Greed and Fear : Reassessing Emerging Markets’ Fair Value Friday, December 2 nd 2005

1. Greed and Fear: Reassessing Emerging Markets’ Fair Value Friday, December 2nd 2005 Marco Annunziata Managing Director Head of Research and Strategy Unicredit Banca Mobiliare 1

2. Global Outlook 2

3. Overview: Key issues • Eurozone’s growth outlook slightly stronger (or rather less weak…) • …but slowing in 2007 on tighter fiscal policies and slowing world growth • Expect ECB to hike a cumulative 50bp through March, on hold thereafter • US growth on track, decelerating to potential (3 ½ %) • Housing market could deflate consumption • Fed to keep hiking: 4.25% by end-05, level off at 4.75% in mid-06 • Bond yields to follow…but how soon? • FX markets: USD to rise before it falls again vs EUR 3

4. UBM Outlook 4

5. FX and Brent Forecasts 5

6. Interest Rates Forecasts • We forecast only a mild increase in benchmark yields • The market is already pricing fully Fed Funds at 4.75% and ECB rate at 2.50% for Sep-06 6

7. Emerging Markets Outlook 7

8. Current Spreads have bottomed out EMBI+ Current Values (with Min, Max and Average since 01/01/2000) 2000 1800 1600 1400 1200 1000 800 704 617 600 566 550 514 400 382 318 273 237 200 179 143 133 0 EMBI+ Africa Asia Europe Latin Non Latin America Last Min Max Average Source: Bloomberg/JPMorgan 8

9. Almost all EM Spreads have tightened over the past year • USD denominated bonds have outperformed EUR bonds • Europe has underperformed • Tightening potential for NE Eurobonds is very limited (thin bars indicate the spread tightening) 9

10. EM Total Returns YoY11% in USD and 7% in EUR 10

11. EM have outperformed other credits in 2005 11

12. EM Total Returns YoYfor the largest components of the EMBI+ • The EMBI+ is highly concentrated on a few issuers: 6 countries represent over 85% of the index • 2005 total returns both in USD and EUR are high 12

13. EM benefit from several supporting factors: Low volatility making funding cheaper Improved fundamentals (Fiscal, debt, CA, rating upgrades) Reduced borrowing needs (2006 pre-financing has started early) Still high risk appetite Currency appreciation Strong commodity prices and robust world growth Widened investor base But also faces important risks: Historically low spreads Increasing benchmark yields and tighter Fed/ECB monetary policy Upcoming elections and reduced margin for policy mistake Bond bubble might still burst instead of deflating Oil price might switch from support to threat Pipeline of inflows remains positive but low Are current levels justifiedSupportive factors vs risks 13

14. Supportive FactorsLow Volatility 14

15. Supportive FactorsCredit quality has generally improved 15

16. Supportive FactorsThe external vulnerability is lower • External indebtedness has decreased in the last couple of years • Current account balances have improved in most of the countries • Only exceptions: Turkey (due to oil and strong import) and Russia (Dutch disease and strong rise in import). • Russia CA surplus is still high. 16

17. Supportive FactorsExternal debt issuance • Net issuance of external debt is generally supportive for most of the countries considered: • Brazil, Mexico, Venezuela, and Philippines show no strong need to access primary market. • Russian sovereign issuance is virtually disappearing, while the government is thinking about capping corporate access to external debt. • Turkey plans to increase net issuance. 17

18. Supportive FactorsHigh risk appetite for EM bonds Appetite for risk has increased despite rising UST yields The EMBI+ has reached a new all time low on Nov. 28th at 236bp 18

19. Supportive FactorsInflows should remain high 19

20. Supporting FactorsReal and nominal exchange rates Differential between nominal and real effective exchange rate highlights pressures Central banks have to face to maintain the chosen currency regime. Since 1995, we’ve seen a contraction of this differential, meaning that the likelihood of a currency risk has been generally reducing. The graph highlights the latest Turkish crisis in 2001, the Russian one in 1998-99 and the recovery from the general Peso crisis in the mid-90’s. Going forward, the only currency that might come under stress is the Venezuelan Bolivar, but this would not entangle a generic contagion effect. 20

21. From supportive to risk?High Commodity Prices • These big-6 are either neutral or even favoured by high oil prices: the fuel and energy items shows a nil or positive contribution to the total balance of goods, the only exceptions being Turkey and Philippines. • The few negative balance of goods (Turkey, Philippines and Mexico) in turn, are further compensated by the balance of services, so that the only country seriously affected by the “oil bill” remains Turkey… • …nevertheless, the appreciation that the currencies under consideration underwent in the last year helps lowering the burden of the negative “oil bills” in Turkey and Philippines. 21

22. Potential threatDecoupling of EM Spreads and BMK yields The relation between UST yields and EMBI+ has inverted in Q3-05 Correlation between 10-year UST and EMBI+ was roughly 60% in 2004 versus –40% in 2005 Sep-05 is the turning point, with the market radically changing its expectations on Fed monetary Policy and UST yields 22

23. Upcoming Elections:Risks of slippage ahead of the vote • Improvement in fundamentals is also partly due to the substantial capital inflows in EM since 2004 and to the global environment that has contributed to these inflows • Borrowers should remain cautious, as the prices of their bonds reflect not only the intrinsic quality of the borrower but also that of the improved global environment… • … therefore, they should not become complacent about their macro or monetary policies and the implementation of structural reforms, especially ahead of elections (Mexico: Jul-06, Presidential + Parliamentary ; Brazil: Nov-06, Presidential + Parliamentary ; Venezuela: 2006, Parliamentary ; Russia: Q2/Q3-08 Presidential, Q4-07/Q1-08 Parliamentary) • If anything, EBV + TMP(Fed, ECB) + RBY => less margin for mistake with EBV: Expensive Bond Valuations TMP(Fed, ECB): tighter monetary policies from both the Fed and the ECB RBMK: Rising Benchmark Yields 23

24. In the end it is all about money • Between Greed and Fear, the Sharks of Finance have made up their mind: • EM total returns are among the highest • EM fundamentals have improved • EM borrowing needs are lower • Global risk appetite is still high • Investor base has widened • Fed Fund Rate at 4.75% is fully priced and the new Fed Chairman should have little incentive to surprise the market • We forecast only moderately higher benchmark yields H1-06 appears safe for EM, with some volatility building in Q2 due to market expectations regarding the end of the monetary policy tightening cycle in the US and EU H2-06 could be more volatile depending on global liquidity and more importantly: local politics. Market conditions remain favourable but more fragile 24