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Financial Pacific: Emerging Market Credit (third party), december 14.2010
 

Financial Pacific: Emerging Market Credit (third party), december 14.2010

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    Financial Pacific: Emerging Market Credit (third party), december 14.2010 Financial Pacific: Emerging Market Credit (third party), december 14.2010 Document Transcript

    • MORGAN STANLEY RESEARCH Morgan Stanley & Co. Regis Chatellier International plc+ Regis.Chatellier@morganstanley.com +44 (0)20 7677 6982 EM Strategy AXJ Strategy EM Economics November 30, 2010Global EM Credit Portfolio Exhibit 2 Sovereign & Corporate EM Portfolio: Risk Exposure Beta Exposure Spread Exposure EM Credit View 1.05 1.03 15 10bp We believe that sovereign risk concerns in the EU 5 1.00 will sustain volatility in the near term, but eventually -5 give way to a path of EM spread compression in 0.95 -15 1Q11. Global and EM macro momentum has turned Source: Morgan Stanley Research more favourable, which should support the market – along with what we believe will be robust fund Exhibit 3 inflows and ongoing support of QE by the Fed. EM Model Portfolio: Top Changes Technical positioning is overall benign, with EM- Monthly Changes in Country Allocation dedicated investors remaining overweight investment grade credits. Although the primary Poland 0.6% market is likely to remain active, new supply should be easily absorbed by strong inflows. Ex posure Kazakhstan 0.6% Increase Exhibit 1 Venezuela 0.6% EM Spread* 3-Month Forecast (bp) Chile -0.4% 380 360 Malay sia -0.4% 340 320 303 Panama -0.4% 300 Decrease Brazil -0.4% 280 Ex posure 260 Bulgaria -0.4% 240 240 220 Turkey -0.4% 200 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Oct-10 Nov -10 Jan-11 Feb-11 South Africa -0.9% 90% 70% 30% confidence interv al Source: Morgan Stanley Research Source: Bloomberg, Morgan Stanley Research; *EMBI Global spread EM Model Portfolio Positioning The model portfolio is a hypothetical portfolio and is not intended to reflect actual trading performance. We remain overweight high-beta credits and favour the CEEMEA region. We increase our exposure to Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As Venezuela, Kazakhstan and Poland, which become a result, investors should be aware that the firm may the most overweight credits along with Argentina have a conflict of interest that could affect the and Hungary. objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a We reduce further our exposure to low-beta single factor in making their investment decision. countries, Chile, Panama and Malaysia remaining our most underweight credits. We also decrease our For analyst certification and other important disclosures, refer to the Disclosure Section, exposure on Turkey and South Africa. located at the end of this report. We add duration exposure as we see curves bull- += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on flattening in the coming months. communications with a subject company, public appearances and trading securities held by a We continue to see value in the Oil & Gas sector. research analyst account.
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioTable of ContentsOutlook, Technicals and Valuations_______________________________________________________EM Market Outlook 4Credit Portfolio 6Curve Monitor 7EM Return versus Risk 8CDS SovRank Model 9Fund Flows 11Cross-Market Monitor 12EM Technicals 13Primary Market 14Bond Payments 15CDS Market 16Credit Views 17_______________________________________________________Sector Views_______________________________________________________Quasi-Sovereign Model 40Oil & Gas Sector 41Appendix 43 2
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioMarket Assessment Country Assessment – Investment Grade Fundamentals Technicals Valuations Market View BBB Credits Fundamentals Technicals Valuations Credit ViewMarket Brazil (BBB-) Bulgaria (BBB-) Hungary (BBB)Country Assessment – Sub-Investment Kazakhstan (BBB-)Grade Lithuania (BBB)Single B Credits Fundamentals Technicals Valuations Credit View Mexico (BBB)Argentina (B) Panama (BBB-)Venezuela (B+) Peru (BBB-)BB Credits Fundamentals Technicals Valuations Credit View Russia (BBB)Colombia (BB+) South Africa (BBB+)Indonesia (BB) Single A Credits Fundamentals Technicals Valuations Credit ViewPhilippines (BB) Chile (A+)Romania (BB+) Korea (A+)Turkey (BB) Malaysia (A-) Poland (A-)Legend:Fundamentals Positive Negative NeutralTechnicals Positive Negative NeutralValuations Cheap Rich FairCredit View Outpeform ++ Outperform + Neutral Underpeform - Underpeform - - 3
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioEM Credit Market Outlook We believe that sovereign risk concerns in peripheral The pressure for upgrades remains in place for the majority of Europe will sustain volatility in the near term but EM countries (see our SCRM model, Exhibit 14 on page 9). eventually give way to a path of EM spread Indeed, Fitch’s revision of Turkey’s outlook to positive on its compression in 1Q11. BB+ rating is in line with our SCRM rating of BBB- for the credit. Global macro momentum has turned more Exhibit 4 favourable, which should support the market along Macro Fundamentals Turning Positive with robust fund flows and QE measures. MDTI Index* Technical positioning is still benign overall, though 100 notably exposure levels have increased; EM 90 dedicated investors maintain their overweight 80 position in investment grade credits. 70 60 The primary market is likely to remain very active but 50 strong fund flows and large coupon payments should 40 largely contribute to absorb new supply. 30 20 We continue to overweight high-beta credits and the 10 CEEMEA region based on more attractive valuations 0 and a medium-term constructive view of the market. Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 We extend duration exposure and we see the market Global AXJ CEEMEA Latin America rallying into early next year. Source: Morgan Stanley Research; *See Appendix The Oil & Gas sector brings substantial alpha versus So why the recent sell-off? As we highlighted, positioning sovereigns and should better capture EM value. deteriorated in the run-up to the November FOMC meeting in anticipation of the announcement of additional QE. So, weTail risks in the EU should take time to affect core Europe have endured a technical correction. This reassessment wasand credit markets in general. The recent turbulence also integral to our rationale for a short-term correction, withsurrounding the bailout of Ireland has triggered a sell-off, in the EMBI spread widening to the 300bp area (see again EMline with our prior month’s forecast (see EM Credit Portfolio, Credit Portfolio). Although the long-term impact on the US realOctober 29, 2010). Given the size of the Irish and Portuguese economy of additional QE is unclear, the vast amount ofeconomies, however, we believe that the problem is still liquidity should help to anchor long-term US yields and in themanageable (at least at this point) should policy-makers process help to benefit risky assets.respond in kind, and the impact on the credit market should inthat case eventually subside. In fact, this structural risk is That said, the EU sovereign risk saga could continue tolikely to take time to permeate core Europe, the market going weigh on investors’ sentiment in the very short term; wethrough different phases of optimism and pessimism in that see EM spread trading in a wide range around 300bp in therespect. As the bailout of peripheral Europe (in this case next few weeks. As the situation stabilises in Europe,Ireland and potentially Portugal) is implemented, investors’ however, the market should rebound and rally moreconfidence should resurface – if only for a time. consistently until early next year; our 3-month spread forecast is 240bp for the EMBI Global (see Exhibit 1).Macro momentum and QE measures by the Fed shouldsupport the market. After consistently moderating for about During most of the year, the performance in EM credit wasa year due to a weak global growth impulse, momentum in largely driven by US Treasuries. Going forward, they shouldmacro fundamentals is finally reversing to positive (see play a relatively modest role in EM performance; as US ratesExhibit 4). Moreover, we reiterate that EM fundamentals – remain relatively low due to QE measures, the bulk of the EMgrowth, fiscal and debt dynamics – remain more favourable performance should come from spread compression (fuelledthan for the majority of DM countries. by both QE and fund flows) and carry. 4
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioStill-benign overall market technicals. Although hard On average, CEEMEA countries are overweight by 0.4% incurrency funds registered outflows in the last couple of weeks, our portfolio, compared to an average underweight of 2.7% forand as a result exposure has increased, overall risk exposure Latin America and 1.2% for Asia. Note that two countries ofremains benign (see Exhibit 5). Despite being overweight the CEEMA region are substantially underweight in oursome high-beta credits (notably Argentina), EM funds are still portfolio: Turkey and South Africa, which brings down thelargely overweight investment grade credits (around 7% average overweight for the CEEMEA region.overweight versus benchmark), making the aggregate Exhibit 6exposure close to neutral. SovRank* Model: CEEMEA Cheap to Other RegionsExhibit 5 HUNRelatively Modest Risk Exposure 400EMEI* Beta Exposure Index 350 Rom 300 100 LITH CRO Bul . 250 5-year CDS (bp) 90 Rus Kaz India 200 POL 80 Soaf INDO Per COL 70 150 Turk PHI 60 Mex Bra 100 50 Mal PAN Thai 50 40 30 0 20 A A- BBB+ BBB BBB- BB+ BB BB- Average Rating (Moodys, S&P, Fitch) 10 0 Source: Morgan Stanley Research; *See Appendix 01-Jan 01-Mar 01-May 01-Jul 01-Sep 01-Nov EMEI EMEI-HC EMEI-LC We extend duration to be overweight the 20/30-year sector. Curves have largely steepened in the last few weeks.Source: Morgan Stanley Research; *See Appendix As the rally materialises, however, curve should largely bull-Besides, the market should benefit from a strong seasonality flatten. Given the steepness of the US Treasury curve, thefactor which typically sees strategic allocations into the asset 20/30-year sector is also where most of the carry remains.class taking place in 4Q/early 1Q. Arguably, the last two We continue to like the Oil & Gas sector, the latter offeringweeks have seen outflows for hard currency (credit) funds, substantial pick-up versus sovereigns, a strong argument forbut the fact that local currency funds are still posting positive investors trying to capture extra yield. Our view is that Oil &numbers is a gauge that the risk appetite for EM is still there. Gas companies are particularly well poised to capture theWe continue to see the primary market as particularly value of EM (see page 41).active during 1Q10 as US Treasury yields trade near tohistorical lows. Amortisations for the next three months reach On the month, the MS model portfolio outperformed theUS$13.7 billion, which should fuel further bond issuance. EMBI Global benchmark by 52bp (see page 7).However, this new supply should be easily absorbed by themarket as investors are expected to receive US$21 billion ofcoupon payments, i.e., 50% more than the amortisationscoming due.Compelling valuations in high-beta names and CEEMEAsovereigns. Given its proximity with the euro-zone, theCEEMEA region has largely underperformed this year.Arguably, fundamentals are a bit weaker than for LatinAmerica and Asia. However, as suggested by our SovRankmodel (see Exhibit 6), such a discount versus other regions isdisproportionate. As tensions become subdued in the EU inthe coming weeks, the CEEMEA region should largelyoutperform. 5
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioEM Credit PortfolioThe recommended sovereign portfolio allocation reflects Exhibit 7our relatively benign view on EM credit until early next Morgan Stanley Portfolio Risk Exposureyear. Beta Exposure Spread ExposureWe believe that the situation in Europe should stabilise, 15 10bp 1.05 1.03and we take this opportunity to increase exposure on 5high-beta credit and extend duration. 1.00 -5The beta of the portfolio versus EMBIG index is 1.03 for a -15 0.95weighted average spread of 314bp (11bp higher than thecurrent EMBIG level). Source: Morgan Stanley ResearchThe proposed allocation continues to favour CEEMEA, whichtrades largely cheap to other regions (see our SovRank model Exhibit 8on page 9). Morgan Stanley Portfolio Allocation (Overweight/Underweight versus EMBIG)Apart from Argentina and Hungary, which were the twobiggest overweight credits in our previous allocation, we Argentina (B) 1.3%increase our exposure to Venezuela as the recent sell-off Hungary (BBB) 1.3%offers a good opportunity to gain high-beta exposure at cheaplevels – note in this respect that our increase in exposure to Kazakhstan (BBB-) 1.3%Venezuela is purely tactical as we remain cautious on the 1.3% Venezuela (B+)long-term perspective of the credit). Romania* (BB+) 0.8%We also increase our exposure to Kazakhstan and Poland. Overweight Indonesia (BB) 0.8%These two credits have consistently underperformed the indexin the last few months and risk/reward on these two countries Lithuania (BBB) 0.8%has become very compelling, in our view. Poland (A-) 0.8%We maintain a large overweight on Hungary. The latest Russia (BBB) 0.8%measures from the government regarding the pension system Bulgaria (BBB-) 0.3%could bring some concerns in the longer term. In the shortterm, however, these measures should bring considerable Korea* (A+) 0.0%savings for the government. Mexico (BBB) -0.2%We increase our underweight exposure to low-beta credits, in Peru (BBB-) -0.2%particular Chile, Malaysia and Panama. These three credits Philippines (BB) -0.2%should largely underperform the index as spreads on higher- Brazil (BBB-) -0.7%beta names tighten in the coming months. Colombia (BB+) -0.7% UnderweightWe also reduce our exposure to South Africa and Turkey.These two low-beta countries have largely outperformed the South Africa (BBB+) -1.2%market in the recent months and valuations have become Turkey (BB) -1.2%unattractive, in our view. Chile (A+) -1.7% Malaysia (A-) -1.7% Panama (BBB-) -1.7% Underweight Overweight Source: Morgan Stanley Research *Off-index 6
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioOn the curve-positioning side, we extend duration to Exhibit 10become overweight the 30-year sector. Curve Attractiveness by Maturity BucketCurves have dramatically steepened (especially in yield (See legend at the bottom of the chart)terms), making the long end more attractive. Moreover, Short End Belly Long Endlong-dated bonds should outperform in cash terms in arally scenario.We largely overweight the long end of Indonesia. We believe Argentinathat the curve should normalise as the 10y30y slope flattens Brazilvery substantially. BulgariaBroadly speaking, the 20y-30y maturity bucket is overweight Chilein our portfolio, including Argentina, Brazil, Colombia, Mexico, Colom biaPeru, the Philippines, Russia, Turkey and Venezuela. Hungary USDHowever, we believe that there is still substantial value in the Hungary EURshort end for high-beta credits, in particular Argentina,Hungary and Lithuania. The spread curves of these Indonesiacountries should disinvert in the coming months, at least Kazakhstan*partially. KoreaThe belly is quite attractive for two particular countries: Lithuania USDRussia and Poland. The 5y10y slope has massively Lithuania EURsteepened in the recent weeks (both in yield and spreadterms), making the 10Y quite attractive at current levels. Note Malaysiathe particular case of the Russia 2030 benchmark, which Mexicoshould perform particularly well. Panam a PeruMS Portfolio Performance versus EMBI Global PhilippinesBased on our previous portfolio allocation (see EM Credit Poland USDPortfolio, October 29, 2010), we outperformed the EMBIGlobal benchmark by 52bp on the month, 3bp due to country Poland EURallocation and 49bp due to curve allocation – see below. Rom ania EURExhibit 9 RussiaMS Portfolio Month-to-Date Performance South AfricaBreakdown Credit Allocation vs. Duration Allocation Turkey Venezuela Total 52bp Country 3bp Curve Very High Medium Very Low Attractiveness Duration 49bp High Low N/A 0 10 20 30 40 50 60 Source: Morgan Stanley Research; *5Y CDS for Kazakhstan assessmentSource: Morgan Stanley Research 7
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit Portfolio EM Return versus RiskExhibit 11 Exhibit 12 Exhibit 13Month-to-Date Index Return Month-to-Date Return vs. Risk MS Portfolio Excess Return*(Percentage) (MTD Return, beta-adjusted, %) (Month-to-date, bp) Composite -1.9% Composite -1.9% Total Portfolio 2.5 Bulgaria (BBB-) +0.7% Bulgaria (BBB-) +2.8% Panama 5.3 Malay sia (A-) -0.0% Malay sia (A-) -0.0% Colombia 2.4 Chile (A+) -0.6% Argentina (B) -0.9% Peru 1.3 Philippines (BB) -0.7% Turkey (BB) -1.0% Turkey 1.0 Lithuania (BBB) -1.1% Philippines (BB) -1.1% Mex ico 1.0 Turkey (BB) -1.1% Lithuania (BBB) -1.2% Chile 0.9 Kazakhstan (BBB-) -1.3% Chile (A+) -1.2% Brazil 0.8 Indonesia (BB) -1.5% Venezuela (B+) -1.3% South Africa 0.7 Russia (BBB) -1.7% Indonesia (BB) -1.7% South Africa (BBB+) -1.9% South Africa (BBB+) -1.9% Philippines 0.3 Poland (A-) -1.9% Russia (BBB) -2.0% Bulgaria 0.3 Brazil (BBB-) -2.3% Brazil (BBB-) -2.4% Malay sia 0.0 Argentina (B) -2.3% Mex ico (BBB) -2.7% Poland -0.4 Hungary (BBB) -2.9% Poland (A-) -2.7% Kazakhstan -0.9 Venezuela (B+) -3.0% Colombia (BB+) -3.0% Russia -1.2 Colombia (BB+) -3.1% Hungary (BBB) -3.1% Indonesia -1.2 Mex ico (BBB) -3.1% Kazakhstan (BBB-) -3.3% Lithuania -1.3 Panama (BBB-) -4.2% Panama (BBB-) -3.5% Argentina -1.3 Peru (BBB-) -4.4% Peru (BBB-) -3.6% Venezuela -2.0 Hungary -3.3 -6% -4% -2% 0% 2% -5% -3% -1% 1% 3% 5% -6 -4 -2 0 2 4 6Source: Bloomberg, Morgan Stanley Research Source: Morgan Stanley Research Source: Morgan Stanley Research *Excluding duration impact 8
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioSovRank Credit ModelExhibit 14 Exhibit 15Sovereign Credit Rating Model (SCRM*) 5Y CDS Z-Scores versus Global Credit Curve* Turkey Poland Hungary Hungary Israel Croatia Lithuania Chile Poland Indonesia Mexico Argentina Venezuela Israel China Malaysia -2 -1 0 1 2 -2 -1 0 1 2 3Source: Morgan Stanley Research; *See Appendix Source: Morgan Stanley Research; *CC-MR Model. *See AppendixExhibit 16SovRank* Credit Model 400 HUN Legend: 350 CHEAP + Cheap - RICH + Rich - Rom 300 LITH Cro Bul 250 Ita 5-year CDS (bp) . Kaz 200 India Rus Pol Soaf INDO 150 Per COL Turk Kor ISR PHI M ex Bra 100 Fra Aut QAT CHILE Thai PAN Uk Mal China Czh 50 Ger Aus Jap Swd 0 AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ Average Rating (Moodys, S&P, Fitch)Source: Morgan Stanley Research; *See Appendix 9
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioEM Curve MonitorExhibit 17 Exhibit 2010-Year EM Yield and Z-Spread Composites 10-Year Bond Z-Spread Level per Country (bp) 400 10Y Bond Z-spread Comp. 6.6 240 1 month ago RUS 10Y Bond Yield Comp. (RHS) 220 10Y Z-spread 350 6.1 POL 200 300 5.6 180 TURK 160 COL SOAF 250 5.1 INDO MEX PER 140 PAN PHI BRA 120 200 4.6 9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov 100Source: Morgan Stanley Research Source: Morgan Stanley ResearchExhibit 18 Exhibit 21Yield 10s30s and 5s10s Bond Slopes (bp) Z-Spread 10s30s and 5s10s Bond Slopes (bp) 150 240 50 10s30s Z-Spread Slope 30 10s30s Yield Slope 5s10s Yield Slope (RHS) 45 5s10s Z-Spread Slope (RHS) 25 140 230 40 20 130 220 35 15 120 210 30 10 110 200 25 5 100 190 20 0 90 180 15 -5 9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov 9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-NovSource: Morgan Stanley Research Source: Morgan Stanley ResearchExhibit 19 Exhibit 2210s30s Bond Slopes (Z-Spread Differential, bp) 5s10s Bond Slopes (Z-Spread Differential, bp) 70 50 1 month ago 1 month ago PHI MEX INDO BRA 5Y -10Y Slope 10Y -30Y Slope 40 PHI 60 SOAF PAN MEX 30 BRA COL PER COL RUS 50 TURK 20 HUN PER 40 TURK RUS 10 INDO 30 0 PAN 20 -10 POL 10 -20 0 -30 Source: Morgan Stanley ResearchSource: Morgan Stanley Research 10
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioFund Flows Exhibit 24Hard currency funds saw consecutive outflows, while EM Debt Fund Flows versus EM Equitiesinflows into local currency funds continue. EM credit (Weekly data, % of assets under management)funds (dedicated hard currency debt funds) had moderatedinflows early this month and saw back-to-back outflows in the 2.5% EM Debt-dedicatedlast two weeks, as returns have started to diminish lately. 2.0% EM EquitiesLocal currency funds, however, have continued to receive 1.5%inflows and the weekly average inflow is now close to US$400 1.0%million. Year to date, cumulative hard currency flows are 0.5%positive for 22.2% of assets under management (AUM),compared to a whopping 98.2% for local currency. Hard and 0.0%local currency combined, EM debt funds’ YTD fund flows have -0.5%reached 48.1% of asset under management (source: EPFR). -1.0% Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10EM hard currency fund flows are moving in tandem withhigh yield. The strong correlation between EM hard currency Source: EPFRand high yield fund flows remains in place even in weakerperiods, as both have registered outflows lately. Flows into Exhibit 25EM equity funds have also shown signs of moderation, but EM Debt Fund Flows versus High Yield Fundsoutflows remain yet to be seen. In fact, they have recorded (Weekly data, % of assets under management)positive flows for 26 consecutive weeks, which is the longeststreak on record. 3.0% EM Debt-dedicatedInvestors seem to be more wary of risky assets. Moderate High Yield 2.0%outflows followed by inflows into money market funds suggesta shift from riskier assets in EM and high yield funds towards 1.0%safer instruments. These movements are likely to reflect an 0.0%overall more cautious stance by investors (see Exhibit 23).We think that this is related to a market pullback and -1.0%hence will be temporary in nature, and expect further -2.0%inflows into year-end and early 2011. Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10 Source: EPFRExhibit 23 Exhibit 26Hard, Local and Mixed Currency Fund Flows EM Debt Fund Flows versus Money Market Funds(Weekly data, % of assets under management) (Weekly data, % of assets under management) 2.5% EM Debt Blend CCY EM Debt-dedicated 3.0% 2.0% EM Debt Local CCY Money Market 2.0% EM Debt Hard CCY 1.5% 1.0% 1.0% 0.0% 0.5% -1.0% 0.0% -2.0% -0.5% -3.0% -1.0% Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10 Feb-10 Mar-10 Apr-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov -10Source: EPFR Source: EPFR 11
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioCross-Market MonitorEroding EM credit returns first due to the widening in US Exhibit 28Treasury yields… EM credit returns have dropped by EM CDX Spread (bp) versus MSCI EMalmost 2% on the month after a stunning performance earlierthis year. Interestingly, as the higher returns were mainly 1200 MSCI EM 0driven by the unprecedented tightening in US Treasury 1150 CDX EM Spread (RHS, rev ersed) 50yields, the turning point has also been triggered by 1100 100Treasuries. Post-FOMC Treasury yields have climbed higher R²=73%and returns have dropped by 1.6% over the past few weeks. 1050 150Nevertheless, EM credit has underperformed Treasuries by 1000 200roughly 40bp. 950 250…and due to intensifying risk-aversion lately. With 900 300European peripheral issues getting back into the spotlight, 850 350risky assets in general have been hit by the latest bout of 07-Jun 05-Jul 02-Aug 30-Aug 30-Sep 28-Oct 25-Novrisk-aversion. This has sparked a decline not only in EMcredit but also in EM equities (see Exhibit 28). However, EM Source: Bloombergequities have closed the month with a moderate decline, Exhibit 29MSCI EM dropping by 0.61%. The outperformance of the EM CDX Spread versus CDX High Yield (bp)equity market can be explained by the muted impact of USTreasury yield widening in the first half of the month, while 720 CDX HY Spread 450 R²=81%bonds have suffered more. CDX EM Spread (RHS) 670 400The correlation between high yield and EM credit 620 350spreads remains strong. The strong relationship betweenEM credit and high yield remains firm, not only with regards 570 300to fund flows (see page 11), but also in terms of price action. 520 250Correlation between spreads in the two asset classes is 83%in the last six months, somewhat lower than last month as 470 200volatility has picked up in the past few weeks (see Exhibit 420 15029). On the month, CDX EM underperformed CDX HY as 7-Jun 5-Jul 2-Aug 30-Aug 1-Oct 29-Oct 29-Novspreads widened by 19bp and 14bp, respectively. Source: BloombergExhibit 27 Exhibit 30EMBIG Return vs. US Treasury Return* (Based 100) EM Spread versus 10Y US Treasury Yield 3.7 R²=38% 380 115 R²=92% UST Return 3.5 360 UST 10Y Yield EMBIG Return 110 3.3 EM Spread (RHS) 340 3.1 320 105 2.9 300 2.7 280 100 2.5 260 95 2.3 240 4-Jun 2-Jul 2-Aug 30-Aug 28-Sep 27-Oct 29-Nov 4-Jun 2-Jul 2-Aug 30-Aug 28-Sep 27-Oct 29-NovSource: Bloomberg; *IBoxx 7-10Y total return index Source: Bloomberg 12
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit Portfolio EM Technicals Gross nominal exposure of EM hard currency debt funds has Argentina remains the biggest overweight credit (both in risen by 18.6% on a compounded basis over the last four cash and risk exposure terms). Exposure to this country has months (versus 24.6% for local currency funds; source: risen back to levels last seen two years ago. By contrast, EPFR). Hard currency fund exposure versus benchmark has Turkey and the Philippines remain the biggest underweight. also risen, climbing back towards neutral from underweight Over the last three months, Turkey is by far the country (see Exhibit 31). This shows that investors’ risk appetite for showing the biggest rise in exposure (+1.1%). The largest the asset class is still there. decreases in exposure over the period are Indonesia On an aggregate basis, however, cash balances have risen (-0.71%), Mexico (-0.58%) and Hungary (-0.54%). to 5.1% of assets under management (0.3% below the long- Year to date, EM hard currency funds have returned over term average), due to the accumulation of inflows. 13%, outperforming their index by 50bp on aggregate. Exposure to EM IG credits has increased to 7.2% overweight See Market Technical Watch: Volatility Driving Exposure from 7.0% – on aggregate, investment grade credits Lower, November 25, 2010, for the full report. (excluding cash balances) represent nearly 62% of the market value of EM fund’s portfolios.Exhibit 31 Exhibit 33EMEI Beta Risk Exposure Index vs. Benchmark* EM Funds YTD Excess Return (Alpha) vs. Benchmark 100 450 90 400 80 350 70 300 60 250 50 200 40 150 30 100 20 50 10 0 0 -50 01-Jan 01-Mar 01-May 01-Jul 01-Sep 01-Nov 01-Jan 01-Mar 01-May 01-Jul 01-Sep 01-Nov EMEI EMEI-HC EMEI-LC EM Alpha Hard Ccy Alpha Local Ccy AlphaSource: Morgan Stanley Research *See Appendix Source: Morgan Stanley ResearchExhibit 32 Exhibit 34Exposure by Rating Category (% AUM) EM Funds’ Cash Balances (% AUM) +10.0% 9% BBB +7.5% BB 7.2% 8% B +5.0% 7% +2.5% 0.0% 6% -1.8% -2.5% 5% -5.0% -5.4% -7.5% 4% -10.0% 3% Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10Source: EPFR, Morgan Stanley Research Source: EPFR, Morgan Stanley Research 13
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioPrimary Market As of November 29, total YTD EM bond issuance Exhibit 35 reached US$288 billion, US$70 billion higher than the EM Gross Bond Issuance (US$ billion) total amount issued for the whole of 2009. So far this year, net supply has amounted to US$200 288 billion, nearly 40% higher than the peak of 2007. 218 The primary market should continue to be particularly 189 165 171 active; however, this should be easily absorbed by 132 coupon payments and strong fund flows. 108 94 55After US$39 billion issued in October 2010, November sawanother US$28 billion of EM bonds issued in the market, 2002 2003 2004 2005 2006 2007 2008 2009 2010putting YTD total issuance at US$288 billion, US$70 billion YTDhigher than the total amount issued for the whole of 2009.YTD net supply (gross issuance, less amortisations) has Source: Bond Radarreached US$200 billion, US$56 billion higher than thr 2007 Exhibit 36record of US$144 billion. Net Supply by Sector (US$ billion)Corporates (including banks and quasi-sovereign names) 147.0have issued US$202 billion over the period, compared to 134.7 SovereignsUS$87 billion for sovereigns. This represents net supply of CorporatesUS$147 billion and US$54 billion, respectively. 89.8Per region (sovereigns and corporates combined), CEEMEAhas once again largely dominated the EM primary market 53.5 46.4this year (US$128 billion), followed by Latin America (US$86 25.6billion) and Asia (US$74 billion). The traditional big issuers, 9.4 9.4including Brazil (US$37 billion), Russia (US$29.4 billion),Mexico (US$25.3 billion), Korea (US$17.0 billion) and Poland 2007 2008 2009 2010 YTD(US$11.9 billion), led the pack. Source: Bond Radar, Morgan Stanley ResearchThe primary market is likely to continue to be very active, at Exhibit 37least until the beginning of next year. In fact, bond Monthly Net Supply (US$ billion)amortisations for the next three months reach US$13.7billion (47% coming from corporate and 53% from sovereign 45issuers), which should fuel further supply. However, this new 40supply should be easily absorbed by the market as investors 35are expected to receive US$21 billion of coupon payments 30over the period, i.e., 50% more than the amortisations 25coming due (see page 15). Moreover, fund flows continue to 20be very strong and provide ample liquidity to the market to 15absorb further supply. 10 5 - -5 Nov -09 Jan-10 Mar-10 May -10 Jul-10 Sep-10 Nov -10 Gross Issuance Amortizations Net Issuance Source: Bond Radar, Morgan Stanley Research 14
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioBond PaymentsExhibit 38 Exhibit 39Amortisation and Coupon Payments* (US$ billion) Bond Amortisations per Country (US$ million) Type Country Dec-10 Jan-11 Feb-11 Total 16.1 Sovereign Brazil 1,582 1,582 14.2 13.9 Mexico 1,540 1,540 3.6 Panama 333 333 11.9 Philippines 1,270 1,270 4.7 5.1 Poland 1,378 1,378 3.2 4.3 Turkey 1,034 1,034 8.5 Uruguay 92 92 5.1 3.0 3.1 Sovereign Total 0 4,156 3,074 7,230 3.5 4.1 Corporate Argentina 179 179 2.6 Brazil 545 545 1.4 0.3 4.4 Colombia 250 250 3.5 4.1 4.1 Croatia 414 414 3.1 1.3 Czech Rep. 138 138 0.1 Hong Kong 76 76 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Hungary 414 414 India 100 284 384 Amortisation Sov ereign Amortisation Corporate Kazakhstan 253 253 Interest Sov ereign Interest Corporate Korea 714 19 615 1,347 Malaysia 260 260* Sovereign & Corporate Other Latam 79 79Source: Morgan Stanley Research Panama 150 150 Russia 93 93 Trinidad & Tob. 100 100 U.A.E. 1,600 1,600 Ukraine 175 175 Corporate Total 3,496 326 2,634 6,456 Total 3,496 4,482 5,708 13,685 Source: Morgan Stanley ResearchExhibit 40Main Corporate Bond Amortisations of the Month Date Country Issuer Cpn Ccy Am ount $ Equiv. ISIN 01-Dec-10 Panama Banco Continental 6.625 USD 150 150 USP09097AA71 06-Dec-10 U.A.E. NatL Bank Of Dubai L+35 USD 750 750 XS0237182513 06-Dec-10 Korea Kookmin Bank L+29 USD 300 300 XS0237030688 06-Dec-10 Other Latam Corp Andina De Fomento 7.625 GBP 49 79 XS0159072668 07-Dec-10 Malaysia Telmal 8 USD 260 260 XS0121434350 08-Dec-10 Korea Woori Bank 35 EUR 300 414 XS0237371678 14-Dec-10 U.A.E. NatL Bk Of Abu Dhabi L+30 USD 850 850 XS0238236243 20-Dec-10 Hungary Otp Bank E+15 EUR 300 414 XS0238379514 22-Dec-10 Argentina Telecom Personal 9.25 USD 174 174 USP9030AAA36 23-Dec-10 India State Bank India L+60 USD 100 100 XS0239218471Source: Morgan Stanley Research 15
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioCDS MarketVolatility has picked up amid declining liquidity… As Exhibit 42concerns around European periphery resurfaced, hedging 5Y CDS and Basis Spreads (Market Composite, bp)activity picked up in the CDS space, mainly led by hedgefunds. However, liquidity in the CDS market has been fairly 30 Basis Spread Comp. 190poor, implying larger spread movements on lighter volumes. 20 5Y CDS Comp. (RHS) 180CDS spreads have widened across EM, with high-beta names 10 170suffering the most. The proximity of Central European 0 160countries to the epicentre of the European woes has been -10reflected in the price action as CEE has underperformed Latin 150 -20America or even South Africa and Turkey, offering more 140 -30attractive valuations in the region (see our SovRank model on -40 130page 9). Low-beta Latin American names have not beenintact, either, with spreads back above the 110bp levels. -50 120…as the bond-CDS basis climbed to neutral territory from 9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Novnegative levels. The CDS market underperformed the bond Source: Morgan Stanley Researchmarket in the first half of the month as most of the widening Exhibit 43took place in the CDS market, pushing the bond-CDS basis 5s10s CDS Slopes (bp)into positive territory, after a long period in negative territory.With prolonged uncertainty in Europe and rising yields in US 45 INDO PHI 1 month agoTreasuries, real money investors have started selling bonds in 40 10Y -5Ythe second half of the month. Consequently, the bond-CDS 35 BRA COL PERbasis has dropped back to neutral levels. SOAF TURK 30 MEX PAN RUS 25 POL 20 15 HUN 10 5 0 Source: Morgan Stanley ResearchExhibit 41 Exhibit 44CDS Slope versus Bond Slope (5s10s, bp) CDS Basis Spreads (5-Year Sector, bp) 25 Bond Slope Comp. 45 100 1 month ago CDS Slope Comp. (RHS) UKR 5Y Basis 20 40 80 15 35 60 PHI 40 BRA MEX 10 30 HUN SOAF INDO 20 PER 5 25 TURK 0 0 20 COL -20 PAN -5 15 RUS -40 9-Jun 8-Jul 5-Aug 2-Sep 1-Oct 29-Oct 29-Nov POL -60Source: Morgan Stanley Research Source: Morgan Stanley Research 16
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioCredit Views 17
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioArgentina (B)Fundamentals Argentina Credit ViewBy Daniel Volberg: Strong growth, a comfortable fiscal position and theelection calendar underpin our positive outlook for Argentina. The Bullish Buy GDP Warrantstrength of the economic expansion in Argentina continues to surprise; Buy Glo 2017in fact, we expect GDP growth to remain robust in 2011 at 5.9% after Bearishnearly breaking into double-digit growth this year. The key seems to bea combination of robust external conditions: elevated soft commodity Bull Credit View Steepening Asset Preferenceprices and robust growth in Brazil as well as a consumption boom,driven by real wage growth. With robust growth comes strong taxrevenue and a comfortable fiscal position. In fact, we expect the Argentina Valuations: Spread to Fair Value* (bp)authorities to cover next year’s financing needs out of a combination ofa primary surplus and US$7.5 billion in international reserve inflow. 1000 800In addition to the comfortable macro fundamentals, especially on the 600growth and fiscal fronts, Argentina may see positive momentum on the 400 378policy front. Presidential and congressional elections in October next 200year have opened up the potential for a change in policy regime once a 0new administration takes office. Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10 Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelStrategy – Outperform ++After the market correction, we believe Argentina is now well poised to Argentina Technicals: Exposure versus Averageoutperform. Indeed, valuations remain very attractive as the credittrades wide to fair value, especially considering the latest macro 0.5%numbers. Positioning has increased over the last couple of months, 0.0% -0.5%which could limit the upside, but only to a certain extent ,in our view. We -1.0%see the Argentina spread curve partially disinverting in the coming -1.5% -2.0%months with the new 2017 global bond benefiting the most from this -2.5%move. We also see compelling value in the GDP warrant at current Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10levels (see Global EM Investor – Update, November 24, 2010). Argentina Av g. Single B Source: EPFR, Morgan Stanley ResearchArgentina Rich & Cheap Model* Argentina Macro Fundamentals, 2011 Forecasts* 800bp B 15 B 17 € Disc SCRM Rating: B- 750bp B 13 GDP Growth 5Y 10Y Av g. B 700bp 5.9% 650bp € Par Argentina 3Y 600bp 17 New 2Y Current Acc./GDP Inflation Z-spread 550bp $ Disc 2.6% 10.7% $ Par 500bp 450bp Legend: 400bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 45% 0.8% 350bp 300bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 18
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioBrazil (BBB-)Fundamentals Brazil Credit ViewBy Gray Newman: After a robust rebound during much of 2009 which Bullishquickened its pace during 1H10, we are starting to see signs of Buy Glo 2037softening. Despite still strong domestic demand, the experience of Buy Glo 2034 Buy Glo 20412008/09 (and even more recently during 2Q10) serves as a reminder Bearish Sell Glo 2040that Brazil’s fortunes remain closely linked to global economic factors. Bull Sell Glo 2014As the Brazilian economy settles back to a much more moderate pace, Credit View Flattening Asset Preferencethe gap with global fundamentals is likely to be reduced.The Brazilian economy may be at a turning point, a fact that we think is Brazil Valuations: Spread to Fair Value* (bp)still underestimated by the market due to deceptive year-on-yearcomparisons. Based on industrial production, and despite record 0releases on the demand side, 3Q10 is likely to be more sluggish than -20during the infamous ‘red hot’ first quarter. Absent a sharp rebound, this -40 -43would likely stall Brazil’s potential growth, in our view. If global -60fundamentals end up relatively benign, then Brazil should do just fine in -802011. Based on these assumptions, we foresee 4% growth for 2011(versus around 7.9% in 2010) and expect a strengthening of the Real Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10(1.65E by year-end 2011). But until then, questions are likely to arise Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelahead of January 2011, when a new administration takes office. Brazil Technicals: Exposure versus AverageStrategy – Underperform 1.0%Despite the underperformance of Brazil until early November, 0.5%valuations are still not very compelling; we therefore remain neutral on 0.0%the credit. In fact, the credit trades expensive to fair value, and the -0.5%technical position has been deteriorating. At this point we see the value -1.0% -1.5%mostly in the long end as the curve has steepened a lot in the last fewweeks. We expect investors to be inclined to extend duration in a rally Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10scenario (our base case for the coming months). Brazil Av g. BBB Source: EPFR, Morgan Stanley ResearchBrazil Rich & Cheap Model* Brazil Macro Fundamentals, 2011 Forecasts* 200bp 180bp 2730 34 37 SCRM Rating: BBB- 41 GDP Growth 160bp 10Y Av g. BBB 24 4.0% 7Y 140bp 5Y 25 Brazil 120bp 19 Z-spread 3Y 20 100bp 15 21 Current Acc./GDP Inflation 2Y 17 -2.6% 5.1% 80bp 40 60bp 14 Legend: 40bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP 13 20bp Rich+ Rich- 60% -2.8% 0bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 19
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioBulgaria (BBB-)Fundamentals Bulgaria Credit ViewBy Pasquale Diana: Bulgaria was one of the countries which Bullishaccumulated the largest external imbalances during the credit boom. Sell 5Y CDSThe current account deficit widened to over 25% of GDP in the course Buy Glo 2015of 2008, on the back of credit flows and solid FDI inflows (largely in real Bearishestate). The subsequent drought in inflows has turned the C/A position Spreadaround dramatically (-1.2% latest, and moving fast into surplus) in a Credit View Tightening Asset Preferencepattern we also saw in the Baltics. The last data show an economywhich is still contracting, albeit at a slower pace (-1.5%Y in 2Q), and isdriven by net exports. Domestic demand components continue to suffer Bulgaria Valuations: Spread to Fair Value* (bp)from low credit creation and high unemployment (around 9% comparedto sub-6% pre-crisis). 250 200We note with concern that Eurostat revised the 2009 ESA-95 deficit to 1504.7% of GDP (up from the previous estimate of 3.5%), a deterioration 100 100worth 6.4% of GDP from 2008, and much worse than the government’s 50 0cash data showing a cash deficit of just 0.8% for the year. The deviationis likely explained by the social security deficit as well as the inclusion of Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10the losses made at the state-owned railway company. For this year, the Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelgovernment targets a 4.6% of GDP cash deficit, which will fall to 2.5%in 2011, based on somewhat optimistic GDP forecasts (+3.6%Y in Bulgaria Technicals: Exposure versus Average2011). True, Bulgaria’s debt stock is very low in a regional perspective,at 14.7% of GDP in 2009 according to Eurostat. Note, however, that the 0.5%recent fiscal trends are not encouraging, and the government has hadto deplete its fiscal reserve in order to fund the budget deficit: the 0.0%reserve is down to around 8% of GDP, roughly half what it was at thepeak in 2008. This fiscal buffer, built over many years thanks to fiscal -0.5%discipline, can be used as a source of liquidity for the banking system in Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10case of a reserve drop and is one of the pillars of the current monetary Bulgaria Av g. BBBpolicy set-up. That is why its depletion is a concern. Source: EPFR, Morgan Stanley ResearchStrategy – Outperform + Bulgaria Macro Fundamentals, 2011 Forecasts*Investors have started reducing their underweight in CEE, trying torebalance their positioning. They have favoured Bulgaria over Hungary SCRM Rating: BBB- GDP Growthand Romania, but we disagree on that. Although the public debt is Av g. BBB 2.0%lower than Hungary, the total external debt hovers at similar level Bulgaria(external debt versus exports is 182% in Hungary and 220% inBulgaria; external debt versus GDP is 142% and 110%, respectively), Current Acc./GDP Inflation -5.8% 2.9%particularly so for the short-end component (short-term external debtversus GDP is 24% in Hungary and 40% in Bulgaria). Bulgaria does notlook attractive at the current level in the CEE space and we prefer either Govt Debt/GDP Fiscal Bal./GDPimproving stories (i.e., Hungary) or more generous credits (i.e., 19% -2.2%Romania). However, we rate Bulgaria as Outperform + in the short termas we see a year-end rally materialising. Source: IMF *The wider the web, the better the fundamentals 20
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioChile (A+)Fundamentals Chile Credit ViewBy Luis Arcentales: The fundamental picture for Chile remains strong. BullishOn the real economy front, activity has rebounded sharply from the Buy 2020tragic earthquake of late February, with substantial strength in domesticdemand (up 18.2% in 3Q compared to a year ago). The rebound Bearish Buy 5Y CDSseems to rest on solid ground: consumers are enjoying risingemployment, positive real wage growth and ample credit availability Credit View Unchanged Asset Preferencewhile confidence among Chile’s captains of industry is riding high,translating into a surge in investment (+18.5% in 3Q). Even if the globalbackdrop deteriorates ahead – an important headwind for a small, open Chile Valuations: Spread to Fair Value* (bp)economy like Chile’s – the post-earthquake rebuilding efforts shouldprovide a significant boost to growth, particularly in 2011. Indeed, GDP 20 10growth expectations have been progressively upgraded and we 0 -3currently forecast 5.6% for 2011. Despite the breakneck pace of growth -10so far this year, inflation has remained muted. -20 -30 -40Given the enviable position of Chile’s public sector – with gross debt toGDP at just 7.0% and assets nearing 10% of GDP at mid-year – Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10funding is unlikely to be an issue for the rebuilding efforts. Importantly, Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modeldespite having ample resources at its disposal, the rebuilding planincludes a balanced approach that mixes temporary tax hikes, sales of Chile Technicals: Exposure versus Averagenon-strategic assets as well as partial use of the stabilisation funds,reflecting the administration’s commitment to fiscal discipline. 0.5%Strategy – Underperform - - 0.0%Despite very solid fundamentals, Chile has been underperforming since -0.5%this summer only to briefly outperform during the latest sell-off. Thetechnical position has improved and valuations are now more in line Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10with fair value. Given its low-beta status, the credit should continue to Chile Av g. Single Aunderperform the index, however. We favour the 2020 global bond. Source: EPFR, Morgan Stanley ResearchChile Z-Spread Curve Chile Macro Fundamentals, 2011 Forecasts* 68bp SCRM Rating: A+ 67bp 12 GDP Growth 66bp Av g. A 5.6% 65bp 20 Chile 64bp Z-spread Current Acc./GDP Inflation 63bp -2.4% 3.1% 62bp 61bp 60bp Govt Debt/GDP Fiscal Bal./GDP 13 59bp 5% -0.8% 58bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 Mod. DurationSource: Morgan Stanley Research Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 21
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioColombia (BB+)Fundamentals Colombia Credit ViewBy Daniel Volberg: There are three key stories in Colombia: the cyclical Bullishbackdrop, the structural reform outlook, and the oil boom. On the Buy 2041cyclical front, the economy is on solid footing: GDP growth is in the Buy 20374-4.5% range (around 5.1% expected for next year), inflation is below Bearish Sell Glo 2024the 3% target and unemployment is falling. This benign macro backdrop Bull Buy 5Y CDShas allowed the authorities to focus on fighting currency appreciation, Credit View Flattening Asset Preferencealthough this goal may be difficult to achieve, given the strong FDI.The new administration has surprised by announcing a commitment to Colombia Valuations: Spread to Fair Value* (bp)structural reforms. One of the key reforms is the proposed fiscal rule,which was submitted to Congress at the end of September and is now 20expected to be approved by mid-2011. This reform should add 0transparency, accountability and discipline to the fiscal accounts. In our -20view, the implementation of the fiscal rule raises the likelihood of a -40 -43rating upgrade for Colombia. -60Lastly, Colombia is also enjoying inflows from the early stages of an oil Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10boom. The government is projecting that technology improvement will Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelboost oil output to around 1.5 million barrels per day by 2015, nearlytwice the current level. This prospect has brought significant FDI inflows(nearly half of FDI this year has been directed to the oil sector. Colombia Technicals: Exposure versus Average 0.5%Strategy – UnderperformColombia should be upgraded at some point, as suggested by our 0.0%SCRM model. The credit has been largely overpriced, however, and forthis reason it largely underperformed in the last three months. Technical -0.5%position continues to be favourable but the upside remains limited in our Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10view, the credit still trading expensive to fair value. The 5y10y slope has Colombia Av g. BBsubstantially flattened recently and we favour the long end of the curve. Source: EPFR, Morgan Stanley ResearchColombia Rich & Cheap Model* Colombia Macro Fundamentals, 2011 Forecasts* 250bp 33 SCRM Rating: BBB- 37 GDP Growth 200bp 41 Av g. BB 20 5.1% 17 Colombia 150bp 19 24 14 Z-spread 10Y 13 7Y Current Acc./GDP Inflation 100bp 5Y -0.6% 4.3% 12 3Y 2Y Legend: 50bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 35% -2.8% 0bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Mod. DurationSource. Morgan Stanley; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 22
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioHungary (BBB)Fundamentals Hungary Credit ViewBy Pasquale Diana: The economy has emerged from recession, but its Bullishrecovery remains tentative and vulnerable to a euro area slowdown, given Buy $2015Hungary’s extreme openness (exports/GDP at around 80%). Risk and Buy $2020 Buy €2018inflation outlooks are inconsistent with rate cuts, we believe. If anything, it Bearish Sell €2020is clear that a move towards weaker risk appetite or a deterioration in the Bullinflation outlook is likely to be met with rate increases. Credit View Steepening Asset PreferenceFollowing some unfortunate communication by the government and thesuspension of the IMF talks, markets began to worry about the direction Hungary Valuations: Spread to Fair Value* (bp)that fiscal policy would take over the coming years. Hungary has one ofthe best primary balance positions in the EU, yet it remains in the spotlight, 300given its history of fiscal profligacy, its comparatively high stock of debt 234(public and private) and its large FX mismatch on the household liabilities 200side. The recent commitment to stick to a sub-3% of GDP deficit target for 1002011 looks encouraging to us, although excessively relying on one-off 0temporary windfall taxes (on energy, retail, telecom and banking sectors).We note with concern the plans to effectively nationalise the funds held in Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10the second pension pillar, worth around 10% of GDP. While the impact on Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelthe debt ratios will be positive in the short-term, this is not necessarily truein the medium-longer term. Hungary Technicals: Exposure versus AverageStrategy – Outperform ++ 1.0% 0.5%Increasing corporate taxes to re-balance the fiscal position and unwinding 0.0%the 1997 pension reform represent a potential problem for the future -0.5%commitment of foreign companies in Hungary. We acknowledge that these -1.0% -1.5%decisions are not forward-looking, but in the short-term will haveconsiderable positive impact on both fiscal balance and debt over GDP Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10(possibly dropping by 7-8%). We like long positions in Hungary. Hungary Av g. BBB Source: EPFR, Morgan Stanley ResearchHungary Rich & Cheap Model* Hungary Macro Fundamentals, 2011 Forecasts* 400bp Cds 10Y Cds 5Y SCRM Rating: BBB+ $ 20 € Jul-14 GDP Growth 350bp Av g. BBB $ 15 € 18 2.8% € Jan-14 Hungary € 17 300bp € 13 € 16 Z-spread Current Acc./GDP Inflation € 20 0.5% 3.5% 250bp Legend: 200bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 80% -3.7% 150bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 23
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioIndonesia (BB)Fundamentals Indonesia Credit ViewBy Deyi Tan: We remain positive on Indonesia’s growth prospects. BullishGeneral consensus tends to be also bullish on the credit given elevated Buy 2038commodity prices, smooth transition to democratic setup and benign Buy 2037 Buy Mar & May 14demographic trends. What differentiates our view is that we see a Bearish Sell Glo 2018structural decline in cost of capital driven by improved macro Bull Sell Glo 2020fundamentals, which should eventually incentivise more investment. Credit View Flattening Asset PreferenceWhile inflation is structurally declining, cyclical inflation pressures are onthe rise in the near term as growth momentum gathers pace amid Indonesia Valuations: Spread to Fair Value* (bp)elevated commodity prices. Though core inflation remains atmanageable levels for now, commodity tradables inflation such as food 0are elevated amid unusual weather conditions and the relatively high -10commodity weights in the CPI basket spell risks of spilling over to core -20inflation amid healthy domestic demand. For now, strong trailing -30 -35currency appreciation from capital inflows has helped to do the policy -40 -50lifting in the interim, keeping a lid on import-led pressures this year, butincomplete liquidity sterilisation adds to that inflationary risk going Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10forward. Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelStrategy – Outperform + Indonesia Technicals: Exposure versus AverageIndonesia is an improving credit, and this should eventually lead to 1.5%substantial upgrades from rating agencies. The technical position has 1.0%been consistently improving for more than a year now and this should 0.5% 0.0%support Indonesian bonds in a rally scenario. According to our Rich & -0.5%Cheap model, the 10y sector is trading expensive, however, and the -1.0% -1.5%value is essentially in the long end of the curve. On a spread basis, the5Y sector is attractive compared to the belly. Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Indonesia Av g. BB Source: EPFR, Morgan Stanley ResearchIndonesia Rich & Cheap Model* Indonesia Macro Fundamentals, 2011 Forecasts* 240bp 38 SCRM Rating: BB+ 220bp GDP Growth 35 Av g. BB 200bp Cds 10Y 6.5% 37 Indonesia 180bp 19 Z-spread Current Acc./GDP Inflation 160bp Cds 5Y 20 1.2% 6.2% 140bp 15 18 May 14 Legend: 120bp Mar 14 16 17 Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 100bp 25% -2.0% 80bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 24
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioKazakhstan (BBB-)Fundamentals Kazakhstan Credit ViewBy Alina Slyusarchuk: We expect Kazakhstan’s real GDP growth to Bullishreach 5.8%Y in 2010 (higher than officials’ forecasts of around 5% and Buy KMG 2015consensus of 5.3%), supported by strong external demand which has Buy Halyk Oct 13already translated into healthy output gains in 1H10. The monthly data Bearishshow fast recovery in industrial production (+10.4%Y, year-to-date in SpreadOctober) and retail sales data point to improvement in domestic Credit View Tightening Asset Preferencedemand (+12.5%Y, year-to-date in October). Our long-term GDPgrowth outlook for Kazakhstan stands at 5%Y (around +4.5% for 2011),higher than its CIS peers, as we are positive on external demand Kazakhstan Valuations: Spread to Fair Value* (bp)(particularly Chinese) for Kazakh exports (oil and gas). The risk is anextended stagnation of credit activity, which can put further pressure on 100 80consumption and construction, in our view. 60 47Inflation accelerated this year, with the October print at 7.3%Y, up from 406.5%Y in August 2010, fuelled by the food prices. The budget deficit 20 0widened in 2010: expenditure growth accelerated due to increases inpublic sector wages and student grants, leaving the budget deficit on Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10track for a 2% of GDP deficit this year, after a 1.5% deficit in 2009. We Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelanticipate fiscal improvement to take place in 2011 as the governmentplans to double oil export duties, from US$20 to US$40 per ton. Kazakhstan Technicals: Exposure versus AverageStrategy – Outperform + + 1.0%Kazakhstan is one of our top picks in CEEMEA, as fundamentals 0.5%remain very strong and we like being exposed to oil. Investors look 0.0%slightly underweight and this should be beneficial for this credit. -0.5%Sovereign CDS has underperformed lately and look very attractive now.However, we recommend investors gain exposure to this credit through Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10the banking and oil sectors to capture the upside. Kazakhstan Av g. BBBOur top pick in the corporate space is KMG ’15, currently offered at Source: EPFR, Morgan Stanley Researchz+394bp (YTM 5.35%). This trade reflects our bullish view on the EM Kazakhstan Macro Fundamentals, 2011 Forecasts*O&G sector (see EM Profile: EM Oil & Gas – Go Long to Capture theEM Growth, October 21, 2010) and in our view is the most attractive SCRM Rating: BBB-route to benefit from the macro story in Kazakhstan. GDP Growth Av g. BBBWe continue to see further stabilization in the Kazakh banking sector 4.5% Kazakhstanwith the level of bad loans stable at 26%. According to the latest datafrom the regulator, depositor flow was 3.4% in October. Our top-pick in Current Acc./GDP Inflationthe Kazakh banking sector is Halyk Bank 9.25% 2013, currently trading 3.5% 7.8%at z+ 397bp (YTM 4.95%). Govt Debt/GDP Fiscal Bal./GDP 17% -1.0% Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 25
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioKorea (A+)Fundamentals Korea Credit ViewBy Sharon Lam: In the recovery cycle, Koreas growth has been driven Bullishby strong exports, capex expansion and rising private consumption. In Buy Apr142H10, growth looks certain to slow due to the diminishing low base Buy 2025effect, less policy stimulus and lower exports following the slowdown of Bearish Sell 2013the major economies. If global demand disappoints, we think Korea’s Sell 2016exports could show more resilience compared to other countries due to Credit View Unchanged Asset Preferenceits high competitiveness, backed by a relatively weak currency, itsstrength in technology and in branding. On the other hand, if the globalrecovery moves ahead, we believe Korea could be a beneficiary, given Korea Valuations: Spread to Fair Value* (bp)its export distributions towards more high-growth emerging markets. 60The current spike in food prices could very easily trigger inflation 40expectations among consumers. At this point, we expect Korea’s CPI 20 18inflation to rise to above 3.0% in 4Q10 and 2011, but it is not likely to 0get out of control, in our view, as the BoK would be likely to raise the -20policy rates to anchor pre-emptive inflation pressures. Administrativemeasures are also very likely if inflation rises too fast. Given its high Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10dependence on imported raw materials, Korea remains vulnerable to a Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelpotential rise in commodity prices in the international market. With theCRB index regaining momentum, this risk could become more tangible Korea Technicals: Exposure versus Averageif the pace of appreciation of the index were to accelerate. 0.5%Strategy – Underperform - 0.0%Fundamentals remain very solid, but at current levels Korean bondslook fairly priced. At this point, we believe the current political tensions -0.5%with North Korea should not have a very significant impact on the credit.Korea should still underperform the market in a rally scenario because Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10of its low-beta status. We see most of the value in the wings of the Korea Av g. Single Acurve (4Y and 15Y sectors). Source: EPFR, Morgan Stanley ResearchKorea Rich & Cheap Model* Korea Macro Fundamentals, 2011 Forecasts* 140bp Apr 14 19 SCRM Rating: A+ 130bp 25 GDP Growth Av g. A Sep 14 4.5% 120bp 16 Korea 110bp 13 Z-spread Current Acc./GDP Inflation 100bp 1.5% 3.2% 90bp €15 Legend: 80bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP 70bp Rich+ Rich- 38% -0.2% 60bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 26
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioLithuania (BBB)Fundamentals Lithuania Credit ViewBy Paolo Batori: Exports and inventories are expected to lead the Bullishrecovery in 2010 and GDP growth is set to move back to positive Buy $2015territory (IMF forecast: 2.1% in 2010 and 3.2% in 2011). However, the Buy €14extent of the recovery is limited by weak domestic demand and lack of Bearishcredit. High unemployment reduced the demand for loans on the one Bullside, while deterioration in asset quality (NPLs from 5% in 2008 to 20% Credit View Steepening Asset Preferencein 2009) is likely to stem loan supply, on the other.Debt has increased sharply, but sustainability still looks manageable to Lithuania Valuations: Spread to Fair Value* (bp)us (government debt/GDP 29.3% in 2009, 38.6% in 2010E and 45.4%in 2011E – European Commission forecast). Below-potential GDP and 250deflationary pressures should keep upward pressure on the debt/GDP 200ratio, and this will likely require a tight and orthodox fiscal policy and 150 142reforms for years to come. Lithuania’s linkage to the Southern 100European countries is limited, as mostly Nordic banks are involved in its 50 0financial system. Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10Strategy – Outperform + Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelAs per our SCRM model, Lithuania looks cheap in spread terms andpositioning remains quite light. We think investors are likely to reposition Lithuania Technicals: Exposure versus Averagefrom underweight to (at least) market-weight. Lithuania should largely 0.5%outperform in a year-end rally scenario, although we acknowledge thecountry still faces fundamental challenges and we play this positioning 0.0%tactically. We like steeper USD bonds curve and favour Lithuania 2020USD to the 2018 Euro, although we are aware of the different client -0.5%base. Buy 2015 and 2020 in USD and 2016 in Euro; sell 2018 in Euro. Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Lithuania Av g. BBB Source: EPFR, Morgan Stanley ResearchLithuania Rich & Cheap Model* Lithuania Macro Fundamentals, 2011 Forecasts* 350bp $ 15 $ 17 SCRM Rating: BBB+ 300bp $ 20 GDP Growth Av g. BBB 3.2% 250bp Lithuania € 14 200bp € 18 Z-spread Current Acc./GDP Inflation € 16 150bp 2.6% -1.1% Legend: 100bp € 13 € 12 Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP 50bp Rich+ Rich- 45% -8.5% 0bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley, EU forecasts, IMF *The wider the web, the better the fundamentals 27
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioMalaysia (A-)Fundamentals Malaysia Credit ViewBy Deyi Tan: Malaysia should continue to get support from elevated Bullishcommodity prices, constructive global environment and stillexpansionary fiscal policy, which should help sustaining growth ataround 5% in 2011 and 5.5% in 2012. In terms of growth outlook in the Bearish Buy 5Y CDSregion, we rank Malaysia on par with Thailand (below Indonesia andSingapore). In the longer-term, however, structural issues such as soft Credit View Unchanged Asset Preferenceinfrastructure gaps in labour force quality have implications on potentialgrowth prospects and are still in the midst of being addressed. Malaysia Valuations: Spread to Fair Value* (bp)Compared to other Asian credits, Malaysia arguably falls in the camp ofthe countries facing relatively low inflationary pressures. We forecast 0inflation to remain fairly contained at 2.3% (2011) and 2.2% (2012). This -10is because with commodity prices elevated, the first phase of inflation -20pressures tend to come from the tradables front, but a subsidy system -30 -33on selected items (such as certain retail fuel and food items) helps defer -40inflation to a certain extent until the next round of subsidy rationalisation.The fact that the economy is not going into an overheated mode will Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10also keep demand-pull pressures and core inflation in check. Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelStrategy – Underperform - - Malaysia Technicals: Exposure versus AverageMalaysia benefits from strong fundamentals, but valuations remain tight 1.0%(Malaysia 5Y CDS now trades in line with DM countries like Austria andFrance). Technical position has been deteriorating since the beginning 0.5%of the year; this factor should contribute to the country’s 0.0%underperformance in a market rally scenario. -0.5% Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Malay sia Av g. Single A Source: EPFR, Morgan Stanley Research Malaysia Macro Fundamentals, 2011 Forecasts* SCRM Rating: A- GDP Growth Av g. A 5.0% Malay sia Current Acc./GDP Inflation 13.7% 2.3% Govt Debt/GDP Fiscal Bal./GDP 51% -3.5% Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 28
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioMexico (BBB)Fundamentals Mexico Credit ViewBy Luis Arcentales: Mexico remains in the midst of a two-tier recovery, Bullishcharacterized by a robust industrial rebound coupled with sluggish Buy 2033consumption and anemic investment. Against this backdrop, the Buy 2034 Buy 2040economy is likely to remain heavily dependent on the US cycle. Part of Bearish Buy 5Y CDSMexico’s weak momentum in domestic demand seems to be explained Bull Sell 2015by the negative income shock the country has experienced due to a Credit View Flattening Asset Preferencerelative deterioration in the terms of trade. After expanding at a pace inexcess of 5% annualized during 1H10, growth has cooled off andshould continue to expand at a moderate pace thanks to the support Mexico Valuations: Spread to Fair Value* (bp)from US industrial activity. The deficit of the current account remainscontained at this point (-0.2% of GDP in 1H10), although some 20deterioration is likely to take place ahead. 0 -20Fiscal accounts have improved due to the combination of higher oil -33 -40prices and output, a strong bounce in VAT and tax revenues, as well as -60under-execution of expenditures. The authorities are committed to agradual reduction of the fiscal deficit through 2012, as delineated in the Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10fiscal reform of 2009 which projected to lift revenues by near 1.0% of Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelGDP. The 2011 budget approved in mid-November had a deficit of2.5% of GDP; most of the parameters in the budget seem reasonable, if Mexico Technicals: Exposure versus Averagenot necessarily conservative as was the case in 2010. 2.5% 2.0%Strategy – Neutral 1.5% 1.0%Technical position and valuations have improved over the last few 0.5% 0.0%months, but like many other Latin American credits, Mexico remains -0.5% -1.0%expensive to fair value. The shape of the curve has largely normalized,and at presents we favour the very long end which trades 20bp to 25bp Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10cheap to Brazil despite showing better average rating (high BBB for Mex ico Av g. BBBMexico, BBB- for Brazil). Source: EPFR, Morgan Stanley ResearchMexico Rich & Cheap Model* Mexico Macro Fundamentals, 2011 Forecasts* 250bp SCRM Rating: BBB- GDP Growth 200bp 31 Av g. BBB 40 3.9% Mex ico 10Y 33 34 150bp Mar 19 5Y Z-spread 20 Current Acc./GDP Inflation Feb 14 Dec 19 -1.3% 3.8% 100bp 17 3Y 16 22 2Y 15 Legend: 13 Jan 14 Govt Debt/GDP Fiscal Bal./GDP 50bp Cheap+ Cheap- Rich+ Rich- 35% -2.3% 0bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 29
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioPanama (BBB-)Fundamentals Panama Credit ViewBy Rosa Velasquez: The economy is recovering at a robust pace: real BullishGDP expanded by 6.1% during 1H10 (up from 2.8% in 1H09) and Buy 20206.24%Y in July 2010. We expect the growth momentum to continuethrough the end of the year. Bearish Buy 5Y CDSThe fiscal accounts are improving. The NFPS deficit narrowed to 0.3% Credit View Unchanged Asset Preferenceof GDP in 1H10, down from 0.9% in 1H09 and well below the officialNFPS/GDP 2010 limit of 2%. The primary balance improved as well,increasing to 1.0% of GDP in 1H10 from 0.6% in 1H09. Monthly Panama Valuations: Spread to Fair Value* (bp)inflation rose by 0.5% in August, bringing inflation to 3.6%Y, up from1.8% in August 2009. 0 -20On the external side, the current account registered a deficit of US$1.3 -40billion in 1H10. Nevertheless, the deficit was virtually covered by strong -51 -60FDI flows of US$1.1 billion (up 26% from 1H09). The debt/GDP ratio -80stood at 42.4% on June 30, 2010, down from 45.1% in December 2009. -100 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10Strategy – Underperform - - Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelApart from the current account, Panama is on solid ground. Despiteunderperforming peers in the last six months, the credit is still trading Panama Technicals: Exposure versus Averagerich to fair value. Technical position is not supportive either. Given thelimited liquidity on the credit, we recommend sticking with the main 1.0%benchmarks (essentially the 2020 global). 0.5% 0.0% -0.5% Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Panama Av g. BBB Source: EPFR, Morgan Stanley ResearchPanama Rich & Cheap Model* Panama Macro Fundamentals, 2011 Forecasts* 250bp SCRM Rating: BBB- 29 GDP Growth 200bp Av g. BBB 27 6.3% 36 S Panama 150bp 26 Z-spread 15 Current Acc./GDP Inflation 20 Cds 10Y -8.9% 2.9% 100bp 12 Cds 5Y Legend: 50bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 42% -1.1% 0bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 Mod. Duration Source: IMF *The wider the web, the better the fundamentalsSource: Morgan Stanley Research; *See appendix 30
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioPeru (BBB-)Fundamentals Peru Credit ViewBy Daniel Volberg: With GDP growing above 9% on a year-on-year Bullishbasis, Peru’s economy continues to be one of the strongest in Latin Buy 2050America (and indeed in EM). Somewhat surprisingly, despite very Buy 2037 Buy 2025strong growth inflation remains near the 2% target. However, this near- Bearish Sell 2016double-digit GDP growth does pose demand driven inflation risks for Bull Buy 5Y CDSnext year. Credit View Flattening Asset PreferenceYet the central bank has paused the rate hiking cycle, leaving the policyrate on hold at 3.00%. The decision to pause rate hikes appears to be Peru Valuations: Spread to Fair Value* (bp)largely due to concerns that rising rates – though necessary to slowgrowth and head of inflation risks – were contributing to currency 0strengthening. Faced with this dilemma, we expect the central bank to -20resume tightening monetary policy next year, but at a slower pace as -40 -43the authorities engage in a tight balancing act between growth and the -60currency. -80Strategy – Neutral Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10The credit has been consistently underperforming the market since mid- Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelAugust. Initially, Peru started to underperform due to political turmoiltriggered by the results of local elections, but it continued to do so as Peru Technicals: Exposure versus Averagethe market perceived Peru as quite expensive on a pure valuation 0.5%basis. Macro fundamentals remain very strong, however, which shouldlimit the downside; we believe the country should now perform more in 0.0%line with the index. We favour the recently issued 2050 global bond, -0.5%which offers substantial pick-up relative to the 2037 benchmark; also, its -1.0%very long duration should make this bond outperforming in a rallyscenario. Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Peru Av g. BBB Source: EPFR, Morgan Stanley ResearchPeru Rich & Cheap Model* Peru Macro Fundamentals, 2011 Forecasts* 250bp SCRM Rating: BB+ GDP Growth 200bp 50 Av g. BBB 33 5.5% Cds 10Y 37 S Peru 150bp Cds 5Y 25 Z-spread Current Acc./GDP Inflation 15 19 0.6% 3.1% 100bp 16 Legend: 50bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 26% -0.7% 0bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 Mod. Duration Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentalsSource: Morgan Stanley Research; *See appendix 31
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioPhilippines (BB)Fundamentals Philippines Credit ViewBy Pieter Van Der Schaft: Economic prospects remain positive, with Bullish2010 full-year GDP growth likely to exceed the government’s 5-6% Buy 2034forecast after 7.9% GDP growth during 1H10 amid continuing growth in Buy 2032 Buy 2031foreign worker remittances (+7.4%Y during 8M 2010). Moreover, Bearish Sell 2021subdued inflation (+3.8%Y, and within the 3.5-5.5% inflation target) has Bull Sell 2020allowed BSP to keep rates on hold, while strong foreign capital inflows Credit View Flattening Asset Preference(BSP’s FX reserves rose by US$9 billion during 9M 2010 to US$53.5billion, equivalent to 13 months’ import coverage) and a further shift ingovernment funding towards domestic and offshore PHP issuance have Philippines Valuations: Spread to Fair Value* (bp)further improved the Philippines’ external funding profile. Finally, 0prospects are for political stability as President Aquino has started hissix-year term, while Congressional elections are not due until 2013. -50 -76 -100That said, we believe that two risks remain: i) potential fiscalslippage related to the government’s narrow tax revenue base; and -150ii) the Philippines’ traditional sensitivity to rising food and oil prices, Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10which may also be exacerbated by possible crop damage due to Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modeltyphoon Megi. We view these risks as moderate though as: i) strongGDP growth is tentatively showing up in stronger growth in revenuecollections; this may facilitate government efforts to reduce the fiscal Philippines Technicals: Exposure versus Averagedeficit to 2% of GDP by 2013; and ii) the Philippines has a strongexternal liquidity profile. 0.5% 0.0%Strategy – Neutral -0.5% -1.0%Early November, S&P upgraded the Philippines by one notch to BB, -1.5%reflecting a continuous improvement in fundamentals. However, thecredit remains well overpriced compared to peers, in our view. Given its Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10high-beta nature, it should still perform reasonably well in a rally Philippines Av g. BBscenario. We rate the Philippines as neutral in our portfolio. Source: EPFR, Morgan Stanley ResearchPhilippines Rich & Cheap Model* Philippines Macro Fundamentals, 2011 Forecasts* 250bp SCRM Rating: BB- GDP Growth 200bp 30 31 Av g. BB 10Y 4.0% 34 25 32 Philippines 150bp 24 Jan 19 Z-spread 5Y Current Acc./GDP Inflation 17 20 2.3% 4.0% 100bp N 16 Jun 19 14 21 13 15 Legend: Old-16 50bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 63% -2.5% 0bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 Mod. Duration Source: IMF *The wider the web, the better the fundamentalsSource: Morgan Stanley Research; *See appendix 32
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioPoland (A-)Fundamentals Poland Credit ViewBy Pasquale Diana: Polish regional growth outperformance continues, Bullishwith GDP growth in 2Q reaching 3.5%Y, above expectations. We have Buy $2019raised our 2011 forecast to 4.4% (from 3.2% previously), on the back of Buy €2025 Buy €2016a better trajectory into next year and a more optimistic view on public Bearish Sell $2014and private capex ahead of the 2012 European football championships. BullThat said, we view with concern the lack of serious fiscal tightening, and Credit View Flattening Asset Preferencewould note that Poland is the only country in Central Europe that hasnot tackled the issue of the budget deficit decisively, partly also due tothe electoral calendar (elections in 2011). The ESA-95 deficit could Poland Valuations: Spread to Fair Value* (bp)reach 8% of GDP this year, a level many would have deemed 60unthinkable just a few quarters ago. 40 29We think that the NBP will be among the first central banks to start 20raising rates in CEE, in response to better growth, stronger domestic 0demand and inflation moving stably above the 2.5% target. Our rate -20profile shows that the MPC will raise rates by 100bp next year, in an Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10effort to normalize monetary conditions. Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelStrategy – Outperform +Poland has been penalised lately, due to uncertainty on its debt Poland Technicals: Exposure versus Averagesustainability and the need for investors to hedge against a possible 1.5%GIPS-CEE contagion. In our view, investors should reduce their current 1.0%underweight, as CEE has still comfortable access to external funding 0.5%(i.e., the 1y CCS swap basis is improving) and a change in the fiscal 0.0%rules is unlikely. We favour the long end in the euro-denominated bond -0.5% -1.0%curve. Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Poland Av g. Single A Source: EPFR, Morgan Stanley ResearchPoland Rich & Cheap Model* Poland Macro Fundamentals, 2011 Forecasts* 250bp $ Jul-15 SCRM Rating: A- GDP Growth 200bp $19 Av g. A $ 14 $ Oct-15 4.4% Cds 10Y Poland € 25 € 14 Cds 5Y 150bp € 18 € 19 € 21 Z-spread € 22 Current Acc./GDP Inflation € 16 € 17 € 20 -3.7% 2.8% 100bp $ 12 € 13 Legend: 50bp Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 56% -6.2% 0bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 33
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioRomania (BB+)Fundamentals Romania Credit ViewBy Pasquale Diana: In the last GFS we revised the growth outlook Bullishlower, and we now see 2010 GDP growth at -2.9% and 2011 growth at Sell 5Y CDS-1.7%. Such a weak growth outlook is a function of additional fiscal Buy €2018 Buy €2015tightening on top of the original IMF package: a 5% VAT hike, an Bearishincrease in the retirement age to 65, the announcement of over 70,000job cuts in the public sector and a 25% salary cut for state employees. Credit View Unchanged Asset PreferenceMost of the weakness should be seen in the next two/three quarters,and this is enough to depress the near-term growth outlook significantly. Romania Valuations: Spread to Fair Value* (bp)Romania has a low stock of debt (24% of GDP), but it is struggling tocontain the deficit (now running at 8% on an annual basis) to the 6.8% 300the IMF is demanding. Moreover, the government does not enjoy a 200stable majority and continues to face the threat of a no-confidence vote. 162 100The latest confidence motion in October failed, but the tensions looks tohave abated only temporarily. The coalition remains quite shaky, and 0with yet another electoral campaign looming (elections in 2012), Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10austerity will prove rather hard to implement. Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelStrategy – Outperform +Uncertain political environment and challenging fiscal dynamics make Romania Technicals: Exposure versus AverageRomania a possible target of investors’ concerns on possible contagion 0.5%from Peripheral Europe (PE). In fact Romania spreads have increasedin the past two weeks or so, as well as Hungary. Our base case is for 0.0%no contagion from PE into the CEE region. Therefore we are stillcomfortable with an ‘Outperform +’ stance on this credit. -0.5% Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Romania Av g. BB Source: EPFR, Morgan Stanley ResearchRomania Z-Spread Curve Romania Macro Fundamentals, 2011 Forecasts* 350bp Cds 5Y Hun € 17 Rom € 15 SCRM Rating: BBB- 300bp Rom € 18 GDP Growth Av g. BB -1.7% 250bp Romania Rom € 12 Bul 15 200bp Z-spread Current Acc./GDP Inflation -5.8% 4.8% 150bp Bul € 13 100bp Govt Debt/GDP Fiscal Bal./GDP 50bp 33% -6.2% 0bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Mod. Duration Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentalsSource: Morgan Stanley Research 34
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioRussia (BBB)Fundamentals Russia Credit ViewBy Alina Slyusarchuk: Russia GDP slowed down to 2.7%Y in 3Q10 Bullishafter a robust recovery in 2Q, due to the extended heat wave. Activity in Buy 2030early 4Q got off to a good start and we still expect the rest of 4Q to Buy 2020 Buy Gazprom 34prove strong helped by recovering credit activity and improving Bearish Sell 2015corporate investment demand. We are positive for 2011, with a GDP Bullforecast at 4.3%. Note, that the government plans to increase social Credit View Steepening Asset Preferencespending prior to presidential elections in 2012. We therefore remainconcerned about upside inflation risks, although we are still optimisticon household consumption (+5.5%Y in 2011). Russia Valuations: Spread to Fair Value* (bp)We anticipate inflation pressures from food prices, monetary 80aggregates growth and recovering consumer demand – our year-end 60CPI forecast is at 8%Y for 2010. However, the Central Bank of Russia 40should stay on hold until the end of the year and start tightening only in 20 232011, when the recovery is on firmer ground. Under the official 2011 0budget, a deficit of 3.6% of GDP is planned after a 4.4% deficit in 2010 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10(on our forecasts). The 2011 budget funding will rely heavily on Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modeldomestic borrowing, which can potentially drain some liquidity.Strategy – Outperform + Russia Technicals: Exposure versus AverageThe Russian credit is one of our favourites in CEEMEA in terms offundamentals but, at current levels, the credit is arguably trading close 1.0% 0.5%to fair value. In fact, we prefer implementing our bullish view through the 0.0%banking and oil sectors. Strong banking sector fundamentals position -0.5%the sector to benefit from the strong domestic demand and overall -1.0%macro story: we favour VTB 18p ’13 and Alfa Bank ’15 to play this -1.5%strategy. In the oil sector, we recommend the longer dated Gazprom Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10bonds, namely GAZPRU ’34 currently offered at z+329bp (YTW 6.85%) Russia Av g. BBB(see Oil & Gas section on page 42). Source: EPFR, Morgan Stanley ResearchRussia Rich & Cheap Model* Russia Macro Fundamentals, 2011 Forecasts* 300bp SCRM Rating: BBB 30 R GDP Growth 250bp Av g. BBB 20 4.3% 28 15 Russia 18 200bp 10Y Current Acc./GDP Inflation Z-spread 150bp 5Y 2.2% 8.5% Mf 7 3Y 2Y 100bp Legend: Cheap+ Cheap- Govt Debt/GDP Fiscal Bal./GDP 50bp Rich+ Rich- 10% -3.8% 0bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 Mod. Duration Source: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 35
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioSouth Africa (BBB+)Fundamentals South Africa Credit ViewBy Andrea Masia: External and fiscal accounts remain the key drivers Bullishfor South Africa. Although we expect the current account deficit to Buy 2020widen in 2H10 (expected -3.7% of GDP for 2010), large-ticket inwarddirect investment transactions are likely to combine with strong, carry- Bearish Buy 5Y CDSrelated portfolio inflows to fully fund the current account gap. Thisshould also help to stabilise inflation around current levels for longer, Credit View Unchanged Asset Preferenceengendering a relatively stable growth outlook (expected +3.5% for nextyear, versus 3% for 2010). South Africa Valuations: Spread to Fair Value* (bp)With regard to the fiscal accounts, revenue outperformance continuesto exceed expenditure outlays, resulting in projections of future fiscal 40deficits which are narrower than previously anticipated. Overall debt 30 20levels, although on the rise, are still within comfortable limits. The risk is 10for a disorderly correction in the currency that destabilises both inflation 0 3and growth outlook. -10 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10Strategy – Underperform - Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelSouth African fundamentals remain solid; on the valuation side, thecredit is trading close to fair value. Positioning is neutral in absoluteterms, but a bit heavy when compared to the BBB average. South South Africa Technicals: Exposure versus AverageAfrica has outperformed considerably in the past month and this made 1.0%us change the stance from Neutral to Underperformance -. 0.5%The general strong demand for long-dated EM bonds has caused the 0.0%10-year sector to move towards rich levels. Investors looking for -0.5%duration should switch out of the 2020 into the 2022, in order to improve -1.0%the performance. In the short end, we prefer 2014 to the 2012, as the Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10former presents better carry and very steep roll-down. South Africa Av g. BBB Source: EPFR, Morgan Stanley ResearchSouth Africa Rich & Cheap Model* South Africa Macro Fundamentals, 2011 Forecasts* 180bp 10Y SCRM Rating: BBB+ 160bp GDP Growth 5Y 22 Av g. BBB 140bp 19 20 3.5% South Africa 120bp 14 Z-spread 100bp Current Acc./GDP Inflation 80bp -4.5% 5.4% 12 60bp Legend: Cheap+ Cheap- 40bp Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 20bp 37% -3.5% 0bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 Mod. Duration Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentalsSource: Morgan Stanley Research; *See appendix 36
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioTurkey (BB)Fundamentals Turkey Credit ViewBy Tevfik Aksoy: We expect real GDP growth to reach 7%Y in 2010 on Bullishthe back of robust growth in private consumption, investments and the Buy 2036inventory cycle – despite the negative contribution of net exports Buy 2040 Buy 2025stemming from weak demand from Europe and relatively high oil prices. Bearish Sell 2015We expect 2011 growth to be slower but still robust at around 4.2%. We Sell 2017consider the main risk to these forecasts to be protracted weakness in Credit View Steepening Asset Preferenceexternal demand. As Turkey is facing general elections in June 2011,we expect the fiscal stimulus to be present at least in 1H11, essentiallyresulting in a noticeable slowdown in 2H11. Turkey Valuations: Spread to Fair Value* (bp)Inflation is forecast to decline gradually to 7.6% at end-2010 and 6% at 40end-2011, but in the meantime we expect the headline inflation rate to 30 20hit 5.5-6%% in 1Q11 as base effects kick in. The current account deficit 10 0is widening and likely to reach 5.7% of GDP in 2010. While financing is -10 -13unlikely to be an issue, we think that the quality of the financing mix is -20less than ideal. The fiscal picture had been stable and safe thanks to Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10higher-than-anticipated growth that led to strong revenues. If the Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelgovernment maintains the current practice of controlled discretionaryspending, we expect debt-to-GDP ratio to decline gradually. Turkey Technicals: Exposure versus AverageStrategy – Underperform - 1.0%Investors are still largely underweight the credit, but momentum has 0.5%changed lately and positioning is moving towards more balanced levels. 0.0% -0.5%Our SCRM model is anticipating a strong rating upgrade, but the credit -1.0% -1.5%is already trading at rich value. We advise investors to keep their -2.0% -2.5%current underweight as current valuation does not give cushion toabsorb possible volatility. We favour the 30y sector. Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Turkey Av g. BB Source: EPFR, Morgan Stanley ResearchTurkey Rich & Cheap Model* Turkey Macro Fundamentals, 2011 Forecasts* 220bp 30 34 38 SCRM Rating: BBB- 200bp 40 GDP Growth 10Y 36 Av g. BB 4.2% 180bp Mar 19 20 Turkey 25 160bp 15 21 16 Nov 19 €17 18 Z-spread €14 17 Current Acc./GDP Inflation 140bp 5Y €19 -5.3% 6.0% 14 120bp 13 3Y €16 Legend: 100bp Cheap+ Cheap- €12 2Y Govt Debt/GDP Fiscal Bal./GDP Rich+ Rich- 80bp 43% -3.8% 60bp 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Mod. Duration Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentalsSource: Morgan Stanley Research; *See appendix 37
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioVenezuela (B+)Fundamentals Venezuela Credit ViewDaniel Volberg: We continue to see medium-term deterioration in BullishVenezuela’s fundamentals, though the near term may prove more Buy 2025manageable. In the near term, access to credit (even if at high rates) Buy 2014has not been compromised and the asset cushions – more than $28 Bearish Sell 2034billion in international reserves and near $8-9 billion in other liquid dollar Bull Sell 2024assets held by the public sector – appear sufficient to provide a dose of Credit View Steepening Asset Preferencenear-term comfort for investors.That said there are major pitfalls. In the medium term Venezuela Venezuela Valuations: Spread to Fair Value* (bp)appears to be facing a severe shortage of hard currency – roughly $20-25 billion per year – that is forcing it to rapidly accumulate debt. 1500Meanwhile, major near-term risks seem to be the potential arbitration 1000 910penalties as well as headline risk associated with policy radicalization. 500And in the one area that could significantly improve the overall outlook –development of the Orinoco belt oil resources – progress appears to be 0very limited. Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Sep-10 Nov -10 Source: Morgan Stanley Research; *CDS spread to fair value as per SCRM modelStrategy – Outperform + +Investors have been looking for yield, and deeply discountedVenezuelan bonds should benefit from investors’ risk appetite. In the Venezuela Technicals: Exposure versus Averageshort term – to the extent that the country has enough FX reserves and 2.5%risk of default is not imminent – Venezuelan bonds should outperform 2.0%as oil prices remain strong. In fact, benign technicals should support the 1.5% 1.0%credit. 0.5% 0.0% -0.5%As we run our Par Bond Equivalent Spread model, the 2014 and 2025 -1.0%global bonds appear to be the most compelling assets when taking into Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10account the recovery value. Our Rich & Cheap model also confirms the Venezuela Av g. Single Battractiveness of these two bonds. Source: EPFR, Morgan Stanley ResearchVenezuela – Rich & Cheap Model* Venezuela Macro Fundamentals, 2011 Forecasts* 1400bp 14 22 S 13 SCRM Rating: B 19 23 GDP Growth 1300bp 16 28 24 Av g. B 2Y N 18 -0.7% 3Y Venezuela 1200bp 5Y Old 18 25 34 7Y 20 1100bp 10Y Current Acc./GDP Inflation Z-spread 27 38 3.8% 35.5% 1000bp 900bp Legend: Govt Debt/GDP Fiscal Bal./GDP Cheap+ Cheap- 800bp 15% -3.8% Rich+ Rich- 700bp 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 Mod. DurationSource: Morgan Stanley Research; *See appendix Source: Morgan Stanley Research forecasts; *The wider the web, the better the fundamentals 38
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioSector Views 39
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioQuasi-Sovereign ModelWe introduced our quasi-sovereign (QS) model in August  Asia – Korean QS spreads over the sovereign generally(see EM Quasi-Sovereigns – Valuations on a Global Basis, compressed during the period, driving the overall spreadAugust 27, 2010) to establish a framework within which to tightening of the Asian QS.value QS bonds on a consistent basis across the EM credit  CEEMEA – ME QS (TAQA, TDICUH, MUBAD) showeduniverse. The key investment thesis is to consider quasi- similar spread compression as the Asian QS. CIS QSsovereigns as corporate credits, plus a put option to the generally continue to lag the rest of the universe, with thegovernment. exception of KAZATOM.Quasi-sovereign corporates continue to be one of our  Latam – ENAP and CDEL were the best performers inpreferred strategies to gain exposure to strong underlying Latam, with ELEBRA and ECOPET showing considerablemacro fundamentals. Exhibit 45 shows that the CIS region spread widening during the past month.represents the best risk/reward, and this is in line with ouroverall bullish view on CEEMEA credit. Key recommendations based on the QS scoring: Asia: We prefer PETHAI ’14 to KOROIL ’14.The performance of the quasi-sovereigns in the past monthhas been mixed. CEEMEA: KZOLKZ ’15 looks most attractive; we also like GAZPRU ’13. Latam: We prefer the pick-up PETBRA ’18 offers over PEMEX ‘19.Exhibit 45Quasi-Sovereign Model 250 KZOLKZ 15 200 Quasi-Sovereign vs Sovereign (Z-Spread) 150 TNEFT 14KAZATO 15 KOLAHO 14 GAZPROM 13 TAQA 14 PETBRA 18 NAFTO 14 TDICUH 14 100 ECOPET 19 ELEBRA 19 RZD 17 KORESC 15 PLNIJ 19 HIGHWY 15 KORGAS 14 KOSPO 14 MUBAD 14 PETROL 14 KOROIL 14 AXIATA 20 KOHNPW 14 ENAP 14 PSALM 19 PEMEX 19 MISCMK 14 50 TENAGA 15 PETHAI 15 KORELE 14 CDEL 14 0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 Stronger Score Weaker ScoreSource: Morgan Stanley Research 40
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioOil & Gas SectorWe maintain our bullish view on the EM O&G sector. The Exhibit 46sector is highly strategic to EM economies and in our MS Oil Price Forecast – Bullish Outlookview is one of the most effective methods to capture the Historical MS Forecast (starting YE2010)EM growth story (see EM Profile: EM Oil & Gas – Go Long Current Price Forward Curveto Capture the EM Growth, October 21, 2010). $175 Bull Case $150 $150Latam O&G names have underperformed. We use our EMO&G composite in Exhibit 47 as the basis to look at the $125 Yearend 2010 $105performance of the EM oil and gas sector in the past month. $100 $95Overall, the EM O&G composite spread has remained flat, $75with Latam O&G underperforming CEEMEA and Asia. $83.76 Bear Case $70Meanwhile, the DM O&G composite has tightened very $50marginally (3bp). $25 Current Price & Forw ard Curve as of: 11/28/10Issuance has been significant. EM O&G companies have $0issued US$14.2 billion in external debt in 2010, of which Mar-2006 May-2007 Jun-2008 Aug-2009 Nov-2010 Sep-2010 Nov-2011 Dec-2012 Source: Morgan Stanley Research estimatesUS$5.0 billion of this has come in 4Q10. The sector hasrather modest Eurobond redemptions in 2011 of US$5.0 Exhibit 47billion, but looking at potential capex funding requirements in EM O&G Composite: Attractive Pick-Up vs DM2011, we can expect external debt supply from the sector to 800 600be considerable. Assuming that demand-side dynamics 700remain relatively unchanged, we estimate that supply from the 600 500sector may be in excess of US$10 billion in 2011. 500 400Commodity outlook: supply-side risks. Our commodity 400 300research team forecasts a 2011 base case oil price of 300US$100/bbl, increasing to US$105/bbl in 2012. The key driver 200 200 100of higher oil prices in 2011 and 2012 according to our 100 0commodity team is a decline in spare capacity which is -100 0expected to pose challenges to increasing global demand. As Jul-06 Nov-06 Jul-07 Nov-07 Jul-08 Nov-08 Jul-09 Nov-09 Jul-10 Nov-10 May-06 May-07 May-08 May-09 May-10 Jan-07 Jan-08 Jan-09 Jan-10 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10a result, prices will likely tick higher, driven by the need to EM Oil&Gas Composite vs. DM Oil&Gas Composite (rhs) EM Oil&Gas Composite DM Oil&Gas Compositeration demand (see Exhibit 46). Source: Bloomberg, Morgan Stanley ResearchCIS region the most attractive. We continue to see the best Exhibit 48value in the CIS O&G names, in particular the quasi- Focus Trade: Buy KZOKZ ’15sovereign integrated operators. Our top pick in the sector isKZOKZ ’15, currently offered at z+420bp (YTM 5.6%). As 440highlighted earlier (see page 25), we like Kazakhstan’s macro 410 $ 15 KZOKZ $ 18 KZOKZfundamentals and view the state-owned operator KMG as the 380 $ 20 KZOKZ $ 21 KZOKZmost effective way to capture the favourable Kazakh macro 350 $ 34 GAZdynamics. As highlighted in CIS O&G – KazMunaiGaz: Life $ 13 KZOKZ Spread $ 25-Mar-14 GAZ $ 18 GAZ $ 20 GAZ $ Jul-14 GAZ $ 22 GAZ $ 37 GAZ 320Outside the Indices, October 28, 2010, we see fair value of $ Mar-14 GAZ $ 15 GAZ $ 19 GAZthe KMG spread versus Gazprom of 60-75bp flat across the 290 $ Jul-13 GAZ $ 16 GAZcurve. At current prices, KZOKZ ’15 trades 110bp wider than 260 $ Apr-13 GAZthe new GAZPRU ’15 – see Exhibit 48. 230 $ Mar-13 GAZ 200 0 2 4 6 8 10 12 14 Duration Source: Bloomberg, Morgan Stanley Research 41
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioExhibit 49EM Oil & Gas: Benchmark Regional Curves 340 GAZPRU16 GAZPRU22 GAZPRU34 GAZPRU18 GAZPRU 8.125% 14 GAZPRU20 GAZPRU37 GAZPRU 25-Mar-14 GAZPRU 8-Mar-14 GAZPRU19 290 GAZPRU15 PEMEX38 GAZPRU 7.51% 13 PEMEX35 GAZPRU 9.625% 13 240 GAZPRU 7.343% 13 PETBRA40 PEMEX14 Z-spread PEMEX19 PEMEX21 190 PETBRA Dec-18 PETBRA Mar-185.75% Mar-18 PEMEX PETBRA19 PETBRA20PEMEX20 RASGAS 6.332% 27 PETBRA16 PEMEX Mar-15 RASGAS 5.838% 27 PETROL14 PETBRA14 140 RASGAS20 PETROL26 PETBRA13 PETROL22 RASGAS16 RASGAS19 RASGAS14 RASGAS14 90 PETROL15 PETROL19 PETROL12 RASGAS12 40 0.0 2.0 4.0 6.0 8.0 Modified Duration 10.0 12.0 14.0Source: Morgan Stanley ResearchExhibit 50Spreads versus Fundamentals (Free Cash Flow/Debt) 800 VOSTOK15 700 NAFTO14 600 500 MOLHB17 Z-spread KZOLKZ18 400 PETRTT19 TMENRU18 LUKOIL19 GAZPRU18 300 ENAPCL19 ECOPET19 TNEFT18 PETHAI15 GSCCOR17 RILIN20 200 PETBRA18 IOCLIN15 PEMEX18 QGTS33 DOLNRG19 KOROIL14 BPLN19 RASGAS19 SKENER13REPSM17 QPETRO11 100 PETROL19 RDSALN18 XOM18 COP18 CNOOC13 TOTAL16 0 -75% -65% -55% -45% -35% -25% -15% -5% 5% 15% 25% 35% 45% 55% 65% 75% 85% 95% FCF/DebtSource: Morgan Stanley Research 42
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioAppendixEM Funds TechnicalsEM Exposure Indicator (EMEI): This index tracks the beta risk exposure of EM debt-dedicated funds relative to their benchmark. EMEI is constructedusing a basket of 73 dedicated EM fixed income or FX funds. A reading of 0 represents a significant underweight, 50 is equivalent to a neutral stance and100 reflects a substantial overweight in the part of fund managers relative to their benchmarks. A rising EMEI indicates that exposure of funds, collectively,is rising relative to the market. Levels below 25 tend to be followed by rallies and levels above 75 tend to be followed by sell-offs. For a detailed descriptionof the model, see EM Profile: The Second Generation of EM Exposure Indices, November 9, 2010.SovRank ModelThis model combines macro fundamentals, valuations and market risks using the results of SCRM, CC-MR and C-VOL in order to give a model-drivenassessment on the attractiveness of sovereign CDS. The sub-components of SovRank are detailed below: The Sovereign Credit Rating Model (SCRM) focuses on fundamental changes. It aims at predicting the future level of sovereign credit ratings based on key macro inputs; eventually we gauge in which extent the market is pricing-in these rating changes. The CC-MR model focuses on mean-reversion patterns. In this model, rating upgrades and downgrades are assumed to be slow to take place so that short-term movements in CDS are mainly driven by market considerations (e.g. supply/demand, risk appetite, etc.). To the extent that the model assumes no changes in fundamentals (in the short term), the CDS of each country is meant to revert to the level it usually trades versus the credit curve once technical factors also mean-revert. The C-VOL model reflects the market risks on each country. We adjusting the CDS of each country by its level of volatility. Concretely, we divide CDS levels by the volatility and normalise the result multiplying by the average volatility of the market. We then assess if the country is trading “rich” or “cheap” taking into account its level of volatility.For a detailed description of the models, see EM Profile: SCRM and SovRank, July 22, 2010.Credit View pagesCredit rating. The credit rating shown in the top left corner (next to the country’s name) is the simple average of foreign currency long-term issuer ratingby S&P, Moody’s and Fitch.Rich & Cheap model: For each bond, we calculate the difference between market z-spread and fair value on the fitted curve (i.e. the regression line). Aswe keep an historical of this spread, a Z-score indicator is computed to gauge how far each bond is trading relative to its average spread versus the curve.Depending on their Z-score level, bonds are then assessed as “cheap” or “rich” with a certain degree, as follows: The ‘Cheap+’ status (very cheap) is given for bonds which meet two conditions simultaneously: 1.) their current spread (in absolute terms) trades above the fitted curve and 2.) their current spread trades more than 1.5 standard deviation above their average level versus the regression line. A ‘Cheap-’ (cheap) status is given for bonds which Z-score indicator is positive but does not meet the previous two conditions. Symmetrically, the ‘Rich+’ status (very expensive) is given for bonds whenever they meet two conditions: 1.) their current spread (in absolute terms) trades below the fitted curve and 2.) their current spread trades less than -1.5 standard deviation below their average level versus the regression line. Bonds are given the ‘Rich-’ status (expensive) when their Z-score indicator is negative but it does not meet the previous two conditions.It is important to stress that the model is linear. Although this can appear as an imperfect fit compared to other types of regressions (such as a logarithmicor a polynomial), the linear regression is intended to capture the changes in the shape of the curves (i.e. changes in convexity) and the attractiveness ofeach bond for a given duration exposure. From this point of view, the regression line is more a reference point rather than an actual ‘fit’. Note also that theliquidity and the high (or low) dollar price of a bond are taken indirectly into account to the extent that we do not consider the spread relative to theregression as the relevant variable (a bond can be systematically trading above or below the curve given its higher or lower coupon, or because of betteror worse liquidity levels), but rather the spread versus historical average. By doing so, these particular features are neutralised to a large extent to onlyconsider the volatility of the spread versus its average point.Asset Preference: Our asset preference is based on our Rich & Cheap model (see above) but also takes into account our view on the curves (typically,steepening or flattening). Note that our asset preference for each country does represent a trade recommendation per se; instead, we highlight the bestrisk-reward opportunities for fund managers willing to get exposure on the credit. 43
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioSpread to Fair Value: Our country fair value estimate is derived from the SCRM model (see above under SovRank model). The chart shows thedifference between the 5-year CDS and the fair CDS level implied by the model given the SCRM projected rating.Technicals – Exposure vs. Average: We show EM funds’ exposure versus 12-month historical average relative to benchmark. This is a better reflectionof shifts in exposure for countries which have been historically over-/underweight for a long period of time.Macro Fundamentals: We represent macro forecasts in a radar chart, including GDP growth, inflation, fiscal balance (% of GDP), government debt (% ofGDP) and current account balance (% of GDP). The wider the radar chart (i.e. the wider the “web”), the better the fundamentals of the country relative toother EM credits. We rank each indicator among EM countries and represent the ranking value in the chart. For growth, fiscal balance and currentaccount, the ranking is in ascending order (i.e. the higher these indicators, the better for the country); for inflation and debt/GDP the ranking is indescending order (i.e. the lower these indicators, the better for the country). These indicators are Morgan Stanley forecasts, unless specified otherwise.OtherMacro-Dynamic Trend Indicator (MDTI): MDTI measures the momentum in underlying EM macro fundamentals. The model tracks 30 EMcountries at present. The indicator tracks the rate of change in the year-on-year change in inflation, industrial production, trade balance and FXreserves. Each of the four component series are equally weighed to derive the overall index reading. A rising MDTI suggests improving macrofundamentals momentum, a falling MDTI deteriorating macro fundamentals momentum. 44
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioEM Strategy and Economics TeamsEM Fixed Income and Foreign Exchange StrategyLondonRashique Rahman Team Head, EM Macro Strategy Rashique.Rahman@morganstanley.com +44 (0)20 7677 7295Paolo Batori, CFA Head of EM Credit Strategy, CEEMEA Paolo.Batori@morganstanley.com +44 (0)20 7677 7971Regis Chatellier Global EM Credit Strategy Regis.Chatellier@morganstanley.com +44 (0)20 7677 6982Vanessa Barrett EM Corporate Credit Strategy Vanessa.Barrett@morganstanley.com +44 (0)20 7677 9569Chuan Lim, CFA CEEMEA Local Markets Strategy Chuan.Lim@morganstanley.com +44 (0)20 7677 7597James Lord CEEMEA Macro Strategy James.Lord@morganstanley.com +44 (0)20 7677 3254 +44 (Robert Tancsa Credit Relative Value, EM Analytics Robert.Tancsa@morganstanley.com +44 (0)20 7677 6671Meena Bassily EM Strategy Meena.Bassily@morganstanley.com +44 (0)20 7677 0031New YorkRogerio Oliveira Head of EM Trade & Quant Strategy Rogerio.Oliveira@morganstanley.com +1 212 761 1204Vitali Meschoulam Head of Latin America Strategy Vitali.Meschoulam@morganstanley.com +1 212 761 1889Juha Seppala EM Quantitative Strategy Juha.Seppala@morganstanley.com +1 212 761 1949Rosa Velasquez Latin America Credit Strategy Rosa.Velasquez@morganstanley.com +1 212 761 8278Andrew Slusser EM Strategy Andrew.Slusser@morganstanley.com +1 212 761 0383Hong KongViktor Hjort Head of AXJ Credit Strategy/ Viktor.Hjort@morganstanley.com +852 2848 7479 Fixed Income ResearchStewart Newnham AXJ Currency Strategy Stewart.Newnham@morganstanley.com +852 2848 5320Yee Wai Chong AXJ Currency Strategy Yee.Wai.Chong@morganstanley.com +852 2239 7117Pieter Van Der Schaft Head of AXJ Rates Strategy Pieter.Van.Der.Shaft@morganstanley.com +852 3963 0550Rohit Arora AXJ Rates Strategy Rohit.Arora@morganstanley.com +852 2848 8894Kelvin Pang AXJ Credit Strategy Kelvin.Pang@morganstanley.com +852 2848 8204Nishant Sood AXJ Credit Strategy Nishant.Sood@morganstanley.com +852 2239 1597EM EconomicsManoj Pradhan Global Manoj.Pradhan@morganstanley.com +44 (0)20 7425 3805Tevfik Aksoy Head of CEEMEA Economics Tevfik.Aksoy@morganstanley.com +44 (0)20 7677 6917 / Turkey, Israel and MENAMohamed Jaber MENA Mohamed.Jaber@morganstanley.com +44 (0)20 7677 8189Michael Kafe South Africa, Nigeria Michael.Kafe@morganstanley.com +27 11 587 0806Andrea Masia South Africa Andrea.Masia@morganstanley.com +27 11 587 0807Pasquale Diana Poland, Hungary, Czech, Romania Pasquale.Diana@morganstanley.com +44 (0)20 7677 4183Alina Slyusarchuk Russia, Kazakhstan, Ukraine, Baltics Alina.Slyusarchuk@morganstanley.com +44 (0)20 7677 6869Gray Newman LatAm Gray.Newman@morganstanley.com +1 212 761-6510Luis Arcentales Chile, Mexico Luis.Arcentales@morganstanley.com +1 212 761-4913Daniel Volberg Argentina Daniel.Volberg@morganstanley.com +1 212 761-0124Qing Wang Greater China Qing.Wang@morganstanley.com +852 2848 5220Denise Yam China, Hong Kong Denise.Yam@morganstanley.com +852 2848 5301Sharon Lam Korea, Taiwan Sharon.Lam@morganstanley.com +852 2848 8927Steven Zhang China, Hong Kong Steven.Zhang@morganstanley.com +86 21 2326 0015Ernest Ho China, Hong Kong Ernest.Ho@morganstanely.com +852 2239 7818Jason Liu Korea, Taiwan Jason.JL.Liu@morganstanley.com +852 2848-6882Chetan Ahya Asia ex-Japan, India Chetan.Ahya@morganstanley.com +65 6834 6738Deyi Tan Singapore, Malaysia Deyi.Tan@morganstanley.com +65 6834 6703Shweta Singh ASEAN Shweta.Singh@morganstanley.com +65 6834 6739Tanvee Gupta India Tanvee.Gupta@morganstanley.com +91 22 2209 7927Morgan Stanley entities: London/South Africa – Morgan Stanley & Co. International plc; New York – Morgan Stanley & Co. Incorporated.; Hong Kong/Shanghai – Morgan Stanley Asia Limited.;Singapore – Morgan Stanley Asia (Singapore) Pte.; Japan – Morgan Stanley MUFG Securities Co., Ltd.; Dubai – Morgan Stanley & Co International plc (DIFC Branch); India – Morgan Stanley IndiaCompany Private Limited. 45
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit Portfolio Disclosure SectionThe information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/orMorgan Stanley C.T.V.M. S.A. and/or Morgan Stanley & Co. International plc and/or RMB Morgan Stanley (Proprietary) Limited and/or MorganStanley MUFG Securities Co., Ltd. and/or Morgan Stanley Asia Limited and/or Morgan Stanley Asia (Singapore) Pte. (Registration number199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley TaiwanLimited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N. 67 003 734 576, holder ofAustralian financial services license No. 233742, which accepts responsibility for its contents), and/or Morgan Stanley Smith Barney Australia PtyLtd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813, which accepts responsibility for its contents), and/or MorganStanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley").For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see theMorgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative orMorgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.Analyst CertificationThe following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed andthat they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views inthis report: Regis Chatellier.Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.Global Research Conflict Management PolicyMorgan Stanley Research has been published in accordance with our conflict management policy, which is available atwww.morganstanley.com/institutional/research/conflictpolicies.Important US Regulatory Disclosures on Subject CompaniesWithin the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of Mexico, Panama, Peru, ThePhilippines, Korea Electric Power, Petrobras.Within the last 12 months, Morgan Stanley has received compensation for investment banking services from Brazil, Panama, Peru, The Philippines,Turkey, Gazprom, Korea Electric Power, Petrobras, Pemex.In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Argentina, Brazil,Chile, Colombia, Panama, Peru, Turkey, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB BankJSC, Alfa Bank, Pemex..Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services fromBrazil, Bulgaria, Korea, Panama, Peru, Russia, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTBBank JSC, Alfa Bank, Pemex.Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking clientrelationship with, the following company: Argentina, Brazil, Chile, Colombia, Panama, Peru, The Philippines, Turkey, Gazprom, Halyk Bank ofKazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex.Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in thepast has entered into an agreement to provide services or has a client relationship with the following company: Brazil, Bulgaria, Korea, Panama,Peru, Russia, Gazprom, Halyk Bank of Kazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex.Morgan Stanley & Co. Incorporated makes a market in the securities of Petrobras.The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensationbased upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overallinvestment banking revenues.Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making,providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit,investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered inMorgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in thisreport.Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.STOCK RATINGSMorgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below).Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are notthe equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, sinceMorgan Stanley Research contains more complete information concerning the analysts views, investors should carefully read Morgan StanleyResearch, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon asinvestment advice. An investors decision to buy or sell a stock should depend on individual circumstances (such as the investors existing holdings)and other considerations.Global Stock Ratings Distribution(as of October 31, 2010)For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sellalongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to thestocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommendedrelative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buyrecommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively. 46
    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit Portfolio Coverage Universe Investment Banking Clients (IBC) % of % of % of RatingStock Rating Category Count Total Count Total IBC CategoryOverweight/Buy 1122 40% 413 44% 37%Equal-weight/Hold 1158 41% 411 43% 35%Not-Rated/Hold 121 4% 22 2% 18%Underweight/Sell 393 14% 103 11% 26%Total 2,794 949Data include common stock and ADRs currently assigned ratings. An investors decision to buy or sell a stock should depend on individualcircumstances (such as the investors existing holdings) and other considerations. Investment Banking Clients are companies from whom MorganStanley received investment banking compensation in the last 12 months.Analyst Stock RatingsOverweight (O or Over) - The stocks total return is expected to exceed the total return of the relevant country MSCI Index or the average total returnof the analysts industry (or industry teams) coverage universe, on a risk-adjusted basis over the next 12-18 months.Equal-weight (E or Equal) - The stocks total return is expected to be in line with the total return of the relevant country MSCI Index or the averagetotal return of the analysts industry (or industry teams) coverage universe, on a risk-adjusted basis over the next 12-18 months.Not-Rated (NR) - Currently the analyst does not have adequate conviction about the stocks total return relative to the relevant country MSCI Indexor the average total return of the analysts industry (or industry teams) coverage universe, on a risk-adjusted basis, over the next 12-18 months.Underweight (U or Under) - The stocks total return is expected to be below the total return of the relevant country MSCI Index or the average totalreturn of the analysts industry (or industry teams) coverage universe, on a risk-adjusted basis, over the next 12-18 months.Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.Analyst Industry ViewsAttractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. therelevant broad market benchmark, as indicated below.In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevantbroad market benchmark, as indicated below.Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevantbroad market benchmark, as indicated below.Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index;Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.Important Disclosures for Morgan Stanley Smith Barney LLC CustomersCiti Investment Research & Analysis (CIRA) research reports may be available about the companies or topics that are the subject of Morgan Stanley Research. Ask yourFinancial Advisor or use Research Center to view any available CIRA research reports in addition to Morgan Stanley research reports.Important disclosures regarding the relationship between the companies that are the subject of Morgan Stanley Research and Morgan Stanley Smith Barney LLC,Morgan Stanley and Citigroup Global Markets Inc. or any of their affiliates, are available on the Morgan Stanley Smith Barney disclosure website atwww.morganstanleysmithbarney.com/researchdisclosures.For Morgan Stanley and Citigroup Global Markets, Inc. specific disclosures, you may refer to www.morganstanley.com/researchdisclosures andhttps://www.citigroupgeo.com/geopublic/Disclosures/index_a.html.Each Morgan Stanley Equity Research report is reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval is conducted by thesame person who reviews the Equity Research report on behalf of Morgan Stanley. This could create a conflict of interest.Other Important DisclosuresMorgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of Brazil, Bulgaria, Chile, Colombia, Hungary,Indonesia, Kazakhstan, Korea, Lithuania, Mexico, Panama, Peru, The Philippines, Poland, Romania, South Africa, Turkey, Venezuela, Gazprom, Halyk Bank ofKazakhstan, Korea Electric Power, Petrobras, PTT Public Company, VTB Bank JSC, Alfa Bank, Pemex.The model portfolio is a hypothetical portfolio and is not intended to reflect actual trading performance. As a hypothetical model, the portfolio does not necessarilyrepresent a portfolio of securities that the Firm holds or trades. Any references to losses, gains or positions with respect to the portfolio represent hypothetical not actuallosses, gains or positions.Morgan Stanley produces an equity research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to therecommendations or views expressed in research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors.For all research available on a particular stock, please contact your sales representative or go to Client Link at www.morganstanley.com.Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financialcircumstances and objectives of persons who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, andencourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investors individualcircumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certaininvestors may not be eligible to purchase or participate in some or all of them.The fixed income research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based uponvarious factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading and capital markets profitability orrevenues), client feedback and competitive factors. Fixed Income Research analysts or strategists compensation is not linked to investment banking or capital marketstransactions performed by Morgan Stanley or the profitability or revenues of particular trading desks.Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy.The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1%or more of a class of common equity securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have aninvestment of less than 1% in securities/instruments or derivatives of securities/instruments of companies and may trade them in ways different from those discussed inMorgan Stanley Research. 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    • MORGAN STANLEY RESEARCH November 30, 2010 EM Credit PortfolioWith the exception of information regarding Morgan Stanley, Morgan Stanley Research is based on public information. Morgan Stanley makes every effort to use reliable,comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in MorganStanley Research change apart from when we intend to discontinue equity research coverage of a subject company. Facts and views presented in Morgan StanleyResearch have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment bankingpersonnel.Morgan Stanley Research personnel may participate in company events such as site visits and are generally prohibited from accepting payment by the company ofassociated expenses unless pre-approved by authorized members of Research management.The value of and income from your investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates,securities/instruments prices, market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of optionsor other rights in securities/instruments transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based onassumptions that may not be realized. 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