we see investment adding 0.7% to
overall growth in 2012, after subtracting 0.4% in 2011,
 Main Risks: The sovereign debt crisis in Euroland
while private consumption contribution should fall slightly,
pose serious downside risks to growth.
to 1.2% in 2012 from 1.3% in 2011.
 Strategy Recommendations: We look for further
steepening on the KTB curve. Concerns about lack of Export growth to slow…
reinvestment demand from offshore fund investors %yoy Index
50 SK exports 65
should reduce, which is supportive of 2Y-3Y segment. US ISM (rhs)
40 60
30
Macro View 20
55
10 50
Growth thus far this year has been broadly in line with 0 45
expectations, driven by exports… Performance of the -10
40
South Korean economy was broadly in line with our -20
-30 35
forecast in terms of the headline numbers. A year ago, we
-40 30
forecasted that the economy would grow by 4.0% in 2011
2004 2005 2006 2007 2008 2009 2010 2011
and it expanded 3.7%yoy ytd in Q3 2011. On the other
hand, there were some notable differences in detail, with Sources: CEIC and Deutsche Bank
exports outperforming our expectations and domestic

…guiding facility investment lower… Facility
demand proving to be weaker than our forecast noted a
investment growth continued to fall relatively sharply, to
year ago. In particular, we saw export growth of
1.4% in Q311, despite a relatively stable export growth of
11.9%yoy ytd in Q311, vs. our earlier forecast of 6.3%
9.5% in the quarter. In light of the slowdown in 2011, we
growth for the whole year, while private consumption
expected further weakness in facility investment growth
expanded 2.7% and investment contracted 1.7% in 2011,
to be limited to 1.7% in 2012, down from 5.4% in 2011,
vs. our forecasts of 3.4% and 4.3%, respectively, noted a
especially as the operation ratio remains high at 104.3 in
year ago. The contraction in overall investment was largely
October. This would add 0.2% to overall growth in 2012,
due to construction investment.
vs. 0.5% in 2011. On the other hand, we do not expect a
GDP growth supported by domestic demand notable pick up in facility investment in 2012 amid weak
Net exports Stocks export growth and poor business sentiment. The latter
% contribution to growth
8.0 Investment Govt continued to fall in December, to its lowest level since
PCE GDP early 2009, led by concerns about export weakness and
6.0
inventory accumulation.
4.0
2.0 …weighing on facility investment growth
0.0 %yoy Facility Investment
40 Exports
-2.0
30
-4.0
20
2007 2008 2009 2010 2011F 2012F 2013F
10
0
-10
Slowing G2 demand points to weaker South Korea
growth in 2012… Looking forward, we see weaker G2 -20
growth, at 1% in 2012 vs. 1.7% in 2011, guiding South -30
Korea’s export growth lower, to 5.5% in 2012 from 10.6% 2002 2004 2006 2008 2010
in 2011, with the net trade contribution to growth falling Sources: CEIC and Deutsche Bank
to 1.0% from 2.0% in the same period. In comparison, we

expect private consumption to remain relatively stable,
supported by lower inflation, contributing 1.2% to overall

...while private construction investment recovers… In 3mma, supporting private consumption despite high
contrast, we expect construction investment to expand inflation. Private consumption rose 2.7% in the first three
2.3% in 2012, after contracting 6.3% in 2011, adding quarters. Looking forward, we see private consumption
0.3% to growth in 2012, vs. -1.0% in 2011, as the growth to weaken further, to 2.4% in 2012 from 2.6% in
government seeks to increase housing in response to 2011, as a result of weaker payrolls gain. On the other
rising rental prices. Construction investment fell 7.6% in hand, we also see falling inflation to support real wage
the first three quarters of this year, after contracting 1.4% income growth, which stood at -3.4%yoy in Q311, as
in 2010, led by weakness in residential building. inflation averaged 4.3%. We note that consumer
sentiment improved in November, as a result of
…while housing construction to recover anticipation of falling inflation and interest rates. In
%yoy Non-residential Building Construction
particular, consumer inflation expectation fell to 4.1% in
40 November from 4.2% in October.
Residential Building Construction
30
20 …amid persistent payrolls gain
10 %yoy %yoy 3mma
8 PCE 2.5
0
Employment (rhs)
6 2.0
-10
4 1.5
-20
-30 2 1.0
0 0.5
2002 2004 2006 2008 2010
-2 0.0
-4 -0.5
...in response to rising rental prices… While purchasing -6 -1.0
prices have moved sideways in Seoul, rental prices 2005 2006 2007 2008 2009 2010 2011
continued to move upward, as households hold off on Sources: CEIC and Deutsche Bank
home purchases, expecting a notable fall in housing prices

ahead. As households opted for rent, the jeonse (rental) …supported by falling inflation... The trend in CPI
prices continued to rise, constituting 50.5% of purchasing inflation remains downward, at 4.0%yoy 3mma in
prices in October 2011, after bottoming at 38.2% in October, vs. 4.3% in September. This fall was led by food
January 2009. price inflation, which fell to 6.4% from 9.1% in the same
period. We note that the Korean Statistical Information
…in response to rising rental prices Service (KOSTAT) rebased the consumer price index in
November to better reflect recent economic and social
75 %
Jeonse to Purchase Price changes and introduce established international standards
70 and advanced statistical techniques. The KOSTAT deleted
eight items from the basket, including Korean costume,
65 camcorder, electronic dictionary and gold ring. As a result,
the new series left headline CPI inflation 0.4ppts lower, at
60
4.0%yoy ytd in October.
55
Inflation to fall
50
%yoy CPI Forecast
2001 2003 2005 2007 2009 2011 5
4
Housing prices (rental this time) remain a source of
3
concern for the authorities. They continue to face a
difficult task of limiting rental price inflation by providing 2
more supply while preventing a sharp correction in the
1
housing market. We expect a more decisive policy
response on the issue in 2012. Furthermore, government 0
measures to alleviate households debt burden pose 2009 2010 2011 2012
upside risks to our private consumption growth outlook. Sources: CEIC and Deutsche Bank
Private consumption growth to slow, modestly…

Payrolls continued to expand in October, by 1.7%yoy

Looking ahead, we expect inflation to fall to 3.4% in 2012 capital outflows rose sharply in September, rendering the
from 4.0% in 2011, as a result of moderation in food price won 10.4% weaker against the US dollar. In particular,
inflation and below-trend growth. We note that the IMF while South Korea’s current account surplus widened to
food price inflation has fallen 11.3%yoy 3mma in October, USD3.1bn in September, up from USD0.3bn in August, its
after reaching its recent peak of 34.3% in April, capital account deficit rose to USD4.7bn in September
suggesting that imported food inflation will be limited. from USD1.7bn in August, due to deterioration in ‚other
Meanwhile, our commodity analysts expect little change investments‛. The latter reported a net outflow of
in oil prices in 2012 – only 3.5% increase in Brent oil USD17.1bn in September vs. a net inflow of USD4.6bn in
prices from this year. August, as a result of outflows of trade credit, FX loans
and deposits. In contrast, portfolio investment rebounded
Taylor rule model in line with our rate call in September, registering a net inflow of USD1.8bn vs. a
6 % USD2.9bn outflow in August. FX reserves fell to
Actual Forecast Taylor
USD303.4bn in September, from USD312.2bn in August,
5 as a result. On a positive note, the Korean authorities
expanded FX swap lines with their Chinese and Japanese
4
counterparts, resulting in their increase to about
3 USD125bn combined.
2
Capital flow weighs on the won…
1 USDbn Fgn net purchase of debt securities
00 01 02 03 04 05 06 07 08 09 10 11 12 20 Fgn net purchase of equity securities
15 Fgn other investment
10
5
…points to no rate change by the Bank of Korea until
0
2H 2013... Weaker growth and falling inflation point to no
-5
rate change by the Bank of Korea (BoK) in 2012. We do
-10
not expect rate hikes by the BoK until mid-2013. Given our
-15
growth and inflation projection, our Taylor rule model
-20
suggests that the BoK rate is where it should be.
Moreover, risks to rates remain to the downside, as 2008 2009 2010 2011
conditions in the G2 economies – Euroland in particular – Sources: CEIC and Deutsche Bank
remain precarious, at best. Moreover, given Korean

households’ high gearing ratio (worse than their We note that South Korea’s current account surplus
counterparts in the US), lower rates would reduce the widened further in October, to USD4.2bn from USD2.8bn,
household debt servicing burden. The fifth percentile driven by the goods account. Meanwhile, the financial
(lowest) income group’s debt servicing ratio stood at account, excluding reserve assets, reported a surplus of
20.4%, vs. the nation’s average of 11.5% in 2010. USD4.3bn in October vs. the USD17.2bn deficit reported
in September, as other investments stood at a surplus of
Debt servicing ratio by income group USD2.96bn in October vs. a deficit of 16.8bn in
% September. Looking forward, we see the sovereign debt
25 crisis in Euroland and deleveraging by its banks to
20.4
20 continue to weigh on the won for the early part of 2012,
14.7 especially as South Korea’s current account reports a
15
11.5 12 deficit, temporarily in Q1, due to seasonal effects.
9.4 9.1
10 However, as mentioned earlier, with a much larger FX
reserve of USD311bn in October (225% and 79% of
5
short-term and total FX debt outstanding in Q311), and
0 USD125bn of FX swaps, we see limited volatility in the
Total 1st quintile 2nd 3rd 4th 5th won in 2012.
Sources: OECD, Bank of Korea
…while the sovereign debt crisis in Europe check the

won’s gain. Despite large current account surpluses, the
won remained vulnerable to the sovereign debt crisis in
Europe. In response to the sharp increase in risk aversion,

…despite the positive fundamental South Korea: Deutsche Bank forecasts

%yoy 3mma USD bn 2010 2011F 2012F 2013F
70 Trade Balance (rhs) 7 National income
Imports
50 Exports 5 Nominal GDP (USDbn) 1015 1115 1165 1280
Population (m) 48.8 48.9 49.0 49.1
30 3
10 1
-10 -1 Real GDP (YoY%) 6.2 3.7 3.4 4.0
-30 -3 Private consumption 4.1 2.6 2.3 3.0
-50 -5
Gross fixed investment 7.0 -1.3 2.8 3.5
2007 2008 2009 2010 2011 Exports 14.5 10.6 5.5 9.8
Sources: CEIC and Deutsche Bank Imports 16.9 7.6 4.4 8.7
Juliana Lee, Hong Kong, (852) 2203 8305 Prices, money and banking
CPI (YoY%) eop 3.0 4.1 3.1 4.3
CPI (YoY%) ann avg 2.9 4.0 3.4 3.5
Investment strategy Broad money (M3) 9.5 8.0 8.5 9.0
Local rates: Given the strong technicals, we maintain our Bank credit (YoY%) 3.4 6.8 7.0 7.0
moderate bullish steepening view with a target on 10Y
KTB yields of 3.75% by year end. Concerns over lack of Fiscal accounts (% of GDP)
reinvestment demand from offshore investors have Central government surplus 1.4 1.6 0.3 0.3
reduced, which is supportive of 2Y-3Y segments. We also Government revenue 23.3 23.2 21.9 22.8
see December KTB issuance plan of KRW6.5tn as an Government expenditure 21.9 21.5 21.7 22.5
indicator of the likely KTB issuance pattern in 2012, with Primary surplus 2.8 3.1 1.8 1.8
increased allocations towards the 10Y and 20Y KTBs,
given large maturities in 2014 (KRW56.6tn). Asian central External accounts (USDbn)
banks remain key on the demand side, having bought
USD9.9bn (net) till September this year. It is less than
Trade balance 41.9 32.1 14.9 20.1
certain if they would buy an equivalent amount in 2012. To
% of GDP 4.1 2.9 1.3 1.6
that extent, we think swaps would outperform bonds,
especially in the long-end. The risk on BOK is skewed
% of GDP 2.8 2.3 0.7 1.2
towards the possibility of a rate cut if global conditions
FDI (net) -19.4 -11.0 -10.0 -13.0
worsen. With milder RRR regulation, the spread between FX reserves (USDbn) 297.1 317.6 320.7 344.7
the 91D CD rates and the policy rate could also gradually FX rate (eop) KRW/USD 1135 1120 1080 1050
tighten towards the year's low of 23bp. This will likely
cause swaps to outperform bond equivalents, which Debt indicators (% of GDP)
would be more pronounced in the long end as rolldown Government debt1 35.2 34.7 34.2 33.9
and carry for the front-end swap receivers is expensive. Domestic 34.3 33.9 33.4 33.1
The risk to this view could be radical household measures External 0.9 0.8 0.8 0.8
aimed at shifting more household debt into fixed rate Total external debt 35.8 34.8 23.4 22.5
loans. Such measures would reduce the interest from in USD bn 359.4 395.0 288.0 286.0
banks to receive long end swaps. Short-term (% of total) 37.6 35.4 45.1 42.0
FX: The won’s high beta to global risk sentiment appears General
to be the only reason to be underweight this currency at Industrial production (YoY%) 17.3 8.5 6.8 8.8
this juncture. Even so, we note that the won is now less Unemployment (%) 3.7 3.4 3.4 3.3
sensitive to global USD funding conditions, not least
because Korean FIs have reduced their dependence on s/t Financial markets Current 3M 6M 12M
external funding in recent years. A strong current account, BoK base rate 3.25 3.25 3.25 3.25
91-day CD 3.60 3.60 3.60 3.70
cheap currency valuations, a positive carry and growing
10-year yield (%) 3.80 4.00 4.10 4.20
foreign demand for Korean bonds are reasons to retain a
KRW/USD 1143 1130 1100 1080
core medium-term bullish view on the currency. Source: CEIC, Deutsche Bank Global Markets Research, National Sources
Note: (1) FX swap funds unaccounted for. (2) Includes government guarantees..
Kiyong Seong, Hong Kong, (852) 2203 5932

Sri Lanka B+(Pos)/BB-

S&P/Fitch
 Economic Outlook: Real GDP growth likely to Inflation to stay in mid single digits
moderate to 7.5% in 2012 (from 8% in 2011), led by
a negative base and weak external demand. CPI inflation moderated to 4.7% in November, after
peaking at 8.8% in April of this year. We forecast CPI
 Main Risks: There is a non-trivial risk that the
inflation to moderate further, led by lower food inflation
ongoing fiscal consolidation process suffers a
and stable fuel prices, to end the year around 4.0%, which
setback, in the event of any external shock, that
should lead to an annual average inflation rate of 6.7% for
threatens to lower growth below 7% in 2012.
2011 (up slightly from 6.2% in 2010). Core inflation should
also moderate to around 4.5% by year-end. The inflation
Growth to moderate to 7.5% in 2012
trajectory should remain favorable through the first half of
Through 2011, the Sri Lankan economy has shown 2012 as well, after which CPI inflation should rise to touch
exceptional resilience, despite a highly unsupportive 7.5% by end-2012. Overall, we expect inflation to
global environment and severe flooding in early part of the average 5.5% in 2012, barring any supply shocks.
year, which affected domestic agricultural production
This benign inflation trajectory should have allowed the
substantially. Notwithstanding these adversities, the
Central Bank of Sri Lanka (CBSL) to cut interest rates to
economy will likely record 8% real GDP growth in 2011
support growth, especially in an environment, where the
(same as in 2010), aided by an acceleration in non-farm
government is expected to continue with its fiscal
sector growth to 9.0%, up from 8.2% in 2010. But will Sri
consolidation process and given potential growth risks
Lanka manage to record 8% growth for the third year in a
due to heightened global uncertainty. But broad money
row in 2012? We think it is unlikely. Our estimates show
supply (20.7%yoy) and bank credit growth (34.4%yoy)
that non-farm growth momentum in Sri Lanka is likely
remains exceptionally high, indicating strong demand side
to moderate in 2012 (to about 7.8%), led by a negative
pressures. Perhaps owing to this, the CBSL Governor
base and weak external demand, which should drag
Ajith Cabrral recently described the current monetary
overall growth to around 7.5% (the government expects
policy stance as ‚appropriate‛, thereby signaling that
growth to be around 8.5-9.0% in 2012). In contrast,
the central bank is not yet ready to cut the policy rate or
agricultural sector growth is likely to be supportive,
the reserve ratio immediately.
bouncing back from a low base of this year. Note that our
base case growth forecast of 7.5% assumes an orderly But we think that there is a possibility for this stance
resolution to the present debt crisis in EU. However, if the to change in the first quarter of 2012, as i) inflation
EU crisis were to unfold in a disorderly fashion, downside moderates further in the coming months; ii) credit growth
risk to growth could rise appreciably, through the trade eases; iii) 4Q 2011 GDP growth falls below 8%; and iv)
and confidence channel. In such a scenario, the central global conditions worsen. Consequently, we factor in two
bank would cut rates aggressively and the government 25bps rate cuts, each in the first and (early) second
would likely compromise on its fiscal consolidation goal to quarter, which should take the reverse-repo rate to 8% by
ramp up public spending, in an effort to prevent growth mid-2012, from the current 8.50% levels.
from heading below the 7% mark.
Colombo CPI and core CPI inflation forecast
Resilient growth despite various adversities % yoy CPI CPI proj.
% yoy 12
12 Real GDP Non-farm GDP Core CPI Core CPI proj.
10
10
8
8
6
6
4
4
2
2
0
0 2009 2010 2011 2012
2007 2009 2010 2011 Source: CEIC, CBSL, Deutsche Bank
Source: CEIC, CBSL, Deutsche Bank

Fiscal consolidation will be challenging Sri Lanka: Deutsche Bank Forecasts

2010 2011F 2012F 2013F
We think the 2012 budget deficit target of the Sri Lankan National Income
government (6.2% of GDP) is slightly on the optimistic Nominal GDP (USD bn) 49.6 58.2 64.5 75.4
side. While the expenditure target seems broadly Population (mn) 20.7 20.9 21.1 21.3
reasonable, we think the government is overestimating GDP per capita (USD) 2401 2789 3062 3541
likely revenue outturn, based on its expectation of 8.5-
9.0% real GDP growth for 2012, which is unlikely in our Real GDP (YoY %) 8.0 8.0 7.5 8.0
view. Further, while the various expenditure targets look Total consumption 8.6 8.6 8.2 8.3
realistic in line with the past trend, there is a non-trivial risk Total investment 8.0 9.2 8.7 10.0
that those targets could be breached, in the event growth Private 7.0 9.0 8.0 10.0
starts slowing sharply. In such a scenario, the Sri Lankan Government 12.0 10.0 11.0 10.0
authorities could decide to sacrifice the fiscal targets by Exports 9.0 12.0 10.0 11.0
boosting expenditure, to give impetus to growth. Given Imports 10.0 13.0 11.5 12.0
these various risks, our base case scenario therefore
builds in a budget deficit forecast of 7.0% of GDP Prices, Money and Banking
CPI (YoY%) eop 6.8 4.1 7.6 6.3
(unchanged from 2011 levels), with further upside risks
CPI (YoY%) avg 6.2 6.7 5.6 6.7
likely, if global conditions worsen. Consistent with our
Broad money (M2b) eop 15.8 19.0 15.6 15.5
budget deficit forecast, we expect the debt-GDP ratio to
Bank credit (YoY%) eop 24.9 28.2 15.4 13.4
edge lower to 75.1% in 2012, from a likely 78.5% in 2011.
Deutsche Bank vs. Government forecast for 2012 Fiscal Accounts (% of GDP)
% of GDP 2010 2011 2012 DB 2012 budget Central government balance -8.0 -7.0 -7.0 -6.5
forecast forecast Government revenue 14.9 14.3 14.3 14.5
Total revenue and grants 14.9 14.3 14.3 15.0 Government expenditure 22.9 21.4 21.3 21.0
Total expenditure 22.9 21.4 21.3 21.2

Recurrent 16.7 15.6 14.8 14.7
Capital and net lending 6.1 5.8 6.5 6.5 Merchandise imports 13.5 18.2 19.9 23.9
Trade balance -5.2 -7.4 -8.0 -9.6
Budget deficit -8.0 -7.0 -7.0 -6.2 % of GDP -10.5 -12.8 -12.4 -12.7
Source: Department of Fiscal Policy, Deutsche Bank
% of GDP -2.9 -5.6 -4.9 -5.2
Rupee likely to appreciate in 2H 2012 FDI (net) 0.4 0.8 0.8 1.0
Post the devaluation of the rupee by 3% on 21 November, FX rate (eop) LKR/USD 111.0 113.9 112.5 111.0
the LKR is currently trading at 113.9 levels versus the
dollar, as against 110.4 previously. The central bank Debt Indicators (% of GDP)
governor has assured market participants that there Government debt 81.9 78.5 75.1 71.5
will be no further sharp depreciation of the rupee in Domestic 45.8 44.3 42.4 40.3
the immediate future, although risks remain, in our External 36.1 34.2 32.7 31.2
view. We expect the rupee to depreciate further to 114.5 Total external debt 43.3 41.3 40.3 37.2
levels by mid-2012 as dollar strength intensifies in the in USD bn 21.4 24.0 26.0 28.0
coming months. However, there could be a bigger Short-term (% of total) 13.5 12.9 12.9 12.9
depreciation risk to the rupee if the BOP position worsens
significantly from our baseline forecast (we forecast General
current account deficit to be 4.9% of GDP in 2012, and Industrial production (YoY %) 10.4 3.8 7.6 7.4
overall BOP surplus to be 0.8% of GDP ), led by a severe Unemployment (%) 4.9 4.8 4.7 4.5
external shock. Without an external shock, we expect the
rupee to reverse course in the second half of 2012, and Financial Markets Current 3M 6M 12M
Reverse Repo rate 8.50 8.25 8.00 8.00
appreciate to 112.5 levels by end-Dec 2012.
LKR/USD 113.9 114.2 114.5 112.5
Kaushik Das, Mumbai, (91) 226658-4909 Source: CEIC, DB Global Markets Research, National Sources

Taiwan Aa3/AA-/A+
Moody’s/S&P/Fitch
 Economic Outlook: With exports at 74% of GDP, sustained weakness in investments in 2012, providing no
we see weak G2 growth of 1% in 2012, vs. 1.7% in support to growth in 2012, albeit better than the -0.6% in
2011, guiding Taiwan’s growth lower to 3.0% from 2011. Meanwhile, we believe inventory destocking will
4.4% in the same period. likely continue to weigh on growth, by 1.1% in 2012 vs.
0.3% in 2011.
 Main Risks: Risks to our rates outlook remain to the
downside amid the sovereign debt crisis in Euroland.
Net export contribution to growth to fall
 Strategy Recommendations: We believe TWD % contribution to growth
interest rate swap curve is unlikely to break its recent 20 PCE Govt Investment
range in the next three months unless CBC surprises Stocks Net exports GDP
the market with cuts in the policy rates. We
10
recommend to hold paying the belly in TWD 2x5x10
notional neutral butterfly position.
0
Macro View
Weak exports to depress growth in 2012… We see -10
Taiwan’s GDP growth slowing to 3.0% in 2012 from 4.4% 2007 2008 2009 2010 2011F 2012F 2013F
in 2011, as export growth remains weak. After soaring to Source: CEIC and Deutsche Bank
25.7% in 2010, we see export growth slowing to 5.0%
this year and 4.2% next year. In 2012, we see Taiwan’s The Central Bank of China to stay on the sidelines
growth coming under further pressure, as G2 (US/EU) until 2H 2013, with risks to the downside. We expect
growth should slow sharply, to 1.0% from 1.7% this year. CPI inflation to ease modestly in 2012 to 0.9% from 1.3%
As for the growth dynamics, we see Taiwan’s growth in 2011, as food price inflation eases and oil price increase
bottoming at 1.7% in Q1 2012, as export growth troughs. remains limited. We note that the IMF food price inflation
The latter will also push private consumption growth has fallen 11.3%yoy 3mma in October, after reaching its
lower, to 2.6% in 2012 from 3.1% in 2011, further recent peak of 34.3% in April, suggesting that imported
depressed by negative wealth effects of lower stock food inflation will be limited. Meanwhile, our commodity
prices. Note that the securities share of households’ total analysts expect little change in oil prices in 2012 – only
assets (including fixed assets) stood at 18.6% (in 2009). 3.5% increase in Brent oil prices from this year. Moreover,
We note that consumer sentiment continued to decline in housing price inflation continued to fall in 2011, as has
November 2011 to 80, below the 12mma of 84.9, after credit growth, after peaking in April 2011 at 8.7%yoy
peaking in August at 87. 3mma. While we expect no rate change by the CBC until
2H 2013, we see risks to our rates outlook to the
GDP growth to bottom in Q1 downside amid falling inflation and weak growth.
%yoy GDP (lhs) GDP Forecast %yoy
15 Exports Exports forecast 50 Inflation to fall modestly
40
10 %yoy
30 CPI Forecast
4
5 20
10
3
0 0 2
-10 1
-5
-20 0
-10 -30 -1
2007 2008 2009 2010 2011 2012 2013 -2
Source: CEIC and Deutsche Bank -3
2009 2010 2011 2012
On average, we see private consumption contribution to
Source: CEIC and Deutsche Bank
growth falling to 1.4% in 2012 from 1.7% in 2011, while
the net trade contribution also declines to 2.6% from Meanwhile, low rates and weak exports point to only a
3.6% in the same period. The latter in turn points to limited appreciation of the TWD in 2012. Weak exports

suggest a narrower current account surplus of 7.6% of Taiwan: Deutsche Bank’s forecasts
GDP, although still high compared to its peers. Moreover, 2010 2011F 2012F 2013F
although risks to growth, rates and the TWD remain to the National Income
downside due to the sovereign debt crisis in Euroland, we Nominal GDP (USDbn) 433.2 475.0 472.5 505.5
see a relatively stable TWD – compared to the KRW, for Population (m) 23.2 23.2 23.3 23.4
example – as Taiwan remains a net investor to the world. GDP per capita (USD) 18706 20456 20297 21639
We also note that its FX reserve of USD393.3bn in
October stood more than three times its total external Real GDP (YoY%) 10.9 4.4 3.0 4.4
debt of USD124.6bn (in Q211). Private consumption 3.7 3.1 2.6 2.9
Government consumption 1.8 -0.4 1.0 1.4
Juliana Lee, Hong Kong, (852) 2203 8312 Gross fixed investment 23.4 -3.1 -0.3 3.7
Exports 25.7 5.0 3.9 9.1
Investment strategy Imports 28.2 0.2 0.6 9.6
Rates. We believe TWD interest rate swap curve is Prices, money and banking
unlikely to break its recent range in the next three months. CPI (YoY%) eop 1.2 1.0 0.6 1.9
A potential near-term catalyst is any surprise cuts in the CPI (YoY%) annual average 1.0 1.3 0.9 1.1
Broad money (M2) 4.5 6.0 6.0 7.0
policy rates, which could be justified if domestic growth
Bank credit1 (YoY%) 5.3 5.8 4.0 6.0
slowdown is a more material threat than the upside risk
on inflation.
Budget surplus -2.4 -3.2 -3.4 -2.3
Currently the market is pricing in the scenario that CBC
will remain on hold for the next 12 months, which is in line
with our expectation. We are less convinced on the Primary surplus -0.6 -1.0 -1.2 -0.1
directional risk on the IRS curve in the near-term and we
prefer to maintain our TWD 2Y/5Y/10Y butterfly spread. External accounts (USDbn)
FX. We think gains in TWD will lag regional currencies in Merchandise imports 247.3 285.2 313.6 373.8
2012 and thus prefer to use it as a funder for intra-region Trade balance 26.5 25.4 22.5 20.3
trades. The main argument is that Taiwan’s exports % of GDP 6.1 5.3 4.8 4.0
growth has slowed considerably, and that central bank’s Current account balance 39.9 40.7 35.8 34.1
FX policy has tended to be motivated by cyclical factors. % of GDP 9.2 8.6 7.6 6.7
The Taiwanese government is the first in the region to FDI (net) -9.1 -15.0 -13.0 -13.0
have announced an economic stimulus package, including FX reserves (USD bn) 382.0 395.5 412.9 428.6
measures to help the exports sector. With headwinds to FX rate (eop) TWD/USD 30.3 30.0 29.0 27.5
exports still growing and layoffs (unpaid leave for workers)
on the rise, we think CBC is likely to intervene more Debt indicators (% of GDP)
actively to slow gains in the currency to provide support Government debt2 40.5 43.3 46.2 47.5
for the exports sector. One key risk for the TWD in 2012 Domestic 38.7 41.4 44.3 45.6
is the presidential elections. A change in political External 1.9 1.8 1.9 1.8
leadership could potentially slow economic integration
in USDbn 101.6 130.0 145.0 155.0
with the mainland, a key economic development that has
provided significant support to Taiwan’s economic activity
and BoP (exports, tourism inflows, freight and passenger
General
transportations services, etc.) in recent years.
Unemployment (%) 5.0 4.4 4.4 4.4
DennisTan, Singapore, (65) 6423 5347 Financial markets Current 3M 6M 12M
Discount rate 1.88 1.88 1.88 1.88
90-day CP 0.80 0.80 0.80 0.80
10-year yield (%) 1.32 1.25 1.30 1.30
TWD/USD 30.1 30.0 29.7 29.0
Source: CEIC, Deutsche Bank Global Markets Research, National Sources
Note: (1) Credit to private sector. (2) Including guarantees on SOE debt

Thailand Baa1/BBB+/BBB
Moody’s/S&P/Fitch
 Economic Outlook: We see GDP growth rebounding rice price guarantees, we see domestic demand
to 3.9% in 2012 from 1.8% in 2011, supported by expanding at a faster pace, with its contribution to growth
reconstruction activities. The latter and weak exports, increasing to 3.8% in 2012, from 2.2% in 2011. In
however, point to a current account deficit of 1.9% of contrast, we see a relatively weak export growth of 5.4%
GDP in 2012. in 2012 vs. 8.3% in 2011, as G2 growth falls to 1.0% in
2012 from 1.7% in 2011. With import growth relatively
 Main Risks: Risks to growth remain to the downside
stable, supported by stronger domestic demand for
due to fragile external conditions and implementation
capital goods, we see net trade becoming a drag on
risks to reconstruction plans.
growth, by 0.2% in 2012, after contributing 1.2% in 2011.
 Strategy Recommendations: Bond and swap curves Meanwhile, we expect a modest positive contribution to
to steepen driven by valuations, supply concerns and growth from inventory restocking.
a more dovish outlook on monetary policy.
…while the Bank of Thailand stays on the sidelines
Macro View until Q3, as inflation eases. The Bank of Thailand (BoT)
delivered a 25bps rate cut as the flood’s effect was
Growth to rebound sharply ahead, as the country deemed ‚more widespread and severe.‛ The BoT
rebuilds… Natural disasters continued to pressure expects the economy to expand 1.8% in 2011, vs. its
Thailand’s production this year. Although far from home, earlier forecast of 2.6%. While the extent of the rate cut
Japan’s earthquake earlier this year rendered Thailand’s was less than our forecast of 50bps, the BoT’s tone was
manufacturing production weaker than it otherwise would dovish, noting that ‚the MPC would remain vigilant in
have been in 1H, due to supply chain disruptions. This monitoring developments in the global economy, as well
quarter the manufacturing sector saw its worst downturn as progress on domestic restoration efforts and stand
on record, due to the floods. According to the latest data, ready to take appropriate actions.’ The BoT sees GDP
manufacturing production fell 35.4%mom (35.8%yoy) in growth of 4.8% in 2012, sharply higher than our forecast
October, after contracting 4.1% in September. For the of 3.8%. We see weaker G2 growth; 1.0% in 2012 vs.
quarter, we see the economy contracting 4.5%qoq (down 1.7% in 2011, to weigh on Thailand’s export growth.
2.2%yoy) in Q4. In contrast, we see a strong start to Hence, with growth disappointing, we see the BoT
2012, with the qoq growth rebounding to +3.6% in Q1, as delivering another 25bp rate cut in Q112, as inflation
reconstruction efforts gain their full momentum. As the continues to ease.
economy moves further into the year, however, we see
growth momentum slowing to around 1% in Q4. As a Inflation moderates and stay within the target range
result, we see qoq growth of 2.4% in 2012, vs. the 0.5%
%yoy CPI forecast
contraction we forecast for 2011, while the yoy growth 6
surging to 9.9% in Q412, supported by favourable base
4
effects.
2
Domestic demand drives growth in 2012 0
% contribution to growth PCE Govt -2
Investment Stocks
10 -4
Net exports GDP
-6
5
2009 2010 2011 2012
0 Sources: CEIC and Deutsche Bank
-5
We see inflation continuing to trend downward in 1H
2012, bottoming in June at 3.5%yoy 3mma, then move
-10
more or less sideways, ending the year at 3.6%. On
2007 2008 2009 2010 2011F 2012F 2013F
average, we see headline inflation falling to 3.7% in 2012
Sources: CEIC and Deutsche Bank from 4.1% in 2011. We see food price inflation easing
further in 2012, as the flood effect drops out of the data
…but limited by weak exports… As Thailand rebuilds and as the Brent price increase is limited to 3.5% in 2012
itself, also supported by credit support, wage hikes and (the latter calculation derived from our commodity

research forecast). Given the inflation dynamics and weak Thailand: Deutsche Bank Forecasts
growth, we see the BoT remaining on the sidelines until 2010 2011F 2012F 2013F
2013, after one more rate cut in Q112. We note that the National Income
BoT will be targeting headline inflation of 1.5-4.5% in Nominal GDP (USDbn) 318.8 350.4 378.7 626.2
2012, vs. core inflation of 0.5-3.0% in 2011. With the BoT Population (m) 63.9 64.2 64.5 64.8
on hold, we see no notable support for the baht until 2H GDP per capita (USD) 4989 5458 5871 9664
2012, as stronger domestic demand vs. exports result in a
current account deficit of 1.9% of GDP in 2012. Real GDP (YoY%) 7.8 1.8 3.9 4.8
Juliana Lee, Hong Kong, (852) 2203 8305 Government consumption 6.4 1.8 7.3 5.3
Investment Strategy Exports 14.7 8.3 5.5 11.0
Rates: For FY12 (Oct-2011 to Sep 2012), the MoF plans to Imports 21.5 8.6 7.5 11.8
issue THB540bn of bonds(including T-bills and linkers)
which is close to 20% higher than the issuance last year. Prices, Money and Banking
CPI (YoY%) eop 3.0 4.1 3.3 4.1
On a net basis, the issuance will be up nearly 40% YoY.
CPI (YoY%) ann avg 3.3 3.9 3.7 3.7
On a slightly positive note, the entire increase in gross
Core CPI (YoY%) 0.9 2.4 2.7 2.7
issuance comes from the introduction of the new 3Y
Broad money 8.0 8.0 8.0 9.0
benchmark and T-bills. Therefore we note duration of
Bank credit1 (YoY%) 8.4 8.0 8.5 9.0
supply is not as concerning as the headline numbers
suggests.
Fiscal Accounts2 (% of GDP)
However, there are still a few reasons why bond investors Central government surplus -1.1 -3.7 -4.9 -3.2
should be cautious going into 2012: 1) The above Government revenue 16.8 16.3 15.6 16.5
issuance plan was announced before the budget deficit Government expenditure 17.9 19.9 20.5 19.7
got revised upwards from THB350bn THB400bn due to Primary surplus -0.8 -2.6 -3.9 -2.2
floods. In fact the deficit number could still be revised
External Accounts (USDbn)
higher as the damage due to floods has been much more
severe than initially anticipated. 2) Roughly 50% of the net
issuance in FY11 was bought by foreigners. Given the
Trade balance 32.2 15.7 8.7 21.1
possible impact on currency due to sharply slowing
% of GDP 10.1 4.5 2.3 3.4
exports and systemic risks emanating from Europe,
Current account balance 14.8 0.1 -7.3 5.5
inflows into EM debt funds could be more muted next
% of GDP 4.6 0.0 -1.9 0.9
year compared to FY2011. FDI (net) 1.0 -4.5 3.1 2.2
We would like to point out that onshore liquidity remains FX reserves (USDbn) 172.1 173.0 174.7 188.9
abundant and AUM of insurers and pension funds FX rate (eop) THB/USD 30.6 31.0 30.5 29.5
continues to grow at double digit rates. In fact, Thailand is
one of the few countries in Asia, where domestics have Debt Indicators (% of GDP)
Government debt2,3 35.2 35.9 39.5 38.8
continued to buy aggressively despite rich levels of the
Domestic 33.0 34.9 38.2 37.7
curve. The question then becomes, how much could be
External 2.2 1.1 1.3 1.1
the increase in supply. This would depend on how
aggressively the administration plans to implement the
in USDbn 100.6 115.0 125.0 135.0
reconstruction projects and how it plans to finance it.
FX: Thailand is likely to see temporary weakness in the
BoP due to recent nation-wide floods which have severely General
disrupted exports and tourism activities. Imports are likely Industrial production (YoY%) 15.4 -7.0 10.0 7.0
to rise in the near-term to meet shortages in domestic Unemployment (%) 1.1 1.1 1.0 1.0
supplies, while FDI plans are likely to be put on hold. As
such, the buffer from current account flows against capital Financial Markets Current 3M 6M 12M
BoT o/n repo rate 3.25 3.00 3.00 3.00
outflows has weakened. However, we expect BoT to
3-month Bibor 3.30 3.05 3.10 3.10
maintain stability or limit gains in the THB to provide some
10-year yield (%) 3.40 3.50 3.80 3.80
support to the exports sector during the recovery phase.
THB/USD (onshore) 31.0 31.0 30.9 30.5
Arjun Shetty, Singapore, (65) 6423 5925
Dennis Tan, Singapore, (65) 6423 5347 Note: (1) Depository institutions credit to the

Vietnam B1(Neg)/BB-(Neg)/B+
Moody’s/S&P/Fitch
 Economic outlook: We expect a modest slowdown the headline inflation to 18.7% this year, from 9.2% in
in GDP growth, to 5.6% in 2012 from 5.9% in 2011, 2010. Note that food constitutes 32.5% of the CPI basket
as lower inflation and rates counter the negative in Vietnam. In 2012, we expect a reversal of this trend,
impact of weaker external demand. with lower food price inflation guiding overall inflation
lower, further pressed by below-trend growth.
 Main risks: The banking system remains under
pressure, posing downside risks to growth and the Note that the IMF world food price index rose at a sharply
dong. lower pace of 11.3%yoy 3mma in October compared to
its recent peak of 34.3% in April. Meanwhile, our
Macro View commodity analysts expect little change in oil prices in
2012 – only 3.5% increase in Brent oil prices from 2011.
Weaker exports to leave overall growth weaker, at We expect inflation to continue to trend downward,
5.6% in 2012 from 5.9% in 2011… Year-to-date, the bottoming below 11% in Q4 2012, providing the SBV
economy expanded 5.8%yoy in Q3 2011, down from sufficient room to maneuver.
6.5% in the same period last year. We expect growth to
remain under pressure in Q4, compared to 2010, leaving …and lower inflation to prompt rate cuts
the growth at 5.9% in 2011 compared to 6.8% in 2010.
% Refinancing rate
This weaker growth is the consequence of
30 Headline inflation
macroeconomic imbalances which resulted in high
inflation and weakness in the dong. To address these 25 Forecast
issues, the authorities have adopted various tightening 20
measures, including raising rates and credit tightening. 15
We discussed their efforts in detail in our report ‚Vietnam:
10
Seeking sustainable growth‛ published on 4 November.
5
Weaker growth… 0
2006 2007 2008 2009 2010 2011 2012
% contribution to growth %
20 Net trade Changes in Stock 9 Sources: CEIC and Deutsche Bank
Investment Private Cons 8
15 Govt Cons GDP (rhs) 7 …prompting the State Bank of Vietnam (SBV) to
10
6 deliver rate cuts in 2012… In response to lower inflation
5 5 and weak growth, we expect the SBV to deliver 300bps
0 4
rate cuts in 2012, leaving the refinancing rate at 12% by
3
-5 end-2012. We expect the SBV to stop short of guiding the
2
-10 1 policy rate below inflation, to keep the economy on the
-15 0 path of sustainability and balanced growth. Note that the
2007 2008 2009 2010 2011F 2012F 2013F National Assembly passed a resolution on socioeconomic
plans which target GDP growth of 6.5–7.0% in 2011–
2015, compared to its earlier target of 7.5–8.0%, while
targeting a headline inflation of 5.0–7.0% in the same
As for 2012, we expect weak external demand – we see
period.
G2 growth falling to 1.0% in 2012 from 1.7% in 2011 -- to
guide Vietnam’s growth lower, to 5.6% from 5.9% this
Meanwhile, we reiterate the importance of reforming the
year. That is, we expect net trade to become a heavier
banking sector, as it would play a key role in stabilizing the
drag on growth, at 2.1% in 2012 vs. 1.7% in 2011. In
economy and its currency. Although those efforts may
contrast, we see domestic demand growth remaining
bring on bouts of volatility and thereby pose downside
relatively stable, with its contribution to growth
risks to growth, we believe that the negative impact is
moderating slightly, to 6.8% in 2012 from 7.1% in 2011.
likely to be short term in nature. We again highlight the
importance of preparing for a more dramatic consolidation
…while inflation falls… We expect headline inflation to
of the banking sector, thereby reducing systemic risks and
fall to 12.7% in 2012 from 18.7% in 2011, led by food.
pursuing restructuring of the state-owned enterprises.
The latter rose 23.3%yoy ytd in November 2011, leading

Needless to say, the stability of the banking system is Vietnam: Deutsche Bank Forecasts
critical in the dong’s stability. 2010 2011F 2012F 2013F
National Income
External imbalances to continue Nominal GDP (USD bn) 103.4 117.2 132.4 150.1
%yoy 3mma USD bn Population (m) 86.9 87.9 88.8 89.8
Trade Balance (rhs)
80 4 GDP per capita (USD) 1190 1334 1491 1672
Exports
60 Imports 3
Real GDP (YoY%) 6.8 5.9 5.6 6.5
40 2
20 1
0 0 Gross fixed investment 10.9 6.0 6.8 7.5
-20 -1 Exports 16.0 10.0 5.5 9.0
-40 -2 Imports 15.4 9.4 6.2 8.5
-60 -3
2004 2005 2006 2007 2008 2009 2010 2011 CPI (YoY%) eop 11.7 18.6 10.8 13.5
Sources: CEIC and Deutsche Bank CPI (YoY%) ann avg 9.2 18.7 12.7 13.0
Broad money (M3) 25.0 19.0 22.0 25.0
…while the dong continues to weaken, albeit Bank credit (YoY%) 27.0 15.0 17.0 18.0
relatively modestly… We expect a relatively weaker
external demand to result in a larger current account Fiscal Accounts1 (% of GDP)
deficit in 2012, albeit at a below five-year average of Federal government surplus -6.5 -5.3 -6.0 -5.0
6.57%, at 5.0% of GDP. However, we expect falling Government revenue 28.1 28.0 27.5 28.0
inflation to ease the pressure on the dong, limiting its Government expenditure 34.6 33.3 33.5 33.0
depreciation against the US dollar to about 5.0% in 2012. Primary fed. govt surplus -5.2 -3.8 -4.5 -2.5
As noted earlier, the dong’s fragile stability rests much on
the Vietnamese public, not foreigners, as Vietnam remains External Accounts (USD bn)
a highly dollarized economy. We also expect the Merchandise exports 72.2 90.0 106.0 132.0
Vietnamese authorities to continue to monitor FX market Merchandise imports 77.4 95.5 114.0 139.0
activities closely to curb grey market activities. Risks to Trade balance -5.2 -5.5 -8.0 -7.0
% of GDP -5.0 -4.7 -6.0 -4.7
our FX outlook remain to the downside, due to the
sovereign debt crisis in Euroland and sustained pressure
% of GDP -4.2 -3.8 -5.1 -4.0
on the domestic banking system.
FDI (net) 7.0 7.0 6.0 7.0
Dong remains under pressure, but limited FX rate (eop) VND/USD 19500 21100 22200 23000
VND/ USD
Reference rate
Spot rate Debt Indicators (% of GDP)
22,000
21,000
Domestic 21.0 21.0 22.0 22.5
20,000 External 31.1 32.0 32.0 32.0
19,000 Total external debt 42.2 42.7 41.5 40.7
18,000 in USD bn 43.6 50.0 55.0 61.0
17,000 Short-term (% of total) 2.1 11.6 12.7 14.8
16,000
General
15,000
2008 2009 2010 2011
Unemployment (%) 4.3 4.5 4.5 4.5

Juliana Lee, Hong Kong, (852) 2203 8305 Refinancing rate 15.00 14.00 13.00 12.00
VND/USD 21011 21100 21500 22200
Note: (1) Fiscal balance includes off budget expenditure, while revenue and expenditure include only on
budget items.

Theme Pieces
November 2011 March 2011
 Foreign Reserve Adwquacy in EMEA  High Oil Prices: Winners and Losers Updated
 Africa’s Frontier Markets: Growing Up  Hedging the Non-Linear Effects of Oil Prices
 Clustering Patterns in EMFX  Sovereign Credit: CDS as Substitute for Bonds
 Argentina – FX&Rates Outlook Amid Tighter Capital  Macro Repercussions of MENA Crisis
Controls  Oil Spike: Ways to Play the Spike in LatAm Equities
 Venezuela – Analyzing Negative Basis Trades
February 2011
October 2011  EM Rates: Repricing the Cycle and Commodities Risk
 Inflation Pass-through, Monetary & FX Policies in EM  Is Inflation in EMEA Back?
 Trading Tails in EM: Leaders & Laggards  Introducing Sovereign Credit Relative Value Monitor
 Asian Growth is Slowing, That’s All  A Closer Look at Ruble Fixed Income
 Em Corporates: Preserving Value  Colombia: Introducing COP/IBR Interest Rate Swaps
 Equities—Latam factors: What’s Working, What’s Next  Impact of Technical Rotation: Too Much Ado
 Latam Equities: Tactics to Combat EM Outflows into
September 2011
US
 EM and the Global Slowdown
 EMEA: Still Vulnerable to an External Financing Squeeze January 2011
 Introducing the EM Rates Volatility Report  EM Inflation Acceleration: The Commodity Fuel Once
 A Primer on Asia Interest Rate Options Again
 GCC Macro Updates: Still Resilient  Argentina CER Bonds: Seitch from Duration to Carry
 Financial Condition Indicators in Latin America  GCC 2011 Outlook
 Argentina: The Limits of Policy Continuity  2011 Outlook: Key Themes for Latam Equities
 Latam Equities: Stress Testing  The Year of the Rub
July 2011 December 2010
 EM Trend Decoupling but Cyclical Coupling  Outlook for EM Rates
 CEE: Examining Contagion from Peripheral Europe  Outlook for EM FX
 EMFX: Revisiting the Vol Dispersion Trade  Outlook for EM Sovereign Credit
 EM Exchange Rate Fundamentals  Perspectives on the Capital Flows to EM
 Venezuela: Sailing on Uncharted Waters  EM Sovereign Risks in 2011 ( and Beyond)
June 2011  EMEA Domestic debt – 2011 Supply and Demand
 Global EM Equities – Evolving Structural Drivers
 Sovereign Credit- Trading the Soft Patch
 2011 Latin America Equity Market Target
 EMFX: Favoring EUR Funding
 Dislocations in EM Swaption Vols November 2010
 Revisiting the Credit Impulse in EMEA  A Detailed Examination of Local Currency Debt
 EMEA: Updating Our Breakeven Oil Price Estimates Returns
 Is Indonesia the Next Brazil?  Surveying Onshore/Offshore Relative Pricing in EM
 Brazil Equities – Navigating Through Choppy Waters  EM Sensitivity to Greater Renminbi Flexibility
May 2011  Responding to Capital Flows in EMEA
 Asia Rates: Supply to Force Greater Differentiation in
 Perceived Inflation Asymmetries and Rate Anomalies
2011
 Reacting to Core Vs Headline Inflation in EMEA
 Assessing CDS Curve Dynamics in EM October 2010
 EM Rates: How Much Carry is Left?  Ever Emerging Markets
 The Pressure Cooker in Asia – Bubbling Away  Lessons From a decade of Outperformance
 LatAm Factors – What’s Working, What’s Next?  Revisiting EMEA External Positions
 Argentina: Not Yet Time to Take Profit
April 2011
 Asian Equity Volatility – The World’s Cheapest Buy?
 LatAm Rates: Is There Any Value Left?
 CEE: Food Inflation Ahead
 Monetary Policy in EMEA: Who’s (Running) Hot and
Who’s Not
Regulatory Dis
 Peru: Countdown to Presidential Elections
 In Vogue: Reserve Requirements in Turkey and Russia
 In a Sideways Market: Buy LatAm Dividend Elite

Contacts
Name Title Telephone Email Location
EMERGING MARKETS
Balston, Marc Head of EM Quantitative Research 44 20 754 71484 marc.balston@db.com London

Brown, Latashia EM Strategy 1 212 250 5774 latashia.brown@db.com New York
Cañonero, Gustavo Head of Economic Research LA&EMEA 1 212 250 7530 gustavo.canonero@db.com Buenos Aires
Cassard, Marcel Global Head - Macro & Fixed Income Research 44 20 754 55507 marcel.cassard@db.com London
Evans, Jed Head of EM Analytics 1 212 250 8605 jerrold.evans@db.com New York
FIlho, Jose LatAm Strategy 1 212 250 5932 jose.vieira-filho@db.com New York
Giacomelli, Drausio Head of EM Strategy 1 212 250 7355 drausio.giacomelli@db.com New York
Jiang, Hongtao EM Strategy 1 212 250 2524 hongtao.jiang@db.com New York
Parisien, Denis Global Head of EM Corporates 1 212 250 7568 denis.parisien@db.com New York
Zhang, Jack EM Strategy 1 212 250 0664 jack.zhang@db.com New York
LATIN AMERICA
Faria, Jose Carlos Senior Economist, LA 5511 2113 5185 jose.faria@db.com Sao Paulo
Losada, Fernando Senior Economist, LA 1 212 250 3162 fernando.losada@db.com New York
Marone, Guilherme EM Strategy 1 212 250 8640 guilherme.marone@db.com New York
Roca, Mauro EM Strategy & Senior Economist 1 212 250 8609 mauro.roca@db.com New York
Menusso, Marcelo Head of LatAm Corporates 1 212 250 6135 marcelo.menusso@db.com New York
EMERGING EUROPE, MIDDLE EAST, AFRICA
Akyurek, Cem Senior Economist, EMEA 90 212 317 0138 cem.akyurek@db.com Istanbul
Bougueroua, Lamine EM Strategy, EMEA 44 20 7545 2402 lamine.bougueroua@db.com London
Boulos, Tala EMEA Corporates 44 20 754 53664 tala.boulos@db.com London
Burgess, Robert Chief Economist, EMEA 44 20 754 71930 robert.burgess@db.com London
Grady, Caroline Economist, EMEA 44 20 754 59913 caroline.grady@db.com London
Gulberg, Henrik Economist,EMEA 44 20 754 59847 henrik.gulbberg@db.com London
Lissovolik, Yaroslav Senior Economist, EMEA 7 495 967 1319 yaroslav.lissovolik@db.com Moscow
Kapoor, Siddharth EMEA Strategy 44 20 754 74241 siddharth.kapoor@db.com London
Masia, Danelee Senior Econom st, EMEA 27 11 775 7267 danelee.masia@db.com Johannesburg
Ozturk, Kubilay Economist, EMEA 44 20 7547 8806 kubilay.ozturk@db.com London
Shilin, Viacheslav Head of EMEA Corporates 44 20754 79035 viacheslav.shilin@db.com London
ASIA
Baig, Mirza FX Strategy 65 6423 5930 mirza.baig@db.com Singapore

Baig, Taimur Chief Economist, India 65 642 38681 taimur.baig@db.com Singapore
Goel, Sameer Head of Asia Rates & FX Research 65 6423 6973 sameer.goel@db.com Singapore
Das, Kaushik Economist 91 22 6658 4909 kaushik.das@db.com Mumbai
Lee, Juliana Senior Economist 852 2203 8312 juliana.lee@db.com Hong Kong
Leung, Mickey EM Economics 852 2203 8307 mickey.leung@db.com Hong Kong
Liu, Linan Rates Strategy 852 2203 8709 linan.liu@db.com Hong Kong
Ma, Jun Chief Economist, China 852 2203 8308 jun.ma@db.com Hong Kong
Seong, Ki Young Rates Strategy 852 2203 5932 kiyong.seong@db.com Hong Kong
Shetty, Arjun Rates Strategy 65 6423 5925 arjun.shetty@db.com Singapore
Spencer, Michael Chief Economist, Asia Pacific 852 2203 8305 michael.spencer@db.com Hong Kong
Tan, Dennis FX Strategy 65 643 5347 dennis.tan@db.com Singapore

Appendix 1
Important Disclosures
Additional information available upon request
For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see
the most recently published company report or visit our global disclosure look-up page on our website at
http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.
Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the
undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in
this report. Drausio Giacomelli
Deutsche Bank debt rating key
CreditBuy (‚C-B‛): The total return of the Reference

Credit Instrument (bond or CDS) is expected to
outperform the credit spread of bonds / CDS of other
issuers operating in similar sectors or rating categories
over the next six months.
CreditHold (‚C-H‛): The credit spread of the
Reference Credit Instrument (bond or CDS) is expected
to perform in line with the credit spread of bonds / CDS
of other issuers operating in similar sectors or rating
categories over the next six months.
CreditSell (‚C-S‛): The credit spread of the Reference
Credit Instrument (bond or CDS) is expected to
underperform the credit spread of bonds / CDS of other
issuers operating in similar sectors or rating categories
over the next six months.
CreditNoRec (‚C-NR‛): We have not assigned a
recommendation to this issuer. Any references to
valuation are based on an issuer’s credit rating.
Reference Credit Instrument (‚RCI‛): The Reference

Credit Instrument for each issuer is selected by the
analyst as the most appropriate valuation benchmark
(whether bonds or Credit Default Swaps) and is detailed
in this report. Recommendations on other credit
instruments of an issuer may differ from the
recommendation on the Reference Credit Instrument
based on an assessment of value relative to the
Reference Credit Instrument which might take into
account other factors such as differing covenant
language, coupon steps, liquidity and maturity. The
Reference Credit Instrument is subject to change, at the
discretion of the analyst.

Regulatory Disclosures
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Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent
or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at
http://gm.db.com.
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affected by revenues deriving from the business and financial transactions of Deutsche Bank.
EU countries: Disclosures relating to our obligations under MiFiD can be found at
http://www.globalmarkets.db.com/riskdisclosures.
Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc. Registration
number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117.
Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures Association of Japan,
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Risks to Fixed Income Positions

Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to pay
fixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases in
interest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer the
maturity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises in
inflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks to
receivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assets
holding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currency
conversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses are
also important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may be
mitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these are
common in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure the
actual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularly
important in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest rate
reference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differs

from the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps
(swaptions) also bear the risks typical to options in addition to the risks related to rates movements.
Hypothetical Disclaimer
Backtested, hypothetical or simulated performance results have inherent limitations. Unlike an actual performance record
based on trading actual client portfolios, simulated results are achieved by means of the retroactive application of a backtested
model itself designed with the benefit of hindsight. Taking into account historical events the backtesting of performance also
differs from actual account performance because an actual investment strategy may be adjusted any time, for any reason,
including a response to material, economic or market factors. The backtested performance includes hypothetical results that
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commissions, and any other expenses that a client would have paid or actually paid. No representation is made that any
trading strategy or account will or is likely to achieve profits or losses similar to those shown. Alternative modeling techniques
or assumptions might produce significantly different results and prove to be more appropriate. Past hypothetical backtest
results are neither an indicator nor guarantee of future returns. Actual results will vary, perhaps materially, from the analysis.

David Folkerts-Landau
Managing Director
Global Head of Research
Guy Ashton Marcel Cassard Stuart Parkinson

Head Global Head Associate Director
Global Research Product Fixed Income Research Company Research
Asia-Pacific Germany Americas Europe

Fergus Lynch Andreas Neubauer Steve Pollard Richard Smith
Regional Head Regional Head Regional Head Regional Head
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Global

Emerging Markets 2012 Outlook

Survival of the Fittest Marc Balston

EM Technicals in 2012: Structurally Sound; Cyclically Vulnerable

This Month’s Special Reports

FX in 2012: The Vehicle to Trade Global Risk

Sovereign Credit in 2012: Diminished Returns; Country Selection Key

EM: Survival of the Fittest

EM Performance: The Grass is Grayer on the Other Side

EM Technicals Outlook in 2012: Structurally Sound; Cyclically Vulnerable

A Closer Look at Real-Money Positioning

IMF Financing: Possibilities and Limitations

EMEA Domestic Debt: Supply and Demand in Focus

Theme Pieces .................................................................................................................................................................. 184

Deutsche Bank Securities Inc. Page 3

Summary Views – LatAm

Page 4 Deutsche Bank Securities Inc.

Summary Views – LatAm

Deutsche Bank Securities Inc. Page 5

Summary Views – EMEA

Page 6 Deutsche Bank Securities Inc.

Summary Views – EMEA

Deutsche Bank Securities Inc. Page 7

Summary Views – EMEA

Page 8 Deutsche Bank Securities Inc.

Summary Views – Asia

Deutsche Bank Securities Inc. Page 9

Summary Views – Asia

Vietnam We expect a modest slowdown in The banking system remains

Page 10 Deutsche Bank Securities Inc.

Emerging Markets and the Global Economy in the Year Ahead

appreciation in RMB and PHP.

Deutsche Bank Securities Inc. Page 11

Page 12 Deutsche Bank Securities Inc.

policy has little room to maneuver, and – with banks 65 65

forced to increase their capital ratios – there is less

when compared with post-Lehman performance, an

Deutsche Bank Securities Inc. Page 13

Page 14 Deutsche Bank Securities Inc.

EM: Policy flexibility and resilience to shocks -0.5

Deutsche Bank Securities Inc. Page 15

EMEA’s high external debt levels Overall vulnerability map

Page 16 Deutsche Bank Securities Inc.

UST total returns closely as shown in the table below.

Deutsche Bank Securities Inc. Page 17

Searching for RV trades vs. UST: COP, MXN, ILS lead

3M 10s receiver carry (bp)

In Asia, the outlook for rates is less constructive. Curves

Page 18 Deutsche Bank Securities Inc.

As we discuss in more detail in the rates outlook piece, 1

Source: Deutsche Bank

Value has been restored, but risks remain asymmetric.

Deutsche Bank Securities Inc. Page 19

continue to appreciate but at a smaller pace than in 2011, 0.2

favor trading SGD NEER on a range basis, and would look

Selected defensive trades in EMFX options

Page 20 Deutsche Bank Securities Inc.

0% In terms of the overall return outlook for the asset class

Deutsche Bank Securities Inc. Page 21

Rates in 2012: Identifying Pockets of Value

 EM receivers performed well after a rocky start. EM receivers: Back-loaded returns

 In our 2012 outlook, we analyze those country USD LatAm EMEA

specifics effects using a model which integrates 100