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					MORGAN STANLEY RESEARCH

May 20, 2013
                                                                                                     MORGAN ST ANLEY RESEARCH

Global EM Investor                                                                                   GLOBAL EM M ACRO STRATEGY TEAM
                                                                                                     For research analysts, please see contact list at the
                                                                                                     back of this material.
Dollar Dominance
                                                                                                     Chart of the Week: Short-Term
Tactically speaking, EM currencies are approaching oversold territory                                Aggregate Momentum Index (SAMI)
versus what has been a broadly strong USD. Yet we remain cautious on EM
                                                                                                      100
risk and constructive on rates, given the still-prevalent divergences across
                                                                                                                                         Oversold
markets. Global demand conditions remain weak, which belies resilience                                 80
seen in core equity markets – justified by even easier monetary policy.
                                                                                                       60
Trades
                                                                                                       40
Sell SGD/INR: We re-enter our short SGD/INR position. We think that India is
likely to benefit from falling commodity prices and the recent restriction on                          20
imports of certain goods. Meanwhile, China and global growth concerns remain                                                                      Overbought
                                                                                                        0
significant risks for SGD. The trade also has high carry, at around 5.5%.                               Dec-11        Apr-12    Aug-12     Dec-12   Apr-13
Switch into PETBRA’23 from PETBRA’19: Although on the sovereign side, we                                                      EM FX Momentum
                                                                                                                              EM Credit Momentum
position for underperformance in Brazil, we see a tactical opportunity in the new
                                                                                                     Source: Morgan Stanley Research, Bloomberg
PETBRA’23 bonds, which offer more liquidity, a lower dollar price and 15bp
pick-up in spread terms to the PETBRA’19s.
                                                                                                     Currencies: Sell SGD/INR
Comments of the Week
                                                                                                      47
Where Is the Value in EM Rates? We assess EM rate markets by utilising a
local bond scorecard, our EMTrend model and our strategy views. Brazil, Israel                        45
and India rank highest on our scorecard while South Africa, Turkey, Mexico and                        43
Thailand rank lowest. Meanwhile, EMTrend shows that a sell-off in DM rates is a
key risk to EM swap rates – particularly in 5y tenors and in CEEMEA – while                           41
bonds should fare better, especially in Mexico, as inflows remain strong.                             39
Reflation, Deflation and Tail Risk Hedges: We look at a fast-moving, market-                          37
based indicator which summaries information about global reflation/deflation
pressures. There are interesting divergences between the indicator and global                         35
growth/asset prices. The indicator and our commodity model lead us to propose                           A-11 N-11 F-12 M-12 A-12 N-12 F-13 M-13
selling USD put/PLN or NOK call spreads as tail-risk hedges.                                                      SGD/INR            Target             Stop

Sell ILS on Spikes: The BoI cut rates and introduced a USD purchasing                                Source: Morgan Stanley Research, Bloomberg

programme designed to offset the balance-of-payments effect of rising domestic
gas production. We think that the policy proposals will be sufficient to end ILS                     Credit: Switch into PETBRA’23 from
outperformance, and see other reasons for ILS to start underperforming too,                          PETBRA’19
including low CPI and as our economists see a risk of further policy rate cuts.
                                                                                                      300       bp
We recommend selling ILS versus EUR and USD on periods of ILS strength.
                                                                                                      250
Assessment Changes
                                                                                                      200
Rates: We upgrade India to neutral/overweight from neutral, and downgrade
Thailand to neutral/underweight from neutral. We also downgrade South Africa                          150
to neutral from neutral/overweight.
                                                                                                      100
Currencies: We downgrade PLN to neutral from neutral/overweight, and
                                                                                                       50
upgrade BRL from neutral to neutral/overweight. We also upgrade CNY to
overweight from neutral/overweight.                                                                        0
                                                                                                               M-13                       J-13
Asset Class Stance                                                                                                PETBRA’23              Target         Stop
      Currencies            Local Rates          Sovereign Credit       Corporate Credit
                                                                                                     Source: Morgan Stanley Research, Bloomberg
        HOLD               ACCUMULATE                 HOLD               ACCUMULATE

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                                                                                                    MORGAN STANLEY RESEARCH

                                                                                                    May 20, 2013
                                                                                                    Global EM Investor




EM Cross-Asset Compass
Rashique Rahman                                                                                     What’s Changed
   Sell           Reduce                     Hold             Accumulate                 Buy        As we have been all month, we stay cautious in the near
                                                                                                    term on EM risk and continue to advocate neutral-to-market
    US dollar strength and rising core rate market yields highlight
     the ongoing divergences prevalent across markets.
                                                                                                    beta in currency and credit portfolios, and an Accumulate
                                                                                                    stance for EM local debt.
    EM currencies are nearing oversold territory but tactically we
     remain cautious on EM risk, given the weak data and no
                                                                                                    We recommend being underexposed to commodity
     signs of a near-term turnaround.                                                               currencies and credits.

    We maintain an Accumulate overall stance on EM rates,
                                                                                                    As much as EM currencies have underperformed the dollar,
     though we acknowledge that risks are increasing and markets                                    there are prospects that a broader risk-market pullback
     are starting to move in an idiosyncratic fashion again.                                        would lead to an even more pronounced sell-off in EM risk.
                                                                                                    Indeed, any indication that the Fed might be considering
                                                                                                    tapering asset purchases any time soon would be taken as a
What We Think                                                                                       negative, in our view. Furthermore, the managed slowdown
                                                                                                    in China as policy-makers seek to rebalance the economy
Broad US dollar strength and core rate yield widening have
                                                                                                    may continue to take its toll on cyclically sensitive
been dominant factors in markets. Far from signalling a
                                                                                                    commodities and also regional growth. We like buying INR
renewed US-driven global recovery, these dynamics
                                                                                                    against SGD as a means of positioning for China rebalancing.
highlight the striking divergences that remain prevalent
across markets. Commodity price weakness, declining                                                 Our work on reflation/deflation signals suggests that there is
breakeven inflation (outside Japan) and disappointing macro                                         likely to be a disinflationary impulse in EM, reflected in
data belie the resilience seen in core equity markets.                                              measured inflation that serves to anchor local bond yields
                                                                                                    (see page 18).
Global demand remains weak, as highlighted by declining
                                                                                                    Valuations in EM local bonds have become an overriding
export growth and softer cyclically sensitive commodities.
                                                                                                    concern among investors, even as new money mandates –
And the growth outturn in EM – most recently in Mexico –
                                                                                                    and fund inflows – continue to be strong. We highlight the
has steadily disappointed to the downside.
                                                                                                    most attractive local bond markets based on a set of key
Technically USD/EM is approaching overbought territory,                                             criteria (see page 14).
but, directionally speaking, we remain cautious overall on EM                                       Within credit, Idiosyncratic risks continue to make us
risk, given that there are no signs of a near-term turnaround                                       cautious on the high yielders, and we instead maintain our
from the macro deterioration.                                                                       overweights on select mid-tier credits.
Exhibit 1
EM Currencies Continue to Underperform *                                                            What’s Next
  180                                                                                         110   This week’s main risk event will be Chairman Bernanke’s
            EMFX strength, Spread
            compression, Equity strength                                                      108   JEC testimony on Wednesday, along with the release of the
  160
                                                                                              106   minutes from the last FOMC meeting. As indicated earlier,
  140
                                                                                              104   the prospect of the Fed tapering its purchases of assets as
                                                                                              102
                                                                                                    part of its QE programme will likely have a negative market
  120                                                                                         100
                                                                                                    impact.
                                                                                              98
  100                                                                                               The main event for EM this week will be the South African
                                                                                              96
                                                                                                    Reserve Bank’s policy meeting, at which rates are expected
                                                                                              94
   80
                                                                                              92
                                                                                                    to remain on hold by Morgan Stanley and consensus. The
   60                                                                                         90
                                                                                                    chances of a rate cut have risen according to our
   May-09    Nov-09    May-10       Nov-10     May-11     Nov-11   May-12   Nov-12   May-13         economists, but it remain unlikely. China’s HSBC Flash
                          MSCI EM          EM Credit Spread    S&P 500      USD/EM                  Manufacturing PMI will also be important to gauge the
Source: Morgan Stanley Research, Bloomberg; *All series Jan ’10 =100                                growth recovery in China.




                                                                                                                                                                 2
                                                                                                        MORGAN STANLEY RESEARCH

                                                                                                        May 20, 2013
                                                                                                        Global EM Investor




Risk Events of the Week
                                                                                                                               Ref
   Date (EST)          Time (EST)           Ccy          Event                                                               period   MS Fcast   Market   Previous
   20-May              8:00                 PLN          Avg Gross Wages (YoY)                                                 Apr     2.80%     2.20%      1.60%
   20-May              8:00                 PLN          Employment (YoY)                                                      Apr     -1.00%    -0.90%    -0.90%
   20-May              8:30                 CLP          GDP (YoY)                                                             1Q       4.30%               5.70%
   20-May              8:30                 CLP          Current Account (USDm)                                                1Q       -1800               -2880
   20-May              17:00                COP          Trade Balance (USDm)                                                 Mar        $413              $386.4
   20-May                                   PHP          Balance of Payments                                                   Apr                         $452M
   21-May              3:00                 ZAR          Leading Indicator                                                    Mar                           133.3
   21-May              8:00                 PLN          Sold Industrial Output (YoY)                                          Apr     3.60%     3.00%     -2.90%
   21-May              8:00                 PLN          Producer Prices (YoY)                                                 Apr               -1.50%    -0.60%
   21-May              19:00                RUB          Producer Prices (YoY)                                                 Apr               3.00%      3.40%
   21-May              20:30                TWD          Unemployment Rate - sa                                                Apr     4.20%     4.17%      4.18%
   22-May              3:00                 HUF          Avg Gross Wages (YoY)                                                Mar                3.00%      2.70%
   22-May              4:00                 ZAR          CPI (all items) (YoY)                                                 Apr     5.80%      5.70%     5.90%
   22-May              5:00                 MYR          CPI YoY                                                               Apr     1.70%     1.70%      1.60%
   22-May              8:00                 BRL          IBGE CPI IPCA-15 (MoM)                                               May      0.42%      0.48%     0.51%
   22-May              9:00                 MXN          Retail Sales (INEGI)                                                 Mar      1.60%     -1.00%    -2.60%
   22-May              9:30                 BRL          Current Account - Monthly                                             Apr     -$6500             -$6873M
   22-May              9:30                 BRL          Foreign Investment                                                    Apr               $5000M   $5739M
   22-May              15:00                ARS          Trade Balance                                                         Apr                         $510M
   22-May                                   ILS          Leading 'S' Indicator (MoM)                                           Apr                          0.10%
   22-May                                   ARS          Consumer Confidence                                                  May                           44.06
   22-May              19:00                RUB          Industrial Production (YoY)                                           Apr               1.90%      2.60%
   22-May              20:00                SGD          GDP (YoY)                                                            1Q F               -0.50%    -0.60%
   22-May              21:45                CNY          HSBC Flash Manufacturing PMI                                         May                 50.4       50.4
   23-May              1:00                 SGD          Industrial Production YoY                                             Apr               1.60%     -4.10%
   23-May              1:00                 SGD          CPI (YoY)                                                             Apr               3.10%      3.50%
   23-May              3:30                 THB          Foreign Reserves                                                    May-17                       $176.3B
   23-May              4:00                 TWD          Industrial Production (YoY)                                           Apr     -0.80%    -0.52%    -3.28%
   23-May              7:00                 BRL          FGV CPI IPC-S                                                       May-22                         0.38%
   23-May              8:00                 BRL          Unemployment Rate                                                     Apr     5.50%     5.60%      5.70%
   23-May              8:00                 PLN          NBP Publishes Minutes of Rate Meeting
   23-May              9:00                 MXN          GDP Current $ YoY                                                     1Q                          3.90%
   23-May              9:00                 MXN          Bi-Weekly CPI                                                       May-15    -0.32%              0.01%
   23-May                                   ZAR          SARB Announce Interest Rate                                         May-23     5.00%    5.00%     5.00%
   23-May                                   PEN          GDP YoY                                                               1Q       4.80%    4.90%     5.90%
   23-May                                   BRL          Treasury Releases Federal Debt Data                                   Apr
   23-May              21:00                PHP          Trade Balance                                                        Mar                         -$967M
   23-May              21:35                CNY          MNI Flash Business Sentiment Indicator                               May
   24-May              3:00                 CZK          Consumer & Business Confidence                                       May                            -5.3
   24-May              4:00                 TWD          GDP - Constant Prices (YoY)                                          1Q F                1.50%     1.54%
   24-May              4:00                 PLN          Retail Sales (YoY)                                                    Apr    3.20%      1.10%     0.10%
   24-May              4:00                 PLN          Unemployment Rate                                                     Apr    13.90%     13.90%    14.30%
   24-May              9:00                 MXN          Unemployment Rate                                                     Apr               4.65%      4.51%
   24-May              9:00                 CLP          PPI (MoM)                                                             Apr                         -2.90%
   24-May              10:00                MXN          Current Account Balance                                               1Q     -$4500M             -$6490M
   24-May              15:00                ARS          Industrial Production (YoY)                                           Apr               1.80%      0.20%
Note: Italics indicates earliest date possible release date. Bold indicates a monetary policy meeting. Source: Bloomberg


AXJ Weekly Publication, May 17; CEEMEA Weekly Publication, May 17; LatAm Weekly Publication, May 17




                                                                                                                                                                    3
                                                                                          MORGAN STANLEY RESEARCH

                                                                                          May 20, 2013
                                                                                          Global EM Investor




Re-enter Trade: Sell SGD/INR                                                                                                                         AXJ FX
Kritika Kashyap, James Lord
                                                                                        With SGD now trading at the top of the trading band,
Rationale
                                                                                        fundamental trends in the economy have tilted the risk/reward
We are re-entering our short SGD/INR trade, after hitting our                           in favor of a move towards the middle of the trading band.
stop last week. INR underperformed on the back of some
                                                                                        Risks
poor trade data, but we doubt the move will last. The rationale
for the trade remains intact, with India likely to benefit from                         Significant global risk-aversion could prompt outflows from the
falling commodity prices, and recent restrictions on the import                         Indian equity market, and given India’s reliance on capital
of certain goods (such as gold).                                                        flows to fund its current account deficit, this would undermine
                                                                                        the INR. Also, any decision by the Singapore government to
China and global growth concerns remain significant risks for
                                                                                        implement structural reforms and improve productivity and
the SGD. A manufacturing slowdown in China places a
                                                                                        lower the supply-side restrictions would be SGD supportive.
number of AXJ currencies at risk, including TWD and SGD.
The associated move lower in commodity prices benefits INR.                             Levels

INR has been under sharp depreciation pressure since mid-                               We recommend a positioning via 3m forwards. This trade is
2011 due to its high twin deficits, which had led to a poor                             high positive annualized carry, at around 5.5%.
macro backdrop of structurally low growth and high inflation.
                                                                                        We target spot SGD/INR at 42.0, with a stop at 45.5. The
As prices of India’s largest imports – oil and gold – decline,
                                                                                        entry is the current 3m forward rate of 44.3. Risk/reward for
we think this reduces India’s macro vulnerability through an
                                                                                        this trade is around 4:1, when measured in terms of total
improving trade balance and lower imported inflation.
                                                                                        return.
Meanwhile, Singapore is the most export-oriented economy in
                                                                                        The trade complements our recommendation to buy INR/IDR,
AXJ. Its highest export market share – 21% of total exports –
                                                                                        given prospects for the ongoing balance-of-payments
is to China (including Hong Kong), and so a slowdown in
                                                                                        deterioration in Indonesia to weigh on the rupiah.
China/global growth poses significant risks for SGD. Its
exports are mainly in the form of electronics and machinery
components, which are also under threat due to JPY
weakness. Restrictive policy and subdued growth has led to a
sharp flattening of the IRS curve over the past couple of
months.

Weak Growth, Flat IRS Curve                                                             S$NEER Is Trading at the Top of the Band

   1.32
                                                                                          125
                                                                                                        S$NEER Model       SGD Strength
                                                                                   85
                                                                                                        Top
    1.3                                                                                   120
                                                                                                        Center
                                                      SGD Weakness,                                     Bottom
                                                                                   70
   1.28                                               Steeper IRS Curve                   115

   1.26                                                                                   110
                                                                                   55

   1.24
                                                                                          105
                                                                                   40
   1.22
                                                                                          100

    1.2                                                                            25
     Jan-12       Apr-12       Jul-12        Oct-12           Jan-13      Apr-13           95
                                                                                            Jan-02      Jan-04       Jan-06      Jan-08   Jan-10   Jan-12
                                  USD/SGD             SGD IRS 1s5s (bp)

                                                                                        Source: Morgan Stanley Research, Bloomberg
Source: Morgan Stanley Research, Bloomberg




                                                                                                                                                            4
                                                                                          MORGAN STANLEY RESEARCH

                                                                                          May 20, 2013
                                                                                          Global EM Investor




New Trade: Switch into PETBRA’23 from                                                                                                                          Corporate Credit
PETBRA’19
Vanessa Barrett, Kristina Obrtacova

Rationale                                                                   Although the new 10-year benchmark is inside the curve (see
                                                                            Exhibit 2), the bond offers liquidity and low dollar price,
On the sovereign side, we continue to maintain our Brazil
                                                                            compared to the rest of the curve. We expect to see some
underweight as we believe that it will be some time before we
                                                                            repricing tighter in the secondary market more generally, as
see a meaningful impact of any reforms that could see Brazil
                                                                            PETBRA has traded as wide as the GAZPRU curve over the
outperform (see Global EM Investor: Big Data, May 13, 2013).
                                                                            past few months. The new bonds, PETBRA’23, offer an 81bp
Within our quasi-sovereign O&G framework, we have been
                                                                            pick-up over PEMEX’23, which were issued at the start of the
monitoring Petrobras’ pick-up versus the respective sovereign
                                                                            year.
bonds (see LatAm: A Rising Class in Investment Grade, April
15, 2013). Year-to-date, we saw an outperformance of                        Risks
Petrobras versus sovereign bonds, with Petrobras bonds
                                                                            With supply risks out of the way, the broader macro risks
recording an average 7bp of spread widening while Brazil
                                                                            related to Brazil continue to weigh on valuations beyond the
sovereign bonds are 30bp wider over the same period.
                                                                            sovereign bond space.
The overhang of anticipation of large supply from Petrobras
                                                                            Levels
has been weighing on the bond curve since the start of the
year, given that, in the previous two years, the issuer came to             We recommend investors switch into the new PETBRA’23
the market in the first month of the year. As a result, the total           bonds, which offer more liquidity, a lower dollar price and a
return of PETBRA bonds is lower than for similar-duration                   15bp pick-up in spread terms to the PETBRA’19s. The current
PEMEX and GAZPRU (see Exhibit 1). The record US$11                          spread of PETBRA’23 is z+232bp and PETBRA’19 trades at
billion issuance printed by Petrobras last week, offering short,            z+218; we set the target for PETBRA’23 at z+200bp and stop-
belly and long duration with both fixed and floating tranches,              loss at z+260bp, which gives the trade a risk/reward of around
met with strong investor demand. The new supply saw only                    1.2.
5bp average spread widening across the rest of the curve and
the new PETBRA’23 are currently 2bp tighter.

Total Return Of Similar-Duration Bonds YTD                                  Switch into PETBRA’23 from PETBRA’19
  105                                                                                                                                                                  PETBRA'40
                                                                                        300
             PETBRA'21 TR     PEMEX'21 TR      GAZPRU'22 TR                                                                                                                              PETBRA'43
                                                                                                                                                                           PETBRA'41



  103                                                                                   250                                     PETBRA'21

                                                                                                                            PETBRA'20                                      PEMEX'38
                                                                                                                                                                                        PEMEX'44N
                                                                                                                                                   PETBRA'23                                  PEMEX'44
                                                                                                                      PETBRA'19
                                                                                                                                                                                PEMEX'41
                                                                                                                                                                     PEMEX'35
                                                                                        200                        PETBRA'18
  101
                                                                                                                                PETBRA 5 7/8%'18
                                                                             Z-spread




                                                                                                                PETBRA'16          PEMEX'21
                                                                                                                           PEMEX'19                PEMEX'23
                                                                                                  PETBRA 3 7/8%'16    PETBRA'17
                                                                                        150                                     PEMEX'20
   99                                                                                                                                     PEMEX'22
                                                                                                  PETBRA 2%'16         PEMEX'18



                                                                                        100
   97                                                                                              PETBRA'15


                                                                                                               PEMEX'15
                                                                                        50
   95                                                                                         0             2               4           6            8          10    12           14            16
    Jan-13           Feb-13           Mar-13              Apr-13   May-13                                                                   Modified Duration



                                                                            Source: Morgan Stanley Research, Bloomberg
Source: Morgan Stanley Research, Bloomberg




                                                                                                                                                                                                         5
                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                  May 20, 2013
                                                                                                  Global EM Investor




Trade Radar (All Open Trades)                                                                                                                    Cross-Asset
Robert Habib, Simon Waever


Local Markets
                                                                                More Compelling    Recent Opened Trades

                                                                                                   Sell SGD/INR
                                                                                                   We re-enter our short SGD/INR after INR underperformed on
                                                                MXN 1s10s                          the back of poor trade data last week. Yet, India is set to
                                                                Flattener*
                Sell SGD/INR                                                                       benefit from falling commodity prices, and recent restrictions
 Trade Score




                                                                                                   on the import of certain goods, while Singapore is vulnerable
                     Buy 2015 BRL BE                                                               to a Chinese slowdown.
                         Inflation
                                                                                                   Buy MXN 1s10s Flattener
                                                                                                   Increased flows into the Mexican local markets, especially
                                                                                                   given Fitch’s upgrade, should keep long-term rates low. The
                  Less Compelling                                                                  short end of the curve is also pricing in many cuts, allowing
                                                                                                   the trade to have a positive 8bp (DV01-neutral).
                                               Reward / Risk
                                            Rates                        FX


Credit

                                                                                                   Recent Opened Trades
                                                                              More Compelling
                                                                                                   Switch into PETBRA’23 from PETBRA’19
                                          Buy SOAF 2022                                            Although on the sovereign side, we position for
                                         vs. SOAF 2041**
               Buy VIP '18**
                             Buy BCOCPE'20                                                         underperformance in Brazil, we see a tactical opportunity in
                                                                                                   the new PETBRA’23 bonds, which offer more liquidity, a lower
 Trade Score




                   Buy SBERRU'21**
                                                    Buy Peru 2019 vs.
                                                                                                   dollar price and 15bp pick-up in spread terms to the
                                                    Brazil Jan-2019**                              PETBRA’19s. (Due to the lack of historical data for this bond, it
                                                                                                   is not included in the chart.)

                                                                                                   Buy KZOKZ’23
                                                                                                   We see an opportunity for spread compression in Kazakhstan
                                                                                                   in KMG bonds, which underperformed similar-duration
               Less Compelling
                                                                                                   Gazprom bonds year to date. We see the new KZOKZ’23 bonds
                                                                                                   as the most attractive way to express this view. (Due to the lack
                                                Reward / Risk
                                                                                                   of historical data for this bond, it is not included in the chart.)
                                       Sovereign Credit            Corporate Credit


*Trade score is a simple sum of four components, with the maximum score for each component given in parentheses. Conviction (4): This is
subjectively assigned based on the trade rationale, with four being the highest conviction level and zero the lowest. Directionality (2): Between
zero and two, with two indicating a non-directional trade and zero indicating a directional trade. Carry (2): A score is given depending on the
trade’s three-month carry. Negative carry gets a value of zero. Positive carry, which is less than the stop-loss of the trade, gets one. Carry in
excess of the stop-loss gets two. Z-Score (2): The difference of the current level of the trade and its mean, divided by the one-year standard
deviation of weekly changes. In any case where mean > current > target, or where mean < current < target, a score of zero is awarded.
Otherwise, a z-score above 4 is given a score of 2, one between 2 and 4 is given a score of 1 and one below 2 is given a zero. Trade Score is
represented below each recommended trade (except for Hedges).




                                                                                                                                                                         6
                                                                                              MORGAN STANLEY RESEARCH

                                                                                              May 20, 2013
                                                                                              Global EM Investor




Trades We Recommend
                                                                              Entry                                                  Notional              Gross P&L
                                                                                                 Current   Target      Stop
Trade                                                   Status         Date           Level                                      ($m, DV01* or Delta**)   bp      US$k
CREDIT
Sovereign Credit
Buy SOAF 2022 vs. SOAF 2041**                                        18-Feb-13         -26          -16      -51        -11             10x5               +5        64
Buy Peru 2019 vs. Brazil Jan-2019**                                  15-Apr-13          -4          -27      -44        16             10x10.5            +24       148
Corporate Credit
Buy VIP '18**                                                        26-Nov-12         473         346       325        400               10              +122      894
Buy SBERRU'21**                                                      25-Mar-13         276         236       220        280               10              +42       371
Buy BCOCPE'20                                                        29-Apr-13         262         237       220        290               10               +6        69
Buy KZOKZ'23                                                         7-May-13          231         235       190        270               10               -11      (77)
Switch into PETBRA’23 from PETBRA’19                     NEW         20-May-13         233         234       200        260               10                -         -

RATES
Buy 2015 BRL BE Inflation                                            18-Apr-13        5.53         5.69      6.20      5.00               10              +16        83
MXN 1s10s Flattener*                                                 10-May-13        112          120        80       130                10               -8       (23)
CURRENCIES
Sell SGD/INR                                             NEW         17-May-13        43.6          43.9     42.0      45.5               10                        (58)
Buy 3m USD/ MXN 1x2 Put Spread (K = atmf, 12.8)                      26-Apr-13        12.14        12.32                                  10
Buy 1y USD/ CNY Put Spread (K = 6, 6.18)                             26-Apr-13        6.22          6.20                                  10

** Trade spreads (Entry, Current, Target and Stop) are displayed in z-spreads, all other Credit trades are displayed in yield (bp). Gross P&L in always in yield terms
Gross P&L includes carry but excludes transaction costs. These are hypothetical, not actual, trades. Past performance is no guarantee of future results.
Source: Morgan Stanley Research

For a longer history of our recommended trades, see Recommended Trade Summary, April 23, 2013.


Morgan Stanley & Co. Limited (“Morgan Stanley”) is acting as financial advisor to Yandex N.V. ("Yandex"), in relation to the proposed formation of a
JV between Yandex.Money and Sberbank of Russia, as announced on 19th Dec 2012. Yandex has agreed to pay fees to Morgan Stanley for its
financial services. Please refer to the notes at the end of the report.




                                                                                                                                                                           7
                                                                           MORGAN STANLEY RESEARCH

                                                                           May 20, 2013
                                                                           Global EM Investor




Currencies
   Sell         Reduce             Hold       Accumulate             Buy    In the CEEMEA region, our continued underweight stance
                                                                            towards the South Africa rand has worked nicely, with
    EM currencies have been very volatile recently, and we
                                                                            USD/ZAR punching through our 9.40 target. We suspect that
     continue to project a cautious stance. We think that USD/EM
                                                                            ultimately USD/ZAR will trend higher as the country’s terms
     will keep heading higher, but any dovish comments from the
     US Federal Reserve could turn sentiment around.
                                                                            of trade continue to deteriorate amid falling gold prices. We
                                                                            also think the TRY will underperform, as the CBT continues
    As such, we continue to recommend defensive positioning,               to foster TRY depreciation on a trade-weighted basis. The
     favoring those currency that benefit from falling oil and other
                                                                            TRY failed to rally post the upgrade from Moody’s to give
     commodity prices (such as INR) and possible policy support
                                                                            Turkey an investment grade credit rating. This is not
     (such as CNY and BRL).
                                                                            surprising, given the falling carry on the TRY, CBT policy and
                                                                            the market environment.
EM currencies have had a torrid time recently, with all those
                                                                            Elsewhere in CEEMEA, the resilience of the HUF continues
under our coverage depreciating versus the USD, which, in
                                                                            to confound us. We have missed the market recovery, but
turn, has been strong versus everything else too. Signs of
                                                                            we do not see justification for the rally to be sustained. More
recovery in the US economy are being pounced upon as
                                                                            rate cuts look likely, with our economist, Pasquale Diana,
evidence that the US Fed could taper asset purchases soon,
                                                                            recently revising his forecast for terminal rates down to 3.5%.
thereby sending the USD higher.
                                                                            Carry is low on the HUF already, and sooner or later this, as
Meanwhile, signs of disinflation are growing everywhere and                 well as the uncertainty over macro policy in general, could
the near-term risk is that Chairman Bernanke uses this                      soon undermine sentiment towards the currency again. This
week’s testimony to push back against market speculation                    is not a high conviction view though.
over any tapering of asset purchases in the context of
                                                                            In Asia, we continue to believe that INR will outperform given
achieving its inflation objectives. If that happens, then EM
                                                                            its improving domestic macro dynamics and the benefits it
currencies will probably recover.
                                                                            receives from falling oil prices. Meanwhile, the SGD should
Certainly, our short-term market timing indicator suggests                  underperform as China’s growth continues to slow.
that EM currencies are approaching oversold territory. But
                                                                            In LatAm, MXN has corrected as we had expected. We see it
we see a good chance that EM currencies will keep falling
                                                                            correcting further to 12.40 by month-end, on the back of the
over the coming weeks, thanks to concerns over global
                                                                            continued USD rally and heavy positioning in the FX
growth, an uncertain outlook for fixed income flows amid
                                                                            (measured using CFTC/IMM data) and bond markets.
highly depressed yield levels in EM, and concern over
                                                                            However, we remain bullish the currency on the medium
tapering at the US Fed.
                                                                            term. Commodity currencies like CLP, PEN and COP should
Exhibit 1                                                                   also weaken from lower metal prices, in line with their
SAMI Starting to Look Stretched                                             respective central banks policies. CLP, in particular, is
                                                                            vulnerable to a slowdown in fixed income inflows.
 100                                                                 102
  90                                          Oversold                      BRL also sold off aggressively last week, reaching levels
                                                                     101
  80                                                                        where the BCB might choose to intervene via selling
                                                                     100
  70                                                                        currency swaps to limit FX weakness. Although inflation is
  60                                                                 99
                                                                            set to lower this quarter on a seasonal basis, it is improbable
  50                                                                 98     that the BCB allows material depreciation from here,
  40                                                                 97     especially given that it just started a hiking cycle. Hence, we
  30
                                                                     96     choose to upgrade BRL this week as we expect the currency
  20
                                                                     95     to outperform in an environment of weakness in broader EM.
  10                                         Overbought
   0                                                                 94
   Jan-12         May-12          Sep-12       Jan-13       May-13
            EM FX Momentum (LHS)                        USD/EM
Source: Morgan Stanley Research, Bloomberg


                                                                                                                                         8
                                                                                           MORGAN STANLEY RESEARCH

                                                                                           May 20, 2013
                                                                                           Global EM Investor




Exhibit 2
Relative Assessments
                                                                                            Assessment Changes
              −     o     +      3m Perf vs USD*                                            We have downgraded PLN, given the weakness of the EUR and
INR                                         -1.3%
                                                                                            the prospect for further EM currency losses in the coming weeks.
CNY                                           1.6%
KRW                                          -3.0%     We have upgraded CNY, as we expect the currency to outperform
BRL                                          -3.2%    in an environment of weakness in broader EM.
MYR                                            2.6%    We have upgraded BRL, as possible BCB intervention to the top-
PHP                                          -1.2%    side should limit losses.
PLN                                          -3.2%
COP                                          -2.4%
RON                                          -1.7%
ILS                                            1.1%
PEN                                          -2.5%
MXN                                            3.1%
TRY                                          -2.3%
CLP                                          -1.5%
HUF                                          -1.8%
TWD                                          -1.2%
CZK                                          -4.8%
THB                                          -0.1%
SGD                                          -1.5%
RUB                                          -3.2%
IDR                                          -0.5%
ZAR                                          -6.0%
Source: Morgan Stanley Research; *CEE performance is versus EUR




                                                                                                                                                               9
                                                                                          MORGAN STANLEY RESEARCH

                                                                                          May 20, 2013
                                                                                          Global EM Investor




Local Rates
   Sell         Reduce             Hold          Accumulate                         Buy    Hungary remains our top pick in EM local bonds, and the
                                                                                           country continues to outperform even as other markets grab
    We maintain an Accumulate overall stance on EM rates,
                                                                                           the lion’s share of headlines. One of those markets was
     though we acknowledge risks are increasing and markets are
                                                                                           Turkey, which benefited from the ‘double whammy’ of a
     starting to move in an idiosyncratic fashion again.
                                                                                           larger-than-expected cut in policy rates and a second
    In CEEMEA, we downgrade South Africa to neutral ahead of                              investment grade upgrade. Although the upgrade doesn’t
     this week’s central bank meeting, given increased risks from                          come as a big surprise – risk premium on Turkish bonds has
     currency volatility.                                                                  been low for over a year now – the bonds should remain
    In Asia, we upgrade India to neutral-overweight and                                   supported in the near term from the twin tailwinds of inflows
     downgrade Thailand to neutral-underweight.                                            and rate cuts.
                                                                                           South Africa will be the focus of attention in our region this
We continue to have a relatively bullish stance on EM rates                                week. April inflation is released on Wednesday and a lower-
(Accumulate), though we are mindful that our markets are                                   than-expected reading will increase anticipation of a rate cut
not all moving in the same direction any more, and                                         by the SARB when it meets on Thursday. Market
idiosyncratic drivers are coming back to the fore. A selective                             expectations are relatively low, with around 30bp of cuts
approach to rates is probably warranted in the near term. EM                               priced over the next six months, and the recent sharp sell-off
currencies are generally weaker and in some markets                                        in ZAR has probably prevented those expectations from
correlations between rates and fx have increased. A further                                increasing further. The renewed weakness in the currency
tail risk to rate markets globally is increased expectation of a                           has concerned us as well, and we have reduced the country
slowdown in the pace of asset purchases by the US Fed.                                     to neutral from neutral-overweight.
Exhibit 1                                                                                  We make no changes to our views on LatAm local bonds this
Risk Premium on Turkish Bonds Already Low                                                  week. Brazil continues to price in a more aggressive hiking
                                                                                           scenario than Morgan Stanley economists’ expectations.
 18                                                                                  12    Still, we think the market is bound to remain volatile and
 16                                                                                  10    positioning is unlikely to increase sharply in the near term,
 14                                                                                  8
                                                                                           given the confusion around policy-makers’ monetary policy
                                                                                           stance. On the other hand, the other LatAm heavyweight,
 12                                                                                  6
                                                                                           Mexico, continues to benefit from an improvement in policy.
 10                                                                                  4     Although positioning in the market is high, we expect Mexico
  8                                                                                  2     to remain one of the key beneficiaries of foreign inflows into
                                                                                           EM and we maintain our neutral-overweight stance.
  6                                                                                  0

  4                                                                                  -2    In Asia, we’ve made two changes to our relative
                                                                                           assessments. We are bullish on Indian bonds and upgrade
  2                                                                                  -4
  Jan-09          Jan-10           Jan-11              Jan-12              Jan-13
                                                                                           the market to neutral-overweight as we expect further easing
                                                                                           from the RBI as inflation drops sharply, and some pick-up in
                    Real yield (RHS)         CPI yoy            5y yield
                                                                                           inflows on the back of relaxation in foreign ownership
Source: Morgan Stanley Research, Bloomberg
                                                                                           restrictions. On the other hand, we are bearish on Thailand
                                                                                           bonds which we downgrade to neutral-underweight, as we
                                                                                           see risks of overheating in the economy, which the market
                                                                                           isn’t currently pricing. At the same time, there is a risk that
                                                                                           the BoT might cut rates to further weaken the currency.




                                                                                                                                                       10
                                                                                                                              MORGAN STANLEY RESEARCH

                                                                                                                              May 20, 2013
                                                                                                                              Global EM Investor




Exhibit 2
                                                                                                                               Assessment Changes
Relative Assessment and Recent Performance
                                                                                                                               We upgrade: India to neutral-overweight from neutral, as we think
             −     o     +   3m Perf of 5y Bonds, b
                                                                                                                               the RBI will continue to ease as inflation declines sharply.
HUF                                                                               -110
INR                                                                                -58    We downgrade: Thailand to neutral-underweight from neutral,
RUB                                                                                 -2    given risk of overheating in the economy, which we think the market
MXN                                                                                -58    isn’t currently pricing.
ILS                                                                                  -60    We also downgrade South Africa to neutral from neutral-overweight,
BRL                                                                                +4    as an increase in currency volatility is likely to impact rates
TRY                                                                                -95
                                                                                                                               negatively.
RON                                                                               -120
NGN                                                                               +76
ZAR                                                                               -26
PHP                                                                                -89
KRW                                                                               -10
MYR                                                                                    -16
IDR                                                                               +18
PLN                                                                                 -84
THB                                                                                 -24
CZK                                                                               -60
COP                                                                               +13
PEN                                                                                -9
CLP                                                                               -63
Source: Morgan Stanley Research




                                                                                                                                                                                                 11
                                                                      MORGAN STANLEY RESEARCH

                                                                      May 20, 2013
                                                                      Global EM Investor




Credit
 Sovereign      Sell    Reduce       Hold      Accumulate      Buy     is in line
                                                                     cumulate with our recent downgrade of Ukraine to market-
                                                                                                                     Buy
 Corporate      Sell    Reduce       Hold      Accumulate      Buy    weight in our portfolio (see assessment changes in box
                                                                     Accumulate
                                                                       opposite). Venezuela has shown some small positive signs,
   Despite long-awaited IG status for both Turkey and the             such as the apparent thaw in relations between the
    Philippines this month, already tight spreads mean the             government and the large food supplier Polar, but as
    impact in the near term is likely to be limited.
                                                                       highlighted in Venezuela: Change on the Horizon, April 24,
   Idiosyncratic risks continue to make us cautious on the high       2013, there are still too many hurdles and too much potential
    yielders and we instead maintain our overweights to select         volatility to make the bonds appear attractive.
    mid-tier credits.
                                                                       Exhibit 1
   We maintain our preference for corporates versus sovereigns        Relative Assessment and 3m Performance
    in EM credit, focusing our allocation on high yield, namely BB
                                                                                   −         o     +       CDS 3m perf. bp
    corporates.
                                                                       INDO                                             -6
                                                                       KAZ                                              -14
Sovereign Credit
                                                                       LIT                                              -0
                                                                       ROM                                              -31
EM credit continues to see its YTD total return oscillate around       TURK                                             -24
zero. With a move wider in US Treasuries over the past two             CRO                                              -14
weeks but no equivalent spread tightening, returns were again          PER                                              -5
pushed into negative territory, with low-beta largely
underperforming. As highlighted in our spring outlook (Global
                                                                       EGY                                              +9
EM Spring Outlook, March 21, 2013), we continue to see the
                                                                       HUN                                              -32
year as one of sluggish returns for EM Credit. Weekly fund
                                                                       RUS                                              -14
flows reinforce this by once again coming in very weak at only         SOAF                                             -10
$US31 million into hard currency funds (Weekly Fund Flows &            UKR                                              +3
Technicals, May 16, 2013).                                             ARG*                                             +483
Both Turkey and the Philippines are now officially Investment
                                                                       COL                                              -17
Grade credits following the widely expected Moody’s upgrade
                                                                       MEX                                              -19
of Turkey to Baa3 on May 17 and S&P’s upgrade of the
                                                                       VEN                                              +148
Philippines at the beginning of the month. At the same time,           CHL                                              -1
we note that the markets have treated both Turkey and the              MAL                                              -2
Philippines as IG credits for a while. In fact, our SovRank            PHI                                              -17
model shows the current CDS spreads and country                        BRA                                              +0
fundamentals imply a BBB- rating for Turkey and a BBB rating
for the Philippines.                                                               Current        Prior
                                                                       Source: Morgan Stanley Research; *We allocate all exposure to the Par bond.
We have been overweight Turkey, with the potential upgrade
to IG as one of the positive drivers for spread compression.           Assessment Changes (May 13)
However, with spreads at recent lows, we believe that we are           We downgrade UKRAINE to a market-weight position: With an
now closer to fair value. On the other hand, Philippine bond           IMF deal seemingly pushed out to the autumn, the catalyst for
spreads are among the tightest in the markets, and we                  spread compression in the near term has been removed. At the
consider the bonds to be very expensive, despite the strong            same time, funding needs remain high this year and we thus expect
macro backdrop. We therefore maintain our underweight                  future supply to keep upwards pressure on yields.
allocation.                                                            We upgrade KAZAKHSTAN to a neutral/overweight position:
Finally, the week also saw S&P confirmed the B rating of               With the recent supply absorbed by the market, favorable
Ukraine while maintaining a negative outlook. Focus was                positioning, an increased resistance to oil price volatility and
again on the reliance on the markets to fund themselves. This          underperformance YTD, we think Kazakh spreads look attractive.



                                                                                                                                                                     12
                                                                  MORGAN STANLEY RESEARCH

                                                                  May 20, 2013
                                                                  Global EM Investor




Corporate Credit                                                   Last week, EM corporates issued US$19 billion in bonds,
                                                                   taking the May supply to over US$35 billion so far. The
Last week saw spreads moving sideways, with both
                                                                   record US$11 billion issuance printed by Petrobras, offering
corporate and EM sovereign spreads ending the week
                                                                   short, belly and long duration with both fixed and floating
relatively unchanged. On a regional basis, Asia outperformed,
                                                                   tranches, met with strong investor demand. The total amount
while LatAm was weaker due to Mexican corporates. On a
                                                                   raised by EM corporates in the first five months of this year
sector basis, utilities continued to outperform, catching up to
                                                                   now stands at US$166 billion, which amounts to 60% of last
their recent underperformance, and M&M spreads lagged the
                                                                   year’s total issuance.
rest of the sectors. BB rated corporates, our preferred
category in EM credit, underperformed the broader EM credit
last week in spread terms.




                                                                                                                             13
                                                                     MORGAN STANLEY RESEARCH

                                                                     May 20, 2013
                                                                     Global EM Investor




Where Is the Value in EM Rates?
Mihail Bozinov, Robert Habib, Kritika Kashyap                         Our EMTrend model (see EM Profile: Introducing EMTrend
                                                                      – A Scenario Analysis for EM Rates, March 7, 2013, for
    We assess EM rate markets by utilizing a local bond              details) shows that given the current low levels of yields,
     scorecard, our EMTrend model, and our strategy views.            EM rates are particularly sensitive to a sell-off in DM rates.
    Brazil, Israel and India rank highest on our scorecard while     While the model sees 2y EM IRS trading more or less
     South Africa, Turkey, Mexico and Thailand rank lowest.           sideways over the next six months, 5y IRS has bigger
    We remain bullish on bonds in Hungary, Israel and Mexico,
                                                                      scope to sell off, particularly in CEEMEA.
     move India to overweight and stay neutral on Brazil. We          However, EMTrend is more bullish on local bonds,
     downgrade South Africa and Thailand to underweight.              forecasting a further small rally in short-dated Mexican and
    EMTrend shows that a sell-off in DM rates is a big risk to EM    Polish bonds, as foreign inflows, which we expect to remain
     swap rates at the moment, particularly in 5y tenors and in       strong, are an important driver of local bond performance.
     CEEMEA, while bonds should fare better, especially in
     Mexico, as inflows remain strong. The interactive version is     The Local Bond Scorecard
     available here.
                                                                      Exhibit 1
                                                                      EM Local Bond Scorecard – Data
EM local bonds have done well this year, on the whole,                              MP exp      Real yield Positioning    DM correl   Credit
                                                                      BRL              0.22          -0.75        -2.18        0.10      0.0
outperforming external bonds by a wide margin. However,               COP              0.18          -0.17         0.22       -0.03      0.0
with the rally now largely behind us and in light of the recent       CZK             -0.07           0.29           na        0.56      0.0
uptick in DM rates, the question on investors’ minds is               HUF             -0.10           1.17        -0.41        0.23      0.0
                                                                      IDR              0.00          -0.95        -0.54       -0.50      0.0
whether there is still any value left in local rates, and if so
                                                                      ILS              0.30           0.09           na       -0.11      0.0
where? In this note we aim to answer this question utilizing          INR             -0.05           0.15           na       -0.48      0.0
a local bond ‘scorecard’, our proprietary EMTrend model for           KRW              0.10           0.29           na        0.40      0.0
local rates, and our subjective strategy views.                       MXN             -0.31          -1.15        -0.54        0.15      1.0
                                                                      MYR             -0.06          -0.56        -0.54       -0.21      0.0
Our local bond scorecard is most bullish on local bonds in            PEN              0.00           0.34        -0.06        0.13      0.0
                                                                      RUB              0.50          -1.96         0.36        0.01      0.0
Brazil, Israel and India and most bearish on bonds in South
                                                                      THB             -0.10           0.34         0.53        0.35      0.0
Africa, Turkey, Mexico and Thailand.                                  TRY             -0.25           0.21         0.22        0.41      1.0
                                                                      ZAR             -0.30          -1.02        -1.27        0.17      0.0
In CEEMEA, we are bullish on Hungary and Israel, which                Avg              0.00          -0.18        -0.36        0.10     0.13
score highly, and Russia, which ranks roughly in the                  Std              0.22           0.82         0.76        0.31     0.34
middle, and we turn more cautious on South Africa, which              Source: Morgan Stanley Research, EPFR, Bloomberg

has a low rank.                                                       We’ve created a local bond scorecard that takes into
In Asia, we like India, which is ranked highest in Asia, are          account a few different metrics that bond investors
neutral on Indonesia and Malaysia even though they too                traditionally consider and standardized the results into
have positive marks on the scorecard, and are bearish on              relative Z-scores, so that the different metrics can be
Thailand, which the has lowest overall score in EM.                   combined.

In LatAm, in contrast to the results of the scorecard, we             The first metric is the difference between market and
maintain our bullish view on Mexican bonds and a neutral              Morgan Stanley economics policy rate expectations on a
view on Brazil. Flows are likely to continue to support the           6m horizon – markets that are pricing less than what our
Mexican local market, in our view, although we                        economists expect are rated highly and vice versa.
acknowledge heavy positioning makes it susceptible to a               The second metric is 10y bond implied real yields, or more
sell-off in US Treasuries. Yet, confusion about monetary              precisely the difference between the current 10y real yield and
policy in Brazil, the BCB’s recent hiking cycle, and high             its 12m average. Markets with high and rising real yields (due
risks of structural inflationary pressures rising should              to most likely falling inflation) are relatively more attractive.
continue to limit foreign interest on the Brazilian market.


                                                                                                                                        14
                                                                         MORGAN STANLEY RESEARCH

                                                                         May 20, 2013
                                                                         Global EM Investor




The third criterion is positioning. Admittedly, reliable and              CEEMEA
timely data on (relative) investor positioning is hard to come
                                                                          The local bond scorecard supports our overweight
by. The best data we have are EPFR’s monthly survey of
                                                                          positioning in Hungary and Israel. Money markets do price
EM investors benchmarked to the widely followed GBI EM
indices, which includes most but not all EM local markets.                a lot of rate cuts in Hungary, but there really isn’t any sign
Here we look at the difference in positioning in 1Q13 and in              that the NBH is going to pause anytime soon with inflation
2012. Markets where positioning has declined score higher.                at all-time lows. And we like rates in Israel, where we see a
                                                                          potent combination of low inflation and a central bank
The fourth criterion is correlation with DM rates. We
                                                                          determined to weaken the currency with further rate cuts.
calculate the correlation between weekly changes in 10y
EM and DM (UST or DBR) bond yields in 2013. We choose                     We are also overweight rates in Russia, which ranks in the
to give a positive score to countries with lower/negative                 middle of the table, and would recommend adding on
correlation, given investors’ concerns of a more sustained                weakness, as although inflation is still high, the data should
rise in DM rates.                                                         turn over the next few months and we expect the CBR to
The fifth and final metric is a credit score, whereby we give             take an increasingly dovish stance.
countries that we think have a higher than 50% probability                South Africa is ranked fourth from the bottom. This in
of a credit upgrade/downgrade over the next three months                  combination with renewed currency volatility makes us
a score of 1/-1. Mexico and Turkey (upgrade) are the only                 slightly more cautious on the local market, and we
countries that meet this criterion.                                       accordingly downgrade it to neutral. Finally, we are keeping
Exhibit 2                                                                 our neutral position on Turkey, which is ranked third last.
EM Local Bond Scorecard – Z-Scores                                        We are aware that valuations are very stretched but the
            MP exp     Real yld       Posit DM correl   Credit    AVG     main driver of rates there is the CBT’s desire to weaken the
BRL            1.02      -0.70         2.39     -0.02     0.00    0.54    currency and address domestic growth and credit
ILS            1.38       0.32         0.00      0.69     0.00    0.48    imbalances via other means. The recent credit upgrade
INR           -0.22       0.40         0.00      1.87     0.00    0.41
IDR            0.01      -0.95         0.24      1.94     0.00    0.25    should also support the market in the near term.
HUF           -0.44       1.64         0.07     -0.45     0.00    0.16
MYR
COP
              -0.26
               0.83
                         -0.47
                          0.01
                                       0.24
                                      -0.76
                                                 1.01
                                                 0.41
                                                          0.00
                                                          0.00
                                                                  0.11
                                                                  0.10
                                                                          LatAm
PEN            0.01       0.63        -0.39     -0.12     0.00    0.03
                                                                          The local bond scorecard views Brazil as the most
KRW            0.47       0.57         0.00     -0.99     0.00    0.01
RUB            2.29      -2.17        -0.94      0.26     0.00   -0.11    attractive market in EM, on the back of low positioning as
CZK           -0.31       0.56         0.00     -1.53     0.00   -0.25    well as the aggressive hikes priced in. Indeed, as
ZAR           -1.36      -1.03         1.20     -0.23     0.00   -0.28
TRY           -1.13       0.48        -0.75     -1.02     1.00   -0.28
                                                                          mentioned in Economics and Strategy: Brazil – Dovish
MXN           -1.40      -1.19         0.24     -0.19     1.00   -0.31    Hikes (April 19, 2013), our Brazil economist, Arthur
THB           -0.44       0.63        -1.16     -0.85     0.00   -0.36    Carvalho, only sees the BCB hiking three more times by
Source: Morgan Stanley Research, EPFR, Bloomberg
                                                                          25bp to 8.25% (with risks to the downside). Yet, despite the
The results of the scorecard are summarized in Exhibit 2,                 possibility of gains in the short end, the DI market is bound
ranked by average Z-score. Brazil ranks No. 1 due to the                  to remain volatile. And positioning as measured by EPFR
market’s aggressive pricing of tightening and the sharp                   has materially decreased this year, given the confusion
decline in positioning in 1Q. Among LatAm, Colombia also                  around policy-makers’ monetary policy stance, to Mexico’s
gets a slightly positive mark on account of policy                        benefit. We do not see this changing near term, and remain
expectations and low correlation with DM.                                 broadly neutral on Brazil.
In CEEMEA, Israel ranks highest on account of market
                                                                          On the other hand, Mexico is unattractive in our
pricing, rising real yield and low DM correlation, followed by
                                                                          scoreboard, and vulnerable to a correction given high
Hungary, which benefits from rising real yields and low
                                                                          positioning, the 35bp priced into the short end of the TIIE
positioning. Most CEEMEA markets actually have a
                                                                          curve, and its sensitivity to US Treasuries. Indeed, we
negative overall score.
                                                                          acknowledge that the increase in positioning makes it
In Asia, India ranks highest due to its negative correlation              particularly vulnerable to a back-up in core rates, especially
with DM and rising real yield. Indonesia and Malaysia also                given the increased foreign ownership of MBonos (to 59%
score highly, mainly on account of their low correlation with             of total) and increased MXN-denominated Toshin assets
DM in recent months and low positioning.

                                                                                                                                      15
                                                                                            MORGAN STANLEY RESEARCH

                                                                                            May 20, 2013
                                                                                            Global EM Investor




(after adjusting for exchange rates; see Exhibit 3).                                         EMTrend – Scenario Analysis for EM Rates
However, we expect the flows into EM to remain very
                                                                                             We’ve updated our EMTrend model (see EM Profile:
strong (see EM Strategy Comment: Weekly Fund Flows &
                                                                                             Introducing EMTrend – A Scenario Analysis for EM Rates,
Technicals, May 16, 2013) and support MBonos. Hence,
                                                                                             March 7, 2013, for details) in view of forecasting the most
we keep our slight overweight position.
                                                                                             likely path for EM local rates based on their historical
Exhibit 3                                                                                    relationship to a set of macroeconomic and financial
Exposure to MXN: MBono Foreign Ownership (% of                                               variables and their projected changes. For the interactive
Total) and Toshin MXN-Denominated Assets                                                     version, please see EMTrend: EM Rates Scenario Builder.
(JPYbn*)                                                                                     We aim to get a sense of the general direction of EM rates,
 450                                                                                  60%    while allowing the user to incorporate his individual
                                                                                             forecasts for chosen variables, and run scenario analysis.
 400
                                                                                      50%    The variables were specifically chosen for each security,
 350
                                                                                             and each set attempts to encompass the most important
 300                                                                                  40%    drivers for each rate.
 250
                                                                                      30%    Exhibit 4
 200                                                                                         EM Local Rates: Actual vs. Forecasts
 150                                                                                  20%
                                                                                             2y            Current     2m F'cast         Diff       2013E F'cast   Diff
 100                                                                                         BRL            8.62         8.84             22            9.33       71
                                                                                      10%
                                                                                             CLP            4.49         4.65             16            4.85        36
  50
                                                                                             CZK            0.51         0.86             35            1.01        50
   0                                                                                  0%     HUF            3.74         5.29            156            5.16       143
       J-03   J-04   J-05   J-06   J-07   J-08   J-09     J-10   J-11   J-12   J-13
                                                                                             ILS            1.39         1.51             12            1.67       28
       Toshin MXN denominated assets (JPYbn*)           Foreign Ownership of Mbonos (%)      KRW            2.57         3.06             49            3.23       67
*MXN-denominated Toshin assets are measures using a constant January 2003 MXN/JPY.           MXN            4.12         4.00            -12            4.06        -6
Source: Morgan Stanley Research, Bloomberg, Banxico, Toshin
                                                                                             MBONO          3.82         3.75             -7            3.63       -19
                                                                                             PLN            2.51         2.76             25            3.23       72
AXJ                                                                                          ZAR            4.97         5.58             61            5.62        65

India has received the highest mark among AXJ markets on                                     5y            Current     2m F'cast         Diff       2013E F'cast   Diff
the scorecard, with which we agree and move our position                                     BRL            9.31         9.26             -5           10.19       88
on the market to overweight. We think the RBI will continue                                  CLP            4.69         5.01             32            5.26       57
to ease as inflation declines, while the government’s recent                                 CZK            0.77         1.27             50            1.57       80
measures on investment limits and withholding taxes                                          HUF            3.83         4.91            108            5.13       130
                                                                                             ILS            1.98         2.60             62            2.91       93
should increase foreign inflows.
                                                                                             KRW            2.63         3.27             64            3.46       83
Indonesia and Malaysia also score highly but mainly on                                       MXN            4.59         4.81             22            5.04       45
account of their low correlation with DM rates, and we                                       MBONO          4.07         4.44             37            4.53       46
prefer to be slightly more cautious on these markets. We                                     PLN            2.70         3.73            103            4.45       176
                                                                                             ZAR            5.61         6.75            115            6.79       119
are neutral on Indonesian local bonds as we see their high                                   Source: Morgan Stanley Research estimates, Bloomberg
yield and low correlation with wider rate markets attractive
enough to offset currently high inflation. We are neutral on                                 In particular, given the very low yields at the moment, we find
Malaysia as well, as we see limited upside after the post-                                   that most EM local bonds are very sensitive to US Treasury
election relief rally given our expectation for unchanged                                    (German Bund) moves. And our US Treasury team sees an
policy rates and a pick-up in correlation with DM rates.                                     important risk that US Treasuries end the year higher, near
                                                                                             2.25% for the 10-year, driving EM yields higher as well
Thailand ranks lowest in AXJ and EM overall. We too are                                      according to this model. Indeed, based on our base-case
slightly bearish on the market and move to an underweight                                    forecasts for the macro and financial variables used, our
position. We see increasing risks of overheating in the                                      model’s results suggest that the aggregate EM 2y IRS will
economy that we think the market is not pricing. Although in                                 trade more or less sideways for the next six months (with
the near term, there is a chance that the BoT cuts rates in                                  some notable exceptions), while the EM 5y IRS has, on
order to curb currency strength.                                                             average, some scope to sell off further.

                                                                                                                                                                     16
                                                              MORGAN STANLEY RESEARCH

                                                              May 20, 2013
                                                              Global EM Investor




Such notable exceptions – namely Hungary, Poland and           Exhibit 5
South Africa – are the direct result of the market pricing     EM 2y IRS Actual vs. Predicted (%)
aggressive easing (the latter in an environment with            15
increasing inflation and a very weak currency) and higher
DM rates. Taking Hungary as an example, the model               13

suggests that if the 10y Bund yield remains relatively
                                                                11
unchanged, the NBH decides to cut rates to 3.50% as
expected by our Hungary economist, Pasquale Diana (see           9

CEEMEA Monitor, May 17, 2013), and idiosyncratic risk
                                                                 7
premium lowers (as measured by the 5y CDS) by year-end,
the 2y swap rate should be close to 4.30 (instead of 5.20        5
above).
                                                                 3
Given our expectations for increased flows into the EM          Feb-04     Mar-05   Apr-06   May-07 Jun-08   Jul-09   Aug-10 Sep-11 Oct-12 Nov-13
local debt space this year (see EM Macro Strategy                                               EM 2Y IRS             Fitted 2Y
Comment: Still Flowing, December 20, 2012), our EMTrend        Simple average of Brazil, Chile, Czech Republic, Hungary, Israel, Korea, Mexico, Poland
                                                               and South Africa 2y swap rates.
model also forecasts the 2y MBono to rally further by the      Source: Morgan Stanley Research estimates, Bloomberg
end of the year, despite our forecast for an increase in DM
                                                               Exhibit 6
rates. Indeed, confirming our slightly overweight stance on
Mexican bonds, we believe that flows will continue to be       EM 5y IRS Actual vs. Predicted (%)
supportive for MBonos this year, especially given that we       16

expect lower inflationary pressures for the year.               14


                                                                12


                                                                10


                                                                 8


                                                                 6


                                                                 4


                                                                 2
                                                                Feb-04 Mar-05       Apr-06 May-07 Jun-08     Jul-09   Aug-10 Sep-11 Oct-12 Nov-13

                                                                                               EM 5Y IRS              Fitted 5Y
                                                               Simple average of Brazil, Chile, Czech Republic, Hungary, Israel, Korea, Mexico, Poland
                                                               and South Africa 5y swap rates.
                                                               Source: Morgan Stanley Research estimates, Bloomberg




                                                                                                                                                    17
                                                                   MORGAN STANLEY RESEARCH

                                                                   May 20, 2013
                                                                   Global EM Investor




Reflation, Deflation and Tail-Risk Hedges
Juha Seppala                                                        Exhibit 1
                                                                    Google Searches for the Term ‘Deflation’ (Max =
    We look at a fast-moving, market-based indicator which         100)
     summarizes information about global reflation/deflation
     pressures. This indicator has been on a deflationary trend
     since April 8, 2011.

    The indicator leads EM inflation and co-moves with both
     USD/EM and a wide dollar index. There have been and
     currently are interesting divergences between the indicator
     and global economic growth and asset prices.

    The indicator and our commodity model lead us to propose       Source: Google Trends

     selling USD put / PLN or NOK call spreads as tail-risk         Exhibit 2
     hedges.                                                        Geographical Distribution of ‘Deflation’ Searches


Reflation/Deflation Indicator
There has been a recent spike up in Google searches for the
term ‘deflation’. As a matter of fact, during the week of April
14 the number of searches was the highest since the week
of September 25, 2011, when the world was in the middle of
a ‘double-dip’ scare (see Exhibit 1 but please note that the
May data are only partial). In addition, the geographical
distribution of the searches is unusually widely spread. They
are elevated in every continent save Africa (see Exhibit 2).
By contrast, Google searches for the term ‘reflation’ are at
the lowest levels since August 2012.

As an alternative measure for keeping track of
reflation/deflation pressures, Exhibit 3 displays another
                                                                    Source: Google Trends
indicator that is more market-based. The indicator has been         Exhibit 3
calculated by taking an equally weighted average of: (i)            Reflation/Deflation Indicator
annual growth rates of copper, gold and oil prices; (ii) levels
of US and average EM 2y breakeven inflation rates; and (iii)        85
China and average G4 countries’ IRS curves 1s2s spread.             75
Each variable is normalized so that the historical max
                                                                    65
corresponds to 100 and the historical min corresponds to 0.
                                                                    55
The indicator reached its min (maximum deflation) in
December 2008 and its max (maximum reflation) in                    45
December 2009. The second-highest level was recorded in
                                                                    35
June 2008 and the third-highest peak was on April 8, 2011.
And, as a matter of fact, the indicator has been trending           25
down ever since. The previous turning points can easily be
                                                                    15
interpreted as maximum commodity inflation pressures                  Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov-
(summer 2008), maximum fear of global depression (4Q08),               06   07   07   08   08   09   09   10   10   11   11   12   12
                                                                    Source: Morgan Stanley Research, Bloomberg
and maximum optimism about global rebound (4Q09). But
what began the most recent deflation trend?


                                                                                                                                         18
                                                                    MORGAN STANLEY RESEARCH

                                                                    May 20, 2013
                                                                    Global EM Investor




The most obvious candidate is the surprise decision of the           Exhibit 4
European Central Bank to raise its key policy rate from 1% to        Reflation/Deflation Indicator vs. USD/EM
1.25% on April 7, 2011. Exhibits 4 and 5 document the
                                                                      70                                                                                  85
subsequent movements in FX: the reflation/deflation
indicator versus USD/EM and the wide dollar index, DXY,               65                                                                                  87

respectively. The co-movement is quite striking.                      60
                                                                                                                                                          89

Does the indicator lead anything? One variable which might                                                                                                91
                                                                      55
be expected to lag the indicator is the average EM inflation.                                                                                             93
This is confirmed in Exhibit 6 and also in statistical tests. One     50
                                                                                                                                                          95
cannot reject the null hypothesis that EM inflation does not          45
Granger cause the indicator with a 20% significance level,                                                                                                97
                                                                      40
but one can reject the null hypothesis that the indicator does                                                                                            99
not Granger cause EM inflation with a 0.5% significance               35                                                                                  101
level. In plain English, the indicator leads EM inflation but EM
                                                                      30                                                                                  103
inflation does not lead the indicator.                                 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13
                                                                                   Reflation/Deflation Indicator                USD/EM (RHS, inverted)
It is also worth looking at the indicator against global
                                                                     Source: Morgan Stanley Research, Bloomberg
economic activity and equity prices, shown in Exhibits 7-9.
                                                                     Exhibit 5
Overall, the behavior of the indicator seems to coincide with
the general movement in global economic activity and asset
                                                                     Reflation/Deflation Indicator vs. Dollar Index
prices, but there are some important divergences. In                  70                                                                                   72
particular, from October 2007 to June 2008 the indicator              65
                                                                                                                                                           74
continued to go up while the equity prices and global
                                                                      60
economic activity plummeted.                                                                                                                               76
                                                                      55
Similarly, in retrospect, the behavior of the indicator from          50                                                                                   78
October 2009 to April 2010 seems to have been ‘overly
                                                                      45
reflationary’, as the relationship between asset prices and                                                                                                80
economic activity diverged significantly but finally corrected        40
                                                                                                                                                           82
starting in December and finalizing by April.                         35
                                                                      30                                                                                   84
Finally, what can we say about the above-mentioned                     Apr-11 Jul-11          Oct-11 Jan-12 Apr-12 Jul-12          Oct-12 Jan-13 Apr-13
deflation trend which began on April 8, 2011? Since then, the               Reflation/Deflation Indicator          DXY (RHS, inverted)
US equity markets and the currency have done very well –             Source: Morgan Stanley Research, Bloomberg
the S&P500 has rallied by 25% and the dollar index by 11%.           Exhibit 6
On the other hand, MSCI-EM has sold off by 13%, USD/EM               Reflation/Deflation Indicator vs. Average EM
by 9%, CRB by 22%, the global PMI has come down by 5                 Inflation
units and EM inflation by almost 2%. That’s quite a
                                                                      80                                                                                  9
divergence again. Is this a permanent decoupling or is one of
                                                                      70                                                                                  8
them going to cry uncle again? If so, which one?
                                                                      60                                                                                  7
The deflationary market signals that our indicator highlights                                                                                             6
                                                                      50
drive our overall market strategy at present. Indeed, with                                                                                                5
                                                                      40
commodity prices under pressure, we think that certain                                                                                                    4
                                                                      30
currencies are vulnerable, including the AUD, CLP, ZAR and                                                                                                3
                                                                      20                                                                                  2
RUB. So far, and as we discuss elsewhere in this
                                                                      10                                                                                  1
publication, the most obvious mispricing is in CLP. Overall
                                                                       0                                                                                  0
though, the deflationary signals in markets make us more                Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan-
bullish on the USD and concerned about the prospects for                 07   07   08   08   09   09   10   10   11   11   12   12   13
                                                                                 Reflation/Deflation Indicator          EM Inflation (RHS)
EM, and we continue to highlight our caution on the market.
                                                                     Source: Morgan Stanley Research, Bloomberg


                                                                                                                                                              19
                                                                                     MORGAN STANLEY RESEARCH

                                                                                     May 20, 2013
                                                                                     Global EM Investor




Exhibit 7                                                                             Related to this, four weeks ago, we highlighted our global
Reflation/Deflation Indicator vs. Global PMI                                          commodities model’s most recent predictions (see Global
                                                                                      Commodity Boom Revisited, Part 1: FX, April 18, 2013). The
 90                                                                             70
 80                                                                             65
                                                                                      model is now predicting that the CRB index will sell off 10%
 70                                                                             60
                                                                                      in the near future. In addition, due to the pick-up in global
 60                                                                             55    PMI and expectations about increased liquidity, especially
 50                                                                                   from Japan, the model is also predicting a 20% rebound
                                                                                50
 40
                                                                                45    starting in 2H13. This would also be consistent with our
 30
 20                                                                             40    global economics team’s forecast of the global economy
 10                                                                             35    moving from “twilight to daylight in 2H13” (see Spring Global
  0                                                                             30    Macro Outlook, March 12, 2013).
      Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan-
       07   07   08   08   09   09   10   10   11  11    12  12    13
         Reflation/Deflation Indicator       Global PMI (RHS)                         Tail-Risk Hedges
Source: Morgan Stanley Research, Bloomberg
                                                                                      In Global Commodity Boom Revisited, Part 1: FX, we
Exhibit 8
                                                                                      analyzed the relationship between the movements in the
Reflation/Deflation Indicator vs. S&P-500
                                                                                      wide commodities index and the major currencies. The main
 90                                                                      1800         result, repeated in Exhibit 10, reveals that the most
 80                                                                                   commodity-sensitive currencies, based on R2 above 0.3, are
                                                                         1600
 70                                                                                   AUD, SEK, GBP, CAD, NOK and PLN.
 60                                                                      1400         Exhibit 10
 50                                                                                   Statistics for b in the Regression: FX(t)/FX(t-3m)-1 =
 40
                                                                         1200         a + b*[CRB(t)/CRB(t-3m)-1]
 30                                                                      1000                           Coefficient White Std Err     t-Stat       R2
                                                                                         AUD                0.4339        0.0570     7.6123    0.3743
 20                                                                                      SEK                0.3762        0.0454     8.2863    0.3295
                                                                         800             GBP                0.2764        0.0445     6.2112    0.3156
 10
                                                                                         CAD                0.2624        0.0354     7.4124    0.3111
  0                                                                      600             NOK                0.3470        0.0519     6.6859    0.3032
      Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov-                   PLN                0.4414        0.0581     7.5972    0.3001
       06 07 07 08 08 09 09 10 10 11 11 12 12                                            SGD                0.1500        0.0215     6.9767    0.2929
            Reflation/Deflation Indicator     S&P-500 (RHS)                              RUB                0.2964        0.0443     6.6907    0.2870
                                                                                         HUF                0.4147        0.0560     7.4054    0.2678
Source: Morgan Stanley Research, Bloomberg
                                                                                         MXN                0.2824        0.0616     4.5844    0.2618
Exhibit 9                                                                                KRW                0.2828        0.0630     4.4889    0.2519
Reflation/Deflation Indicator vs. MSCI-EM                                                USD               -0.2313        0.0372    -6.2177    0.2448
                                                                                         TWD                0.1454        0.0192     7.5729    0.2444
 90                                                                      1400            CZK                0.3508        0.0447     7.8479    0.2437
                                                                                         ZAR                0.4499        0.0649     6.9322    0.2434
 80                                                                      1300            NZD                0.3616        0.0561     6.4456    0.2420
                                                                         1200            MYR                0.1177        0.0210     5.6048    0.2343
 70
                                                                                         INR                0.1760        0.0360     4.8889    0.1980
                                                                         1100            EUR                0.2480        0.0461     5.3796    0.1851
 60
                                                                         1000            BRL                0.4148        0.0715     5.8014    0.1848
 50                                                                                      CLP                0.2743        0.0712     3.8525    0.1714
                                                                         900
 40                                                                                      RON                0.2897        0.0510     5.6804    0.1616
                                                                         800             ILS                0.1645        0.0310     5.3065    0.1332
 30                                                                                      CHF                0.1913        0.0457     4.1860    0.1114
                                                                         700
                                                                                         PEN                0.0814        0.0260     3.1308    0.0994
 20                                                                      600             TRY                0.2980        0.0685     4.3504    0.0918
 10                                                                                      IDR                0.2307        0.0718     3.2131    0.0857
                                                                         500
                                                                                         COP                0.1612        0.0730     2.2082    0.0527
  0                                                                      400             THB                0.0686        0.0223     3.0762    0.0371
   Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov- May- Nov-                      CNY                0.0181        0.0070     2.5857    0.0368
    06 07 07 08 08 09 09 10 10 11 11 12 12                                               PHP                0.0377        0.0341     1.1056    0.0100
             Reflation/Deflation Indicator       MSCI-EM (RHS)                           ARS                0.0336        0.0807     0.4164    0.0011
                                                                                         JPY               -0.0144        0.0646    -0.2229    0.0007
Source: Morgan Stanley Research, Bloomberg
                                                                                      Source: Morgan Stanley Research



                                                                                                                                                    20
                                                                                         MORGAN STANLEY RESEARCH

                                                                                         May 20, 2013
                                                                                         Global EM Investor




Exhibit 11                                                                                4.98%, implying a maximum profit to maximum loss ratio of
Cumulative Return of Currencies and CRB                                                   approximately 5:1 (see Exhibit 13, spot reference: 3.24).
Commodity Index (April 8, 2011 = 100)
                                                                                          Another would be to sell a 3m USD put / NOK call spread
 105                                                                                      with strikes at 6 and 6.25. This would earn an upfront
 100                                                                                      premium of 3.67%, implying a maximum profit to maximum
                                                                                          loss ratio of approximately 6:1 (see Exhibit 14, spot
  95
                                                                                          reference: 5.84).
  90
                                                                                          Both of these are attractive tail-risk hedges against commodity
  85
                                                                                          and/or euro sell-offs within the next three months. Without
  80                                                                                      taking a stand on the probability of the tail risks being realized,
  75                                                                                      in today’s low-volatility environment (see EM Profile: How to
  70                                                                                      Value FX Vol in an Era of Low Volatility, April 26, 2011), we
    Apr-11    Jul-11   Oct-11   Jan-12   Apr-12      Jul-12   Oct-12   Jan-13 Apr-13      believe that global portfolio investors should make tail-risk
             CRB       AUD         SEK          GBP           CAD         NOK      PLN
                                                                                          hedges a part of their asset allocation decision. When risks are
Source: Morgan Stanley Research, Bloomberg
                                                                                          considered to be low, it is cheap to hedge against them. But,
Exhibit 12
                                                                                          more importantly, the era of low vol is also exactly the time
Correlations between Currencies, Commodities and                                          when the potential tail risks can do the most damage.
Euro
                                                                                          Exhibit 13
                   CRB          Food           Oil     Copper          Gold     Euro
AUD                0.66          0.46        0.58        0.72           0.04     0.49     Sell USD Put / PLN Call Spread Payoff Diagram
SEK                0.67          0.46        0.45        0.63          -0.14     0.75
GBP                0.66          0.71        0.43        0.70           0.24     0.62      5.0%
CAD                0.74          0.65        0.58        0.84           0.04     0.58
NOK                0.74          0.59        0.52        0.76           0.09     0.88      4.0%
PLN                0.82          0.71        0.47        0.83          -0.20    0.89
                                                                                           3.0%
Source: Morgan Stanley Research, Bloomberg
Of these currencies, the largest regression coefficient (that                              2.0%
is, the most commodity-sensitive currency) is PLN. This is                                 1.0%
quite surprising as Poland is a net commodity-importing
                                                                                           0.0%
country. However, correlation doesn’t mean causation and it
is quite likely that both variables are driven by a common                                 -1.0%
factor, say, expectations about future global economic                                     -2.0%
growth.                                                                                          3.15       3.2   3.25      3.3   3.35   3.4   3.45   3.5   3.55
                                                                                                   Payoff
This previous study used weekly data from January 1999 to                                 Source: Morgan Stanley Research
April 2013. Exhibit 11 shows the behavior of the CRB                                      Exhibit 14
commodity index and the above six currencies since April 8,                               Sell USD Put / NOK Call Spread Payoff Diagram
2011.
                                                                                           4.0%
Using the same data, we look at correlations between                                       3.5%
different commodity components and also the euro in Exhibit                                3.0%
12. PLN is the most correlated currency to CRB and Food,                                   2.5%
and the second-most correlated to copper. It is also the most                              2.0%

correlated currency against the euro, while NOK is the                                     1.5%
                                                                                           1.0%
second-most correlated currency against CRB and against
                                                                                           0.5%
the euro.
                                                                                           0.0%
Given that, in the near future, the biggest potential risks are                            -0.5%
arguably sell-offs in commodities and the euro, tail-risk                                  -1.0%
                                                                                                   5.7      5.8    5.9       6     6.1   6.2    6.3   6.4    6.5
hedges using these currencies should be attractive. One
                                                                                                   Payoff
alternative is to sell a 3m USD put / PLN call spread with
                                                                                          Source: Morgan Stanley Research
strikes at 3.5 and 3.3. This would earn an upfront premium of

                                                                                                                                                             21
                                                                             MORGAN STANLEY RESEARCH

                                                                             May 20, 2013
                                                                             Global EM Investor




EMFX: Sell ILS on Spikes
Meena Bassily, James Lord                                                     ILS has been the top-performing EM currency over the
                                                                              past six months, as investors have positioned for gas
     The Bank of Israel has cut rates and introduced a USD                   production in the Tamar gas field. As USD/ILS went through
      purchasing program designed to offset the balance-of-                   3.60, and the ILS basket (EUR, USD) neared 4.10 in early
      payments effect of rising domestic gas production.                      April, we saw the BoI begin to show more concern regarding
     While the scale of proposed interventions looks small                   the currency strength and its impact on competitiveness, and
      compared to prior periods of intervention, we think the policy          it purchased USD in small amounts on several occasions to
      proposals will be sufficient to end ILS outperformance.                 help stem the appreciation trend. This did not work, as the
     We see other reasons for ILS to start underperforming too,              market quickly tested the BoI’s willingness to prevent further
      including low CPI and as our economists see a risk of further           ILS strength.
      policy rate cuts.
                                                                              The BoI has taken a more aggressive stance, and we
     We recommend selling ILS versus EUR and USD on periods
                                                                              think that the market will pay attention: Last week, in an
      of ILS strength.
                                                                              unscheduled policy meeting, the BoI decided to cut rates by
                                                                              25bp and introduce a USD purchasing program designed to
List of EM interveners gets longer: Growth and trade have                     entirely offset the balance-of-payments effect of rising
remained weak across most EM economies, and on average                        domestic gas production on the exchange rate. The plan is to
inflation is falling. While EM currencies have generally                      buy about US$2.1 billion over the rest of 2013, covering 75%
performed badly versus USD, they have still appreciated in                    of the improvement in the current account it expects for this
trade-weighted terms this year. Currency resilience has in part               year (US$2.8 billion), considering the other effects on the
been driven by trends in G10 FX, but also by the influx of global             financial account from gas production (such as FX payments
liquidity and reallocation of portfolios into EM fixed income, and            by gas companies).
not by underlying fundamentals. This mismatch has prompted
several EM central banks to pursue policies geared to a weaker                Exhibit 2

exchange rate – be it via rate cuts, verbal intervention or direct            Proposed Interventions Lower than Before
intervention. This diverse array of central bank responses to
                                                                               4500                                                                        5.0
currency appreciation has been a key input in our currency                                USDmn                          ILS                 USD 2.1bn
                                                                               4000                                                          purchase      4.9
strategy this year, and the Bank of Israel (BoI) has been the                                                            Strength
                                                                               3500                                                           planned,     4.8
latest joiner to the group of interveners. As such, our trading
                                                                               3000                                                        averaged over   4.7
strategy on ILS has changed.                                                                                                                rest of year
                                                                               2500                                                                        4.6
Exhibit 1
                                                                               2000                                                                        4.5
ILS Has Been Outperforming for Some Time
                                                                               1500                                                                        4.4
 108                                                                   3.2     1000                                                                        4.3
 106                                                                            500                                                                        4.2
                                                                       3.4
 104                                                                                0                                                                      4.1
                                                                       3.6          Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
 102
                                                                                           BoI Intervention (LHS)                    ILS vs Basket (RHS)
 100                                                                   3.8
                                                                              Source: Morgan Stanley Research, Bloomberg, Bank of Israel
   98
                                                                       4.0
                                                                              Not a large amount of intervention, though the signal is
   96
                                                                       4.2    strong: The announced plan to buy US$2.1 billion over the
   94                                                                         rest of 2013 equates to an average purchase of US$262.5
   92                                                                  4.4    million per month for the remainder of the year. This looks
    Jan-09         Jan-10         Jan-11        Jan-12     Jan-13             small when compared to previous periods of intervention in
               ILS/EM                        USD/ILS (RHS, reversed)          2009/11; however, global macroeconomic conditions are
Source: Morgan Stanley Research, Bloomberg                                    very different now. Back then, ILS appreciation was linked to


                                                                                                                                                           22
                                                                                            MORGAN STANLEY RESEARCH

                                                                                            May 20, 2013
                                                                                            Global EM Investor




an upswing in global growth following the credit crisis,                                     0.8%Y for April (see Exhibit 3). Our economists see inflation
aggressive rate hikes by the BoI (275bp in total) and EM                                     pressures remaining subdued for the remainder of the year,
currencies in general appreciating strongly against USD.                                     and accordingly see scope for further rate cuts – which may
Clearly, ILS appreciation this time round is not linked to any                               be dependent on the level of ILS (for more on monetary
such dynamics – with global growth faltering, the BoI cutting                                policy, see again Israel Economics: Better Late than Never,
rates and EM currencies generally struggling against USD.                                    May 13, 2013). In addition, the change in governor over the
                                                                                             summer may bring about some uncertainty in the market,
Indeed, this past phase of ILS appreciation has been driven
                                                                                             though we do not see this as a major risk for the currency.
more explicitly by the expected impact of gas production on
Israel’s external accounts. Neutralize this and the                                          We recommend selling ILS versus EUR, USD on spikes:
outperformance of ILS should slow, in our view. This is what                                 All these factors, in combination with the strong performance
the BoI has done in planning to purchase US$2.1 billion;                                     and build-up in positioning on ILS over the past six months,
therefore, ILS outperformance should come to an end, in our                                  argue for further currency weakness, in our view. We believe
view.                                                                                        that investors should add to short positions in ILS into
                                                                                             strength. Our preferred way to position for ILS weakness is
Also, the BoI has stated that it will continue to operate
                                                                                             against the EUR, USD basket since the focus from the BoI
against fluctuations it deems as not being in line with
                                                                                             on economic conditions could mean interventions are more
fundamental economic conditions. This gives flexibility to the
                                                                                             closely tied to moves in the basket. We recommend selling
US$2.1 billion figure, and, as our economist Tevfik Aksoy
                                                                                             ILS on moves down to 4.15 on the basket, and 3.60 versus
points out (see Israel Economics: Better Late than Never,
                                                                                             USD.
May 13, 2013), the BoI can clearly buy more USD if it deems
it necessary and as it has done in the past. As such, we see                                 Exhibit 4
the latest moves by the BoI and the signal that it has                                       Trade Balance and Gas Impact
communicated as sufficient, and we think that the market will
                                                                                               60                                                           8%
take this move more seriously. As such, we expect to see                                             12m rolling, USDbn
gradual weakness in ILS versus the basket from here.                                           40                                                           7%

                                                                                               20                                                           6%
Exhibit 3
                                                                                                                                                            5%
Inflation Running below Target Band                                                             0
                                                                                                                                                            4%
  6                                                                                           -20
                                                                                                                                                            3%
  5                                                                                           -40
                                                                                                                                                            2%
                                                                  BoI Target
  4                                                                                           -60                                                           1%
                                                                    Band
  3                                                                                           -80                                                 0%
  2                                                                                                 00 01 02 03 04 05 06 07 08 09 10 11 12 13
  1                                                                                                  Total Fuel Imports      Total Imports exFuel
                                                                                                     Total Exports           Fuel Imports, %GDP (RHS)
  0
                                                                                             Source: Morgan Stanley Research, Bloomberg, Haver Analytics
 -1
                                                                                             Not all bad news for ILS: Clearly, gas production has the
 -2
                                                                                             scope to have other positive effects on ILS in the medium
  Jan-06             Jan-08              Jan-10               Jan-12
                                                                                             term. To name but a few, the build-up in FX reserves from
        Israel inflation y/y %                               Avg of inflation forecasts 1
                                                                                             USD purchases and the formation of a SWF (expected in
        MS 2013 end of year forecast
                                                                                             2018) help to improve Israel’s external vulnerability metrics
Source: Morgan Stanley Research, Bloomberg, Bank of Israel
                                                                                             somewhat, which is ILS positive from a credit risk point of
Subdued inflation also argues for a weaker ILS: There                                        view. Indeed, greater predictability of energy supply and
are other factors that may put ILS under some pressure over                                  current account improvements formed part of the rationale
the coming months. For the first time since 2007, CPI has                                    for Fitch’s recent affirmation of Israel’s local currency rating
breached the lower end of the BoI’s target band, printing at                                 at A+ with stable outlook.




                                                                                                                                                           23
                                                                                                    MORGAN STANLEY RESEARCH

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                                                                                                    Global EM Investor




EM Strategy and Economics Teams
EM Fixed Income and Foreign Exchange Strategy
New York
Rashique Rahman                  Team Head, EM Macro Strategy                     Rashique.Rahman@morganstanley.com                                    +1 212 761 6533
Juha Seppala                     Global FXEM Quantitative Strategist              Juha.Seppala@morganstanley.com                                       +1 212 761 1949
Robert Habib                     EM Strategy                                      Robert.Habib@morganstanley.com                                       +1 212 761 1875
London
Paolo Batori, CFA                European Head of EM Strategy                     Paolo.Batori@morganstanley.com                                       +44 (0)20 7677 7971
                                 & Global Head of Sovereign
                                 Credit Strategy
Vanessa Barrett                  Chief EM Credit Strategist                       Vanessa.Barrett@morganstanley.com                                    +44 (0)20 7677 9569
Mihail Bozinov                   CEEMEA Rates Strategy                            Mihail.Bozinov@morganstanley.com                                     +44 (0)20 7677 1150
James Lord                       CEEMEA Macro Strategy                            James.Lord@morganstanley.com                                         +44 (0)20 7677 3254             +44 (
Kristina Obrtacova               EM Corporate Credit Strategy                     Kristina.Obrtacova@morganstanley.com                                 +44 (0)20 7677 7597
Robert Tancsa                    Sovereign Credit Strategy                        Robert.Tancsa@morganstanley.com                                      +44 (0)20 7677 6671
Simon Waever                     Credit Relative Value, EM Analytics              Simon.Waever@morganstanley.com                                       +44 (0)20 7425 1640
Meena Bassily                    CEEMEA Macro Strategy                            Meena.Bassily@morganstanley.com                                      +44 (0)20 7677 0031
Hong Kong
Viktor Hjort                     Head of AXJ Credit Strategy/                     Viktor.Hjort@morganstanley.com                                       +852 2848 7479
                                 Fixed Income Research
Nishant Sood                     AXJ Credit Strategy                              Nishant.Sood@morganstanley.com                                       +852 2239 1597
Kritika Kashyap                  AXJ Rates Strategy                               Kritika.Kashyap@morganstanley.com                                    +852 2239 7179
EM Economics
Manoj Pradhan                    Global                                           Manoj.Pradhan@morganstanley.com                                      +44 (0)20 7425 3805
Tevfik Aksoy                     Head of CEEMEA Economics                         Tevfik.Aksoy@morganstanley.com                                       +44 (0)20 7677 6917
                                 / Turkey, Israel
Michael Kafe                     South Africa, Nigeria, Ghana, Kenya              Michael.Kafe@morganstanley.com                                       +27 11 587 0806
Andrea Masia                     South Africa, Nigeria, Kenya                     Andrea.Masia@rmbmorganstanley.com                                    +27 11 282 1593
Pasquale Diana                   Poland, Hungary, Czech, Romania                  Pasquale.Diana@morganstanley.com                                     +44 (0)20 7677 4183
Jacob Nell                       Russia, Kazakhstan, Ukraine                      Jacob.Nell@morganstanley.com                                         +7 495 287 2134
Alina Slyusarchuk                Russia, Kazakhstan, Ukraine, Baltics             Alina.Slyusarchuk@morganstanley.com                                  +44 (0)20 7677 6869
Gray Newman                      LatAm                                            Gray.Newman@morganstanley.com                                        +1 212 761-6510
Luis Arcentales                  Chile, Mexico                                    Luis.Arcentales@morganstanley.com                                    +1 212 761-4913
Arthur Carvalho                  Brazil                                           Arthur.Carvalho@morganstanley.com                                    +55 11 3048 6272
Daniel Volberg                   Argentina, Colombia, Peru, Venezuela             Daniel.Volberg@morganstanley.com                                     +1 212 761-0124
Helen Qiao                       China                                            Helen.Qiao@morganstanley.com                                         +852 2848 6511
Sharon Lam                       Korea, Taiwan                                    Sharon.Lam@morganstanley.com                                         +852 2848 8927
Yuande Zhu                       China, Hong Kong                                 Yuande.Zhu@morganstanley.com                                         +852 2239 7820
Yin Zhang                        China                                            Yin.Zhang@morganstanley.com                                          +852 2239 7818
Jason Liu                        Korea, Taiwan                                    Jason.JL.Liu@morganstanley.com                                       +852 2848 6882
Chetan Ahya                      Asia ex-Japan, India                             Chetan.Ahya@morganstanley.com                                        +852 2239 7812
Deyi Tan                         ASEAN                                            Deyi.Tan@morganstanley.com                                           +65 6834 6703
Seen Meng Chew                   ASEAN                                            Seen.Meng.Chew@morganstanley.com                                     +65 6834 6739
Derrick Kam                      Asia ex-Japan                                    Derrick.Kam@morganstanley.com                                        +852 2239 7826
Jenny Zheng                      Asia ex-Japan                                    Jenny.L.Zheng@morganstanley.com                                      +852 3963 4015
Upasana Chachra                  India                                            Upasana.Chachra@morganstanley.com                                    +91 22 6118 2246

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– Morgan Stanley C.T.V.M. S.A.; Russia – OOO Morgan Stanley Bank.




                                                                                                                                                                                         24
                                                                                MORGAN STANLEY RESEARCH

                                                                                May 20, 2013
                                                                                Global EM Investor




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stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended



                                                                                                                                                    25
                                                                                              MORGAN STANLEY RESEARCH

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                                                                                              Global EM Investor




relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy
recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

                              Coverage Universe    Investment Banking Clients (IBC)
                                             % of                   % of % of Rating
Stock Rating Category            Count       Total     Count Total IBC Category
Overweight/Buy                   1034           36%           399          39%           39%
Equal-weight/Hold                1250           44%           479          47%           38%
Not-Rated/Hold                    105            4%            27           3%           26%
Underweight/Sell                  473           17%           123          12%           26%
Total                           2,862                        1028
Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual
circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan
Stanley received investment banking compensation in the last 12 months.
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BRAZIL, GOVERNMENT OF MALAYSIA, HUNGARY, NATIONAL COMPANY KAZMUNAYGAS JSC, REPUBLIC OF CHILE, REPUBLIC OF CROATIA, REPUBLIC OF
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                                                                                                                                                                              26
                                                                                           MORGAN STANLEY RESEARCH

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                                                                                           Global EM Investor




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Cc/wn/po/sm/jf0520




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                                                         MORGAN STANLEY RESEARCH




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Description: Dollar Dominance