Emerging Markets 2012 Outlook
Survival of the Fittest




Table of ContentsEmerging Markets and the Global Economy in the Year AheadThe coming year is clearly going to be a difficult one for the world economy; however, this resilience will not be uniform across EM. Given the headwinds, 2012 may well prove to be a case of ‘survival of the fittest’. We expect the tug of war between structural and tactical drivers of 2011 to extend into 2012 – particularly during the first months of the year, when the future of Europe may be decided. .................................................................................................................... 11
This Month’s Special ReportsRates in 2012: Identifying Pockets of ValueEM receivers performed well after a rocky start. In our 2012 outlook, we analyze those country specific effects using a model which integrates macro-monetary policy interactions and local curve dynamics. Under our benchmark scenario the ‚fair‛ curves are relatively close to forward curves. ..................................................................................................... 22
FX in 2012: The Vehicle to Trade Global RiskDuring 2011, EMFX played the role of shock absorber with a large share of returns attributed to global drivers. External factors should remain the main drivers of EM currencies in 2012. .................................................................................... 30
Sovereign Credit in 2012: Diminished Returns; Country Selection KeyGiven the circumstances, 2011 has been another strong year for EM sovereign credit. We highlight how country selection (as opposed to simple beta-management) has been a key factor in portfolio selection in 2011. With this in mind, we devote much of this year’s outlook to a thorough examination of specific country factors (pricing, macro and technical). ........................................................................................................................................................................... 37
EM: Survival of the FittestWe present a framework for assessing relative vulnerabilities across EM using external, fiscal, financial, and growth sensitivity indicators. EMEA dominates our list of the most vulnerable countries. Other regions look safer though risk from rapid credit growth (Asia) and commodity dependency (LatAm) bear watching. ................................................. 46
EM Performance: The Grass is Grayer on the Other SideWe see the distribution of returns will likely continue to favor fixed income vs. growth-sensitive assets. Though returns are diminishing, EM still seems too important a source of carry and value to drop from investors’ priority list – either in risk-on or risk-off modes. In addition, if returns are less appealing in EM, the opportunities in global markets seem even less so. ............................................................................................................................................................................... 53
EM Technicals Outlook in 2012: Structurally Sound; Cyclically VulnerableA broad set of metrics suggest that structurally global investors are still under-allocated to EM. However, valuation, lack of depth, and market access suggest that the pace of strategic inflows will be considerably slower going forward when compared with 2003-2007. ................................................................................................................................................ 58
A Closer Look at Real-Money PositioningEM local currency funds have grown by a factor of almost 3.5x over the past four years, increasing their impact on the behaviour of local markets. In this article we examine the rise of these funds and also introduce a new analysis of the country positioning of such funds. ..................................................................................................................................... 63
IMF Financing: Possibilities and LimitationsWe review the various options on the table for boosting the financial firepower of the IMF, concluding that an increase in bilateral loans is the proposal most likely to fly. The need for a bigger IMF is primarily to deal with the euro crisis. We think the IMF already has enough in its locker to deal with likely EM needs. ..................................................................... 71
EMEA Domestic Debt: Supply and Demand in FocusSince Q32011, forced deleveraging has caused some foreign investors to either cut or hedge their holdings of local currency government debt. This note presents detailed estimates of the supply/demand dynamics of each EMEA market in 2012. We flag opportunities and threats from the perspective of technicals. ................................................................ 76
Theme Pieces ................................................................................................................................................................. 184