A Fine (Im)Balance: Global macro (dis)equilibrium… Dresdner Kleinwort Emerging Markets Research...

A Fine (Im)Balance: Global macro (dis)equilibrium…

Dresdner Kleinwort Emerging Markets Research

Arnab Das+44 (0) 20 7475 [email protected]

March 2007

Please refer to the Disclosure Appendix for all relevant disclosures and our disclaimer. In respect of any compendium report covering six or more companies, all relevant disclosures are available on our website www.dresdnerkleinwort.com/research/disclosures or by contacting the Dresdner Kleinwort Research Department at the address below. Dresdner Bank AG London Branch, authorised by the German Federal Financial Supervisory Authority and by the Financial Services Authority; regulated by the Financial Services Authority for the conduct of designated investment business in the UK, a Member Firm of the London Stock Exchange. Registered in England and Wales No FC007638. Located at: 30 Gresham Street, London EC2V 7PG. Telex: 885540 DRES BK G. Incorporated in Germany with limited liability. A Member of the Dresdner Bank Group.

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Global macro imbalances at risk: Coyote Ugly aka ‘The Coyote Moment’?

The big picture: Getting to grips with risks

Source: Concept from Krugman, Portes. Cartoon from Hanna-Barbera Cartoons

► Will the world experience a ‘Coyote Moment’ in the unwinding of Global Macro Imbalances?

► In the Roadrunner cartoons, the Coyote would often chase the Roadrunner off a precipice.

► For a short while, the Coyote would fly, but soon enough, he would look down into the abyss below and coming crashing back to earth...

► So, are the markets in for a ‘Coyote Moment’ – an ugly time when reality will collide with unrealistic expectations and everything changes all at once … as some major thinkers have suggested

► Could we be at a turning point?

► The US cycle peaks and the economy heads for a slowdown, even as G7 monetary policies diverge.

Goldilocks encounters three bears, in the driver’s seat of Global Macro and Emerging Markets

► De-Synchronizing G7 monetary policies and business cycles.

► The JPY carry trade – source of risk appetite, or of risk aversion?

► FX reserve accumulation – the flip side of global macro imbalances.

Is the world becoming riskier, safer, or staying about the same? The fine balance between risk appetite and risk aversion hinges on the market’s joint assessment of issues.

3


Synchronicity to de-synchronicity: Diverging monetary policy in the G7

Source: National authorities, Bloomberg, Dresdner Kleinwort Emerging Markets Research

Synchronicity/De-Synchronicity…aka Monetary policy normalisation, divergence

► G10 monetary policies underwent synchronised, emergency easing in response to many shocks in the late 90’s and early 2000’s

► Fast forward a few years: G7 policy is more or less normalised…

► Recovery has run a long way and still seems to have legs of its own in the major economies.

► The Fed is on hold, with the US economy at risk of slowdown. And, rebalancing is occurring.

► The UK is growing robustly; monetary policy is in fine tuning mode.

► The Eurozone continues to recover, amid patches of concern, further tightening is likely.

► Japan is posting growth even though doubts persist about consumption.

► Most EM economies are growing smartly, especially those exporting natural resources or labour intensive services or goods.

► Monetary policy is generally tightening or on hold throughout EM, with the notable exception of Brazil.

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Japan’s BoP saga: A long term trend of capital outflows

The very long run: USD/JPY not driven by interest rate differentials alone

Source: Us Federal Reserve; Bank of Japan, Bloomberg, Dresdner Kleinwort Emerging Markets Research

► Japan’s BoP is a saga of capital outflows, led by outward investment, portfolio and direct, mainly to the United States (not the carry trade in EM countries!) and current account surplus, led by the trade account, underpinned by a long running appreciation of the JPY.

► The nominal yen had been on an upward march since Japan’s re-emergence as a modern industrial giant, with dollar-yen rising from 350ish some 40 years ago, to a 20th Century high of 80ish in March of 1995, at the nadir of the Mexican Tequila Crisis.

► But asset prices were rising sharply amid directed credit and a state-driven, export-led industrial development strategy. Sustained yen appreciation helped drive down inflation in both the data and expectations. Eventually bank asset quality deteriorated. Disinflation turned into deflation when asset bubbles burst, and all after the JPY rally engineered by the 1985 Plaza Accord.

► Japan is still recovering…


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► Carry trades of speculators and hedge funds are one thing…the accumulation of household mortgage debt in CHF and JPY is another, also arising from low interest rates.

► But Japan’s underlying story is of sustained resident investment abroad, driven by considerations of portfolio balance and low rates of return on investment in Japan, reflected in low nominal rates, quantitative easing, and current account surpluses.

► It’s well worth noting in this context that the BoJ largely stopped intervening directly in the FX market in Q1-04.

► During 2006, the monetary story was about quantitative easing, which contributed via money creation and low nominal rates to capital outflows, and thereby to a weak yen.

► And for at least the last two years, outward foreign investment and non-residents’ JPY-funded carry trades have combined to help keep the JPY weak.

► Clearly the carry trade is becoming riskier, with the yen hovering around fresh lows. Further bouts of volatility in dollar-yen, euro-yen and in risky asset prices with underlying yen carry funding can hardly be ruled out.

► This is partly what happened when the end of quantitative easing and faster than expected absorption of excess reserves – liquidity – in the Japanese banking system paved the way for early normalisation of monetary policy, precipitating widespread market volatility including in EM in Q1-06.

► History could well repeat itself if/when the BoJ tightens monetary policy further or faster than expected.

► However, there is an underlying fundamental question – will the rate of return in Japan be high enough to induce a sustained rally in the JPY? Does anyone really expect the BoJ to take policy rates up to a level where Japan can compete not as a funding currency but as a destination of capital?

Would carry trade unwinding imply a turnaround in Japan’s BoP?

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Global imbalances or balances?

0

500

1000

1500

2000

2500

3000

2000 2001 2002 2003 2004 2005 2006

(US$bn)

EU Candidates/Members EM ASIA LATAM FSU incl. Russia

EM reserve accumulation: dominated by EM Asia, led by China

Source: National Authorities , Dresdner Kleinworth Debt Research

► Some highly regarded people dispute even that there really are imbalances, for a few key reasons:

► First, deficits anywhere are offset by surplus elsewhere.

► Second, many countries have opted into a de facto dollar bloc by (in-)formally pegging to the USD for reasons of self-insurance and/or to maintain export-led growth.

► Third, reserve accumulation may be a natural consequence of globalisation/financial integration, even at this pace/rate.


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The aggregate EM Balance of Payments: Surpluses nearly everywhere

► EM current accounts are in surplus nearly everywhere (upper chart).

► Deficits are an issue in the EU Periphery and South Africa, and a few energy importers in EM Asia.

► EM capital accounts are also in surplus in most regions (lower chart).

► EM economies as a group should therefore be able to weather a global macro shock.

► High reserves and BoP surpluses should provide plenty of cushion

► We stick with a mixture of sore surplus and tactical deficit country positions.

Source: IIF , Dresdner Kleinworth Debt Research


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EM Fiscal Accounts: Significant turnaround – excluding the EU Periphery

Source: National Authorities, IIF, Dresdner Kleinwort Debt research.

C. But New EU-10/CE4 run sizeable primary deficits

A. Fiscal balances have improved significantly across EM… B. Led by rising primary fiscal balances in general…

-5

-4

-3

-2

-1

0

1

2

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(% GDP)

EMEEA EM ASIA LATAM

-4

-3

-2

-1

0

1

2

3

4

5

6

7

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(% GDP)

CE4 Turkey South Africa Non EU members/Candidates

► Considerable fiscal adjustment – cyclical and policy-led

► Fiscal deficits cut where financing constraints were binding.

► Primary surpluses in commodity-exporters, high debt countries:

► LatAm; Russia/CIS; Turkey; South Africa

► Sizeable primary fiscal deficits persist in CE-4; EM Asia.

► EM Asia enjoys high domestic savings;

► CE-4, New EU-10, enjoy access to foreign savings.

► (Convergence Funds; ‘EU Umbrella’).

The big picture: Bridging past and future

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EM BoP Accounts: Significant strengthening, surpluses – excluding EU Periphery

C. Basic balances are strong or improving – in general…A. EM countries have swung from capital importers to exporters

B. But the EU Periphery and South Africa run large C/A deficits

-100

-50

0

50

100

150

200

250

300

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(US$bn)

EMEEA ASIA LATAM

-8

-6

-4

-2

0

2

4

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(% GDP)

CE4 Turkey South Africa Non EU members/Candidates

D. Except in CE-4, compared to other deficit countries

-300

-200

-100

0

100

200

300

400

500

600

700

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(US$bn)

EMEEA ASIA LATAM


Source: Bloomberg, Datastream, national authorities, Dresdner Kleinwort Debt Research calculations and 2006, 2007 forecasts

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Taking stock of EM liabilities… Declining and better diversified by region, sector.

-35

15

65

115

165

2003 2004 2005 2006

(US$bn)

Sovereign Corporate

Gross nominal EM external debt issuance declining again, led by sovereign debt

Argentina1.62%

Turkey14.119%China

1.22%

Brazil16.222%

Russia18.927%

South Korea10.314%

South Africa2.23%

Hungary5.58%

India2.43%

Poland0.30%

EM gross issuance is well diversified by country…

1Units: US$bn % total

Source: Bloomberg; national authorities, Dresdner Kleinwort Debt research

As are EM corporate issues



Brazil13.727%

China1.22%

Hungary3.67%

India2.45%

Turkey0.51%

Argentina1.63%

Poland0.31%

Russia18.936%

South Korea8.1

16%

South Africa0.92%

Brazil2.5

12%

Turkey13.763%

South Korea

2.210%

Hungary1.99%

South Africa

1.36%

Though gross sovereign issuance is concentrated



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Disclosures

The relevant research analyst(s), as named on the front cover of this presentation, certify that (a) all of the views expressed in this research presentation accurately reflect their personal views about the securities and companies mentioned in this presentation; and (b) no part of their compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or views expressed by them contained in this presentation.

Any forecasts or price targets shown for companies and/or securities discussed in this presentation may not be achieved due to multiple risk factors including without limitation market volatility, sector volatility, corporate actions, the unavailability of complete and accurate information and/or the subsequent transpiration that underlying assumptions made by Dresdner Kleinwort or by other sources relied upon in the presentation were inapposite.

Recommendation history tables

Past performance is not an indicator of future performance.

Please refer to our website www.dresdnerkleinwort.com/research/disclosures for our tables of previous fundamental credit opinions

Disclosure appendix

Dresdner Kleinwort Research - Explanation of fundamental credit opinions (Euro and Sterling)

Issuer Definition

Overweight The recommendation is based upon Dresdner Kleinwort's assessment of the fundamental credit quality of an issuer together with the expected market performance of the issuer's bonds relative to the iBoxx/iTraxx indices. This approach applies at the borrower level, where the benchmark index for allocation is, unless otherwise specified, the relevant sector iBoxx index for cash instruments or iTraxx index for CDS. The weightings are not indications of particular degrees of expected spread movement relative to the index. An overweight recommendation implies expected outperformance to the relevant index over a three months time horizon. For issuers that are not included in the relevant iBoxx/iTraxx indices, we express expected performance compared to the appropriate sector indices.

Marketweight The recommendation is based upon Dresdner Kleinwort's assessment of the fundamental credit quality of an issuer together with the expected market performance of the issuer's bonds relative to the iBoxx/iTraxx index. This approach applies at the borrower level, where the benchmark index for allocation is, unless otherwise specified, the relevant sector iBoxx index for cash instruments and iTraxx index for CDS. The weightings are not indications of particular degrees of expected spread movement relative to the index. A marketweight recommendation implies expected in-line performance to the relevant index over a three months time horizon. For issuers that are not included in the relevant iBoxx/iTraxx indices, we express expected performance compared to the appropriate sector indices.

Underweight The recommendation is based upon Dresdner Kleinwort's assessment of the fundamental credit quality of an issuer together with the expected market performance of the issuer's bonds relative to the iBoxx/iTraxx index. This approach applies at the borrower level, where the benchmark index for allocation is, unless otherwise specified, the relevant sector iBoxx index for cash instruments and iTraxx index for CDS. The weightings are not indications of particular degrees of expected spread movement relative to the index. An underweight recommendation implies expected underperformance to the relevant index over a three months time horizon. For issuers that are not included in the relevant iBoxx/iTraxx indices, we express expected performance compared to the appropriate sector indices.

Dresdner Kleinwort Research - Explanation of fundamental High Yield opinions

Issuer Definition

Buy The company has an improving credit profile that will likely benefit further from positive credit developments and events/news with a corresponding expected positive effect on bond prices.

Hold The company has an improving or stable credit profile with little headline risk either positive or negative. Bond price movements are likely to be consistent with shifts in the market in general.

Sell The company has a declining credit profile and there is likelihood of negative credit events/news with a corresponding expected negative effect on bond prices.

(Our recommendations for issuers, unless otherwise specified, are for a minimum of a 3-months horizon, but more often for 6 to 12 months)

We started tracking our trading recommendation history in compliance with the requirements of the Market Abuse Directive on 8 April 2005.

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Unless otherwise noted, the securities mentioned in this presentation are priced as of 5 March 2007 at 12:00. Time given is local to the address shown at the bottom of the first page of this presentation.In respect of any compendium presentation covering six or more listed companies, please refer to the following website for all relevant disclosures:www.dresdnerkleinwort.com/research/disclosures

Disclaimer This presentation has been prepared by Dresdner Kleinwort, by the specific legal entity named on the cover or inside cover page.iBoxx and iTraxx are brand names of the International Index Company (IIC). Dresdner Kleinwort is one of 9 investment banks which are shareholders in IIC. An employee of Dresdner Kleinwort or an affiliate is a member of the board of IIC.United Kingdom: This presentation is a communication made, or approved for communication in the UK, by Dresdner Bank AG London Branch (authorised by the German Federal Financial Supervisory Authority and by the Financial Services Authority; regulated by the Financial Services Authority for the conduct of designated investment business in the UK, a Member Firm of the London Stock Exchange and incorporated in Germany with limited liability). It is directed exclusively to market counterparties and intermediate customers. It is not directed at private customers and any investments or services to which the presentation may relate are not available to private customers. No persons other than a market counterparty or an intermediate customer should read or rely on any information in this presentation. Dresdner Bank AG London Branch does not deal for, or advise or otherwise offer any investment services to private customers.European Economic Area: Where this presentation has been produced by a legal entity outside of the EEA, the presentation has been re-issued by Dresdner Bank AG London Branch for distribution into the EEA. Dresdner Kleinwort Research GmbH is authorised and regulated by the Federal Financial Supervisory Authority (‘BaFin’) by the laws of Germany.United States: Where this presentation has been approved for distribution in the US, such distribution is by either: (i) Dresdner Kleinwort Securities LLC; or (ii) other Dresdner Kleinwort companies to US Institutional Investors and Major US Institutional Investors only ; or (iii) if the presentation relates to non-US exchange traded futures, Dresdner Kleinwort Limited. Dresdner Kleinwort Securities LLC, or in case (iii) Dresdner Kleinwort Limited, accepts responsibility for this presentation in the US. Any US persons wishing to effect a transaction through Dresdner Kleinwort (a) in any security mentioned in this presentation may only do so through Dresdner Kleinwort Securities LLC, telephone: (+1 212) 429 2000; or (b) in a non-US exchange traded future may only do so through Dresdner Kleinwort Limited, telephone: (+ 11 44) 20 7623 8000; or (c) in a banking product may only do so through Dresdner Bank AG New York Branch, telephone (+1 212) 969 2700.Singapore: This research presentation is being distributed for Dresdner Kleinwort in Singapore by Dresdner Bank AG, Singapore Branch, purely as a resource and for general informational purposes only, and is intended for general circulation. Accordingly, this research presentation does not take into account the specific investment objectives, financial situation, or needs of any particular person and is exempted from the same by Regulation 34 of the Financial Advisers Regulations ("FAR") (as required under Section 27 of the Financial Advisers Act (Cap. 110) of Singapore ("FAA")).

Distribution of Dresdner Kleinwort credit research recommendations as at 30 Sep 2006

All covered companies Companies where a Dresdner Kleinwort company

has provided investment banking services

Investment grade Euro Recommendations

Overweight (€) 26 14% 7 27%

Marketweight (€) 94 52% 31 33%

Underweight (€) 61 34% 18 30%

Total Euro 181 56

Investment grade Sterling Recommendations

Overweight (£) 4 11% 1 25%

Marketweight (£) 22 59% 6 27%

Underweight (£) 11 30% 4 36%

Total Sterling 37 11

High Yield Recommendations

Buy/Add 0 0% 0 NM

Hold 5 100% 1 20%

Sell/Reduce 0 0% 0 NM

Total High Yield 5 1

Source: Dresdner Kleinwort Debt research

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This presentation contains general information only, does not take account of the specific circumstances of any recipient and should not be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient. Each recipient should consider the appropriateness of any investment decision having regard to their own circumstances, the full range of information available and appropriate professional advice. The information and opinions in this presentation constitute judgment as at the date of this presentation, have been compiled or arrived at from sources believed to be reliable and in good faith (but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness) and are subject to change without notice. Dresdner Kleinwort may amend, supplement or update the contents of this presentation in such form and in such timescales as Dresdner Kleinwort deems appropriate. Recommendations and opinions herein reflect Dresdner Kleinwort's expectations over the 6 month period following publication from the perspective of long-only investment clients. Dresdner Kleinwort reserves the right to express different or contrary recommendations and opinions for different timescales or for other types of investment client. This presentation does not constitute or form part of, and should not be construed as, any offer for sale or subscription of, or any invitation to offer to buy or subscribe for, any securities, nor should it or any part of it form the basis of, or be relied on in any connection with, any contract or commitment whatsoever. Dresdner Kleinwort accepts no liability whatsoever for any loss or damage arising from any use of this presentation or its contents. Whilst Dresdner Kleinwort may provide hyperlinks to web-sites of entities mentioned in this presentation, the inclusion of a link does not imply that Dresdner Kleinwort endorses, recommends or approves any material on the linked page or accessible from it. Dresdner Kleinwort accepts no responsibility whatsoever for any such material, nor for any consequences of its use. This presentation is for the use of the addressees only, is supplied to you solely in your capacity as an investment professional or knowledgeable and experienced investor for your information and may not be reproduced, redistributed or passed on to any other person or published, in whole or in part, for any purpose, without the prior, written consent of Dresdner Kleinwort. Dresdner Kleinwort may distribute presentations such as this in hard copy, electronically or by Voiceblast. Dresdner Kleinwort and/or any of its clients may undertake or have undertaken transactions for their own account in the securities mentioned in this presentation or any related investments prior to your receipt of it. Dresdner Kleinwort specifically draws recipients attention to the disclosures contained in the Disclosure Appendix but notes that, excluding (i) Dresdner Kleinwort Securities LLC and (ii) the research analyst(s) responsible for this presentation unless specifically addressed in the disclosures: (a) Dresdner Kleinwort and its directors, officers, representatives and employees may have positions in or options on the securities mentioned in this presentation or any related investments or may buy, sell or offer to buy or sell such securities or any related investments as principal or agent on the open market or otherwise; and (b) Dresdner Kleinwort may conduct, solicit and/or engage in other investment and/or commercial banking business (including without limitation loans, debt securities and/or derivative, currency and commodity transactions) with the issuers or relating to the securities mentioned in this presentation. Accordingly, information may be available to Dresdner Kleinwort, which is not reflected in this presentation or the disclosures. In this notice “Dresdner Kleinwort” means Dresdner Bank AG and/or Dresdner Kleinwort Securities Limited and any of their affiliated or associated companies and their directors, officers, representatives or employees and/or any persons connected with them. Additional information on the contents of this presentation is available at www.dresdnerkleinwort.com/research and on request.

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A Fine (Im)Balance: Global macro (dis)equilibrium… Dresdner Kleinwort Emerging Markets Research...

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