SEB Report: Still Good Value in Emerging Markets

Emerging Markets Cross Assets EM FI – Still outperforming DM
EM FX – Market drivers to support

No free lunch, but a good smorgasbord EM Equities - Profits sheltered by top line
24 MAY 2011
Emerging Markets Cross Assets
Contents
Executive Summary: No free lunch, but a good smorgasbord............................................................................................................ 3
Macro: Facing up to the task.................................................................................................................................................................... 4
Global economic background............................................................................................................................................................. 4
Key risks ................................................................................................................................................................................................. 6
Headline Inflation Seen Lower............................................................................................................................................................ 8
Asset Allocation .................................................................................................................................................................................. 10
Fixed Income............................................................................................................................................................................................ 12
High inflation strategy paid off......................................................................................................................................................... 12
Inflation management key ................................................................................................................................................................ 12
Growth expectations a key driver......................................................................................................................................................13
Historical relative EM-DM valuation neutral ....................................................................................................................................13
Long-term star outperformance set to continue.............................................................................................................................13
Recovery bullish? Hedge and overhedge! ....................................................................................................................................... 14
Currencies .................................................................................................................................................................................................15
Managing challenges ..........................................................................................................................................................................15
Major FX trends – weaker USD near term ........................................................................................................................................15
Key EM FX drivers ahead.................................................................................................................................................................... 16
SEB EM FX forecasts........................................................................................................................................................................... 18
Fixed income and FX Trading Strategies..............................................................................................................................................20
Long Turkish local bonds with open TRY risk .................................................................................................................................20
Long Polish 5s vs. Hungarian 3s with open FX risk (long PLN/HUF) ........................................................................................... 22
Long Russian Eurobonds in rouble unhedged................................................................................................................................ 23
Increase risk in SEB EM local bond portfolio, keep FX risk open hedging IR risks with short DM yield positions .................24
Short EUR/ISK offshore, place in HFF..............................................................................................................................................24
Long long-end Croatia in USD, 2015 maturity in EUR, both vs DM ............................................................................................. 25
Long Lithuanian short-end in euros................................................................................................................................................. 25
Long EM hard currency bonds vs. DM corporates ......................................................................................................................... 25
Long an EM Asian basket of CNH, KRW and MYR against USD, GBP and JPY ...........................................................................26
Sell USD/CNH......................................................................................................................................................................................26
Retain EM FX basket........................................................................................................................................................................... 27
Equities .....................................................................................................................................................................................................28
Sharp changes in flows ......................................................................................................................................................................28
Earnings still looking good ................................................................................................................................................................29
Profits sheltered by productivity gains ............................................................................................................................................ 30
Easing cost pressure........................................................................................................................................................................... 30
Top line will compensate................................................................................................................................................................... 30
Valuation remains attractive ..............................................................................................................................................................31
Market heading ....................................................................................................................................................................................31
A few market comments on the BRIC’s ........................................................................................................................................... 32
Box: The SEB EM model portfolio ..................................................................................................................................................... 32
A final note on Turkey........................................................................................................................................................................ 34
Cut-off date: 20 May, 2011
2
Executive Summary: No free lunch, but a good smorgasbord

For a few weeks in April, and for the first time this year, Emerging Market (EM) stocks and bonds together attracted
more cash investment than their Developed Market (DM) counterparts. Was that a turning point following their
lacklustre performance in Q1 when EM equity funds reported substantial outflows? Will the good values in EM assets
be realised? In answer we see obvious potential risk concerning the performance of EM assets over the next 3-6
months, mainly including: 1) liquidity connected with terminating US QE2; 2) political volatility in MENA countries
spreading to major oil exporting countries; and 3) disorderly Greek debt reconstruction.
As regards the latter concern, our main scenario discounts defaults in peripheral Europe. Importantly, however, we do
not expect their implications to derail a further global economic recovery. In part, this reflects the fact that EM are
continuing to cement their newly acquired status as centres for growth and stability within the global economy, facing
up to their task of helping to drive the global economy forward. While higher inflation has been, and will remain,
rightly in focus, prices are hardly spiralling out of control while EM policy rate increases are being cautiously
implemented. Indeed, they represent a normalisation of monetary policy, testifying to their respective countries’ faster
and more solid post-crisis recovery.
As DM begin to catch up within the business cycle, the GDP growth advantage held by EM will decline although
remaining significant. Therefore, as the global recovery progresses, albeit with occasional problems, our general
macroeconomic outlook implies a scenario in which attractive values are realised. We favour EM currencies and expect
stocks to outperform bonds. However, partly due to the more advanced EM business cycle, and also because of the
generally low valuation of EM bonds, we continue to expect them to outperform their DM counterparts.
Within a multi asset EM portfolio, we favour overweighting EM stocks and recommend assuming the currency risk. At the
same time, local EM bonds remain significantly undervalued, as they have been for a long time. Consequently, an ideal
allocation would include a fairly large share of such bonds, especially if hedged by a short exposure in DM bonds in case of
positive global growth surprises. Overall, while we do not suggest there are any free lunches to be had we do see an
appetising smorgasbord of trading opportunities with an attractive risk reward balance over the next 3-6 months. Our
favourites are to buy Turkish local bonds vs. UST with currency risk, buy Polish 5s vs. Hungarian 3s going long PLN/HUF,
and buy the Lithuanian short end in euros. We also suggest a risk seeking reallocation in our SEB EM bond portfolio and see
good value in buying an FX basket with long positions in CNH, KRW and MYR vs. short positions in GBP, JPY and USD.
EM FI – STILL OUTPERFORMING DM MSCI EM & GBI EM (unhedged USD)

Given current high yields, we once again expect EM 1400 320
bonds to outperform their DM counterparts. Risks 1300 300
MSCI EM
GBI-EM Div. Global (Local Bonds)

include upside global growth surprises. 1200 GBI-EM 280
EM FX – MARKET DRIVERS TO SUPPORT 1100 260

MSCI EM (Equities)
According to our main scenario, EM FX will strengthen 1000 240
as carry, central bank activism and fundamentals 900 220

become key growth drivers. Nominally, ISK, TRY and 800 200
KRW should appreciate most by year-end. 700 180
EM EQ – PROFITS SHELTERED BY TOP LINE 600 160
Despite current headwinds, we expect the MSCI EM 500

Source: Bloomberg
140
index to increase by 10% to 1275 by year-end, due to 400 120

2006 2007 2008 2009 2010 2011
attractive valuation and good earnings growth.
3
gained 1.8% in absolute and 2.7% relative to DM equities

Macro: Facing up to the task on a USD-denominated basis. The benchmark EM external
Emerging markets (EM) continue to cement their bond index, EMBI+ is up 4.6% while the benchmark index
new position as centers of growth and stability for domestically denominated debt valued in USD, GBI-EM
within the global economy, facing up to the task is 5.8%, also measured on a USD-denominated basis.
of helping drive the global economy forward. Fifteen large EM currencies have recovered by a total of
Faster inflation has rightly been in focus and will 2.8% against the USD. In nominal trade weighted terms
remain so. However, prices are not spiralling out (NEER) the performance was stable in late 2010 and early
of control and increases in EM policy rates are this year but the latest data (April) show an appreciation of
being implemented without panic. Instead, they 1.3%.
represent a normalisation of monetary policy,
EM FX spot vs. USD
testifying to their countries’ faster and more solid 15 EM currencies, equal weigth. 100=1 Jan. 2004
post-crisis recovery. As developed markets begin 117.5 117.5
to catch up within the business cycle, the GDP 115.0 115.0
growth advantage held by EM will diminish but
112.5 112.5
remain significant. Key risks to our positive EM
Index
110.0 110.0
macro scenario include liquidity related to ending
107.5 107.5
US QE2, a disorderly Greek debt reconstruction,
105.0 105.0
and political volatility in MENA countries
spreading to heavier oil exporting countries. 102.5 102.5
100.0 100.0
Our previous report was published in February, in the jan apr jul okt jan apr
midst of the escalating MENA crisis (or opportunity), a 10 11
Source: Reuters EcoWin
period during which a substantial reallocation of

capital occurred from EM equity funds (the big winners Global economic background
in the preceding 18 months) particularly to US equity Prospectively, we begin by analysing what is happening to
funds due to less concern for a double dip in economic the global economic environment. The outlook for growth
activity. The report was entitled “Correction, not trend in OECD economies this year has deteriorated but
reversal”. Reflecting the contemporary tilted improved for 2012 compared to our last report in February.
positioning and shaky risk/reward outlook, it was In particular, we expect a temporary deceleration in the US
subtitled “Defensive tilt until good value is released”. causing us to cut our forecast for 2011 from 3.6% to 2.8%.
This largely reflects a surprisingly weak Q1 performance
Subsequent EM asset performance and erosion of disposable income by higher food and
Overall, EM assets remained under absolute, but energy prices. However, we project a recovery in 2012 as
especially relative, pressure for several weeks. the labour market continues improving and companies are
However, by mid-March good value began to be highly optimistic. With strong corporate balance sheets,
realised. Still, developments have been problematic private sector savings are set to fall. We believe economic
with high commodity prices, the initiation of a central activity will increase by 3.8%, well above the consensus
bank exit strategy, MENA instability and Greek debt forecast.
concerns, all unsettling markets to various degrees.
Meanwhile, Japan is also suffering the economic
Bond Indices, USD consequences of its various disasters although we estimate
Index 100 = Feb 1 2011 that growth will improve next year as the effects of
109 reconstruction projects impact. Western Europe is
107
increasingly characterised by a two speed development.
MSCI EM
GBI-EM Greek debt reconstruction looks increasingly inevitable, a
105 EMBI+ key EM risk and one we discuss in more detail at p6.
103
EM protects global growth in 2011 but relative
101 advantage decreases in 2012
99
Overall, we have raised our Euro-zone growth forecast a
few notches to 2.2% for both 2011 and 2012, albeit
97 lowering our OECD forecast for this year to 2.4% from
Source: Bloomberg
95 2.8%. However, continued strength within EM limit our
Feb-21 Mar-08 Mar-23 Apr-07 Apr-22 May-07 Global GDP (PPP) forecast revision to 0.2%, easing to
Over the entire period since our last Emerging Markets 4.3% in 2011 from 5.0% in 2010. Next year, worldwide
Cross Assets (EMXA) on February 21, EM equities have
4
growth will accelerate to 4.5%, i.e. in line with trend in One factor supporting high growth in EM is the recovery in
both 2011 and 2012. private sector credit growth. With the conspicuous
exception of many countries in Emerging Europe, EM
However, the GDP growth advantage for EM will
entered the global financial crisis with banking systems
decline, as we forecast a decrease in aggregate EM
characterised by much lower leverage and less troubled
growth from 6.5% this year to 6.2% next, lowering our
assets. Aggregate lending to the private sector never
2012 EM GDP forecast below that of, for example, the
stalled and over the last year has regained momentum.
IMF. This reflects two factors. Firstly, we regard EM as
well ahead of developed markets within the business
cycle and believe that while normalisation of monetary
policy will be responsibly implemented in order to limit
inflation risks, it will do so at the expense of (already
high) growth.
Secondly, and obviously interlinked, we expect a
sharper deceleration in two EM giants: China and
India. Therefore, our higher growth forecasts for, for
example, Brazil, Mexico, Poland and Russia are
insufficient to offset downward pressure on the
aggregate EM forecast. It is crucial, however, to
understand that EM growth of 6.2% in 2012 can
hardly be described as “critically low”. Instead, it Source: IIF
reflects the fact that the business cycle is maturing
and that we are no longer living in the euphoric super This is also the case in Emerging Europe subject to two
cycle that precede the Great Recession. important differences compared to the pre-crisis borrowing
frenzy – current credit growth is much more modest and is
SEB GDP f-cast primarily domestically financed. With household and
2009 2010 2011 2012 corporate indebtedness still low, especially in Latin America
China 9.1 10.3 9.3 8.5 and Emerging Europe, the credit engine is likely to continue
India 8.0 10.4 8.0 7.0 driving future EM growth.
EM 2.7 7.3 6.5 6.2
Indonesia 4.6 6.1 6.2 6.5 A few cautious words
Turkey -4.8 8.9 5.8 4.8 While the general outlook for EM remains generally
Malaysia -1.7 7.2 5.5 6.0 positive, several improvements may still be thought
Russia -7.8 4.0 5.3 5.0 desirable with three policy areas of particular significance:
Taiwan -1.9 10.8 5.2 4.9 1. While aggregate fiscal and external balances in
Estonia -13.9 3.1 5.0 4.5 EM remain in better shape than in their developed
Ukraine -15.1 4.2 4.7 4.5 counterparts, current account deterioration is
South Korea 0.3 6.2 4.5 4.3 taking place in several key countries. In Turkey,
Mexico -6.1 5.5 4.5 5.1 the deficit is likely to reach 8% of GDP this year
Poland 1.7 3.8 4.5 4.6 with the structural trade deficit aggravated by very
Thailand -2.3 7.8 4.3 4.1 strong domestic demand, and high oil prices.
World(PPP) -0.5 5.0 4.3 4.5 Negatively, financing is largely derived from
Brazil -0.6 7.5 4.2 4.7 portfolio investments. Indeed, even if the country
Lithuania -14.7 1.3 4.0 4.5 maintained access to financial markets
South Africa -1.7 2.8 3.7 4.2
throughout the Great Recession, its high external
Latvia -18.0 -0.3 3.7 4.3 financing requirements represent a risk in the
Hungary -6.7 1.2 2.7 3.0 event that risk aversion once again unexpectedly
Czech Rep. -4.1 2.2 2.5 3.5 results in a withdrawal of liquidity.
OECD -3.4 2.8 2.4 3.1
Iceland -6.9 -3.1 2.2 3.4
In Poland, the current account deficit increased to
Romania -7.1 -1.3 2.0 4.0 3.3% of GDP last year. However, correcting for
Source: OECD, SEB
high, negative errors and omissions in the
country’s Balance of Payments data, it may in fact
be twice as large. Brazil also suffers from an
increasing external deficit. At only 2.3% of GDP
and with large continuing FDI inflows, financing is
5
not a problem. However, the deficit surprises affecting a sample of Bloomberg consensus
emphasises that the currency is highly valued estimates for the EM “Big Five”; China, Brazil, India, Russia
and that the competitive situation is and South Africa. We track approximately 20 indicators, all
deteriorating (Dutch Disease). For all these equally weighted in our metric. If the index of accumulated
countries, especially Turkey, a better balance forecast deviations is trending upward, surprises are
between fiscal and monetary policies skewed towards higher stronger better growth than
would have been adequate with the former expected, and vice versa.
taking a much larger share of the
Following the sharp negative deviation between forecast
responsibility for dampening domestic
and actual data that occurred during the financial crisis and
demand.
global recession, macroeconomic data once again began
2. In our view, exchange rate policies in outperforming expectations from mid-2009. Since the end
Emerging Asia, particularly in China, have of last year until very recently macroeconomic figures have
been sub-optimal. In previous reports we on average been largely in line with market expectations.
have presented the arguments favouring
faster appreciation. In our February report we The year began with positive macroeconomic momentum
stated that authorities would increasingly only to be replaced by a sudden sharp setback in April.
tolerate FX appreciation. In part, this is what Early indications for May, however, indicate a rebound
has occurred although there is, in our although the situation remains unclear for now. Second
opinion, more to do; see our FX section quarter data could even deteriorate as (still) high
below. commodity prices erode consumption, monetary policy
3. Finally, we note an element of complacency tightening in EM begins to impact and the impact of
among EM policy makers concerning production disruptions in Japan is felt. Such a slowdown is
structural reforms. The paradigm shift suggested by the recent fall in the output to inventory ratio
involving implementation of structural in recent global manufacturing PMIs.
reforms in EM over the past decade has
proved sufficient not only to guide most
countries through the financial crisis but also
help them secure their current positions
within the global economy against a
background of growth and stability. However,
while in relative terms, policy makers
probably feel that additional structural
reforms are not as urgently required, we
believe that is a mistake. Future growth and
stability would be enhanced, we believe, if
greater reform momentum could be
regained.
SEB EM surprise indicator Source: IIF
SEB surprise indicator, Emerging markets The SEB surprise indicator suggests that the EM business
Index, cumulative level
2.50
cycle has begun to progress, consistent with the growth
scenario on which this report is based. If indicator volatility
2.00
continues to increase over the next two quarters it may
1.50
imply a turning point in the business cycle, although we
1.00 would regard such a development as premature.
0.50
0.00
Key risks
The key risks to our generally positive EM macroeconomic
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
-0.50
scenario are as follows:
-1.00
-1.50 1. Liquidity squeeze in connection with the end of US QE2

2. Disorderly Greek debt reconstruction and
Source: Bloomberg, SEB 3. Political volatility in MENA countries spreading to
Over a shorter period, we are guided by our EM heavier oil exporting states.
surprise indicator - a normalized average of the In the following discussion we analyse each of these risk
factors.
6
1. Fed quantitative easing coming to an end? business cycle that previously found support from the Fed’s
We expect unconventional monetary stimulus QE2 program. We expect US monetary policy to tighten
measures to unwind gradually, and therefore avoid the from its current extremely loose position. We forecast a
risk of a sudden negative trigger to enter the market. first rate hike in early 2012 with total increases of 175bps
The US exit strategy is scheduled to begin in June during the rest of the year.
when planned bond purchases end. However, we will
If this proves correct, it will of course lift the short end.
be well into the second half of the year before the Fed
Consequently, we should expect an increase in the 2y yield.
ceases reinvesting both principal and dividends.
However, if the long end of the curve does not respond
Therefore, the real test for the market will occur then.
accordingly or even moves in the opposite direction the
Although this implies a tighter monetary policy we
market will have opted for a more negative scenario. In that
expect only a limited effect on rates and liquidity.
case, risky assets in general and including EM assets (due
Firstly, this position is believed to be largely to liquidity constraints) would perform poorly.
discounted by the market. Secondly, the substantial
2. Next wave of the European debt crisis
increase in liquidity has not filtered into financial
A second crucial risk is the European debt crisis. We regard
markets but instead remained on bank balance sheets.
Greek debt renegotiation as inevitable. We also think it
Thirdly, such a move will be taken by the Fed in order
highly likely that Ireland and Portugal will also be forced
to reflect an improving economy (otherwise we should
into some form of debt renegotiation, although later. In
expect the exit plan to be postponed).
addition, there is a strong probability that Spain will seek a
US monetary base and M2 growth rates ESFS/ESM and IMF bail-out. According to our main
3.0
scenario, the Greek solution will involve hard restructuring
Monetary base (thousand billions)
Adjusted monetary base (right)

10 M2 (real)
M2 (nominal)
2.5 with a haircut of 50% on private debts (vs. approximately
8
2.0
40% currently discounted by the market) and bank
M2, percent y/y
6
recapitalisations.
1.5
4 Although this scenario involves historical components
1.0
(developed countries defaulting, being a reflection of the
2 0.5 paradigm shift we have been discussing in recent years) it
0 0.0 is vital to emphasise that according to our main
assumptions, such a development will be manageable for
-2 -0.5
96 98 00 02 04 06 08 10
the Euro-zone within the framework of its existing crisis
mechanism and further fiscal tightening. It will, however,
Source: Ecowin
When the Fed stopped buying government bonds in imply continued strains on economic, financial and political
October 2009 it did not result in any large upward systems – and large risk premiums and volatility for
pressure on yields. When it ceased purchasing financial markets.
mortgage bonds in March 2010 we saw rapid yield These will be periods when EM assets also come under
declines. Nevertheless, the steep US yield curve (2y- pressure. However, the market is now better prepared. EM
10y) will be monitored closely. Any sudden sharp assets were badly hurt when Greece hit the headlines back
moves could signal a larger effect on markets from in April 2010, but subsequently less so as Ireland and
Fed activity. Portugal followed suit. Furthermore, we believe European
US 10y - 2y yield curve institutions, the IMF and countries involved have both the
Government Benchmark Bonds
motivation and capacity to postpone debt restructuring
4.5 290
4.0 280
until next year. Doing so will provide time for banking
3.5 270 stress tests to be performed and evaluated by markets. In
3.0 260 conclusion, we expect a continued global economic
Percent
2.5 250 recovery despite a new wave of European debt crisis.

BPS
2.0 240
1.5 230 3. MENA and oil prices
1.0 220
0.5 210
A third risk to the overall optimistic macroeconomic
0.0 200 scenario for EM is represented by the possibility that
May Aug Nov Feb May Aug Nov Feb May political unrest in MENA countries spreads to larger oil
09 10 11
US Gov Benchmark bonds spread 10-2y exporting countries in such a way as to disrupt oil supplies.
10 Year
2 Year
While some oil exporting EM would obviously benefit from
a further improvement in terms of trade, most are net oil
A sharp bear flattening of the US yield curve could importers and all EM would suffer an inflationary effect if
signal deteriorating expectations concerning the this risk were to materialise.
7
Regional instability is far from being resolved. In the bond markets, Brazil and South Africa are also pricing in
immediate future we expect oil prices to remain high. slightly lower break-even inflation rates.
During the second half of the year, however, we
Still, an important driver behind EM local bond yields has
believe they will fall due to more favourable supply-
been their tight correlation with Treasuries, with global
side conditions with, for example, a resumption of
business cycle expectations a plausible common factor. A
production in Libya. Overall, we have raised our Brent
significant decrease in treasury yields despite the imminent
oil price forecast for 2011 from an average of USD
end of QE2 has coincided with both lower local EM bond
90/barrel to USD109/barrel. Next year we expect the
yields and softer growth expectations.
price to fall back to USD 95/barrel. In the following
section we broadly elaborate on commodity prices and
their impact on inflation and interest rates in EM. EM Yield Indices
Other risks include political developments, 8 3

especially in Thailand but also in connection with GBI-EM yield
5y Treasury yield
upcoming elections in Turkey, Poland and Peru. In 7.5 2.5
GBI-EM yield % p.a.

Thailand the July elections may offer an outlet of
Treasury yield % p.a.

political tensions but a scenario with renewed
destabilisation can in now way be ruled out with 7 2
demonstrations or even a new military coup. In Turkey
and Poland, we expect the outcome of elections in 6.5 1.5
June and October respectively to be market supportive
with current government reaffirming their position
with positive implications for structural reforms in 6 1
general and fiscal policy tightening in particular. The Source: Bloomberg

second round of the Peruvian presidential election on 5.5 0.5
June 5 also merits close monitoring. In particular it will Jan-10 Apr-10 Jul-10 Oct-10 Dec-10 Apr-11
be interesting to see whether the winner of the two
more populist run-off candidates (centrists failed in Nevertheless, we regard the combination of yield flattening
the first round) lives up to promises made to follow the and slightly tighter break-even spreads as an indication
example of Brazil rather than Chavez’ Venezuela. that EM central banks have so far weathered pressures
exerted by growth induced inflation with market approval.
Headline Inflation Seen Lower
Local yields down, curves flatter and break-even Break-Even Inflation Rates
inflation lower; that is our key message.
7
EM Yield Aggregates
6
Break-even Inflation, % p.a.
8 4 US Tips
GBI-EM yields Brazil
7.8 5
ELMI short rates South Africa
EM Local Bond Yields, % p.a.
7.6 3.5 Korea

EM Short Rates, % p.a.
4
7.4
7.2 3 3
7
6.8 2.5 2
Source: Bloomberg
6.6
1
6.4 2 Jul-10 Oct-10 Jan-11 Apr-11
6.2 Source: Bloomberg
6 1.5
No surprise to running inflation, upward pressure
Jan-10 Apr-10 Jul-10 Oct-10 Dec-10 Apr-11 on core remain
Since February, running inflation in EM has developed in
On average, local bond markets appear satisfied with line with our forecast (reported in our previous EMXA). Our
the management of monetary policy so far. The new forecast is basically the same as its predecessor with
increase in short rates has in fact been accompanied headline inflation expected to peak early in the second half
recently by a decrease in bond yields, aggregated over of this year. And still we see core inflation to continue to
the EM universe. The two high-inflation index-linked rise during the year to soften only gradually in 2012 and
8
onwards which will keep pressure on monetary While crop forecasts have been dragged down by adverse
policymakers. local weather conditions, last year’s dire global situation is
unlikely to be repeated. Base effects on food prices are
CPI in selected emerging market countries, % y/y therefore gradually becoming supportive of lower inflation
7 7
Headline readings.
6 6
Commodity correction shows headline volatility
5 5 works both ways
Commodities in general corrected sharply downward by
4 4 around 10% in early May, a move which shows the dangers
of following the trend in volatile prices too closely when
3 3
assessing the inflation outlook. Nevertheless, it is valuable
2 2 to remember that economic activity is an important
Core common factor behind both commodity prices and general
1 1 inflation pressures.
04 05 06 07 08 09 10 11 12
Food prices remain high Commodities

Food prices have levelled out, albeit at a high level, 120 380
while crude oil has decreased, especially concerning Crude, nearest
contracts for future delivery. 110 contract
UN Food Price Index CRY
CRY Index Value

100 Commodity 320
USD/Barrel
300 Index
250 90
Index Value
200
80 260
150
100 70
Source: Bloomberg Source: Bloomberg
50 60 200
2000 2002 2004 2006 2008 2010 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11
All in all, we expect average inflation turning down in Reserve management has been doubly
2012 towards inflation targets in most countries. supportive
Our analysis in the previous edition of EMXA has also been
Current inflation, next year target and forecast, %
vindicated concerning the effect of inflation pressures in
Apr CPI, y/y CB target, av. 2010 SEB f-cast, SEB f-cast,
2011 av. 2011 av. 2012 making policymakers restrict the build-up of FX-reserves.
EMEA Taking the EM-universe overall, the increase in FX-reserves
Poland 4.5 2.5 2.7 3.7 2.8 (measured in SDRs) has ground to a halt, most probably
Czech 1.6 2.0 1.5 2.0 2.5
supporting EM currency appreciation vs. USD since our last
Hungary 4.7 3.0 4.9 4.4 3.6
Turkey 4.3 5.5 8.6 6.0 6.3 EMXA report.
S. Africa 4.2 4.5 4.3 4.7 5.3
FX reserves in SDR
Romania 8.3 3.0 6.1 6.5 5.0
Thousand billions
Russia 9.6 6.5 8.8 9.3 7.6
4.5 4.5
Estonia 5.4 - 3.0 5.0 4.0
4.0 4.0
Latvia 4.5 - -1.1 4.4 3.1
3.5 3.5
Lithuania 4.4 - 1.2 3.5 4.0
3.0 3.0
SDRs
Ukraine 9.4 - 9.1 9.5 9.0

2.5 2.5
2.0 2.0
LatAm
Brazil 6.5 4.5 5.9 6.2 5.0
1.5 1.5
Mexico 3.4 3.0 4.4 3.8 3.7 1.0 1.0
0.5 0.5
Asia 00 01 02 03 04 05 06 07 08 09 10
China 5.3 4.0 3.3 4.9 4.4
Developing Countries Industrial Countries
Korea 4.2 3.0 3.0 4.3 3.3 Source:IMF
Taiwan 1.3 - 1.0 2.0 2.0
Malaysia 3.2 - 1.6 3.5 3.2 But some CBs still fuel inflation through FX
Thailand 4.0 1.75 3.3 4.0 3.4
However, for some countries, reserves continue to
India* 8.7 - 10.5 7.5 6.9
Indonesia 6.2 5.0 5.1 7.1 5.9 accumulate rapidly, despite strong inflation pressures, with
*Wholesale prices Source: Consensus Economics, SEB Brazil an obvious example. Regardless of the current rate of
9
accumulation, the substantial reserves held represent Rising energy prices, a mixed start to Q1 corporate earnings
a powerful weapon in helping cool inflation pressures results, Portugal’s sovereign debt problems and Japan’s
from currency appreciation through hard-currency crises subsequently drove investors away from developed
sales. markets once again.
Brazil: Inflation and FX-Reserve Changes

After suffering outflows in Q1 (investors withdrew over 20%
of their USD 84bn in EM equity investments in 2010) this year,
8 -20
for two weeks in April investors moved more funds back into
EM assets while reducing those held in their DM counterparts,
Reserve chg on qtr USD bn

7 0
6 20
according to data covered by EPFR.
Inflation, y/y %
So far this year, Russia has remained the jewel in the EM

5 40
crown in general, and amongst BRIC markets in particular,
4 60 benefiting from high energy prices and a low valuation. To
3 Inflation y/y 80 some extent Japan’s nuclear crisis was regarded as positive
2
Reserve Change qtr
100
for South Korean exporters causing investors to switch into
Source, Bloomberg Korean equities. Capital controls in Brazil, imposed to
1 120
dampen speculative money flows, are important in
06 07 08 09 10 11
explaining the disinclination of investors to move capital
back into the market.
Caution still justified, rebalancing needed
With most EM economies still enjoying very high The recovery of flows into EM was driven by retail
growth, their central banks must cautiously defend investors. DM bond funds suffered when retail investors,
their inflation targets. As noted in our May edition of representing up to 80% of the market monitored by EPFR,
Nordic Outlook, stronger EM currencies would be one withdrew cash from the municipal bond market.
appropriate tool for doing so. Allowing currencies to The April’s increase in inflows to EM reflects both cyclical
strengthen would both serve the goal of lowering EM and structural factors. As we elaborated in our last two
inflation rates and rebalance the global economy. EMXA reports the multi-speed nature of the post-crisis
Exports from indebted DM would help satisfy growing recovery has resulted in a cyclical widening of growth
demand in EM, supporting current slow DM recoveries differentials between advanced economies and EM.
while moderating the business cycle in EM. Structural factors suggest that capital flows to EM are likely
Asset Allocation to be sustained over the long term, albeit with periods of
Looking into the question of asset allocation, make increased volatility.
both strategic and tactical valuations. The latter Fed model suggests equilibrium
currently favors equities, while the former, as usual A Fed model1 valuation approach provides a tool with
shows the need for larger allocations into EM-bonds. which to evaluate the risk reward of holding equities
Large fluctuations in flow of funds compared to a “risk-free” bond investment. In general the
After some flattening of net inflows to EM debt funds model argues that if the earnings yield on equities (E/P) is
and even momentous outflows from EM equities due higher than the yield received by buying a bond, investors
to an reduced developed markets risk premium at the should divest bond holdings and buy stocks.
beginning of this year the correction subsequently There are several practical shortcomings to this model,
materialized, fully consistent with our expectations. especially in trying to apply this approach to assets outside
US markets; what is a risk free rate?; should it not be a real
Net flow of funds EM FI & EQ, YTD bond yield?; what about differences in volatility?; what
8.00
bn USD
EM Bonds
triggers revaluation trends (the timing aspect)?; is a ratio of
6.00
EM Equities 1.0x a true equilibrium? However, it offers significant food
4.00 for thought.
2.00
0.00
1
11
11
11
11
11
11
11
11
11
11
The Fed-model was named by Edward Yardeni of Prudential Securities based

20
20
20
20
20
20
20
20
20
20
-2.00
1/
1/
2/
2/
3/
3/
4/
4/
5/
5/
on research conducted at the Federal Reserve in the mid-1990s. The model

/0
/0
/0
/0
/0
/0
/0
/0
/0
/0
12
26
09
23
09
23
06
20
04
18
-4.00 studies long term treasury bonds and expected equity returns. However, the
Source: EPFR Fed has never endorsed the approach and the model can in fact be found to
-6.00 have existed in various forms long before this particular version was
identified.
-8.00
10
We have adopted the basic thoughts behind the Fed 2005 that substantial value existed in EM equities. In the
model in examining pricing of EM assets. The relative second half of 2007 it suggested that the bull run was well
valuation of EM stocks and EM hard currency bonds advanced, with relative performance swinging back sharply
suggests that equities are undervalued, with stocks in favor of EM bonds in 2008. By end of 2008 the FED
currently offering an earnings yield of 9.4%. The gauge pointed to better value in EM equities vs bonds once
implied hard currency yield, derived from US treasuries again, but it took a few more months before started to let
and the EMBI+ spread, is 4.8%. Therefore, the EM equities outperform EM bonds.
stocks/bond yield ratio is 1.9x vs. an historical average
Subsequently however, relative performance between EM
of 1.4x. Adding one standard deviation produces a
local bonds and stocks has been largely stable despite two
ratio of 1.7x. Consequently, EM stocks appear
extreme readings from the Fed model indicator.
extremely cheap.
3.0
MSCI EM value from a Fed-model approach Overall, we conclude that the rather blunt tool for gauging
market timing offered by our EM Fed model valuation
2.5
equities inexpensive
approach, recommends a largely neutral weighting
2.0 between EM equities and (local) bonds according to a
+1stdv
1.5
portfolios normal risk distribution.
1.0 -1stdv
How do we trade it
0.5
equities expensive
As risks abate and the recovery goes on – though not
without obstacles – our general macro view favours EM
0.0
currencies and suggests stocks to outperform bonds.
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11
However, partly due to the more advanced EM business

Note: P/E 12m fwd vs. UST5y and EMBI+ Source: FactSet, Bloomberg, SEB
cycles, and also because of a generally low valuation of EM-
bonds, we continue to see them outperforming developed
market bonds. Although we see a number of potential risks
We also find a similar situation, albeit not as extreme,
looking forward (see p6), we regard the current risk reward
when comparing the earnings yield of DM equities
balance as rather favourable. From various local
(MSCI World index) with US treasuries.
perspectives, we see a multitude of relative trade
However, for a “true” EM investor the alternative to EM opportunities arising from a number of countries’ different
stocks is perhaps not hard currency bonds but rather response to challenging inflation pressures and the
their local currency counterparts. In the graph below markets assessment hereof. Several FX and EM bond
we have made the same calculation using instead the trading recommendations with an investment horizon of
implied GBI yield. We have also added the relative three to six months are presented in the strategy section on
performance between the GBI and MSCI EM index. p20 of this report.
1.7 MSCI EM value from a Fed-model approach 0.4

Allocation
1.6 GBI/MSCI EM Currently holding a bullish absolute view on EM-stocks, we
0.35
1.5 would like to favour these in an intra-EM asset allocation.
equities inexpensive
1.4 +1stdv 0.3 At the same time, little has happened to the long standing
1.3
0.25
strong undervaluation of local EM-bonds. Hence, the ideal
1.2 allocation would include quite a large share of these bonds,
1.1 -1stdv 0.2 especially if hedged by negative exposure against DM
equities expensive
1.0
0.15
bonds to secure against positive global growth surprises.
0.9
Our relative Fed-model inspired indicator of historical EM
0.8 0.1
equity-to local bond valuation is currently in neutral.
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11
Coincidental or not, our similar measure of historical EM-

Note: P/E 12m fwd vs. GBI yield Source: FactSet, Bloomberg, SEB
bond to DM-bond valuation (see p13) also stands near
Over time the market discounts EM stocks and local long-term averages.
debt at a ratio of 1.25x. Currently the market trades In sum, for the strategic allocation, we think it’s likely that
these assets at 1.3x, i.e. very close to their long term most readers would find their allocation into EM-bonds to
average and well within a one standard deviation from small. But in the tactical perspective, our positive
average corridor. This would imply that EM stocks and assessment on the business cycle and absolute EM stock
local bonds are traded close to equilibrium. returns point to a larger than usual share of equities in the
As regards relative price performance our version of EM portfolio. We recommend assuming the currency risk.
the Fed indicator has generally been able to tell the
direction of markets’ relative pricing. It signalled in
11
Fixed Income Some weaker credits underperformed

We expressed caution regarding weaker credits when the
EM bonds have outperformed in line with our
MENA crisis began in the course of publishing our previous
forecast in the previous EMXA due to a
EMXA report. Our call was well directed with, for example,
combination of a general decrease in EM local
Turkish credit spreads in hard currency widening
yields and EM currency gains vs. the USD.
significantly. We recommended taking down exposures to
Negatively, we have seen a less favorable market
Turkey relative to an otherwise fairly index-neutral SEB EM
assessment on EM sovereign credits as shown by
bond-basket. In all however, our basket underperformed,
a widening of the EM hard currency bond EMBI
both relative to EM and DM bond indices, partly as a result
yield index over DM yields.
of its shorter duration.
SEB EM Bond Portfolio 2011 February 21 to May 20
Bond Indices in USD SEB Rating Duration
130 weight S&P Yield years mÉêÑçêã~åÅÉ=ëáåÅÉ=cÉÄJON=êÉéçêí
EM local bonds (LT-FC) `ìêêÉåÅó= içÅ~ä=êÉíK rpa=êÉíK
125
Index 2010-01-01 = 100
DM Governments
Poland 15% A- 5.5% 4.1 MKTB MKRB NKOB
120 Hungary 7.5% BBB- 6.6% 3.6 PKPB NKUB RKOB
US Treasuries Iceland 5% BBB- 2.7% 0.4 JPKVB NKPB JOKTB
115
EM hard ccy bonds S. Africa 7.5% BBB+ 7.2% 3.3 JNKNB NKOB MKNB
110 Turkey 2.5% BB 9.2% 3.0 JNMKUB JOKPB JNOKVB
105 S. Korea 15% A 3.9% 3.2 OKTB JMKRB OKNB
Indonesia 5% BB+ 6.5% 3.0 QKRB NKSB SKNB
100 Malaysia A- 3.4% 2.9
12.5% OKPB MKSB OKVB
95 Source: Bloomberg Brazil 15% BBB- 12.7% 1.7 OKSB PKTB SKQB
Mexico 15% BBB 6.3% 4.1 SKUB JNKMB RKTB
90
Average 100% BBB+ 6.4% 3.1 OKNB MKUB OKVB
Jan-10 Apr-10 Jul-10 Oct-10 Dec-10 Apr-11
Inflation management key

Much of the decrease in yields has been paced by a
recent positive development in US Treasuries, Inflation pressures remain strong in many EM economies.
probably driven by a moderation in global business We expect them to be met by an increased willingness by
cycle expectations. authorities to allow currencies to appreciate, a view
expressed in the last EMXA and already partly vindicated.
High inflation strategy paid off Holders of local bonds have benefited twice, directly from
Our long term dominant strategy of running their unhedged currency positions, and indirectly from the
overweight positions in high inflation countries has cooling effect on the economy which eased pressure on
been well rewarded since our last EMXA in February. monetary policy. Continued rate hikes and currency
During this period, the market has once again appreciation are still needed with threats from food and oil
benefited investors willing to bear diversified local prices about to be replaced by inflationary pressures from
inflation risks. Although this could be taken as further closing output gaps. Fiscal policies that aim to increase
evidence of the market’s approval of monetary investments and productivity rather than spending should
policies, significant inflation pressures persist. With now also be rewarded.
vigilance still justified, risk premia probably remain in
Target relative value
local EM bonds, a situation very positive for future
long term outperformance of debt from high inflation While we forecast continued interest rate hikes, we are far
countries, although of course not without risks. from bearish on EM bonds. Bond markets, even in EM are
speculative and hikes are at least partly discounted. We so
argued in the general section, showing the recent decrease
Emerging Market Bonds Inflation Strategy
Montly Sep-2005 to April-2011
in yields which has occurred despite continued rate hikes.
250
At local level, we see good relative value in several cases, to
GBI-EM which we will return in the strategy section.
230
GBI-EM Inflation EM ahead of DM in the business cycle
210
Index/Portfolio Value
Strategy We observe however that DM economies are continuing to

190 recover from deep business cycle lows, a development
170 usually accompanied by higher bond yields. EM economies
are further ahead in the cycle, which should suggest a less
150
certain outlook for EM yields.
130
110
90
Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10
12
We might ask whether or not local factors should have a

Industrial Production Indices (total year 2000 = 100)
monthly 1991 to Nov 2010 stronger impact on EM bonds. If so, lower EM yields could
80 80 be justifiable as EM economies are ahead of DM in the cycle
and curves eventually flatten as a business cycle high
70 70
develops. At the same time, it would not be unnatural for
60 60
EM bonds currently to be highly responsive to changes in
50 50 global growth expectations. All else being equal, higher
40 40 than expected global growth would severely exacerbate the
30
Advanced
30
inflation burden on EM policymakers.
Economies
20
Source CPB, Neatherland's Emerging 20 Historical relative EM-DM valuation neutral
10
bureau for
economic policy analysis
Economies 10 Taking currency fluctuations (and differences in portfolio
durations) into account, a weaker but still fairly strong
0 0
covariation is apparent between EM and DM debt market
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
indices (both valued in USD). EM return sensitivity to DM is
rather strong, with EM-returns (both positive and negative),
Growth expectations a key driver having a tendency to be double as large as coincident DM
However, EM and DM market yields are following each returns. Banking on this fact we establish an historical
other fairly closely. We have seen a strong tendency valuation indicator. Any deviation from EM’s tendency to
for EM yields to move in the same direction as those in show twice as big (positive and negative) returns as DM is
DM. shown in increases or decreases in the index. As it turns
Bond Indices in USD out, this index currently stands close to its long-term
average, indicating an historically neutral DM vs. EM bond
DM bonds (Citi) Jan 2009=100
130 160
indices valuation.
125 DM Governments 150
EM bond (GBI-EM)
120 EM local bonds 140

115 130 SEB EM/DM historical trend indicator
110 120 1.3
EM expensive
105 110
1.2
100 100
95 Source: Bloomberg 90 1.1
90 80
Jan-09 Jul-09 Dec-09 Jul-10 Dec-10 1
0.9
For each basis point DM yields have changed, those in EM cheap Source: Bloomberg, SEB
EM have tended to change by about the same amount. 0.8

Global growth expectations are clearly an important 2003 2004 2005 2006 2007 2008 2009 2010 2011
driver behind market pricing for both DM and EM

bonds. Long-term star outperformance set to continue
In the longer term, and even from the 3-6 month
SEB forecasts of policy rates for Q2-Q4 2011 and Q2,Q4 2012, %
May, 2011 2Q, 2011 3Q, 2011 4Q, 2011 2Q, 2012 4Q, 2012
perspective discussed here, we still expect continued EM
EMEA local bond outperformance.
Poland 4.25 4.25 4.50 4.50 4.75 5.00
Czech 0.75 0.75 1.00 1.25 2.00 2.50
Hungary 6.00 6.00 6.00 6.00 6.25 6.50
EM Yield Indices
Turkey 6.25 6.25 7.00 7.75 8.25 8.25
S. Africa 5.50 5.50 5.50 6.00 6.50 6.50 9.5 4.5
Romania 6.25 6.25 6.25 6.25 6.75 7.00
9 GBI-EM yield 4
Russia 3.25 3.50 3.75 4.00 4.75 5.00
GBI-EM yield % p.a.
5y Treasury yield
Treasury yield % p.a.
LatAm 8.5 3.5

Brazil 12.00 12.25 12.75 12.75 12.75 12.25
Mexico 4.50 4.50 4.50 5.00 5.50 6.00 8 3
Asia
7.5 2.5
China 6.31 6.56 6.56 6.56 6.56 6.56
Korea 3.00 3.25 3.75 4.25 4.25 4.00 7 2
Taiwan 1.75 1.88 2.00 2.13 2.25 2.38
Malaysia 2.75 3.00 3.25 3.50 3.50 3.50 6.5 1.5
Thailand 2.75 3.00 3.50 4.00 4.00 4.00
Source: Bloomberg
India 7.25 7.75 8.25 8.25 8.00 7.75 6 1
Indonesia 6.75 7.00 7.50 7.50 7.50 7.50 Jan-08 Jan-09 Jan-10 Jan-11
Source: Bloomberg, SEB
13
The fact that local EM bonds are close to their long

term trajectory of doubly outperforming DM bonds
indicates after all that this trend remains unbroken.
Another way of considering this phenomenon is to
observe the ratio of local EM bond yields to Treasury
yields which too remains within its historical range,
especially since 2008. EM yields are more than three
times those in DM.
Also, EM currencies are tending to appreciate against
the background of our own positive currency outlook.
Since the beginning of 2003, GBI-EM has generated an
average return of 15% in USD terms while Citigroup’s
World Bond Index, covering the DM universe, has
averaged 7%. Measured in terms of excess return, i.e.
after carry costs, EM bonds have therefore produced
an exceptionally strong outperformance.
Bond Indices in USD

350 350
300 300
DM Governments
250 250
EM local bonds
200 200
150 150
100 Source: Bloomberg 100
50 50
2003 2004 2005 2006 2007 2008 2009 2010 2011
We, together with a wide range of university

academics, have tried to identify the cause of this
outperformance which appears inconsistent with the
idea of efficient markets. In finance it goes under the
name” Uncovered Interest-rate Parity puzzle”. While
we have no name for it, we have nevertheless
discussed it previously. Probable reasons for such
persistent and strong outperformance include, in our
view, the domestic bias of DM investors, market fears
of inflation risks, and a preference for avoiding lower-
rated securities. We expect any investor able to
overcome these obstacles to enjoy very strong risk-
adjusted long-term returns.
Recovery bullish? Hedge and overhedge!
Nevertheless, as DM economies are still recovering
from deep business cycle lows, higher DM yields are
likely. SEB also expects such an increase, as discussed
in our latest edition of Nordic Outlook. Barring any
sharp increase in risk aversion, we see no reason to
expect a breakdown in the tight connection between
EM and DM yields anytime soon. We therefore
recommend hedging any exposure to EM yields with
an opposite position in DM. In addition, for each
dollars worth of exposure to currency unhedged EM
local bonds, we would suggest shorting the double in
DM.
14
Currencies
The main EM currency drivers will be carry, Obviously, a return to pre-Lehman levels is not a given
central bank activism and fundamentals. We target. But, taking into account that EM passed the
expect monetary policy normalisation to financial crisis in such a good way could be an indication
continue. With rates already much higher in EM that a further increase in NEER towards the 2006-2008
than in their developed counterparts, carry will levels can be achieved without reaching stretched levels.
generate further EM FX gains. Central banks will
When we published our previous report, we recommended
also tolerate more FX appreciation to dampen
retaining a 50% hedge ratio for EM currency exposure with
inflation and alleviate global imbalances.
reference to the adverse risk reward balance. On April 1,
Although the GDP growth advantage of EM will
with some positive news and a resumption of positive
decrease next year, they will still benefit if, as we
weekly fund flows to EM, we lifted the hedge and
expect, fundamentals become investment
recommended assuming full FX risk. While this strategy has
determinants. EM FX appreciation will be more
been satisfactory, EM currencies have appreciated less
pronounced in coming months, partly due to
than we expected. Furthermore, long EM FX positions were
continued strong liquidity. Hence we see good
challenged by the sharp loss in EUR/USD and commodity
value in an EM Asia basket (long CNH, KRW and
prices during the first half of May.
MYR vs. short GBP, JPY and USD), we favour TRY
and RUB and recommend a long PLN/HUF Managing challenges
position. Significantly however, EM currencies have performed
reasonably well under such circumstances. In our view,
During the period since our previous report in
EUR/USD developments have more reflected euro
February, 15 large EM currencies have appreciated by
weakness in response to increasingly dovish ECB rhetoric
2.8% against the USD.
than a strong dollar which would be more problematic for
EM FX spot vs. USD often USD-funded EM positions. Considerable squaring of
15 EM currencies, equal weigth. 100=1 Jan. 2004
crowded positions has, of course, also occurred involving
117.5 117.5
EM currencies although, in the main, it was commodities
115.0 115.0
that were adversely affected. Most likely this has been
112.5 112.5
where the size of speculative positions had become mostly
Index
110.0 110.0 stretched. For example, the scale of speculative long oil
107.5 107.5 positions has decreased by 1/5 of the recent high but still
105.0 105.0 remains long. At the same time, the short USD position has
102.5 102.5 almost eased by half while its yen counterpart has become
100.0 100.0 long. Long positions in, for example, MXN and RUB have
jan apr jul okt jan apr eased by 1/5 and 3/5 respectively compared to their recent
10 11
Source: Reuters EcoWin highs.
In nominal trade weighted terms (NEER) the While many riskier positions (to which long EM currency
performance was stable in late 2010 and early this exposures are still referred) have been USD-financed, we
year but the latest data (April) show an appreciation of note a lower correlation between EUR/USD and, for
1.3%. The recovery since the Great Recession has, example, stocks, commodities and EM currencies than in
however, only come two thirds of than half way for instance in the period preceding the Lehman crash.
leaving plenty of room for further appreciation. Nevertheless, USD value is important and requires special
EM FX NEER
consideration.
15 EM currencies, equal weight. 100=2005
105.0 105.0
Major FX trends – weaker USD near term
102.5 102.5
In our view, the key to the US dollar outlook lies with the
100.0 100.0
Fed. Given the continuing slowdown in the US economy
since Q1 and its large twin deficits, we expect the central
97.5 97.5
bank to maintain its exceptionally loose monetary policy for
95.0 95.0
some time yet. We believe EUR/USD will recover early May
92.5 92.5
losses and return towards 1.50 over the summer. However,
90.0 90.0 as QE2 draws to a close, and the Fed ceases to reinvest
87.5 87.5 loans and interest payments maturing this autumn, the
06 07 08 09 10 11
currency will recover. We expect such a development to
occur without any major impact on either interest rates or
15
the liquidity situation. By January 2012 the Fed will SEB Carry Indic & Risk Appetite Index
begin hiking fed fund rates, we forecast to 2.0% by 0.3 130
end-2012. 0.2 120
We expect the USD to recover after weakening fairly 0.1 110
considerably against many major currencies. We 0.0 100

forecast USD/EUR of 1.40 and USD/JPY of 88.00 by -0.1 90
end-2011. However, the dollar outlook is ambiguous. -0.2 80
We believe the currency will recover ground against
-0.3 70
many majors while depreciating further against 05 06 07 08 09 10 11
fundamentally strong currencies with supportive
SEB Carry indicator 0
interest rates. SEB_RAI_Median100
Initiation of the Fed’s hiking cycle will, however, Secondly, we expect volatility to continue at current levels
terminate a long period of very cheap USD liquidity. or even decrease slightly further.
While Japan will maintain its zero interest rate policy
and the Yen probably replace the US dollar as a EM FX volatility and VIX
funding currency, the withdrawal of cheap USD 50 15
45 14
liquidity should ease pressure both on commodity
40 13
prices and on capital inflows to EM. We expect this
Percent
35 12
development to be the key characteristic of activity 30 11
next year, by which time EM currency diversification 25 10
will have increased. 20 9
15 8
Key EM FX drivers ahead 10 7
In our view, the key EM currency drivers over the next jan mar maj jul sep nov jan mar maj
10 11
3-6 months will be as follows: VIX index
EM FX 3M implied volatility. Average of 12 EM
1. Carry
2. Central bank activism and The graph below illustrates three months carry against the
3. Fundamentals. USD annualized for a number of EM currencies. To little
In the following analysis, we discuss why they are likely surprise, BRL and TRY are at the top of the league. Note
to be important determinants of market activity and also that the actually carry earned on especially the NDF
how they will affect different EM currencies. currencies may differ substantially from the policy rates in
the respective countries. Two striking examples of this are
1. Carry Brazil where carry is around 8% compared to the current
Carry trades were adversely affected by the Japanese policy rate of 12%. In China, investors currently get a
earthquake which resulted in increased FX volatilities negative carry of 1.5% annualised since the NDF market is
rendering positions less attractive. Then, after pricing in some appreciation of CNY vs. USD (too little in
recapturing investor attention once again, they were our view).
hurt by the sharply lower EUR/USD and decreasing
commodity prices in early May. As already argued,
however, we expect carry to become a key driver once
again. We identify two preconditions to helping carry
reassume this role. Firstly, we believe risk appetite will
remain supportive.
16
appreciate too far, too fast. Currency markets were

characterised last October as being the subject of an “FX
Carry %, 3m vs USD, Annualized war”. Subsequently, many EM central banks have
intervened regularly to prevent the market from “having it
10
all their own way”. This strategy has operated together with
8 new capital restrictions mainly in Emerging Asia and Latin
6 America. Central bankers were largely successful, covertly
ensuring EM FX did not appreciate further in NEER terms in
Carry %
4 either late 2010 or early this year.

2
In our previous report we highlighted a likely change in
0 behaviour by central banks as headline inflation had
-2 accelerated to a point where further FX appreciation would
be tolerated to restrict imported price pressure.
-4 Prospectively, we expect this preferential balance to be
MXN
IDR
ZAR
TRY
BRL
PLN
MYR
HUF
RUB
CNY
KRW
maintained given probable further high near-term headline

inflation, and also because markets are refocusing on core
Source: SEB, Bloomberg inflation which will continue to rise from low levels for
longer with output gaps in many cases now filled.
An analysis of risk adjusted carry confirms that EM
FX reserves in SDR
currencies ought to be strong winners if carry Thousand billions
becomes a driving force in FX markets. All 10 4.5 4.5
currencies vs. the USD in our sample have a Sharpe 4.0 4.0
ratio exceeding 0.2, a level often referred to as a 3.5 3.5
minimum for carry trading. The average Sharpe ratio 3.0 3.0
SDRs
for these 10 EM currencies is 0.56 with BRL and TRY 2.5 2.5
2.0 2.0
scoring well again but with IDR in the top of the league
1.5 1.5
according to the latest data. 1.0 1.0
0.5 0.5
00 01 02 03 04 05 06 07 08 09 10
Risk adjusted carry
1.5 Developing Countries Industrial Countries
Source:IMF
The existence of global imbalances also implies that the

1.0 “FX war” will return to the news later this year. Pressure on
Sharp ratio
China and other EM surplus economies to take

responsibility for restoring a more balanced global
economy is likely to intensify ahead of the G20 summit in
0.5
Cannes on November 3-4. Several Asian Development
Bank representatives have highlighted the merits of a joint
EM Asian revaluation. While we agree, it remains to be seen
0.0 whether such policy coordination will in fact materialise.
MXN
IDR
ZAR
TRY
PLN
MYR
BRL
HUF
RUB
KRW
3. Fundamentals
Source: SEB, Bloomberg Fundamentals include the rate and structure of GDP
growth, the internal and external macroeconomic balance
As a comparison, three of most commonly traded
(i.e. fiscal and current account balances), public and
carry currencies among the majors, AUD, NZD and
external indebtedness, as well as the demographic
NOK currently have Sharpe ratios of 0.26, 0.14 and
situation, the status of the banking system, FX reserves and
0.14 respectively against the yen.
net investment positions.
2. Central bank activism
Since last autumn, EM central banks have more
actively managed their currencies. Their doing so
reflects concerns that the combination of vast
differences in GDP growth and interest rates on the
one hand and a QE-induced abundance of global
liquidity on the other could cause EM currencies to
17
The panel of charts below serves to illustrate some of report, we expect these factors to be key drivers of
these factors on an aggregate level: business flows (including trade and FDI) and investment
decisions (through portfolio flows) influencing currency
OECD and EM GDP growth
Percentage change yoy markets.
8
Emerging Markets
8 EM fundamentals are stronger than those of developed
6 6 markets on many accounts. This applies in general, EM Asia
4 4
is best in class. Having said that, it is important to note
that various EM countries provide significant scope for
2 2
further improvement in terms of optimizing their fiscal,
0 0 monetary and exchange rate policy mix. As we highlight on
OECD
-2 -2 p6, we are concerned by evidence of complacency
-4 -4 regarding continued structural reforms.
85 90 95 00 05 10
Source: IMF and SEB
What has been done has in many cases been impressive,
conferring immediate positive benefits. However, the task
remains incomplete. Democratic reforms need to be rooted
and invigorated, and institutional reforms improved. At the
same time, we also see scope for improvements in
corporate governance and combating corruption.
SEB EM FX forecasts
Our analysis of individual currencies in the framework
described above generates the following forecasts:
pb_=bj=cu=ÑçêÉÅ~ëí
j~ó=OM båÇ=OnNN båÇ=PnNN båÇ=QnNN båÇ=OnNO
sëK=bro
mik PKVO PKUU PKUO PKTR PKTM
erc OSV OSR OSR OSR OSR
`wh OQKR OQKO OQKM OPKS OPKP
olk QKNN QKMU QKMR QKMM QKMM
fph OQU ORM OQM OOM OMM
or_ QMKM PVKR PVKO PUKR PTKP
or_L_^ph PPKR POKR POKR POKR POKM
sëK=rpa
or_ OUKO OSKT OTKM OTKR OTKT
r^e TKVV TKVR TKVR TKVR TKVR
qov NKRV NKRQ NKRM NKQU NKQR
w^o SKVN SKTR SKTR SKUM SKUM
_oi NKSO NKRU NKRR NKRT NKRT
juk NNKS NNKR NNKQ NNKP NNKM
`kv SKQV SKPU SKOU SKOM SKMP
pda NKOQ NKOO NKON NKOM NKOM
hot NMUP NMRM NMPM NMOM VVM
qta OUKU OUKP OUKM OTKS OTKQ
qe_ PMKP PMKM OVKS OVKQ OVKO
fko QRKM QQKO QPKT QPKR QOKU
fao URPS UQRM UQMM UQMM UPMM
jvo PKMN OKVU OKVO OKVM OKUR
Percent
broLrpa NKQO NKQU NKQR NKQM NKPR

rpaLgmv UNKT UOKM UQKM UUKM VOKM
We therefore expect most EM currencies to perform well

during the forecast period, particularly in the coming
quarter when:
• high headline inflation will encourage central
banks to accept stronger currencies
Strong fundamentals underpin currencies as they • global liquidity will remain strong and
generate supportive flows and limit the risk of
unpleasant surprises. Over the next 3-6 months, • the USD will continue as a familiar funding
representing the investment horizon of the present currency.
18
Extending the horizon through to the end of this year,

we see the possibility of many EM currencies
appreciating by around 5% against their traded
currency with ISK, TRY and KRW at the top of the
league followed by CNY and PLN having the best
potential for nominal appreciation. At the bottom in
nominal terms we have UAH, HUF and IDR.
EM FX risks…
Obviously, our forecasts are subject to various risks
including:
• a more pronounced cyclical set-back
• a faster/sharper tightening of global liquidity
• earlier and more disorderly than expected
continuation of the European debt crisis
and/or
• a renewed sharp increase in oil prices.
We discuss these risks in more detail on p6. Others
include positioning remaining biased towards many
EM currencies, and volatilities in general being
relatively low, albeit less so than before the correction
during the first half of May.
…and opportunities
The best opportunities in the EM currency space, in
our view, are described in detail in the Fixed income
and FX trading strategy section on p20.
19
Fixed income and FX Trading

Strategies
Investment and consumption

In our previous report we recommended a defensive
positioning bias given the challenging risk reward
GDP
balance prevailing at that time. We advocated an
intra-EM reallocation towards more liquid and more
highly rated instruments. We also suggested
maintaining a 50% currency risk hedge but on April 1,
we lifted that hedge to assume full currency risk.
Looking forward, based on our macro scenario as
described above and in view of the recent correction in
However, high GDP growth is subject to two important
sometimes crowded positions, our investment
caveats, particularly as it is predominantly driven by
strategy is to seek the potential gains from long
domestic demand rather than exports. Firstly, imports have
positions in EM bonds and currencies. In our opinion,
increased. After yet another disappointingly large current
the opportunities offering the best risk reward over
account deficit in March, the full year deficit appears likely
the next 3-6 months are as follows:
to amount to 8% of GDP. The fact that an expensive oil bill
1. Long Turkish local bonds with open TRY risk explains a large part of the trade deficit provides some
2. Long Polish 5s vs. Hungarian 3s with open FX consolation but with portfolio inflows needed to cover the
risk (long PLN/HUF) vast majority of the deficit, this is clearly a cause of
concern.
3. Long Russian Eurobonds in rouble unhedged
4. Increase risk in SEB EM local bond portfolio,
keep FX risk open, hedging IR risks with short
DM yield positions
5. Short EUR/ISK offshore, Place in HFF
USD bn
6. Long long-end Croatia in USD, 2015 maturity

in EUR, both vs DM
7. Long Lithuanian short end in Euros
8. Long EM hard currency bonds vs. DM
corporates
9. Long an EM Asian basket of CNH, KRW and The second caveat is inflation. Headline inflation hit a 40-
MYR against USD, GBP and JPY year low of 4.0% y/y in March despite strong domestically
10. Sell USD/CNH driven growth and soaring global commodity prices. A very
11. Retain EM FX basket good harvest last year is a key explanation. Going forward
In the first five recommendations we suggest however, base effects on local food prices are becoming
assuming risk on local government bonds and the challenging. We believe the country’s high levels of
currency combination. Recommendations 6-8 concern economic activity have strained resources so much that
hard currency papers while the last three proposals inflationary pressure appears inevitable. We therefore
involve pure FX positions. In the following analysis we expect headline inflation to increase towards 7% by year-
set out our key arguments and risks. end.
Long Turkish local bonds with open TRY risk

When last winter arrived, the Turkish economy was
performing very strongly. Q4 GDP was well above
expectations; up 9.2% and 8.9% y/y. FinMin Simsek
expects Q1 growth of 9.0%. We maintain our above
consensus 2011 forecast of 5.8%. Rapid growth
obviously supports government finances with fiscal
data so far this year most encouraging. Significantly,
spending controls have been maintained in the run-up
to elections in June.
20
Consequently, our forecasts show the lira’s potential to be

amongst the best over the rest of the year, especially
discounting carry. Prospectively, we recommend holding
Turkish government bonds. We prefer shorter maturities as
their yields are as high as longer term bonds. For long
Percent
bonds to breakeven against their shorter term counterparts

would require a rate path involving rate reductions early in
the cycle which appears unlikely. Due to high yields even in
the very shortest end some marginal exists against hawkish
surprises in rate policy. Also, three other factors will
support bonds despite rate hikes. Firstly, we believe the
return to orthodox monetary policymaking will succeed in
This will obviously provide a challenge for the central dampening inflation expectations. Secondly, we expect the
bank which has been engaged since late last year in AKP government to win the June 12 election which will
maintaining an unorthodox policy mix of interest rate reassure the market. Finally, we anticipate positive news
cuts and reserve requirement increases to restrict from rating agencies during the second half of the year
capital inflows and dampen credit driven demand and with a transition to an investment grade rating increasingly
imports which adversely affect the external balance. likely.
To some extent, the authorities have succeeded in
maintaining a relatively inexpensive currency, but Turkish yield-curve
credit growth has so far only shown limited signs of
11
slowing. In our opinion, this policy mix will be very
10.5
difficult to maintain with inflation set to exceed its
10
year-end target of 5.5% as early as the summer. We
Yield, % p.a.
9.5
expect rate hikes to be resumed. With only limited
9
support from fiscal policies in helping tighten policies Yield 21-May 2011
we now forecast that the policy rate will be increased 8.5
8 1-month annulized
by 150bps from 6.25% currently to 7.50% by year- roll-down returns
end?. We believe that once the central bank has 7.5
Source, Bloomberg
reverted to orthodox monetary policies, it will 7
0 5 10 15
frontload subsequently measures to dampen future
Maturity, years
inflationary expectations.
While this should help inflation return to target in Regarding flow statistics, a significant share of Turkish
2012, such rate hikes will obviously support the government bonds has been driven offshore as a probable
currency, particularly with carry a key driver in FX result of RRR hikes. Foreigners have been quite prepared to
markets. We therefore expect USD/TRY to fall to 1.48 buy them at low prices from forced sellers. As more
by year-end. A strong lira will prove problematic for foreigners seek to capitalise on this opportunity, prices
the central bank given Turkey’s high current account should begin to increase. However, most of the potential
deficit. We therefore expect more active interventions. for Turkish paper lies in a reduction in risk premia from a
Also, even if sterilisation comes at a significant cost, possible normalisation of monetary policy and RRR
increasing FX reserves will provide useful insurance requirements.
against future setbacks in risk appetite and For a hedge to a positive TRY exposure, we would sell US
withdrawals of liquidity. Treasuries, given orderly historical correlations. We also
observe that the most recent TRY softness has come
despite a strong development in Treasuries, which could
indicate current attractive relative TRY value.
REER Index
USD/TRY
21
outlook. However, we do not think it entirely true. It simply

Turkish Currency and U.S. Yield
does not make sense for a central bank targeting inflation
1.65 3 within a fairly open economy to ignore the exchange rate’s
Turkish
lira
contribution to the decision whether to tighten or ease
1.6 2.5 monetary conditions. Consequently, following the
5y
Treasury announcement that the full amount of EU funds will be
1.55 2
yield exchanged in the open market, we have reduced our
Yield, % p.a.
USDTRY
forecast year-end policy rate from 4.75% to 4.50%.

1.5 1.5
Essentially, we regard our decision to do so as supported by
1.45 1
the knowledge that if the zloty fails to appreciate, for
whatever reason, more rate hikes are likely to occur.
1.4 0.5
Source: Bloomberg
1.35 0
Apr-10 Jul-10 Oct-10 Jan-11 Apr-11
Percent
Long Polish 5s vs. Hungarian 3s with open FX
risk (long PLN/HUF)
Polish authorities have singled themselves out as
more open minded towards currency appreciation
than almost all other EM. The central bank has
supported its own currency while recently the
Government declared that EUR 13-14bn in EU funds
will no longer be exchanged directly with the central April inflation rose further to 4.5% and is likely to remain
bank but on the open market, a move which will around this level throughout the year. As this is well above
provide substantial support for the zloty. It will also the 2.5% +/- 1% target a hawkish policy is warranted. Our
alter the balance of risk as the FinMin is likely to forecasts assume that this strategy will probably succeed
increase market supply of euros during periods of risk with average inflation falling to 2.8% during 2012 despite
aversion and zloty sell-offs. This reinforces our views our above consensus GDP forecast.
expressed in Currency Strategy published on May 10, An important risk for the zloty is the expected revision of
in which the zloty appeared as one of the highest the country’s balance of payments data. If the continuously
scoring currencies, benefiting from a supportive large negative errors and omissions data represent under-
assessment of monetary policy, economic reported imports which have then to be corrected, the
fundamentals and flows. We expect EUR/PLN to trade current account deficit could double from last year’s
at 3.75 by the end of the year. In REER terms, the zloty reported 3.3% of GDP. While we have been emphasising
will probably lag its peers. this risk for several years it has only recently become of
interest to the market. Although it will not come as a great
surprise we expect such news to have at least a temporary
Index 100 = 15 Sep. 2008
adverse effect on the zloty.

What we have seen from polish short bonds and the zloty
this year is a trading pattern consistent with the policy
message. A strong zloty and lower yields (compared to
Germany) have gone hand in hand. Short term deviations
from this pattern have so far suggested trading
opportunities, some of which we have reported in our more
frequent communications (e.g. EM FI Market Views, May
13).
Despite different opinions concerning the link

between the zloty supportive conversion of EU funds
and the central bank’s interest rate policy, the latest
message from Governor Belka is that open market
conversion is not a substitute for policy rate hikes, a
view which lends further weight to our bullish zloty
22
3.6 4.15 industry benefiting from strong economic conditions both

2-yr yield spread in German, and elsewhere. As a result, the current account
3.5 4.1
has swung around, and is now posting a surplus. Also,
EURPLN substantial portfolio inflows have provided considerable
spread % p.a.
3.4 4.05
EURPLN
support for the forint. Overall, we are neutral, forecasting
3.3 4
EUR/HUF at 265 by year-end, while seeing risks as lying on
3.2 3.95 the upside as discussed earlier.
3.1 3.9 Hungarian 3-year local bonds appear expensive on the
curve and could be abandoned together with the
3 3.85
Mar-04 Mar-18 Apr-01 Apr-15 Apr-29 May-13
associated currency exposure, in favour of the
aforementioned exposure to Poland. Assets in the two
From a longer term perspective, we are bullish on both currencies have recently shown a significant correlation,
the yield and the currency, recommending 5yr local especially during the worst periods of the recent crisis.
currency bonds with full currency exposure.
Currencies vs EUR
In order to hedge such a position, we would target
320 5
Hungarian paper, inspired by the current record of
310 Hungarian forint 4.8
Hungary's government led by Fidesz. Despite recent
300 4.6
relative stability, the government's short-sighted fixes Polish zloty
290 4.4
to its long term budget problem do not reassure us.
280 4.2
EURHUF
EURPLN
The underlying deficit remains around 5%, a fairly 270 4
vulnerable situation given a debt/GDP ratio of around 260 3.8
80%. Although short term measures to socialize 250 3.6
private pensions and introduce corporate crisis-taxes 240 Source: Bloomberg 3.4
on companies have resolved the government’s 230 3.2
liquidity problem, solvency is likely to remain an issue. 220 3
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
What are the options next time the market questions
the viability of Hungarian finances? Long Russian Eurobonds in rouble unhedged
Supply in Russian rubles appeared likely to fall to zero for
Hungary has come in from the cold. As the market has
the remainder of the year after statements from FM Kudrin
endorsed the structural reform programme it has also
at the beginning of May in which he stated that Russia
accumulated new positions. Foreign ownership of
would not seek further funding in international markets this
Hungarian government bonds has risen rapidly back to
year due to its high oil revenue and strong trade balance. At
pre-Lehman levels. the time, it appeared as if the market needed to sharply
In our opinion, this has created the basis for a reduce its supply forecast, possibly increasing the yield
potential stop loss rally should confidence once again momentum for Russian Eurobonds in Ruble. However,
deteriorate. This situation is further supported by the barely two weeks later the authorities announced a RUB
fact that the transfer of second pillar private pension 40bn issue in the international 2018 bond.
funds to the state will adversely affect liquidity.
Attention should therefore be paid to the Russian Eurobond ruble 2018
implementation of structural reforms. By July 1, 8
parliament will have passed several additional laws. In 7.8
addition, no proven solution to homeowners troubles 7.6

7.4
has yet emerged with foreign currency loans in sight.
Yield % p.a.
7.2
While overall this implies several risks for the forint, 7
we also note two supportive factors. Firstly, the 6.8
current high interest rate (the policy rate was hiked by 6.6
75bps late last year and early this to 6.0%) provides an 6.4
Source: Bloomberg
important cushion during periods of normal risk 6.2
appetite and volatility. Secondly, the domestic 6

Mar-11 Apr-11 May-11
economy remains burdened by deleveraging of the As
large FX debt and, for several years, by very meagre regards secondary market pricing, Russia will probably pay
real wage developments. GDP growth is therefore a price for trying to manipulate the market. Yields are now
highly imbalanced with a large and competitive export above levels prior to Kudrin’s unreliable announcement.
23
Despite the now proven fact that demand can increase

SEB EM Bond Portfolio 2011May 20
if yields go too low, we still regard the issue as
SEB Rating Duration
attractive due to a Russian ruble supportive flow weight S&P Yield years
situation and otherwise limited investment vehicles. new old (LT-FC)
We see further support from a positive Poland 15% 15% A- 5.5% 3.9
Hungary 2.5% 7.5% BBB- 6.6% 3.3
macroeconomic situation with further potential
Iceland 5% 5% BBB- 2.7% 0.2
benefits from fiscal stimuli ahead of forthcoming S. Africa 10% 7.5% BBB+ 7.2% 3.1
elections. Turkey 12.5% 2.5% BB 9.2% 2.7
S. Korea 7.5% 15% A 3.9% 3.1
Indonesia 12.5% 5% BB+ 6.5% 2.9
Russian currency and U.S. Yield
Malaysia 7.5% 12.5% A- 3.4% 2.8
25 4.5 Brazil 15% 15% BBB- 12.7% 1.5
Mexico 12.5% 15% BBB 6.3% 3.8
27 4 Average 100% 100% BBB 7.0% 2.8
Russian CCY basket
29 3.5
5y Treasury Short EUR/ISK offshore, place in HFF
31 3 Offshore ISK has appreciated since the presentation of the
RUBBASK index
Yield, % p.a.
33 2.5 liberalization plan earlier this spring despite the country’s
failure to accept the Icesave agreement. While we are
35 2
cautious concerning the level at which offshore ISK will be
37 1.5 priced in the upcoming auction, we believe auctions will
39 1
help stabilise the position once they succeed in matching
bidders and sellers. At this point it is unclear whether the
41 0.5
Source: Bloomberg first auctions will represent a positive or negative
43 0 development for offshore ISK, or even if any significant
Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10
volumes will be serviced during early auction rounds. Note
The risk profile of the Russian Ruble is apparently the that Sedlabanki has indicated gradualism in the
opposite of US treasuries as shown in the diagram liberalization process as well as for the ISK price
above. The Ruble is apparently and unsurprisingly developments.
benefiting from increasing risk appetite and improving Once solid price indications are available in connection
expectations concerning the business cycle (i.e. with the upcoming Sedlabanki ISK hard currency auctions,
through crude demand). Those are the same factors offshore and onshore rates should gradually convert. Based
that usually are negative for Treasuries. Rather than on our positive long-term outlook for the Icelandic
recommending this position in a spread to hard economy, and given also the current soft real exchange
currency bonds, we regard it instead as a stand alone rate compared to historical levels, we expect offshore ISK
investment with a favourable negative correlation to to appreciate from levels reported during the first
DM bond holdings. successful auctions. Sedlabanki’s first currency auction is
Increase risk in SEB EM local bond portfolio, due June 7.
keep FX risk open hedging IR risks with short
DM yield positions Housing Finance Fund 2014 Bond
We adjust our EM Bond basket towards lower credit
qualities as we see the MENA implications as now 4.5
being fully priced in. In line with our case on Turkey 4
above, Turkish allocation is increased. We recommend 3.5

holding the position with full currency exposure 3
against an interest rate hedge of DM government
real yield, % p.a.
2.5
bonds. 2
1.5
1
HFF ISK 2014
0.5
0
Jan-10 Jul-10 Jan-11
-0.5
Source: Bloomberg
-1
24
Apart from pure short term paper, we also still see 900
bps
good prospects in the HFF 14 bond, which due to 800
its favourable standing in the Icelandic currency 700
regulations has made strong gains since we first 600

recommended it in February this year. 500 1y spread (EUR, mid)
Long long-end Croatia in USD, 2015 maturity 400
in EUR, both vs DM 300
Croatian 10-year bonds in USD trade at a Z-spread to 200

Treasuries of over 275bps despite relatively low 100
Croatian government debt of around 55% of GPD 0
Source: Bloomberg
(Bloomberg). Their rating is BBB-. In our view it also May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11
appears as if the market needs to take into account
the possibility of Croatia signing an EU accession
A 1y bond maturing in May 2012 currently trades at 60bps
treaty before the end of the year. Further, Croatian
spread vs. Germany. Subject to some fluctuations we
bonds in USD are cheap vs. their EUR-denominated
expect the spread on 1y vs. Germany to continue to narrow
Croatian counterparts as the latter trade near the
approaching maturity, especially in autumn 2011, following
Hungarian curve, and the former well above. Also,
completion of the planned Lithuanian Eurobond issue
compared to the Hungarian EUR curve, the shorter
that’s intended to accumulate funds to redeem among
end of the Croatian curve appears too steep,
others the aforementioned 1y bond. We think it reasonable
underlining the attractiveness of the Croatian EUR
to apply the strategy of going long Lithuanian 1y bond
2015 issue.
(Bloomberg ticker Lithun5 7/8 05/12) currently yielding
Long Lithuanian short-end in euros 2.08% against the German comparable counterpart (DBR 5
While Baltic economic growth continues to accelerate 07/04/12) yielding 1.48% and holding until maturity, which
we think the region’s economies are much safer this would gratify investor with the full current yield potential.
time when it comes to risk of being trapped in the At mid-prices, we see opportunities to realize profits early.
boom-bust scenario. Growth is now more sustainable However, trading costs are likely to cancel out much of
as it is driven by higher competitiveness rather than those and hence we prefer to hold to maturity.
borrowing and slow recovery of domestic demand is Long EM hard currency bonds vs. DM corporates
preventing from forming new bubbles. In Lithuania
After the continuous tightening of corporate spreads and
fiscal outlook continues to improve helping to adjust
the recent widening of sovereign credits, we recommend
public sector disequilibrium. According to FinMin
taking profits in the former to invest in the latter. EM hard
Lithuanian GDP growth forecast has been increased to
currency spreads have widened despite the strong ongoing
5.8% (above our forecast of 4.0%) for this year. The
recovery improving prospects for fiscal balances. In this
FinMin now estimates that the public sector deficit
situation, an important factor is the political position, as
will fall from 7.1% last year to 5.3% this year, which
suggested by the timing of the onset of spread widening
seems realistic in our view.
with the outbreak of the MENA crisis. It is unevenly
Lithuanian bond spreads vs. main markets have been distributed among constituent countries, with Turkey an
narrowing since the beginning of the year driven by important contributor to widening while e.g. the Brazilian
the general trend prevailing in CEE markets as well as hard currency index reports unchanged spreads.
a successful Lithuanian Eurobond issue in March. The
380 270
country’s CDS levels have since March also decreased
EMBI Spread to UST, bps
360
significantly from 250 to 200bps. We see limited
BBB Spread to UST, bps
340 EMBI-spread
scope for further big reductions in Lithuanian risk 320
BBB-spread
230
premium as the country according to our model is 300
fairly valued compared to its BBB rated peers. 280
Nevertheless the short end offers potential value for 260 190
longer term investors due to its relatively favorable 240
carry. 220
200 150
May-10 Aug-10 Nov-10 Feb-11 May-11
Political and local drivers underline the non-systematic

nature of the politically-driven widening of EM sovereign
spreads. We therefore see an attractive diversification
25
opportunity in reallocating credit risk from the strained as subsidy costs continue to increase. Therefore,
probably fully priced corporate universe to better central banks are now more willing to tolerate faster
yielding sovereigns. currency appreciation as a means of alleviating inflationary
pressure on imported goods.
Gov't hard currency yield spreads
Combating inflation also implies that additional tightening
(EMBI)
of monetary policies will take place. To some extent this
350 300 will occur through prudent macroeconomic measures
Turkish hard ccy spread
including increased reserve requirement ratios although
Brazilian hard ccy spread
policy rate hikes are also likely which will improve carry.
Turkey; yield spread, bps
Brazil; yield spread, bps

300 250
While constructive on Asian currencies overall, we see the

250 200 best risk reward in CNY, KRW and MYR. We therefore se
good value in going long all three in equal weights (we
200 150 choose the convertible off-shore CNH rather than the CNY
NDF given its more favourable current price) vs. the three
150 100 worst scored currencies in our recent Currency Strategy, i.e.
Source: Bloomberg
JPY, GBP and USD.
100 50 SEB EM Asia FX Basket
Jan-10 Jul-10 Jan-11 Excl. carry. Index 100 = 31 Dec 2006
105.0 Long CNH, KRW and MYR equal weights vs. 105.0
Long an EM Asian basket of CNH, KRW and 102.5
short GBP, JPY and USD equal weights
102.5
MYR against USD, GBP and JPY 100.0 100.0
97.5 97.5
The case for appreciation of EM Asian currencies is by
95.0 95.0
no means new and rests primarily on two premises:
Index
92.5 92.5
superior fundamentals justify it; and the rest of the 90.0 90.0
world needs it in order to reduce global imbalances. 87.5 87.5
Nevertheless, we still see a region affected by 85.0 85.0
misaligned currency valuations compared to any 82.5 82.5
80.0 80.0
sensible measure of equilibrium. Countries themselves
77.5 77.5
have retained an old export oriented growth model 06 07 08 09 10 11
with the painful Asian crisis fresh in their minds, and
have intervened extensively to prevented market
forces from strengthening their currencies. Sell USD/CNH
On May we recommended selling a 3-month USD/CNH
So, what’s new? Two things are in our view, changing forward. Headline inflation in China came in at 5.3% y/y in
the ball game. Firstly, with the adoption of its twelfth April. While this was a tad below the March reading of 5.4%
five year plan in March, China has confirmed that the it is still uncomfortably high for policy makers. The target is
overriding goal of its economic policymaking will be to set at 4%. Some other data such as retail sales and
increase private consumption, reducing dependence industrial production also showed signs of slowing but
on investments and exports in stimulating GDP from elevated levels in Q1. We expect headline inflation to
growth. A stronger currency is a key part of this gradually ease in the second half of the year but during the
objective as it strengthens household purchasing next few months it will remain in the 5-6% range. Base
power. Clearly, gradualism remains a virtue and we effects will not become supportive for disinflation until the
should not expect major changes overnight. The very end of the year.
competitive pressure which China is exerting on other
countries cannot be overstated. Therefore, if its Meanwhile, authorities will increasingly focus on core
authorities tolerate faster renminbi appreciation, it will inflation which has doubled since Sep. 2010 to 2.3% and is
pave the way for other regional central banks to do the likely to keep rising as wage pressure rises further. Against
same without having to worry too much about adverse this backdrop, we expect policy makers to remain firmly on
competitive consequences. guard against inflation. Indeed, the lower headline CPI
reading in April was immediately followed by yet another
Secondly, inflation is a major concern for policymakers rise in RRR to 21% for big banks. Looking forward we
not only in China but throughout the region. Where expect all tools to be used and look for one more hike by
headline inflation or, particular, food prices have 25bps of interest rates and, more importantly, three
increased, and subsidies have been more generously additional hikes in RRR by a total of 150bps. In addition
employed, the fiscal situation generally becomes policy makers will also choose to maintain the somewhat
26
faster pace of CNY appreciation vs. the USD. Policy A LEVERAGED ALTERNATIVE
makers have recently acknowledged that appreciation
can help keeping imported prices down. Furthermore, For investors who can trade on the Swedish Stock
the sharp improvement in the trade balance in April Exchange we recommend a USD/CNH Certificate
(exports + 30% and imports +22% in USD) indicates called Kina Bull with leverage (currently about 5
that exporters are not under water from FX times). It is listed in SEK and documentation is in
appreciation. Swedish. Contact your SEB sales person for further
information.
Retain EM FX basket
We recommend investors retain the EM FX basket initiated
last October. The basket consists of an equally weighted
USD/CNY
long position in KRW, INR, PLN, TRY, BRL and MXN vs. a
Index
short basket comprising 50% USD, 25% EUR and 25% JPY.
The basket has increased 3.4%, of which carry represents
2.6%. Given our EM currency outlook, together with our
present forecasts we see no reason to close the position.
SEB EM FX Basket #2
Excl. carry. Index 100 = 21 Oct. 2010
105 105
After all, in trade weighted terms, the yuan has 104 Long KRW, INR, PLN, TRY, BRL, MXN equal weights 104
vs. USD (50%), EUR (25%), JPY (25%)
weakened during the last couple of years. We expect 103 103
yuan appreciation vs. the USD to be faster during the 102 102
next quarter, as inflation remains elevated, but that 101 101
the pace eases to an annual appreciation of 6% later 100 100
in the year. We expect USD/CNY to fall to 6.38, 6.28 99 99
and 6.20 at the end of Q2, Q3 and Q4. We regard risk 98 98
reward as favourable given the massive pressure on 97 97
CNY appreciation. 96 96
jan mar maj jul sep nov jan mar maj
10 11
USD/CNY
Both the NDF and the convertible offshore market

(CNH) are pricing in much less yuan appreciation than
we forecast. On May 17, the latter was more
favourable and we thus recommended selling
USD/CNH 3 months forward at 6.4820 with spot ref.
6.4980 implying that the market is only pricing in
0.2% yuan appreciation compared to about 2.5% in
our 3 moths forecast. We set a take profit target at
6.35 and stop at 6.58 in USD/CNH spot.
27
From an MSCI AC World Index perspective, the worst

Equities performers year-to-date have been Egypt and Peru even
EM equities continue to struggle. So far this year, underperforming Greece, but with India, Brazil and Mexico
the MSCI EM index has fallen 0.9%, not far behind. However, since our previous cut-off (Feb
underperforming its DM counterpart that has 18) both Greece and Japan have significantly
risen 4.4%. However, since the cut-off date for underperformed the negative return posted by the
our last edition of Emerging Markets Cross Assets Peruvian market. (All calculated in local currency).
(EMXA) in February EM equities are up 1.7%,
outperforming DM that have since slipped 1.9%. Equity Market Price Performance (local ccy)
While EM price momentum at the time of writing Since
YTD 1 Year
18/02/2011
faces headwinds we forecast the MSCI EM index
MSCI AC World 1.95 17.11 -2.84
to increase by 10% to 1275 by year-end EM, based
MSCI Czech Republic 10.99 6.83 9.75
on attractive valuation and good earnings. MSCI New Zealand 10.56 14.60 5.46
MSCI Hungary 7.06 1.26 0.46
MSCI Indonesia 6.31 33.20 13.03
Emerging Markets equities relative the world MSCI USA 6.18 25.16 -0.59
Index 2011-01-01 = 100
MSCI Thailand 4.84 37.30 7.92
105.0 105.0
EMXA Feb. cut-off MSCI Poland 3.29 24.89 6.35
102.5 102.5 MSCI Spain 2.87 7.13 -8.97
MSCI Portugal 2.72 17.00 -3.14
100.0 100.0
MSCI Korea 2.69 32.70 4.49
97.5 97.5 MSCI China 2.09 18.42 2.19
MSCI Germany 1.84 20.60 -4.62
95.0 95.0
MSCI Malaysia -EM 1.46 19.53 1.71
92.5 92.5 MSCI Sweden 1.38 24.09 5.31
MSCI Canada 1.21 17.01 -3.76
90.0 90.0
MSCI Denmark 1.07 20.56 -1.65
Dec Feb Mar Apr May Jun
10 11 MSCI United Kingdom 1.03 17.07 -2.30
Emerging Markets, MSCI MSCI Australia -0.09 8.98 -4.16
MSCI EM vs MSCI the World
Source: Reuters EcoWin MSCI Colombia -1.73 28.66 9.49
Regional rotation so far this year has been fairly MSCI Taiwan -1.73 19.03 -0.36
MSCI South Africa -2.98 17.06 -1.42
strong. The EMEA region outperformed strongly,
MSCI Philippines -3.16 18.53 6.78
mainly due to Russia, to the end of March before MSCI Morocco -3.18 -5.17 -5.05
falling back, alongside Latin American markets, from MSCI Chile -3.25 24.22 8.23
mid-April. It was superseded as best performer by the MSCI Norway -3.33 22.68 -3.25
large EM Asian region within the EM universe. MSCI Russia -3.53 26.66 -4.02
MSCI Finland -6.52 9.68 -4.17
EM Equities - Regions relative (vs. EM) price performance
Index 2011-01-01 = 100
MSCI Turkey -6.55 11.88 -5.10
112.5 112.5 MSCI Japan -8.16 -7.68 -15.20
MSCI Mexico -9.15 15.02 -6.45
110.0 110.0
MSCI Brazil -9.39 6.35 -8.33
107.5 107.5
MSCI India -11.19 7.42 0.62
105.0 105.0 MSCI Greece -11.77 -25.69 -28.83
102.5 102.5 MSCI Peru -19.65 27.08 -8.85
100.0 100.0 MSCI Egypt -24.86 -17.32 -5.61
Source: FactSet
97.5 97.5
95.0 95.0 The best performing markets so far this year have been the
92.5 92.5 Czech and New Zealand markets, and with in the top four
Dec Feb Mar Apr May Jun we can also include Hungary and Indonesia. The latter has
10 11
EM Asia EMEA Latin America also been the star performer since our EMXA cut-off in
February.
So far this year, the Czech Republic has been the
strongest market performer, both from single market Sharp changes in flows
and local currency adjusted perspectives. The recovery The net flow of funds into EM managed and index funds
in Hungary at the beginning of the year ensures it (including ETFs) jumped USD 84bn in 2010, peaking at USD
remains a leading performer still, together with 91bn in the third week this year, the strongest inflows ever
Thailand, Indonesia and, in part, Korea, all of which reported by EPFR. Subsequently however, international
have enjoyed solid relative momentum since the year investors rapidly withdrew funds from EM equities. During
end. the last week of March alone, peak to trough withdrawals
28
totaled USD 28bn. Thereafter, investors have net outflows. So far this year, the market has increased
reinvested USD 14bn in EM equities. AUM by 6% while during the past 6-7 weeks the Korean
Emerging Markets - Flow of funds & Price return
and Polish markets have reported inflows sufficient to
EPFR data & MSCI EM index result in a positive increase in AUM since year-end. In
100 1300 addition, South Africa, Taiwan and Turkey look set to follow
90 1250
80 1200
suit, while AUM in Brazil, China, India, Indonesia and
70 1150 Mexico are down some 2-3% in the YTD.
Bn USD
60 1100
Index
50 1050 China and Brazil still Index heavy weighters
40 1000 Breaking down the MSCI EM benchmark index by market
30 950
20 900
still shows China and Brazil to be the largest by market size.
10 850 The index is weighted by free float. Korea and Taiwan
0 800 follow close behind. These four countries represent almost
10 11
60% of the total index, a share little changed in recent
EPFR Cumulative flows EM EQ years. Including the next four largest markets, South Africa,
Emerging Markets, MSCI, USD Index, Price Return, USD
Source: Reuters EcoWin, EPFR India, Russia and Mexico, the collective share of the MSCI
Interestingly to note is how these fluctuations in flows EM index increases to 85%, and to 90% including our three
have influenced the return on EM stocks. In particular, remaining “primary” markets, Indonesia, Turkey and
after around 75% of the strong inflow to EM funds Poland, which we follow closely.
took place in 2010 the MSCI EM index lost momentum,
trading sideways, a development which continued MSCI EM Regional Breakdown
during Q1-11. During this same period (Q4 2010 – Q1
Latin Amerika,
2011) international investors first committed an 23%
additional USD 27bn to EM stocks and then swung

around and net sold USD 28bn. Such a large outflow
had only previously occurred during the post-Lehman EM Europe, 11%
era in 2008. That such fund flows did not seriously EM Asia, 59%
affect EM equity prices suggests equal and opposite Middle
buying interest. Despite the lack of corroborative East/Africa, 8%
aggregate data, we believe that local investors were

acquiring stock. Consequently, as foreign investors Source: FactSet, MSCI
returned to EM equities, markets have begun to edge From a geographical perspective EM Asia continues to hold
higher. the lion part of tradable stocks, 59%. Latin America is the
second largest region with close to a quarter (23%), out of
which Brazil hold close to 70% and Mexico close to 20%.
EM Europe make up for about 10% and the brunt of this is
Russian stocks. Middle East and Africa so far only 8% and
South Africa is the major market with 90% of the regions
index weight.
Historically, significant changes have occurred in regional
weightings within the MSCI benchmark index. Following
the Great Recession, EM Asia has increased its share of the
index at the expense of EM Europe and Middle East/Africa.
However in relative order much has stayed the same; EM
Asia is by far largest region, LatAm the second largest, EM
Europe in third place while Middle East /Africa has
A closer examination of individual EM equity market remained as the smallest.
flows so far this year reveals significant differences. In Earnings still looking good
the graph above we calculate cumulative net flows of We expect EM earnings to increase 22% in 2011, a realistic
funds as a percentage of assets under management forecast in our view with consensus EPS estimates for this
(AUM). We restrict our analysis to include (only) our 11 year upgraded from 15% in Q4-10 to 18% in February,
primary markets, representing almost 90% of MSCI peaking at 22% at end-April before being downgraded to
EM total market capitalization. currently 19.9%. Our estimates suggest that around 2
While investors were otherwise withdrawing cash from percentage points of the correction over the last month is
EM equities, Russia was the only market not to report solely attributable to a stronger US dollar and should
29
therefore not be mistaken for a revision in underlying MSCI EM sales and margins
25%
earnings. Sales growth
20% Net margin
EM EPS% Consensus Estimates 2010-2012
50%
15%
2010
45%
40% 10%
35%
30% 5%
25%
2011 0%
20% 2003 2004 2005 2006 2007 2008 2009 2010 e2011 e2012 e2013
Source: FactSet
15% 2012
10%
Profits sheltered by productivity gains
09
10
0
9
1
0
1
9
0
10
11
We continue to argue that, in the short- to medium term at
v-0
v-1
-0
-1
-1
-1
r-1
l-0
l-1
p-
p-
n-
n-
y
ar
ay
ay
Ju
Ju
Ma
No
No
Ma
Se
Se
Ja
Ja
M
M
Source: FactSet
least, the margin squeeze should remain limited. The scope
Strong EM earnings growth remains fairly broadly for continued productivity gains is still high. The
based within our coverage, with most expected to interconnection between measured costs from short term
report double digit increases. Exceptionally however, macroeconomic indicators, such as PMI output/input price
Taiwan is unlikely to do so, largely due to tough data, is weak. This is possibly due to differences in
comparables with earnings having already increased population; not only listed companies in are included the
by 46% in 2009 and almost 100% in 2010. Further, PMI surveys and only part of the listed companies on the
EPS growth in Turkey is forecast at 1.2% this year after stock market are found within the manufacturing sector.
being downgraded from 4% as recently as February High productivity growth allows firms to absorb rising input
this year. costs in production.
Consensus EPS-growth* Emerging Markets Output & Input Prices
PMI Manufacturing Sector, SA
2010 2011 2012 2013 75 1.100
Emerging markets 45.1% 19.9% 13.3% 9.9% 70 1.050
MSCI Russia 40.3% 32.0% 7.6% 2.3%
65
MSCI Mexico -3.1% 31.7% 18.7% 12.7% 1.000
60
Index
Ratio
MSCI Poland 38.1% 26.9% 6.4% 3.2% 0.950
MSCI South Africa 21.9% 22.2% 17.5% 4.1% 55
0.900
MSCI India 19.7% 22.1% 18.1% 14.7% 50
MSCI Korea 67.2% 22.1% 12.4% 9.4% 45 0.850
MSCI Indonesia 22.1% 19.6% 18.2% 10.4% 40 0.800
MSCI China 29.5% 14.2% 15.5% 13.4% 06 07 08 09 10 11
MSCI Brazil 43.1% 13.3% 9.0% 7.5%
Output prices/Input prices (3m ma)
MSCI Taiwan 96.9% 7.3% 19.4% 9.8% Output prices
MSCI Turkey 22.4% 1.2% 9.8% 12.1% Input prices
*MSCI local currency Source: FactSet
The downgrade in Turkey is largely attributable to the Easing cost pressure
country’s large financial services sector, particularly Latest EM PMI data also suggest negative cost pressures
banks. To some extent it is also due to base effects. are receding, mainly due to a slowdown in the rate at which
However, more significantly, the central bank input prices have been rising.
increased bank industry reserve requirements to
The graph above showing corporate margins and sales also
restrict credit growth without raising interest rates (i.e.
indicates that the market discounts a clear slowdown in top
to avoid carry inflows, resulting in an overvalued
line growth. Following the sharp rebound in 2010 when
Turkish lira).
companies reported 18% sales growth, a decrease of 14%
In addition to the overall EM earnings outlook, we still this year and 12% and 10% in 2012 and 2013, respectively
expect improved profit margins. In recent months, net is expected the market in general.
margins have edged upward from 13% in February to
currently around 14%. The post-recession recovery
Top line will compensate
appears to be continuing. Although we forecast a modest slowdown in global growth
this year, world output is expected to increase in 2012.
Furthermore, even acknowledging that EM GDP growth in
2012 is likely to decrease slightly for a second consecutive
year, consensus appears too cautious on companies’ ability
30
to increase sales. Over the super-cycle years average counterparts of 13%, compared with 15% in February. The
sales growth was 18%, with a low of 14.5% and high stock market recovery which occurred between mid March
of 20.6%. Even including the post-Lehman period the and early April lowered the discount to 8%. From a long
average only falls to 16%. term perspective it is difficult to identify a normal relative
valuation for EM and DM equities. Our historical database
This implies that even if consensus profit margin
is relatively short while major fundamental changes have
estimates from 2012 appear slightly optimistic, our
affected EM stock markets and their constituents. We have
main scenario suggests that more modest earnings
frequently discussed such topics.
growth will be offset by stronger sales.
EM vs DM, relative P/E (12m fwd)
Valuation remains attractive 1.10
1.05
Having devised a credible earnings outlook with which Par
1.00
we are satisfied, based on available indicators, we now 5%
0.95
consider current valuation metrics. EM equities remain 0.90 10%
attractively valued. The table below summarizes key 0.85 15%
metrics for our primary EM, regions and aggregated 0.80
coverage universes. 0.75
0.70
Key Figures, consensus estimates (12m fwd) 0.65
P/E EPS% ROE Yield% P/B PEG
0.60
Emerging Markets 10.6 17.1% 15.7% 3.0% 1.7 0.6
01/09/2006
01/01/2007
01/05/2007
01/09/2007
01/01/2008
01/05/2008
01/09/2008
01/01/2009
01/05/2009
01/09/2009
01/01/2010
01/05/2010
01/09/2010
01/01/2011
01/05/2011
Brazil 9.3 11.5% 15.7% 3.7% 1.5 0.8
China 10.9 14.8% 16.8% 3.0% 1.8 0.7
Korea 9.3 17.8% 14.5% 1.5% 1.3 0.5 Source: FactSet, SEB
Russia 6.1 20.9% 15.3% 2.5% 0.9 0.3 From a medium term perspective, since the period
Taiwan 13.2 12.2% 14.1% 4.2% 1.9 1.1
South Africa 11.2 20.2% 18.0% 3.9% 2.0 0.6 following market stabilization after the Lehman crash, EM
India 14.6 20.4% 16.6% 1.4% 2.4 0.7 have traded at a 5-15% discount to DM. Current EM
Mexico 14.5 25.8% 15.8% 2.1% 2.3 0.6
Indonesia 14.0 19.0% 24.3% 2.8% 3.4 0.7 valuations imply a discount towards the upper end of this
Poland 10.8 17.7% 13.7% 4.2% 1.5 0.6 range suggesting that EM equities are also attractively
Turkey 9.8 4.6% 16.0% 3.3% 1.6 2.1
valued from a global perspective.
EM Asia 11.4 17.5% 15.6% 2.7% 1.8 0.7
EM Europe 7.2 18.3% 15.1% 3.0% 1.1 0.4
LatAm 10.6 16.0% 15.7% 3.3% 1.7 0.7
Market heading
World 12.1 16.6% 13.7% 2.8% 1.7 0.7 In October last year we identified our six month MSCI EM
Source: FactSet index target at 1225 compared to its then present value of
EM equities trade at a 12m fwd P/E ratio of 10.6x, 1100. On April 6, the index reached 1206 before
down from 11x in February, at a discount to their long consolidating until May 2 and decreasing to its current
term average of 11.8x. Earnings (EPS) are for the level. Our February index target update argued that it could
corresponding period eased to 17.1%, down from take awhile longer for the MSCI EM index to reach 1225.
17.3% since February, a slowdown attributable to our
Emerging Markets, MSCI
further progression into 2012 estimates. The USD Index
corresponding PEG ratio (P/E relative to expected EPS 1400 1400

growth) remains at 0.6x. The conventional “rule of 1300 1300
thumb” declares that a ratio below 1.0x represents an 1200 1200
1100 1100
undervaluation. Over the last decade, EM have traded
1000 1000
at an average PEG ratio of 0.9x.
Index
Index
900 900
MSCI EM Stock Market PEG-ratios

800 800
6.0 700 700
5.0 600 600
4.0 500 500
400 400
3.0
06 07 08 09 10 11
2.0
1.0
0.0 As regards the second half of this year, and based on

Taiwan
Thailand
India
Indonesia
MSCI EM
Turkey
Czech
Chile
Morocco
Malaysia
Colombia
China
South
Poland
Mexico
Korea
Peru
Russia
Brazil
Egypt
Philippines
Hungary
fundamental arguments proposed in this report, we expect

the MSCI EM index to trade at 1275, implying a price return
Source: FactSet
of just over 10%. As we still expect earnings to increase
Looking at the valuation from a P/E (12m fwd) slightly further, this forecast implies that the EM P/E
perspective, EM trades at a discount to DM valuation remains at a discount to its long term average.
31
From a very short term perspective, however, our

chartists are signalling more headwinds for EM stocks. Box: The SEB EM model portfolio
They expect the index to test a floor estimated at just On August 1, 2008, we launched the SEB EM Model
portfolio for equities. It was created as a tool to track
below 1100. If it holds it would probably represent an
our recommendation on country allocation among our
attractive entry point for those focused on our
11 (originally 10) primary EM stock markets, covering
fundamentally based target for this year.
approximately 90% of MSCI EM market capitalization.
Ratio MSCI EM/MSCI World We aggregated all other markets into the EM Tail.
Value
index
SEB EM Model portfolio attribution, from 1 Aug. 2008
USD index spread
130 7.0
c
120 6.0
1.12 110
MSCI EM Bench
SEB EM Portfolio 5.0
100 Spread
a 4.0
1.1 90
3.0
80
2.0
70
1.08 60
1.0
50 0.0
b
40 -1.0
1.06
30 -2.0
01/08/2008
01/09/2008
01/10/2008
01/11/2008
01/12/2008
01/01/2009
01/02/2009
01/03/2009
01/04/2009
01/05/2009
01/06/2009
01/07/2009
01/08/2009
01/09/2009
01/10/2009
01/11/2009
01/12/2009
01/01/2010
01/02/2010
01/03/2010
01/04/2010
01/05/2010
01/06/2010
01/07/2010
01/08/2010
01/09/2010
01/10/2010
01/11/2010
01/12/2010
01/01/2011
01/02/2011
01/03/2011
01/04/2011
01/05/2011
1.04
01 16 01 16 03 17 01 16 01 16 01 18 02 16 01
Q4 2010 Q1 2011 Q2 2011
Since its inception, the SEB EM model portfolio has

Source; Reuters, SEB
provided a return of 16.1%. During the same period the
The bearish technical view is not based on MSCI EM index has risen 10.6%. Following a difficult
shortcomings exclusive only to EM. Although the first two months, our recommendation to overweight
relative price between EM and DM stocks shown in the EM Asian countries and aggressively short EM Europe
previous chart has broken several key resistance and Latin America, especially index heavyweights
points recently, it is currently balanced at the so-called Russia and Brazil, finally paid off.
b-wave low. If that is breached, markets are likely to
test relative pricing at the February low. Our frequent trimming of portfolio country allocations
continued to generate attractive excess returns to mid-
A few market comments on the BRIC’s 2009. Subsequently, a period of consolidation and, in
Despite its apparent attractive valuation, we would retrospect, over-cautious risk taking caused our
avoid assuming extra risk in the Brazilian equity portfolio to perform largely in line with the index.
market at present. While we agree that P/E and P/B
ratios indicate a discount of 15-20% under normal In mid-2010 our risk taking began to pay off once again.
market conditions, the vast majority of listed firms are Our total retrieved excess return of 5.5% implies annual
reporting poor earnings momentum, leaving our EPS outperformance of 2 percentage points.
revision gauge posting negative readings.
Due to personnel changes at SEB EM research we now
close all EM equity risk positions. EM model portfolio
Brazil 2011 eps revisions ratio
20% country allocations deviating from the index are
therefore set to neutral for time being.
10%
The chart above implies that current earnings upgrades are
attributable to a few very large companies. Furthermore,
0% the economy is clearly overheating. Capacity utilization is
high with unemployment depressed and inflationary
-9%
pressures rising. As a result, the central bank has been
-10%
forced to raise its policy rate (currently at 12%) with further
hikes to come. The Dilma led administration has
-20% encountered serious difficulties in altering its fiscal policy in
10-06-30 10-08-30 10-10-30 10-12-30 11-02-28 11-04-30
a more structurally oriented way. Instead, it has introduced
#Estimates (Ups-downs)/total
capital controls that increase costs for foreign investors.
Discussions are also taking place on whether to force state
Source: FactSet, SEB
controlled large corporations to change their business
models by raising taxes on commodity exports. In our
opinion, it would be far better to let market forces reshape
32
the industry and politicians focus on deregulating and India: PE, 12m fwd vs 5y average
harmonizing laws and taxes.
25
According to most metrics, Russia is the cheapest 23
market at a 12m fwd P/E ratio of 6.1x compared with 21
6.7x in February, and an historical average of 8.5x. In 19
other words, the market trades at an historical relative 17
discount of 28% and EM benchmark relative discount 15 14,5

of 42%, compared with 28% over the longer term. 13
Consequently, we believe Russia provides very 11
attractively valued investment opportunities. 9
7
Russia - Equities and Oil
12/05/2006
31/07/2006
17/10/2006
03/01/2007
08/06/2007
27/08/2007
13/11/2007
30/01/2008
04/07/2008
22/09/2008
09/12/2008
25/02/2009
31/07/2009
19/10/2009
05/01/2010
24/03/2010
27/08/2010
15/11/2010
01/02/2011
20/04/2011
22/03/2007
17/04/2008
14/05/2009
10/06/2010
3000 150
130 MSCI India 5y average PE 5y average +2sd 5y average -2sd

2500
2000 110
USD/Barrel
Source: FactSet, SEB
Index
1500 90
The central bank has raised its main policy rate nine times
1000 70 since March last year or by 250bps to 7.25%. Inflation,
500 50 based on the wholesale price index, has levelled off but
remains high at around 11%. Consequently, the implied
0 30
06 07 08 09 10 11
real rate is still negative, forcing further tightening by the
central bank. We expect growth to slow, from 10.4% last
Crude Oil - North Sea (Brent) USD
RTS USD year to 8% in 2011 and 7% in 2012.
India - Inflation
There are many factors explaining why Russian stocks 20 20
should be traded subject to an extra risk premium, 18 18
15 15
mainly concerning corporate governance issues.
13 13
However, in the short- to medium term the price of oil
Percent
Percent
10 10
is the single most important explaining the returns on 8 8
the Russian stock market. As shown in the graph 5 5
3 3
above, since mid-2008 the strong correlation between 0 0
Brent and the RTS-index has increased further to -3 -3
almost one. Our previous market upgrade to -5 -5
05 06 07 08 09 10 11
overweight in November last year and its downgrade
to underweight in April served, thus our model India, Wholesale Prices, Total, Index, 2004-2005=100
CPI, rural labourer
portfolio well. As we expect the price of oil to stabilize CPI, urban non-manual employee
around current levels and believe the Russian market
In
enjoys very attractive key valuation metrics an the short term, investors would reinvest in Indian equities
upgrading our underweight position to neutral would on a broad scale if global growth slowed sharply. India’s
be recommended. large domestically oriented economy would provide some
shelter. However, this is not our main scenario. Another
The Indian stock market has been a clear alternative would be a faster reduction in inflation resulting
underperformer, restricted by rich valuation, increased in an earlier than expected end to the tightening cycle.
central bank policy rates and poor corporate
governance. Despite the recent decline in Indian The Chinese (free) equity market has lagged the EM
equity valuations to currently below its own historical benchmark for most of the past year. Since February, the
average, they still possess the highest valuation market has performed better. We recommended
multiples of any of our primary markets, ratios overweighting China in February based on two important
exceeded only by a small number of minor EM. pillars; valuation had become attractive and the market had
largely discounted tighter policy conditions implemented
by the administration.
33
China - the (free) equity market

Index 1 Jan, 2010 = 100
pressure is mainly due to the financial services sector,
115 115 particularly banks. The central bank’s (CBT) slightly
unorthodox policy mix involving raising the reserve
110 110
requirement rather than interest rates is eroding banking
105 105 industry profits. However, we think it only a matter of time
Index
100 100 before the CBT switches to hiking rates instead. Due to soft
95 95
earnings this year, valuation metrics are unattractive.
90 90
Turkey: PE, 12m fwd vs 5y average
16
85 85
Jan Mar May Jul Sep Nov Jan Mar May 14
10 11
China vs EM bench
China, MSCI, Free Index, Close, HKD 12
10 10,2
Currently the Chinese free market trades at an
historical relative valuation discount of 20-30% based 8
on a range of valuation metrics. Earnings momentum

6
remains attractive both from a momentum perspective
and in terms of actual data. We do not expect the 4
economy to grind to a halt, on the contrary. We regard
12/05/2006
28/07/2006
13/10/2006
29/12/2006
16/03/2007
01/06/2007
17/08/2007
02/11/2007
18/01/2008
04/04/2008
20/06/2008
05/09/2008
21/11/2008
06/02/2009
24/04/2009
10/07/2009
25/09/2009
11/12/2009
26/02/2010
14/05/2010
30/07/2010
15/10/2010
31/12/2010
18/03/2011
the 7% growth projection set out in the most recent 5-
year plan as a floor for the minimum growth rate MSCI Turkey 5y average PE 5y average +2sd 5y average -2sd
allowable in any quarter by the Chinese government.

In the previous 5-year plan “targeted” growth of 7.5% Source: FactSet, SEB
was exceeded by 10.6% average growth over the Extending the forecast horizon into 2012 or even 2013 to
whole period (2006-2010). The slowdown in the find valuation multiples under presumably more normal
economy according to our calculations implies GDP conditions the market appears very attractively valued.
growth of 9.3% this year and 8.5% in 2012. We Furthermore, we expect the upcoming election in June to
therefore continue to see attractive risk reward in the be a supportive trigger for Turkish assets. It should create a
Chinese market, especially from an EM perspective. more positive rating agency view, moving the economy
A final note on Turkey closer to an investment grade rating. Overall, risk-reward
As we cut our recommended overweight in Russia in appears uncertain in the case of the Turkish stock market
April on the back of lost momentum in energy prices for at least a month or so and we would look for better
we chose to hike Turkish stocks into a (small) returns in South East Asia meanwhile. Closely monitor
overweight from a previous underweight. That was Malaysia, which will benefit from its own enormous
obviously a premature move. expansion plans, and Indonesia, which is progressing
solidly is recommended.
Turkey - the equity market
Index 1 Jan 2010=100
140 140
135 135
130 130
125 125
120 120
Index
Index
115 115
110 110
105 105
100 100
95 95
90 90
Jan Mar May Jul Sep Nov Jan Mar May
10 11
Turkey vs EM bench
Turkey, MSCI, Index, Close, TRY
The Turkish stock market is struggling with a single

disadvantage this year: earnings. In sharp contrast to
most EM markets, earnings growth generally is
expected to be poor. Currently, EPS growth is forecast
at 1.2% this year, down from 4% in February. Negative
34
Contacts
Emerging Market
Magnus Lilja Head of EM +46 8 506 23 169
Emerging Market Research

Arvid Böhm Equity Strategist +46 8 506 23 198
Mats Lind Fixed Income Strategist +46 8 506 23 351
Mats Olausson FX Strategist +46 8 506 23 262
Jurgis Rosickas Analyst +370 526 82 418
Andrius Olechnovicius Analyst +370 562 81 623
Emerging Markets Sales

Stockholm +46 8 506 23 110
Lars-Erik Kristensen FX, Fixed Income Sales +46 8 506 23 110
Louise Valentin FX, Fixed Income Sales +46 8 506 23 094
Julius Dukšta Fixed Income Trading +46 8 506 23 295
Magnus Sabel Equity Sales +46 8 506 23 020
Christopher Flensborg Fixed Income Sales +46 8 506 23 138
Gothenburg
Magnus Green EM Sales +46 31 62 22 69
Malmö
Tomas Anelli EM Sales +46 40 667 6958
Helsinki
Camilla Laitinen Head of EM Helsinki +358 9 6162 8508
Sami Huttunen EM Equity Sales +358 9 6162 8540
Heidi Alanko EM Equity Sales +358 9 6162 8540
Oslo
Silje Ingeberg Head of EM Oslo +47 22 82 66 35
Trond Solstad EM Sales +47 22 82 72 84
Copenhagen
Peter Lauridsen EM Sales +45 3317 7734
London
Chris Dorman EM Sales +44 208 246 4676
Frankfurt
Detlef Joenhnk FX Sales +4969 9727 1252
Christian Bardehle EM Fixed Income Sales +49 69 9727 1237
Alexander N. Maximilian EM Equity Sales +49 69 9727 7743
New York
Oskar Elmgart FX Sales +1 212 286 0608
Steve Tropper FX Sales +1 212 907 4910
Singapore
Gustaf Ljungdahl EM Sales +65 65 05 05 05
Shanghai
Fredrik Hähnel Head +86 21 539 666 81
This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document are 35
given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any direct
or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice. Any US person
wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the US.
Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the
conduct of investment business in the UK.

SEB Report: Still Good Value in Emerging Markets

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SEB Report: Still Good Value in Emerging Markets

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Emerging Markets Cross Assets EM FI – Still outperforming DM

EM FX – Market drivers to support

Cut-off date: 20 May, 2011

Executive Summary: No free lunch, but a good smorgasbord

EM FI – STILL OUTPERFORMING DM MSCI EM & GBI EM (unhedged USD)

GBI-EM Div. Global (Local Bonds)

EM FX – MARKET DRIVERS TO SUPPORT 1100 260

According to our main scenario, EM FX will strengthen 1000 240

as carry, central bank activism and fundamentals 900 220

EM EQ – PROFITS SHELTERED BY TOP LINE 600 160

Despite current headwinds, we expect the MSCI EM 500

index to increase by 10% to 1275 by year-end, due to 400 120

gained 1.8% in absolute and 2.7% relative to DM equities

period during which a substantial reallocation of

-1.50 1. Liquidity squeeze in connection with the end of US QE2

Adjusted monetary base (right)

2.5 250 recovery despite a new wave of European debt crisis.

Other risks include political developments, 8 3

GBI-EM yield % p.a.

Treasury yield % p.a.

general and fiscal policy tightening in particular. The Source: Bloomberg

7.6 3.5 Korea

Food prices remain high Commodities

UN Food Price Index CRY

CRY Index Value

Ukraine 9.4 - 9.1 9.5 9.0

Brazil: Inflation and FX-Reserve Changes

Reserve chg on qtr USD bn

So far this year, Russia has remained the jewel in the EM

The Fed-model was named by Edward Yardeni of Prudential Securities based

on research conducted at the Federal Reserve in the mid-1990s. The model

However, partly due to the more advanced EM business

1.7 MSCI EM value from a Fed-model approach 0.4

Coincidental or not, our similar measure of historical EM-

Fixed Income Some weaker credits underperformed

Inflation management key

Strategy We observe however that DM economies are continuing to

We might ask whether or not local factors should have a

120 EM local bonds 140

EM have tended to change by about the same amount. 0.8

driver behind market pricing for both DM and EM

LatAm 8.5 3.5

The fact that local EM bonds are close to their long

Bond Indices in USD

We, together with a wide range of university

We expect the USD to recover after weakening fairly 0.1 110

considerably against many major currencies. We 0.0 100

appreciate too far, too fast. Currency markets were

4 either late 2010 or early this year.

maintained given probable further high near-term headline

The existence of global imbalances also implies that the

China and other EM surplus economies to take

broLrpa NKQO NKQU NKQR NKQM NKPR

We therefore expect most EM currencies to perform well

Extending the horizon through to the end of this year,

Fixed income and FX Trading

Investment and consumption

6. Long long-end Croatia in USD, 2015 maturity

Long Turkish local bonds with open TRY risk

Consequently, our forecasts show the lira’s potential to be

bonds to breakeven against their shorter term counterparts

outlook. However, we do not think it entirely true. It simply

forecast year-end policy rate from 4.75% to 4.50%.