RBS em 121921

20 August 2010
Emerging Markets Strategy
EM Sovereign Radar
This material should be regarded as a
marketing communication and may have
been produced in conjunction with the RBS Market Spin: Emerging markets remain in something of a sweet spot, with weak
trading desks that trade as principal in the
data out of the US suggesting official policy rates will stay in lower for longer mode,
instruments mentioned herein.
thereby providing plentiful global liquidity, and underpinning commodity prices for
the time-being at least. Both should continue to see demand for EM assets held up
by strong inflows into dedicated EM funds (helped by the lack of consensus on the
outlook for developed market economies), aided by an increasingly powerful local
bid (particularly seen now in the Middle East). At the same time, fiscal data across
Emerging markets is proving better than expected, assisted by nominal GDP
growth and fiscal tightening, and is acting to cap budget financing needs, making
for continued gains across sovereign external and local currency debt.
Spreads/yields appear very tight, but as long as the lower for longer mantra
remains in tact, all this remains an EM bond-friendly environment; albeit the same
cannot necessarily be said for equities and even perhaps FX. The concern will
come when the rate cycle turns decisively (some way off) or we see
governments/corporates step up borrowing – this could come in September – and
turn away from IMF orthodoxy (e.g. Hungary).
Summary of Cross Asset Trading Recommendations (page 2)
Special Feature (page 3): India: is lower inflation enough? We note recent
positive trends in inflation in India but reviewing wider economic developments
we conclude that evidence of overheating in the economy (e.g. widening in the
trade deficit and over-reliance on portfolio flows for funding) still suggests
upward pressure on policy rates. The tightening will need to continue until
growth is realigned with domestic resource availability. This tightening will also
need to come at a time when funding requirements of Indian corporates are
already excessive by historical standards which suggests a more challenging
environment than perhaps currently priced by the market.
The Week Ahead: Monday sees Hungary and Israel rate decisions; we expect
steady policy from Hungary and would not be surprised by a 25bp hike in Israel.
Timothy Ash We expect no change from Poland on Tuesday, while Thailand should see a
Global Head of EM Research 25bp hike on Wednesday. Finally, we expect steady policy in the Philippines on
+44 207 085 6630 Thursday.
timothy.ash@rbs.com
Sovereign Views (page 6):

Sanjay Mathur
Head of NJA Research and Strategy Asia Central and Eastern Europe Latin America
Korea Czech Republic Brazil
+65 6517 5884
Malaysia Poland Mexico
sanjay.mathur@rbs.com
Thailand Russia Venezuela
Serbia
Siobhan Morden Turkey
Head of Latam Research and Middle East Africa Ukraine
Strategy Bahrain
+1 203 897 79344 South Africa
siobhan.morden@rbs.com
www.rbsm.com/strategy
The Royal Bank of Scotland
Summary of Cross Asset Trading Recommendations
Recommendation Date Credit FX Local Rates Sovereign Ratings
Emerging Markets Strategy | 20 August 2010

Asia
China 13/08/2010 n/a Positive Bull flattener A1/A+/A+
India 06/08/2010 Neutral banks Short Bull flattener Baa3/BBB-/BBB-
Indonesia 06/08/2010 Positive Positive Bearish Ba2/BB/BB+
Kazakhstan 30/07/2010 Overweight Long Neutral Baa2/BBB-/BBB-
Korea 20/08/2010 Overweight Long Bullish A1/A/A+
Malaysia 20/08/2010 Positive Short Bull flattener A3/A-/A-
Pakistan 06/08/2010 Underweight n/a n/a B3/B-/NR
Philippines 23/07/2010 Underweight Long/neutral n/a Ba3/BB-/BB
Singapore 13/08/2010 Overweight Positive Bull steepener Aaa/AAA/AAA
Taiwan 13/08/2010 Neutral Neutral Bearish Aa3/AA-/A+
Thailand 20/08/2010 Neutral Neutral/flat Bear flattener Baa1/BBB+/BBB
Central and Eastern Europe
Bulgaria 16/07/2010 Overweight n/a n/a Baa3/BBB/BBB-
Croatia 09/07/2010 Marketweight Neutral n/a Baa3/BBB/BBB-
Czech Republic 20/08/2010 Underweight Neutral Neutral A1/A/A+
Hungary 13/08/2010 Underweight Short Bull flattener Baa1/BBB-/BBB
Latvia 13/08/2010 Underweight n/a n/a Baa3/BB/BB+
Lithuania 06/08/2010 Marketweight Neutral Neutral Baa1/BBB/BBB
Poland 20/08/2010 Overweight Long PLN/CZK Bull flattener A2/A-/A-
Romania 13/08/2010 Overweight Short Bear flattener Baa3/BB+/BB+
Russia 20/08/2010 Marketweight Neutral Bear flattener Baa1/BBB/BBB
Serbia 20/08/2010 Overweight Long Pay NR/BB-/BB-
Turkey 20/08/2010 Underweight Long Receive Ba2/BB/BB+
Ukraine 20/08/2010 Overweight Neutral Receive B2/B+/B
Latin America
Argentina 20/08/2010 Overweight Neutral n/a B3/B-/B
Brazil 20/08/2010 Underweight Long Jan ’11 & ’12 receiver Baa3/BBB-/BBB-
Chile 20/08/2010 Neutral Long 5Y CLP receiver Aa3/A+/A
Colombia 20/08/2010 Overweight Long Receive Ba1/BBB-/BB+
Costa Rica 16/07/2010 Overweight n/a n/a Ba1/BB/BB
El Salvador 09/07/2010 Underweight n/a n/a Ba1/BB/BB
Mexico 20/08/2010 Underweight Short MXN/CLP 2Y5Y10Y fly Baa1/BBB/BBB
Panama 09/07/2010 Marketweight n/a n/a Baa3/BBB-/BBB-
Venezuela 20/08/2010 Neutral n/a n/a B2/BB-/B+
Middle East Africa
Bahrain 20/08/2010 Underweight n/a n/a A2/A/A
Egypt 30/07/2010 Marketweight Long n/a Ba1/BB+/BB+
Ghana 16/07/2010 Overweight Neutral n/a NR/B+/B+
Iraq 06/08/2010 Underweight n/a n/a Not rated
Israel 13/08/2010 Overweight Long Bull flattener A1/A/A
Lebanon 20/08/2010 Marketweight Neutral Receive B1/B/B
South Africa 20/08/2010 Overweight Short Receive A3/BBB+/BBB+
UAE Abu Dhabi 13/08/2010 Marketweight n/a n/a Aa2/AA/AA
UAE Dubai 13/08/2010 Overweight n/a n/a Not rated
Source: RBS; Bloomberg
2
Special feature | India

Is lower inflation enough?

Food and fuel prices, the two most septic components of India’s inflation are
finally starting to peak, while the slope of the yield curve suggests that
inflationary expectations are finally starting to anchor. Easing inflation is good but
not good enough for policymakers to take their foot off the tightening cycle.
There is still significant imbalance in the economy that is being manifested in the
external accounts and mitigating it will require a policy stance that decisively
slows growth. In this regard, June’s weaker than expected production numbers
are a welcome development, but will need to be sustained.
Details: At least selectively, price pressures are starting to ease. On an annual

basis, food price increases have slowed to single digits and the favourable
monsoon season indicates further correction. Commodity prices including fuel
are still strong in annual terms but have started to soften sequentially. Assuming
no renewed spike in international commodity prices, annual readings are set to
ease in the coming months.
Inflationary expectations are also stabilising. We note that corporate

expectations of selling prices are peaking while the yield curve (as measured by
the difference between the 10 yr and 3mth t-bill yield) has flattened. Typically,
yield curve flattening tends to precede lower inflation by 6-9 months.
Figure 1: Evolution of selling price expectations Figure 2: Yield curve and inflation
60 14 5
50 12
4
40 10
3
30 8
%
6 2
% yoy
20
4
10 1
2
0 0
0
-10
-2 -1
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10
2003
2004
2005
2006
2007
2008
2009
Business Expectation Survey: Selling Prices WPI (% yoy) (advanced 9 mths)

(diffusion index) Yield curve (10 yr - 3mth t-bill yield) (RHS)
Source: Dun & Bradstreet, RBS Source: CEIC, RBS
These developments are unambiguously positive. That said, they are unlikely to
be sufficient to allow policymakers to ease up on the tightening cycle: the
external situation is still uncertain although as characterised by impressive
increases in external reserves, improved in both June and July. External reserves
increased by USD4bn and USD7bn in the two months.
It is uncertain because much of the improvement was due to a spurt in portfolio

flows. Portfolio flows during the month amounted to USD5.3bn, the highest in the
current fiscal period. This may or may not be repeated even though persistently
3
loose monetary policies in developed countries should remain supportive of

capital flows into the region. This is because capital flows into India are
overwhelmingly into the equity market and this is an asset class that is most

vulnerable to slowing global growth. Moreover, capital flows are by their very
nature volatile and at a minimum, mismatches between external funding and
requirements are likely.
It is also important to note that relatively faster and domestic demand driven
growth in India will only widen the trade deficit as imports continue to hold up in
the face of weaker export growth. Meeting this gap will therefore require a further
enhancement in external funding. In this context, India bulls have consistently
argued that India’s non-oil imports reflect improving investment activity in the
economy and funding for productive purposes is never a problem. This is not
borne out by the data – the reality is that precious metals (gold and silver) have
been driving up India’s import bill. In fact, the share of precious metals in overall
imports is now close to capital imports.
Figure 3: Trends in external reserves and foreign Figure 4: Composition of India’s imports
portfolio flows
10,000 25
8,000 Share in overall imports (3mma)
6,000 20
4,000
2,000 15
0
USD mn
-2,000 10
-4,000
-6,000 5
-8,000
-10,000 0
2004
2005
2006
2007
2008
2009
2010
Apr-09
Jun-09
Aug-09
Oct-09
Feb-10
Apr-10
Jun-10
Dec-09
Capital goods Gold and silver Intermediates

Change in external reserves FII portfolio flows
Source: CEIC, RBS Source: CEIC, RBS
Another disconcerting issue that will need to be addressed is rising property

prices i.e. asset price inflation (Figure 5). Though property market data in India is
sparse and lacks history, prices had risen by 16% from their cyclical troughs
(around Q2 2009) through to April on a country wide basis. In Delhi and Mumbai,
price increases have been more severe at around 35% and 20% respectively.
Addressing this problem will require tightening of lending standards.
The bottom line is that policy will need to be tightened further even though
conventional inflation may well ease in the coming months. The tightening will
need to continue until growth is realigned with domestic resource availability.
This tightening will also need to come at a time when funding requirements of
Indian corporates are already excessive by historical standards. To validate this
we have considered relative trends in the corporate sector’s retention ratio (1-
dividend yield * earnings multiple) and capital goods output, a reasonable proxy
for capital spending. The results in Figure 6 are self explanatory.
4
Figure 5: Evolution of property prices in India Figure 6: Corporate internal accruals and capital
spending

1400 70 0.85
60
1300 50 0.80
40
1200 0.75
30
Jan 2009: 1000
% yoy
1100 20
0.70
10
1000
0 0.65
900 -10
-20 0.60
800
03
04
05
06
07
08
09
Jan-09
Apr-09
Jul-09
Feb-09
Mar-09
May-09
Jun-09
Aug-09
Sep-09
Oct-09
Nov-09
Jan-10
Apr-10
Feb-10
Mar-10
Dec-09
20
20
20
20
20
20
20
Capital goods production (% yoy)
Retention ratio
Delhi Mumbai India
Source: Makaan, RBS Source: CEIC, RBS
We do acknowledge that the leading index for India and the June manufacturing
growth at 7.3% yoy was also weaker than anticipated. This is a good
development but its drivers are unclear. We cannot assess whether the weaker
data reflects a maturing of the business cycle or growing infrastructure
constraints. Output of infrastructure industries slowed quite sharply during the
month. Capital goods production was also soft at 10% yoy but again was due to
a less favourable base effect. Consumer goods output continues to expand at a
rapid pace suggesting robust end-demand. Also supporting this view are the
PMI and Dun & Bradstreet corporate surveys that suggest continued strong
momentum.
Figure 7: Trends in industrial output Figure 8: Corporate expectations on sales and new
orders
25 90
80
20
70
15 60
Diffusion index
50
10
% yoy
40
5 30
20
0
10
-5 0
Mar-10
Mar-08
Mar-09
Jun-08
Sep-08
Jun-09
Sep-09
Jun-10
Sep-10
Dec-08
Dec-09
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
IIP Manufacturing Volume of Sales New Orders

Infrastructure Industries
Source: CEIC, RBS Source: Dun & Bradstreet, RBS
On balance, we believe that growth needs to adjust much more before we can
be comfortable with Indian rates or the INR.
5
Sovereign Views

Bahrain (A2/A/A)
Credit: Underweight FX: n/a Local Rates: n/a
Bahrain’s Central Informatics Organisation has published July consumer prices, which showed the annual CPI at 2.1%,
down from 2.3% in June 2010. Following the regional trend, the continued price declines in housing & utilities sub-segment
is keeping headline inflation well contained. Food prices which declined by 2% mom were the key reason for the 0.2% mom
decline in CPI, yet this trend is expected to be short lived due to the global upward trend in agricultural commodity prices.
However, we see a major jump in inflation as being unlikely in the medium term, mostly due to the high weight of housing in
the index, which is expected to be subdued. On politics, the tension seems to be increasing in the run up to the elections,
as reflected in recent press reports which suggest that the Bahraini authorities have arrested eight leading members of
Shiite organisations and clerics on security grounds. Even though we do not expect ongoing tensions to turn into a full
blown political crisis, it is still unclear whether the arrests would serve to tamper or boost the opposition protests, and we
maintain our “underweight” recommendation. Okan Akin
For our latest coverage on the sovereign, please click here.
Brazil (Baa3/BBB-/BBB-)
Credit: Underweight FX: Long Local Rates: Jan ’11 & ’12 receiver
We reiterate our opportunistic receivers in Jan’11 and Jan’12 DI on a macro view of a protracted central bank pause
heading into the September 1 COPOM meeting. The technicals are favorable with only light flows from abroad to receive,
no term premium anywhere else across Latin American curves against the ongoing search for duration and yield. This
implies a further reduction in risk premium on Jan'12-Jan'13 with the forthcoming economic data unlikely to undermine the
dovish central bank bias and the headline confirmation of a central bank pause likely to trigger additional inflows. Our in
house macro view has been consistent on not only the conclusion of the rate hike cycle but also for an extended pause.
There are still some doubts about the pace of the deceleration in activity; however the trend is for a slow closing of the
output gap. The data scheduled for release up to the next Copom meeting is unlikely to change the central bank’s view for
an improvement of the balance of inflation risks due to lower inflation risk coming from the external scenario and the
deceleration of economic activity (we estimate 1.0% qoq sa growth for 2Q GDP from 2.7% in Q1) . For next week, there will
be the release of July unemployment rate, for which we estimate 7.0% nsa (roughly stable sa figure), and bank lending for
July, which is likely to remain firm, but with no further acceleration. (Please see, “Brazil: opportunity at end of rate hike
cycle, published 4 August 2010). After breaking through 11.4%, the next resistance is 11.3% then 11.15%. We assume any
pullback will be bought with investors seeking to arbitrage the 70bp risk premium in the Jan'12. There is some market
directionality to the receiver trade with the recent recovery in risk appetite perhaps slowing but not reversing the downward
trend on rates. In terms of FX, the treasury’s comments that it has already anticipated USD purchases for external debt
payments within its 2-year window confirms involvement by the government in the FX market as a key player alongside the
central bank. The treasury is likely to already have purchased the necessary USD to meet this year’s debt payments and
external debt obligations for next year imply another USD7bn in purchases. Strong official support for the use of the SWF
ready in place for immediate use would further reinforce the government’s presence in the market. The appetite for
intervention is clear and the government is aiming or maximum effectiveness in view of the strong outlook for flows into EM
and Brazil in the short to medium-term underpinned by real money flows, appetite from Asian investors and renewed wave
of IPO activity expected in Q3 and Q4. Timing for Petrobrás’ secondary market offering remains uncertain though
approaching elections and lack of resolution on the oil-for-shares portion of the capitalization deal has raised the risk of
delays to November and potentially beyond to next year. With USD/BRL stuck at 1.75, it feels that the market has already
priced in the risk of delays which leaves upside risk (positive BRL) if it does go through. Any negative market reaction to a
delay is an opportunity to build on short USDBRL position in view of this favourable outlook for flows notwithstanding
Petrobrás. We like building short positions around 1.77 (1-m BM&F) for renewed attempts to break 1.75 support, and
managing tight stops on account of risk of more aggressive intervention and swings in global risk environment. Siobhan
Morden, Zeina Latif, Flavia Cattan-Naslausky
6
Czech Republic (A1/A/A+)
Credit: Underweight FX: Neutral Local Rates: Neutral

Central Bank governor Miroslav Singer remains dovish, warning that any prospect for interest rate increases “is being
somewhat pushed back”. With austerity measures kicking in and the global recovery still fragile, motivations for a rate hike
in the Czech Republic are weak, especially as inflation remains below the midpoint of the CNB’s 1%-3% target range
and updated forecasts point to converge to 2% at the monetary policy horizon (i.e. H2 2011). On the growth front, Q2 GDP
growth was slightly disappointing for the market, but at 2.2% yoy was the fastest rate of expansion in seven quarters.
Growth in Q1 was primarily driven by exports and manufacturing while private consumption and gross capital formation
continued to contract. It is likely this trend continued in Q2 with industrial output and new orders proving resilient while
Germany, which accounts for roughly 30% of Czech exports, enjoyed surprisingly strong growth in the quarter (4.1% yoy).
That said, hopes of a strong export-led recovery in the Czech Republic will be dampened by the prospect of fiscal
consolidation across the EU and an end to car scrappage schemes. On the FX front, the Koruna remains strong with
EURCZK consolidating near 24.80 on the back of strong balance of payments dynamics and increasing confidence in the
government’s ability to reduce the budget deficit. Interestingly, the CNB has forecast an improvement in the current account
deficit in 2011, to CZK60bn from CZK70bn this year, and that FDI will remain solid at CZK75bn, which is a positive for the
Koruna ahead. Lucy Bethell/David Petitcolin
Korea (A1/A/A+)
Credit: Overweight FX: Long Local Rates: 3Y receivers
Incoming data supports our view that the BOK will remain in tightening mode. The number of employed increased by
105,000 in July, compared to an average monthly rise of 60,000 in the first half of 2010. Also, household debt—already
higher than in the US at the outset of the sub-prime crisis—continued to rise by 8.4% qoq in July, compared to 6.7% qoq in
June. The BOK decided to keep its benchmark rate at 2.25% last week. This is to allow leveraged households and SMEs to
catch some breath before the next rate hike. The policy statement highlighted global risk factors, but leaves no doubt that
the Bank’s central scenario—like our own—is one of steady expansion and rising inflationary pressures. We maintain our
call for a 75 bp rate hike through 2011Q1, with 25 bp hikes now in September and November. As before, we see rates at 3-
3.25% over 2011, given global headwinds, followed by a gradual normalization of monetary policy to 4.5% over 2012.
Despite the above, the yield curve has sufficiently priced in our call for a 75bp rate hike on a one-year horizon but not the
longish pause that we expect before resuming tightening which we see as a base case. Reflective of this we are
constructive on Korean rates, suggesting receiving rates around the 3-year point on the curve which is a cautious view but
consistent with the idea of a pause between rate hikes. The KRW, meanwhile, remains undervalued relative to fundamentals
and we see the currency at 1140 by end-2010 and 1110 by end-2011. The won remains 7-9% below its long-term average
in real effective terms. This cannot be explained by Korea’s relative productivity gains or losses, which correlate purely with
the real effective exchange rate. Neither can it be explained by Korea’s terms of trade which are exceptionally strong by
historical standards. The won is also undervalued when benchmarked against the notion of an equilibrium current account.
For example, the current account amounted to 1.3% over 2001-2008; assuming that this constitutes an equilibrium level the
won would have to appreciate to bring the current account—presently projected at 2% of GDP—into equilibrium. Similarly,
assuming that the current account which stabilizes Korea’s NFA-to-GDP ratio constitutes an equilibrium (-1.2% of GDP), the
won would move upwards from here. Erik Lueth/Woon Khien Chia
7
Malaysia (A3/A-/A-)

Credit: Overweight FX: Short Local Rates: Bull flattener
At 8.9% yoy (8.1% qoq saar) second quarter growth was predictably stellar. Underlying this strong performance was
domestic demand expansion of 16.5% yoy with solid contributions from private and government consumption, investment
and inventories. Export growth was 13.8% yoy compared with 19% in the first quarter. As a result, the share of net exports
fell to 7.9% of GDP, the lowest level since the GDP series on the 2000 base were compiled. This divergence suggests that
domestic demand is becoming more independent of the export cycle and as such, is a turning point in the economy’s
growth dynamics. At the same time, sustaining this pace of growth will be difficult. Exports should be further hit by slowing
G-3 demand – this will impact overall manufacturing wage growth/consumption and also lead to inventory destocking.
Inventories amounted to 4.6% of GDP in Q2 10. Gains from improving terms of trade are also set to diminish with the best of
the upturn in global commodity prices now behind us. On balance, growth is expected to slow though our full year 2010
forecast of 7.4% is not under threat. Based on this outlook, we believe that there will be no further increases in the policy
rate this year. Further MYR appreciation is also unlikely considering the policy outlook, slowing exports and stable
commodity prices. Our end-2010 USD/MYR forecast is 3.15. Sanjay Mathur
Mexico (Baa1/BBB/BBB)
Credit: Underweight FX: Short MXN/CLP Local Rates: 2Y5Y10Y fly
Initial jobs claims and Philly Fed results is what further feeds into concerns of double dip risks for the US economy and
consequently MXN underperformance. Data results like that of Thursday’s are a reminder of why relative value trades are
the best alternatives in this current market. There is the obvious tight economic and financial integration between the US
and Mexico. Not only are an estimated one-fourth of the variations in Mexican growth explained by shocks in the US, with
half of these variations linked to financial conditions in the US and the other half related to trade. The low domestic leverage
in Mexico, one of the lowest in the region, and consequent tepid push for domestic demand reinforces the necessary “pull”
from the US. With its strong domestic story highlighted by Q2 GDP and a more solid footing in Asia, CLP stands to
outperform the Mexican peso and we continue to hold your long CLPMXN position. Verbal intervention by Chilean FinMin
Larrain has dampened the momentum in the cross. Yet concerted intervention is more likely towards the 480 handle given
that the government is currently a dollar seller in order to raise local funds from their USD bond issuance to cover the fiscal
deficit and reconstruction costs. We tighten our take-profit to 2.49 to assure some gains after last week’s sharp move in
CLP. We are likely to hit that target in the near-term on more of a squeeze in USDCLP, but we would look to get back into a
long CLP position once that the market has cleaned out. Flavia Cattan-Naslausky
8
Poland (A2/A-/A-)

Credit: Overweight FX: Long PLN/CZK Local Rates: Bull flattener
Polish inflation surprised on the downside in July, dropping to a 35 month low of 2.0% yoy. Lower contributions from the
transport and alcoholic beverages/tobacco components were to blame, but crucially food prices surprised on the downside
too. Poor weather conditions had been expected to drive food prices higher, although against the backdrop of Russia’s
wheat production problems and local floods, it is too early to claim that food won’t contribute to an acceleration in inflation
ahead. In response to this downside surprise, the market has reined in its interest rate expectations slightly, pricing in a rate
hike over the next 3 months with 92% confidence. For his part, NBP governor Belka has given very little away of late with the
suggestion that there is a chance that policy tightening commences this year, but greater caution is supported by slightly
disappointing output growth of 10.3%yoy in July, and the fact that wage growth remains subdued. In July wages increased
just 2.1%yoy, despite a further improvement in labour market conditions: the seasonally adjusted jobless rate has declined
in the past four consecutive months. We also see downside risks to retail sales growth due on August 24 and maintain our
bias for steady policy into year end. However, we remain positive on the zloty, reflecting comparatively strong growth in
Poland relative to its peers, and the potential for additional capital inflows as the privatisation process continues. The
government is due to select the successful bidder for ENEA before the end of August, and its 51% stake in this company
alone is estimated at PLN4.26bn. Fiscal policy risk remains high, but the market has been forewarned of delays to cutting
the budget deficit below 3% of GDP, and if anything, early elections next year could create scope for spending cuts in
2012. We remain long PLNCZK on a relative value play. Lucy Bethell/Roderick Ngotho
Russia (Baa1/BBB/BBB)
Credit: Marketweight FX: Neutral Local Rates: Bear flattener
All the focus remains on the impact of drought on inflation and its implications for policy. Clearly with food making up a high
weight (38%) in the consumer basket the concern/risk is that the CPI heads north. One school of thought is that policy
makers will allow the rouble to appreciate to bite off the inflationary impact of higher food prices– the exchange rate remains
a stronger tool of monetary policy still than interest rate policy. Our sense though is that the government will be more
concerned still about the impact on growth, from the disruption to the agricultural sector (agricultural production was down
5.9% yoy in July) and will be loathed to allow FX appreciation from already appreciated levels – they will hence continue to
try and hold the currency stable while opening up the fiscal coffers to boost grain/food imports and lashing out aid for the
worst affected regions. The pressure point will hence be felt in fiscal space, while the large current account surplus still
suggests that the impact on the BOP from large food/grain imports will be muted overall. Macro data flow continues to be
mixed, with retail sales remaining strong – helped by large hikes in pensions/public sector salaries earlier in the year and
real wage growth, the latter of which was helped by the earlier year low inflation print. Worryingly though fixed capital
investment rose by just 0.8% yoy in July, and was down 7.4% mom, after showing signs of a rebound earlier in the year.
This tends to build back into a weak recovery story, which we think the CBR will try and alleviate by continuing to intervene
aggressively to keep the rouble stable or even weaker. Timothy Ash
9
Serbia (NR/BB-/BB-)

Credit: Overweight FX: Long Local Rates: Pay
IMF officials arrived this week to begin the latest review under the government’s USD3.9bn SBA. The government seems to
have been chastened by the sell off in the dinar experienced over the past couple of months, and seems to be back-
tracking now on earlier suggestions from the economy minister, Dinkic, that commitments to freeze pensions/public sector
pay could be eased back. Finance minister Dragutinovic has though now signalled that the government plans to hold to the
terms of the programme. Dragutinovic is considered a hawk within the cabinet, albeit some of her cabinet colleagues have
also gone on record this week in suggesting a similar line, suggesting that she has allies against the heavy-hitting Dinkic.
Clearly the government has been surprised by the extent of the exchange rate weakening, and is eager that this does not
now extend to broader economic weakness, undermining solid evidence now of a recovery in the real economy. The NBS
for its part seems to have stabilised the dinar, following its surprise 50bps rate hike last week and the sale of EUR400m in
FX reserves in July – over EUR700m since reserves peaked in April. The concern still on the exchange rate front is that the
current account deficit remains wide, while foreign bank inflows seem to have slowed significantly, as banks presumably
look to reduce exposure locally, part of a regional trend but in Serbia’s cause perhaps accentuated by the large Greek bank
presence. This leaves a hole in the balance of payments which will need to be closed either through an exchange rate
adjustment (hopefully achieved) or a slowing in domestic demand which presumably the rate hike will begin to address;
more be needed hence out pay rates view at present. Hope of privatisation-related FDI on the horizon this year at least
seems to have been disappointed by news that while a tender for the sale of a significant stake in Telekom Srbija will be
held this year, the receipts from the sale are not expected to hit the BOP/Treasury until 2011; the government had hoped to
generate USD2bn in privatisation-related receipts (mostly foreign) this year but with the SP sale being delayed, receipts
may now be reduced to only around one-third of this total. The absence of receipts from state-asset sales will leave the
government that much more dependent on official financing, hence the willingness to toe the line with the IMF. Timothy Ash
South Africa (A3/BBB+/BBB+)
Credit: Overweight FX: Short Local Rates: Receive
We have seen a dramatic fall in long end yields, 10 year swaps are now at 7.48% over 70bp lower than at the start of July.
We continue to like receiving rates in South Africa, but given the speed and magnitude of the bull flattening move we
anticipate time for a pause and some consolidation next week; albeit still mindful of the carry we hold the receiving
recommendation. A few major data releases in South Africa next week, starting with Q2 GDP on Tuesday with lofty market
expectations for 3.2% yoy growth, helped by trade data which is expected to hold up given the World Cup. Overall Q2
growth is likely to disappoint the market given the weakness in mining production which fell in both May and June. Growth
data on Tuesday is followed by CPI on Wednesday, given the World Cup boost and strong retails sales data of late, we
would not be surprised if we get an above consensus mom increase leading to headline inflation increasing above the
current low 4.2% level in June. While we have been firmly in weak inflation camp until now, risks loom on the horizon for
many EMs given the current grain “crisis” and subsequent surge in soft commodity prices. Food accounts for 21% of the
CPI basket for South Africa and around 50% of wheat is imported so South Africa could feel the pinch if global food prices
remain elevated over the coming months. Meanwhile, it is summer striking season in South Africa and if the strikes by the
auto sector and the public sector continue, there could be widespread economic disruption impacting consumption, a
sector just finding its feet given the heavily indebted consumer base and also production activity a sector bracing its self for
a slowing global economy. Imran Ahmad
10
Thailand (Baa1/BBB+/BBB)

Credit: Neutral FX: Neutral/flat Local Rates: Bear flattener
Exports are starting to moderate. July customs trade data out this week showed exports up just 20.6%yoy, significantly
slower than market consensus of 37%, and a June reading of 46.3%. Imports rose broadly in line with expectations
(+36.1%yoy), taking the trade balance to an unexpected deficit of USD 940mn (unadjusted). After seasonal adjustments,
we estimate that exports were in fact down by over 10%mom, a relatively sharp drop following two straight months of gains.
Admittedly, trade data is typically volatile. Nonetheless we are of the view that the July number marks the beginning of a
moderating trend in external demand. This should not come as surprise – in recent months various indicators have
suggested as much, with PMIs easing across the region and a peaking of shipments among raw-material exporters like
Indonesia and Malaysia. The slowdown in exports means two things for markets. First, the THB’s recent rally will probably
lose some momentum. Given the export outlook, authorities are unlikely to want to see the USD/THB go into free-fall, even if
the currency has only recently come unshackled from the sticky 32.00 level. In the near-term, the 31.00-31.50 range is
probably as much as authorities will be willing to stomach; pressure for the Bank of Thailand (BOT) to act has already come
from the Commerce Minister, who said following the trade release that baht strength was a “risk” that needed to be
“stabilized.” The second implication of exports moderating is that we can rule out aggressive rate hikes from the BOT in the
coming months. Unlike many other countries in the region, Thailand will head into the external headwinds of H2 without the
buffer of robust domestic demand. Consumer spending in particular was weak in Q1, and, as next Monday’s Q2 GDP report
will show, was further eroded by the political unrest in April/May. Although GDP growth will appear ‘high’ at 9%yoy, base-
year effects are at play, and net exports – rather than domestic demand – will probably account for the bulk of the rise. To
this end, we expect one, or at most two more, 25bps rate hikes from the BOT before a pause. The next move will come at
next Wednesday’s policy meeting, taking the policy rate to 1.75%. Su Sian Lim
Turkey (Ba2/BB/BB+)
Credit: Underweight FX: Short Local Rates: Pay
Our country visit to Turkey this week left us with mixed impressions. On the one part political risks around the Ergenekon
case seem overdone – all sides look set to let the democratic process run its course. That said Turkey does face
parliamentary elections by July 2011, and depending on the outcome of the Constitutional Reform referendum on
September 12, and given the decision to stall implementation of the new fiscal rule, the obvious concern is still that the
government embarks on aggressive fiscal easing in the run up to elections. Combine this and a likely flurry of new issuance
both from the sovereign and also from local banks in September and we have moved our credit recommendation to
underweight. For similar reasons we have also moved more cautious on local rates, concerned that the combination of
drought and the Ramadan effect could see headline inflation push higher than expected over the next few months which
could well begin to spook the market. That said, the CBRT continues to make it clear that it is in no mood to tighten policy
rates anytime soon, holding to the lower for longer mantra and which supported the rally over the past week. The problem
thought is that with benchmark rates close to 8% now, I am now struggling to see much further upside from herein.
Meanwhile, and despite the partial re-assurance we secured from our Turkey trip, we still recommend buying Turkey FX
volatility as levels remain very low/attractive and we would expect markets to increasingly fret over the outlook as the
elections date approaches. Timothy Ash
11
Ukraine (B2/B+/B)

Credit: Overweight FX: Neutral Local Rates: Receive
Pretty mixed domestic news flow at present: On the one hand UkrStat confirmed strong Q2 2010 real GDP growth with a
print of 6% yoy, accelerating from 4.9% yoy in Q1 2010. The low base period effects and still competitively priced UAH are
helping herein, albeit there is much to suggest that growth could begin to slow as a reflection of the reversal of the above
factors, plus also the impact of the on-going drought on Ukraine’s important agricultural sector. The NBU’s own production
activity index, a close proxy for real GDP growth, slowed to just 1.4% yoy in July with problems in the agricultural sector
being important herein. That said, it still seems that the official 3.7% full year real GDP growth target is well within reach. As
with Russia the obvious concern remains as to what impact the drought will have on inflation, as food comprises a large
weight (around 40%) in the CPI basket. Recent trends have remained encouraging with the CPI dropping to a 7-year low of
just 6.8% as of July 2010, and the enduring strength of the UAH is helping herein. The government is still hinting of placing
restrictions on grain exports (Ukraine is still likely to run a small surplus on grain production of several million tons), albeit it
seems unclear how this can be squared with Ukraine’s obligations under WTO. This could well limit the government’s
options. Disappointment also this week with news that the government is now not expected to complete the privatisation of
Ukrtelekom this year. The latter sale was expected to cover the bulk of the UAH10bn initial planned target for privatisation
receipts for the budget, albeit this latter target was subsequently revised down to UAH3.7bn. The government’s financing
position has however been significantly improved by the provision of USD1bn in IMF funding, USD600m in additional official
credits and by a USD2bn loan from a Russian state-owned bank. Recent fiscal trends have also been much more
encouraging, with budget revenues rising by 11% yoy over H1 2010, itself appearing as a reflection of the strong real
economy performance over this period. We still view Ukraine as an improving credit story, hence our overweight
recommendation across local and external government debt. Timothy Ash
Venezuela (B2/BB-/B+)
Credit: Neutral FX: n/a Local Rates: n/a
The deluge of supply risk has only aggravated the high beta status of Venezuelan credit risk with the pent up demand from
corporates unique to this transaction after having been starved of USD over the past few months. Our assessment of fair
value for the USD’2022 remains a moving target to the shift on the Venezuelan USD curve at 150bp-200bp spread pickup to
the USD’2023 to penalize for the high price premium. The settlement this coming week (August 23) should provide insights
on the severity of the supply risk, with hedge funds looking for distressed prices to accumulate a long position. It is worth
remembering that Venezuela is the highest yielding sovereign with a hefty market capitalization across the benchmark
indices. This suggests that the technical position remains quite favorable with any stabilization in external risk appetite likely
to trigger forced buying of Venezuela credit. The relative underperformance of Venezuela is best reflected on the 5Y CDS
differential to Argentina with the spread widening back out to the worst levels of 475bp and the recent recovery in risk
appetite providing some support. Siobhan Morden
12
EM FX performance: 2nd Jan 2006 = 1 Czech Republic: Real GDP yoy (%)
1.4

10
1.3
8
1.2
6
1.1
4
1.0 2
0.9 0
0.8 -2
Latam Glo bal EM
0.7 CEEM EA A sia -4
0.6 -6
01/06 10/06 07/07 04/08 01/09 10/09 07/10 05 06 07 08 09 10
Source: Bloomberg, RBS Source: Bloomberg,RBS;
Venezuela: VEN-ARG 5Y CDS vs. SPX Mexico | CLP/MXN
-300 1250 2.7
-200 2.6
1200
-100
2.6
0 1150
2.5
100
1100 2.5
200
300 2.4
1050
400 2.4
500 1000 2.3

Jan-10 Apr-10 Jun-10 Aug-10 1-Jan-10 1-M ar-10 1-M ay-10 1-Jul-10
SPX VEN-ARG 5Y CDS Cro ss (spo t) 200d/ma 50d/ma
Source: RBS Source: RBS
Korea: Household debt vis-à-vis the banking sector Malaysia: Trends in domestic demand and net exports
2.5 430 25 25
420 20
2 410
Domestic demand (% yoy)
15 20
Net exports (% GDP)
400
10
1.5 390 15
380 5
1 370 0
10
360 -5
0.5 350
-10 5
340
-15
0 330
-20 0
Ja 8
Ja 9
Ap 8
Ap 9
Ap 0
8
0
8
0
t -0
t -0
0
1
l -0
l -0
l -1
r-0
r-0
r-1
2009
2009
2009
2009
2009
2010
2010
2010
n-
n-
n-
Oc
Oc
Ju
Ju
Ju
Ja
trillion won (RHS) % growth qoq (LHS) Domestic demand (% yoy) Net exports (% GDP)
Source: CEIC RBS Source: CEIC,RBS

13
Selected Data and Events Calendar
CEEMEA data calendar Asia data calendar Latin America data calendar
Date Events Survey Last Date Events Survey Last Date Events Survey Last
Current Account –
23 Aug LN Jul Industrial Production (yoy) - 4.80% 23 Aug TH 2Q Gross Domestic Product (yoy) 8.00% 12.00% 23 Aug BZ Jul Monthly (USD) -4.50 -5.18 bn
24-25 UA Jul Money Supply - M3 (yoy) - 12.90% 23 Aug SI Jul CPI (yoy) 3.10% 2.70% 23 Aug BZ Jul Foreign Investment (USD) 2.00 708 mn
24 Aug CZ Aug Business Confidence - 11.6 23 Aug TA Jul Unemployment Rate - sa - 5.20% 23 Aug MX Jun Retail Sales (INEGI) 4.90% 5.00%
24 Aug CZ Aug Consumer Confidence - -7.3 23 Aug TA Jul Industrial Production (yoy) 20.84% 24.33% Trade Balance (FOB) Weekly
23 Aug BZ Aug (USD) - 427 mn
24 Aug PD Jul Retail Sales (yoy) 4.10% 6.40% 23 Aug TA Jul Commercial Sales (yoy) - 10.52%
23 Aug AR 2Q Unemployment Rate Total - 8.3%
24 Aug PD Jul Unemployment Rate 11.40% 11.60% 24 Aug SK 2Q External Short-Term Debt (USD) - 154.6 bn
24 Aug BZ Aug FGV Consumer Confidence - 120
24 Aug LN 2Q Unemployment Quarterly (%) - 18.10% 24 Aug SK Aug SK Consumer Confidence - 112
24 Aug BZ Jul Total Outstanding Loans (BRL) - 1.53 tn
24 Aug TU Jul Foreign Tourist Arrivals yoy - 7.30% 25 Aug PH Jun Total imports (yoy) - 31.4%
24 Aug BZ Jul Private Banks Lending (BRL) - 879 bn
24 Aug RO Jul Money Supply (yoy) - 7.10% 25 Aug PH Jun Trade Balance (USD) - -513 mn
24 Aug MX Jul P Trade Balance (USD) -550 -340.5 mn
24 Aug SA 2Q GDP n.s.a. (yoy) 3.20% 1.60% 26 Aug PH 2Q GDP (yoy) 6.30% 7.30%
24 Aug AR Jul Trade Balance (USD) - 1.29 bn
24 Aug SA 2Q GDP (Annualized) 4.00% 4.60% 26 Aug SI Jul Industrial Production (yoy) 8.50% 26.10%
24 Aug BZ Jul Central Govt Budget - 63.00%
25 Aug HU Jun Retail Trade (IA) (yoy) -5.40% -4.70% 26 Aug HK Jul Exports (yoy) - 26.7%
25 Aug BZ Aug FIPE CPI - Weekly - 0.20%
25 Aug SA Jul CPI (all items) (yoy) 4.00% 4.20% 26 Aug HK Jul Imports (yoy) - 31%
25 Aug BZ Jul Nominal Budget Balance (BRL) - -13.6 bn
25 Aug RR Jul Real Wages (yoy) - 3.70% 26 Aug HK Jul Trade Balance (HKD) - -30.6 bn
25 Aug BZ Jul Primary Budget Balance (BRL) - 2.1 bn
25 Aug TU Aug Industrial Confidence - 112.7 27 Aug SK Jul Current Account (USD) - 5.04 bn
25 Aug BZ Jul Net Debt % GDP - 41.40%
26 Aug RU Aug Gold & Forex Reserve (USD) - 478.3 bn 27 Aug SK Jul Goods Balance (USD) - 6.35 bn
25 Aug MX 2Q Current Account Balance (BRL) -300 -765 mn
26 Aug SA Jul PPI (mom) - 4.00% 27 Aug TH Aug Foreign Reserves (USD) - 152.9 bn
25 Aug MX Jul Unemployment Rate 5.34% 5.05%
26 Aug SA Jul PPI (yoy) 8.20% 9.40% 27 Aug TA Jul Leading Index (mom) - -0.10%
25 Aug MX 2Q GDP Current $ yoy - 9.90%
26 Aug IS 2Q Unemployment Rate - 7.20% 27 Aug TA Jul Coincident Index (mom) - 0.30%
26 Aug BZ Aug FGV Construction Costs (mom) 0.69% 0.62%
27 Aug HU Jul Unemployment Rate 11.00% 11.10% 27 Aug MA Jul M3 Money Supply (yoy) - 8.8%
26 Aug BZ Jul Unemployment Rate - 7.00%
27 Aug LN 2Q F GDP (constant prices) (yoy) - 1.10%
27 Aug CL Aug Central Bank Meeting Minutes
27 Aug LN Jul Retail Trade (yoy) - -6.40%
27 Aug AR Jul Shop Center Sales (yoy) - 23.80%
Source: RBS, Bloomberg Source: RBS, Bloomberg Source: RBS, Bloomberg

14

RBS EM Essentials RBS EM Top 10 reads (12 Aug-19 Aug)
Top View | Asia | Double Dip: Indicators to Top View | India | A primer on India's fixed

watch income market
Top View | Asia | Nothing to fear but fear itself EM Sovereign Radar | CEE-3 Fiscal diversion
Top View | India | A primer on India's fixed China | CNY takes its lead from EUR/USD
income market
Asia at Noon
Sovereign Insight | The GCC Countries
Top View | India | Is lower inflation enough?
Sovereign Insight | Turkey
Bond Highlights | EM Asia | Week beginning 16
Top View | What to sell first in EMFX August
Top View | Where has all the FDI gone? Top View | Korea | 75bp more hikes before
pause
Colombia | Bullish on Santos, upgrade and oil
boom Alert | Asia FX | Better entries ahead
Argentina | Full Throttle Ahead Hungary | A short sighted approach
Latin America | Opening Views
http://strategy.rbsm.com/disclosures - View this page for additional Important Disclosure Information for Research Recommendations including
Recommendation history.
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20 August 2010

Emerging Markets Strategy

 Summary of Cross Asset Trading Recommendations (page 2)

 Sovereign Views (page 6):

Summary of Cross Asset Trading Recommendations

Recommendation Date Credit FX Local Rates Sovereign Ratings

Emerging Markets Strategy | 20 August 2010

Special feature | India

Emerging Markets Strategy | 20 August 2010

Details: At least selectively, price pressures are starting to ease. On an annual

Inflationary expectations are also stabilising. We note that corporate

Business Expectation Survey: Selling Prices WPI (% yoy) (advanced 9 mths)

Source: Dun & Bradstreet, RBS Source: CEIC, RBS

It is uncertain because much of the improvement was due to a spurt in portfolio

loose monetary policies in developed countries should remain supportive of

Emerging Markets Strategy | 20 August 2010

Capital goods Gold and silver Intermediates

Source: CEIC, RBS Source: CEIC, RBS

Another disconcerting issue that will need to be addressed is rising property

Emerging Markets Strategy | 20 August 2010

Source: Makaan, RBS Source: CEIC, RBS

IIP Manufacturing Volume of Sales New Orders

Source: CEIC, RBS Source: Dun & Bradstreet, RBS

Emerging Markets Strategy | 20 August 2010

Credit: Underweight FX: n/a Local Rates: n/a

For our latest coverage on the sovereign, please click here.

For our latest coverage on the sovereign, please click here.

Czech Republic (A1/A/A+)

Credit: Underweight FX: Neutral Local Rates: Neutral

Emerging Markets Strategy | 20 August 2010

For our latest coverage on the sovereign, please click here.

Credit: Overweight FX: Long Local Rates: 3Y receivers

For our latest coverage on the sovereign, please click here.

Emerging Markets Strategy | 20 August 2010

For our latest coverage on the sovereign, please click here.

Credit: Underweight FX: Short MXN/CLP Local Rates: 2Y5Y10Y fly

For our latest coverage on the sovereign, please click here.

Emerging Markets Strategy | 20 August 2010

For our latest coverage on the sovereign, please click here.

Credit: Marketweight FX: Neutral Local Rates: Bear flattener

For our latest coverage on the sovereign, please click here.

Emerging Markets Strategy | 20 August 2010

For our latest coverage on the sovereign, please click here.

South Africa (A3/BBB+/BBB+)

Credit: Overweight FX: Short Local Rates: Receive

For our latest coverage on the sovereign, please click here.

Emerging Markets Strategy | 20 August 2010

For our latest coverage on the sovereign, please click here.

Credit: Underweight FX: Short Local Rates: Pay

For our latest coverage on the sovereign, please click here.

Emerging Markets Strategy | 20 August 2010

For our latest coverage on the sovereign, please click here.

Credit: Neutral FX: n/a Local Rates: n/a

For our latest coverage on the sovereign, please click here.

Emerging Markets Strategy | 20 August 2010

Source: Bloomberg, RBS Source: Bloomberg,RBS;

Venezuela: VEN-ARG 5Y CDS vs. SPX Mexico | CLP/MXN

-300 1250 2.7

500 1000 2.3

SPX VEN-ARG 5Y CDS Cro ss (spo t) 200d/ma 50d/ma

Source: RBS Source: RBS

Source: CEIC RBS Source: CEIC,RBS

Summary of Cross Asset Trading Recommendations (page 2)

Sovereign Views (page 6):