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MORGAN STANLEY RESEARCH Morgan Stanley & Co. International plc+

CEEMEA Economics Team CEEMEA Strategy

For team listings, please see the last page of this report.

August 19, 2011 CEEMEA

CEEMEA Macro Monitor Slower Growth, Lower Rates Ahead Slower growth, lower rates ahead: Our global GDP forecasts have been cut substantially, for both 2011 (3.9%Y versus 4.2%Y) and 2012 (3.8%Y versus 4.5%Y). More relevant from CEEMEA's standpoint, our euro area colleagues have sharply downgraded their GDP growth forecast to just 0.5%Y for 2012. In response to these changes, we have lowered the aggregate real GDP growth forecast for our region to 4.3%Y for 2012 (from 4.9%Y previously). For the current year, the change is marginal, with a slight cut to 4.7%Y from 4.9%Y. Aggregate numbers mask significant intra-regional differences: Given that the region is so diverse, the extent of revisions varied noticeably across countries. However, the two key inputs that affected our forecasts were: i) the further weakness in growth in Europe; and ii) a lower oil price assumption for the coming year. The former is a key driver of growth for countries in CEE as well as for Turkey, Israel and South Africa, especially as our colleagues in the European Economics team expect stagnation in 4Q11 and 1Q12. The latter clearly plays a role in Russia, Nigeria and partially Kazakhstan: we are now assuming an oil price that is 10% lower than our previous assumption. While lower oil prices, along with other factors such as policy measures, result in lower growth rates in these countries, other countries in the region fare well from it in terms of inflation and the current account outlook. Easier policy ahead in most countries: In terms of policy response, most central banks in the region, with the exception of Russia, Ukraine and Kazakhstan, are likely to be easing rates (Poland, Turkey and Israel) and/or keeping rates unchanged for a considerable period (Czech Republic, Hungary, South Africa and Nigeria). That said, the diverse nature of economies in CEEMEA might call for varying degrees of responses. For instance, using noninterest rate measures such as the reserve requirement ratio to address deteriorating growth prospects or even hiking the policy rate in extreme cases should a deteriorating risk environment lead to undesired and disorderly moves in the currency.

Contents Country Snapshots

2

Focus: CEEMEA: Slower Growth, Lower Rates Ahead

3

Hungary: Fiscal Risks on The Rise as Growth Downshifts

8

Poland: Growth, the MPC and the Zloty

10

Russia: Debt Set to Double?

12

South Africa: 2Q GDP Collapse; July CPI Rising Further

14

Turkey: Growth Data Likely to Disappoint in Near Term

15

CEEMEA Strategy: CEEMEA FX Still Underperforming

16

Recent Research

18

CEEMEA Sovereign Rating Monitor

19

CEEMEA Inflation Monitor

20

CEEMEA Real Exchange Rate Monitor

21

Global Monetary Policy Rate Forecasts

22

Structural Indicators

23

Annual Economic Forecasts

24

Calendar

25

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MORGAN STANLEY RESEARCH

Country Snapshots Credit

Czech Republic

Hungary

Following the sharp moves of the past weeks, Hungarian bonds are trading somewhat cheap, as reflected by our MSI indicator. However, the credit is very sensitive to, mainly, European risk sentiment; hence we remain neutral on the credit.

Israel

August 19, 2011 CEEMEA Macro Monitor

CEEMEA Strategy Team

Local rates

Currencies

MS no longer believes that rate hikes will be forthcoming in the Czech Republic, in 2011 or 2012. The curve is still pricing in modest hikes out to the end of 2012, so we are now switching our bias to receiving the front end.

We have not changed our CZK forecasts, and expect the currency to follow a relatively flat profile. A likely resurgence in attention on Peripheral Europe and weak external backdrop keep us cautious on the CZK. Indeed, in a weak EUR environment we would expect the CZK to underperform relative to EM.

We think that the time is now right for paying the front end of the Hungarian swap curve. Over the coming 12m, MS thinks that the NBH policy rate will remain on hold, compared to the market’s expectation of around 50bps in cuts. Paying the 1y or 2y contract has good risk reward, in our view.

We have weakened our forecast profile for the HUF and now expect EUR/HUF to end the year at 270. We are more cautious than before, given the ongoing deterioration in the Eurozone. We recommend buying EUR/HUF on dips.

We continue to recommend receiving 10y ILS rates. The contract has moved far below our original and then secondary targets. We believe that we could soon trade as low as 4.2%. The curve is not yet pricing much in the way of cuts and with inflation and inflation expectations likely to continue falling, we think there is further room to rally across the curve.

In the most recent bout of risk-aversion, we can see that the ILS is not completely immune to extreme periods of market unrest, and we are also weary of a narrowing current account surplus. That said we do continue to believe the currency should fare better than its CEEMEA peers, given a better fundamental story.

Kazakhstan

Solid fundamentals and limited supply should support the credit going forward. In fact, we see the recent drop in oil prices as a good opportunity to add exposure to Kazakhstan. In the absence of sovereign issuance, we believe the national oil company, KMG, remains the most effective trade to get exposure to the strong macro fundamentals in Kazakhstan.

Poland

Poland is trading relatively cheap, both in view of macro fundamentals and on a volatility-adjusted basis. The upcoming elections in October are a key risk, however, and despite relatively benign technicals, we see increasing volatility affecting the credit going forward.

Given a downgrade in inflation and growth projections, our economists now expect rates to be cut in Poland, with a potential 50bps of cuts in 1H12. We have been recommending flatteners in Poland, and while previously we had felt that this trade was running out of steam, there is now more impetus given the falling inflation risks.

Our PLN forecasts have been revised in anticipation of more PLN weakness then we had previously anticipated. Indeed, we now expect EUR/PLN to end the year at 4.15, up from 3.95. PLN, along with HUF, will likely suffer in line with continued deterioration in the external environment, and the prospect of rate cuts.

Romania

Despite the recent upgrades by Fitch, we continue to see Romania as a relatively challenging credit in terms of fundamentals. Given the ongoing debate surrounding Peripheral Europe, we retain no exposure on this off-index credit at present.

We remain sidelined in RON rates.

In line with our broadly negative view on the CEE currencies we have weakened our forecasts for the RON. We see the RON as one of the most exposed currencies in the CEEMEA region to a further deterioration in Peripheral Europe. However, given the NBR has an unofficial target of 4.00-4.30, we expect spikes beyond 4.30 to be met with NBR intervention.

Russia

In the current volatile environment, we prefer the quasi-sovereign names, including Alrosa and Gazprom. The former benefits from improving credit fundamentals and sovereign support. Recent weakness in oil prices will affect gas prices with some lag, however, overall levels remain supportive for the credit.

Russia is one of few countries within the CEEMEA region that has a case for raising the policy rate before year end, in our view. Rates in Russia have continued to trade soft in line with the recently more accommodative stance of the CBR. These factors leave us biased to pay rates in Russia.

RUB was unduly punished during the recent sell-off. Russia runs a significant current account surplus and we would expect it to be an outperformer during the current uncertain period. Moreover, the RUB is close to levels versus the basket where the Central Bank of Russia would intervene to support the currency.

South Africa

Strong gold prices and, being a low-beta credit, falling UST yields have been supporting South Africa so that the credit has outperformed the market overall. Based on our models, however, South Africa trades somewhat rich on a relative basis; we therefore see little upside on the credit. Besides, liquidity remains low. We recommend positioning in the belly and the long-end, namely the 2022 and the 2041 globals.

We continue to favour the back end of the South African swap curve. The curve has not flattened as we had anticipated, but the whole curve has moved lower, bringing the back end with it. The curve is not yet pricing cuts in South Africa. Given the momentum in the market at present, and the state of the global economy, it is quite possible that we see further steepening as cuts become priced in. Medium-term though, flatteners are the right trade.

We expect the ZAR to be a regional underperformer, especially as we move into 2012, with an expected 7% depreciation versus the USD by end-12.

Turkey

Despite the recent drop in oil prices, the country is penalised by relatively high oil levels which adversely impact the current account. The political instability in neighbouring Syria – although a tail risk at this point for Turkey – may make investors cautious about adding risk in the region, we believe.

Turkish rates have been volatile recently, reflecting moves in the currency. We are biased to receive rates on any spikes higher. The curve is already pricing in rate cuts in Turkey, which MS expects to materialize in 2012. Given the slowing growth momentum, we are biased toward lower rates and receive on moves higher.

We think The TRY is likely to underperform EM too. While the current account position will likely improve in coming months, it will still likely weigh on the currency. The Central Bank of Turkey remains biased toward easing which should keep downward pressure on the currency.

We think the KZT should benefit from a strong balance of payments position and a central bank that is allowing increasing flexibility in its exchange rate. However, we do see downside to being too bullish the KZT, since with a potential deterioration in global growth, there are increased risks of oil prices weakening.

Source: Morgan Stanley Research *Blank areas represent assets for countries that are either illiquid or are not covered by Morgan Stanley Research; Discussion of certain names in this report may be restricted to due legal or internal policy issues

2


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA: Slower Growth, Lower Rates Ahead Our global GDP forecasts have been cut substantially, for both for 2011 (3.9%Y versus 4.2%Y) and 2012 (3.8%Y versus 4.5%Y). More relevant from CEEMEA’s standpoint, our euro area colleagues have sharply downgraded their GDP growth forecast to just 0.5%Y for 2012. In response to these changes, we lowered the aggregate real GDP growth forecast for our region to 4.3%Y for 2012 (from 4.9%Y previously). For the current year, the change is marginal, with a slight cut to 4.7%Y from 4.9%Y. Given that the region is so diverse, the extent of revisions varied noticeably across countries. However, the two key inputs that affected our forecasts were: i) the further weakness in growth in Europe; and ii) a lower oil price assumption for the coming year. The former is a key driver of growth for countries in Central Europe as well as for Turkey, Israel and South Africa, especially as our colleagues in European Economics expect stagnation in 4Q11 and 1Q12. The latter clearly takes a higher priority for Russia, Nigeria and to some extent Kazakhstan: we are now assuming an average oil price of US$103/bbl (based on oil futures) for 2012, which is some 10% lower that our previous assumption. While lower oil prices, along with other factors such as policy measures, result in lower growth rates in these countries, other countries in the region fare well from it in terms of inflation and the current account outlook (Turkey among others). Overall, the aggregate CPI inflation forecast for 2012 remains unchanged at 6.7%Y, following a marginal improvement of 0.2pp to 6.9%Y for 2011. Easier policy ahead in most countries: In terms of policy response, most central banks in the region, with the exception of Russia, Ukraine and Kazakhstan, are likely to ease rates (Poland, Turkey and Israel) and/or keeping rates unchanged for a considerable period (Czech Republic, Hungary, South Africa and Nigeria). That said, we need to underscore that the diverse nature of economies in CEEMEA might call for varying degrees of responses. For instance, using non-interest rate measures such as the reserve requirement ratio to address deteriorating growth prospects (in Turkey); or even hiking the policy rate in extreme cases should a deteriorating risk environment lead to undesired and disorderly moves in the currency (e.g., in Hungary, though not our base case). We look at each country in detail below, focusing on the forecast revisions as well as discussing the policy outlook. On page 7, we provide a summary of the scope to use monetary and fiscal policies across CEEMEA. Turkey: Will overcooling be the next concern? In Turkey, we have long been arguing that the economy has been on a slowdown course, helped by the monetary policy stance, loss of momentum in domestic consumption, lack of robust external

CEEMEA Economics team

demand coupled with the depreciation in the currency. And in recent months, the noticeable deterioration in sentiment both on the consumer and the corporate fronts is likely to limit the upside to growth through private consumption and investment spending channels. Following impressive growth in 2010 (8.9%Y) that saw a 3.6%Q (sa) expansion in 4Q10, 1Q11 sequential growth eased to 1.4%Q (sa). We expect 2Q to witness a contraction of around 1%Q followed by a marginal improvement in 3Q and 4Q. The good news is that we revise up our 2011 full-year GDP growth forecast to 5.9%, mostly reflecting some possible improvement in the contribution of net exports to headline growth in 2H. The bad news is that the expected weakness in growth in Europe that will have direct implications for Turkey’s exports, coupled with the ongoing loss of momentum in domestic demand, mean we lower our 2012 growth forecast by a full percentage point to 3.5%Y. Clearly, this will be a sub-trend growth and likely to offset the adverse implications of a weak currency and more accommodative monetary policy. That is why we have not changed our average CPI inflation forecasts materially. However, slower growth should lead to limited expansion in non-energy-related imports and the lower oil price assumption for 2012 should help to improve the current account dynamics noticeably. While we expect the current account deficit to GDP ratio to reach a record 9.4% in 2011 (previously 8.7%), we project a material decline to 7% in 2012. Given that the current account has been perceived as the most significant risk facing the economic outlook, we believe that this reversal projection should provide some level of comfort to market participants. Exhibit 1

Turkey Forecast Revisions GDP

2011 2012

CPI

Policy rate (year-end)

Old

New

Old

New

Old

New

5.5 4.5

5.9 3.5

5.8 6.4

5.7 6.4

6.25 7.50

5.75 5.50

Source: Morgan Stanley Research estimates

In terms of the policy rate outlook, we believe that the CBT will definitely be ready to ease should global macro conditions worsen to an extent that domestic growth comes under significant pressure. However, since the CBT recently already made a pre-emptive move and cut the policy rate by 50bp (in early August), we believe that the downside to current policy rates is rather limited. Instead, we believe that the next policy option might involve easing of the required reserve ratio and, should further easing prove necessary, more rate cuts could follow. That said, we pencil in at least another cut for early 2012, which might be a response to a rate cut by the ECB.

3


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Central Europe: Nowhere to hide: As a result of slower euro area growth as well as clearly slower momentum going into 2H11, we have downgraded growth extensively across Central Europe. We were already on the low side on consensus, but this revision firmly pushes us into the bearish camp. We also took this opportunity to revisit the CPI profiles in light of the recent softer-than-expected inflation releases as well as a lower oil price trajectory in 2012. Poland: Rate cuts on the way: In Poland, we see growth momentum easing sharply in 2H on the back of lower IP growth and exports. We now see growth averaging 3.7% this year and 3.2% next year, quite a sharp revision from our previous forecasts of 4.2% and 3.6%, respectively. At the same time, we have downgraded our inflation forecast to reflect both better news on food prices as well as a more benign oil price path: we now see inflation averaging 4.1% this year (previous: 4.4%) and 2.7% next year (previous: 3.4%). In terms of the monthly profile, we think CPI could now end the year just under 4%Y and then edge sharply lower in 1Q12 on a VAT-related base effect. Inflation could fall as low as 2% by mid-year before settling around the 2.5% target. A key upside risk to inflation would be a possible rise in the VAT rate already in mid-2012 should a weak zloty and weaker growth push the debt/GDP ratio above 55% already at end2011. Our new GDP and CPI profiles will bring rate cuts back on the agenda, we think. We think rates have already peaked at 4.50%, and forecast 50bp of rate cuts in 1H12. Exhibit 2

Poland Forecast Revisions GDP

2011 2012

CPI

Policy rate (year-end)

Old

New

Old

New

Old

New

4.2 3.6

3.7 3.2

4.4 3.4

4.1 2.7

5.00 5.00

4.50 4.00

Source: Morgan Stanley Research estimates

Hungary: Limited room to act for the NBH: In Hungary, we think that the external shock will penalise exports and growth, within the context of already depressed domestic demand. Hungary will likely flirt with recession and we expect it to hardly grow in quarterly terms for the next six months. Note that already in 2Q GDP growth stalled in quarterly terms. Our GDP growth forecasts are now 1.6% in 2011 (previously: 2.6%) and 1.4% in 2012 (previously: 2.0%). True, the government’s scheme to help FX debtors should boost disposable income temporarily starting in 4Q11, but we doubt that a substantial portion of the subsidy will be spent, rather than saved. The external risks to growth should definitely dominate, and put at risk the government’s structural reform programme. The government plans to implement structural fiscal tightening are worth about 2% of GDP next year. This is predicated on

growth of 3% in 2012, which quite frankly seems a very tall order. A growth undershoot may put pressure on the government to postpone some of the most socially unpopular measures, but the markets may not react kindly. Against this kind of backdrop, the NBH may be unable to lower interest rates, despite slower growth and a reasonably benign inflation environment (we see CPI at 3.9% in 2011 and 3.3%Y in 2012, down from 4.2% and 3.6% previously). This is because the risk environment remains a key variable for the NBH, and the bank is unlikely to feel comfortable taking rates lower unless it feels that Hungary’s risk premium warrants such a move. Therefore, while we no longer see rate hikes in Hungary next year, we do not pencil in cuts either, and see rates holding at 6.0% (down 50bp from the previous forecast). Exhibit 3

Hungary Forecast Revisions GDP

2011 2012

CPI

Policy rate (year-end)

Old

New

Old

New

Old

New

2.6 2.0

1.6 1.4

4.2 3.6

3.9 3.3

6.00 6.50

6.00 6.00

Source: Morgan Stanley Research estimates

Czech Republic: CNB to postpone hikes indefinitely: In the Czech Republic, we have raised our GDP forecast for this year on account of a better 1H than we expected. But the real change in our forecast is that we now see much weaker growth in 2H11 and into 2012, for the same reasons as elsewhere. Our new GDP forecasts are 2.1% for 2011 and 1.7% for 2012, from 1.5% and 2.3% previously. In essence, where we previously saw acceleration, we now see deceleration, particularly over the next three quarters. We see inflation averaging 1.9% this year (previously: 2.0%) and 2.9% in 2012 (previously: 2.0%). The sharp upgrade to next year’s inflation forecast is entirely due to the incorporation of the 1% VAT hike in January, and has no implications for monetary policy, in our view. The CNB already has rates at 0.75%, so the bar for rate easing is rather high. But at the very least the clear slowdown in growth momentum that we expect to materialise implies that the CNB can find no reason to hike rates any time soon. In fact, rate cuts and rhetoric aimed at softening CZK may well become central to monetary policy in the coming quarters. For now, we have postponed rate increases indefinitely and see CNB rates on hold at 0.75% throughout 2012 (100bp lower than previously). Exhibit 4

Czech Republic Forecast Revisions GDP

2011 2012

CPI

Policy rate (year-end)

Old

New

Old

New

Old

New

1.5 2.3

2.1 1.7

2.0 2.1

1.9 2.9

1.00 1.75

0.75 0.75

Source: Morgan Stanley Research estimates

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MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

South Africa: Rates on hold as growth falters: As a result of our global growth downgrades, we believe that the prospects for South African GDP growth have deteriorated, leading us to downgrade our 2011 and 2012 growth forecasts to a below-consensus 3.0% pace for both years, from 3.8% and 3.7%, respectively. As we have shown in previous research, South African exports are particularly sensitive to demand conditions in Europe. As such, we have slashed our export growth forecasts from 3.5% to 1.6% in 2011, and from 6.2% to 3.6% in 2012. We also believe that business confidence is likely to take a knock from the sombre pace of global expansion, delaying the long-awaited recovery in gross fixed investment even further. At the household level, downside risks to our employment forecasts and a likely increase in precautionary savings could dampen durable and semi-durable goods spend too. Against this background of softer domestic demand, we have scaled back our current account forecast from -3.7% of GDP to -3.5% in 2011, and from -4.5% to -4% in 2012. The smaller deficit, together with some fine-tuning of expected FDI flows, suggests that the monetary authorities may now be in the position to acquire some R7 billion of FX reserves in 2012 compared with our earlier forecast of a flat reading. The slightly more optimistic outlook is not enough to change our currency forecasts, however. We continue to expect USDZAR to close 2011 at 7.00 and 2012 at 7.50. With regards to inflation, we no longer expect CPI to breach the upper end of the target band, thanks to weaker domestic demand conditions and the downward revision in oil prices from our earlier estimate of US$113/bbl to US$103/bbl. We now see CPI peaking at around 6% in 1Q12 before falling back to close that year at 5.6%Y and averaging 5.6% in 2013. The lower inflation forecast suggests to us that domestic monetary conditions are likely to remain accommodative for much longer than we had previously anticipated. To be clear, we do not expect the SARB to raise rates in 2011 or 2012. If anything, we believe that the risks of a further rate cut are rising, and will not be surprised to see the SARB resume policy easing if there was a major contraction in European GDP growth (as this will have significant implications for South African exports and GDP), or if the G20 group of countries were to embark upon coordinated policy easing. This is not our base case, however.

In terms of the RUB, in light of the weaker balance of payments at lower oil prices, the ruble might appreciate at a slower pace than we had previously anticipated. Clearly, the sharp recent correction revealed the fragility of sentiment towards Russia. Nonetheless, at forecast oil prices, Russia will continue to run a persistent surplus on the current account and, absent other factors, the RUB would grind higher. We then see the RUB broadly maintaining the rate of 33 RUBBSKT through 2012. On rates, in the light of the softer global monetary stance and falling food prices, we have already softened our call, and now see only one deposit rate hike to 3.75% before year-end. We then expect policy to go on hold until after the elections, when we expect a mild tightening of both fiscal and monetary policy, with a signaling hike in the refinancing rate to 8.5% and a further three hikes in the deposit rate to 4.25%, as part of the policy of narrowing the bands between policy rates and seeking to get back on top of inflation. Exhibit 6

Exhibit 5

Russia Forecast Revisions

South Africa Forecast Revisions GDP

2011 2012

Russia: Domestic stimulus dominates drag from net exports: The main change in our Russian growth forecast has been to shave them from 5% to 4.7% in 2011 and 5.5% to 5.2% in 2012 to reflect the impact of the lower-than-expected growth in 2Q, and lower net exports from the falling oil price. On the back of this reduction, we now see investment growth in 2011 weakening to just under 2% in 2012, before recovering strongly in 2012 at 7.5%, powered by the fiscal expansion and an autonomous pick-up in investment after the elections. In terms of inflation, our view has not changed much, with the seasonal impact of the harvest bringing prices down below 8%Y this autumn, before prices start to rise again with the fiscal expansion, peaking in mid-2012, before the tightening of policy post-election from 2Q gradually brings inflation back down to around 7%Y by end-2012. The reduction in the oil price forecast to slightly over US$100/bbl from US$110/bbl Urals has a small impact in 2011, and a more significant impact in 2012. On the budget, it contributes to a widening in the forecast deficit to -0.3 and -1.7% of GDP from balance and -0.5% of GDP, respectively. On the balance of payments, it reduces the trade balance significantly, with the current account falling from 4.8% and 3.4% previously to 4.3% and 2.0% in the current forecast.

CPI

Old

New

Old

New

Old

New

3.8 3.7

3.0 3.0

5.0 5.9

5.0 5.7

5.50 7.50

5.50 5.50

Source: Morgan Stanley Research estimates

GDP

Policy rate (year-end)

2011 2012

CPI

Policy rate (year-end)

Old

New

Old

New

Old

New

5.0 5.5

4.7 5.2

9.0 8.0

8.9 8.1

8.50 9.00

8.25 8.50

Source: Morgan Stanley Research estimates

5


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Ukraine: Maintaining a precarious balance: Ukraine is in a complicated situation, with significant funding challenges on both the fiscal and external accounts, which means a wide range of possible outcomes and an enhanced level of risk around our central case. Nonetheless, we have not adjusted our forecast significantly, which continues to be based on an assumption of compliance with the IMF programme, reducing the broad fiscal deficit to 4% in 2011 and 3% in 2012. In particular, we see a fall in the growth rate to 4.6% from 5.0% in 2011 and 4.2% from 5.0% in 2012, reflecting weaker external demand and more restraint on the authorities’ scope for policy stimulus in the 2012 Rada election year, due to funding challenges. We also see a reduced funding challenge on the current account, with the deficit falling, with the lower oil price assumption, from 4.2% and 4%, to 4% and 3.4% respectively. Exhibit 7

Ukraine Forecast Revisions GDP Old

2011 2012

5.0 5.0

CPI Old

New

4.6 4.2

9.7 9.5

New

Policy rate (year-end) Old New

9.3 9.1

8.00 9.00

Israel: Well prepared for a challenge? We have recently revised our 2011 growth forecast (4.8%Y) and for the time being we maintain it, although we acknowledge the downside risks as the economy has already started to slow. For 2012, we cut our growth forecast by 0.6pp to 3.4%, which is almost equal to the trend growth rate in Israel. Hence, it is unlikely to cause significant concern on part of policy-makers, but at the same time should limit the downside risks to inflation, in our view. Still, we lower our average inflation forecasts, reflecting the impact of recent prints and more importantly the new macro assumptions. We now expect average CPI inflation at 2.9%Y (end-2012 at 2.7%Y), which will be within the official target range. In order to address the ongoing and the expected slowdown in growth, as well as taking into account subdued risks on the inflation front, we expect the BoI to keep the policy rate unchanged this year (as opposed to our previous expectation of hikes) and we also pencil in a 50bp cut to take place in 1H12. Exhibit 9

Israel Forecast Revisions

Nigeria: Revised oil assumption reins in growth outlook: We maintain our 2011 GDP forecast of 8.4%, but downgrade our 2012 forecast from 8.5% to 8.0%. We estimate that every US$10/bbl decline in Brent crude oil prices subtracts some 0.2pp from our 2012 growth estimate. Our dim view on the global business cycle suggests that Nigeria’s non-oil sector – especially the finance, manufacturing, construction and real estate sectors – is also likely to soften somewhat, dragging our overall GDP estimate even lower. Even so, we remain more constructive than consensus GDP estimates of 7.5% in 2011 and 7.2% in 2012. With regards to the external accounts, we expect the downward revisions to oil prices to result in a US$5 billion deterioration in the overall balance of payments – a relatively small move that is unlikely to significantly impact the currency. We therefore maintain our constructive view on the naira and still expect USDNGN to close the year at 153 before strengthening further to 150 by end-2012. Lower oil prices are likely to place a lid on domestic inflation too, capping headline CPI at some 10.5% in both 2011 and 2012. From a monetary policy perspective, we continue to see terminal rates at 9.0% by end-2011, and highlight the risk that the CBN may in fact unwind part of the recent tightening in monetary policy were global conditions to deteriorate markedly.

2011 2012

Exhibit 8

Exhibit 10

2011 2012

8.4 8.5

New

8.4 8.0

Source: Morgan Stanley Research estimates

CPI Old

10.8 10.7

Policy rate (year-end)

Old

New

Old

New

Old

New

4.8 4.0

4.8 3.4

3.7 3.2

3.6 2.9

3.75 4.50

3.25 2.75

Source: Morgan Stanley Research estimates

Kazakhstan: Insulated on the fiscal and external accounts: We see a slowdown in growth to 6% next year, as a result of lower commodity prices reducing net exports, and the authorities tightening policy in late 2011 to bring inflation back towards the target range (after the spurt that is caused by the major wage and tariff increases in summer 2011), which is likely to curb private consumption growth. Kazakhstan is well insulated on both the external and fiscal accounts from significant repercussions of the c.US$10/bbl move in the oil price. On the external account, the lower oil price assumption should reduce the enormous trade balance (28% of GDP in 2011) by about 4% of GDP, and the current account deficit by ~2% of GDP, since lower exports will be partially offset by lower investment income payments. The lower oil price should also reduce the inflow into the national oil fund, by ~US$2 billion (1.2% of GDP) in 2011 and ~US$6 billion (3.2% of GDP) in 2012. However, since the national oil fund will continue to accumulate reserves in excess of the annual US$8 billion transfer to the budget, the budget should be substantially shielded from any impact.

Kazakhstan Forecast Revisions

Nigeria Forecast Revisions GDP Old

CPI

GDP

Source: Morgan Stanley Research estimates

New

10.3 10.4

9.00 9.00

9.00 9.00

CPI

GDP

Policy rate (year-end) Old New

2011 2012

Policy rate (year-end)

Old

New

Old

New

7.0 7.0

7.0 6.0

9.0 7.4

8.5 9.0

Old

New

7.50 9.00

Source: Morgan Stanley Research estimates

6


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Exhibit 11

Scope to Use Monetary and Fiscal Policies Across CEEMEA Turkey

Israel

Russia

Ukraine

Kazakhstan

Cz. Rep

Hungary

Poland

Romania

South Africa

Nigeria

Room for Monetary Policy Stimulus? Yes. The CBT acted rapidly and cut the policy rate in a pre-emptive move. We believe that the bank would not hesitate to ease monetary conditions via further rate cuts and/or easing RRR rate both on TRY and FX deposits in order to mitigate the impact of a global downturn. Inflation has been reasonably contained and is likely to deviate marginally from the year-end target, which leaves some further room for the CBT to maintain an accommodative stance. In order to eliminate speculative moves in the currency it introduced daily FX sale auctions and raised the o/n rate. We would not rule out additional monetary measures that the CBT might introduce to stem the depreciation of the currency such as cuts in required reserves, cuts in FX funding rates, verbal and when necessary direct interventions. Yes. We believe that the first line of attack to a recession scare would come from the monetary authority by a series of policy rate cuts as experienced during the previous recession. The rate normalisation cycle commenced fairly early in Israel and recently the ex ante real policy rate turned slightly positive, which can be reversed in the coming quarters. This can happen via a series of rate cuts and the gradual decline in inflation and inflation expectations are likely to facilitate the move. We believe that inflation will be easing on the back of the rise in rates that had been taking place over the past 12 months, coupled with lower energy prices and the indirect impact of ongoing domestic protests as well as easing domestic demand. Some. Rates and RRR are at levels similar to 2008, since Russia only started tightening in Dec 2010 and the limited tightening implemented to date constrains the scope to cut. However, since the CBR has widened the bands around the exchange rate so significantly, it is unlikely to tighten rates to defend the ruble, as it did in autumn 2008. In fact, with inflation falling fast as a result of lower food prices, near-term cuts are a policy option. However, given the fiscal expansion and higher political sensitivity to inflation, we do not expect rate cuts yet, and expect to see RRR cuts and an expansion in the list of eligible collateral for repo first. In case of a rate spike, the MinFin is a key source of additional liquidity. Some. Ukraine now has and – in light of funding needs and difficulties in accessing external markets – needs an IMF programme. So, it will need to comply with IMF conditionality in order to access funding, which means that it will have to convince the IMF to agree a stimulus package. While the scope for cutting rates and RRR is low, since Ukraine only started hiking at end-June and rates are much lower than in 2008, the IMF supports a move to a more flexible exchange rate regime, which would reduce the risk of repeating the 2008 experience when Ukraine tightened rates domestically to defend the currency during the crisis. No. Kazakhstan has not yet started tightening monetary policy, and so has little scope to loosen it. It also has kept the tenge at an undervalued post-crisis level even as the oil price has climbed, and has moved to a flexible exchange rate regime, so the currency is unlikely to move much unless there is a radical drop in the oil price, and then, unlike 2007-08, the NBK will not raise rates to defend the currency. More generally, the lack of financial markets and the high level of NPLs in the banks make it difficult to deliver a monetary stimulus. Some. The CNB has rates at 0.75%, so that clearly limits the amount of easing it can do compared to 2008, when the bank cut rates ahead of the pack and reduced them by a cumulative 300bp, to their current level. That said, the CNB can still take rates to zero, signal its preference for a weaker currency and even contemplate QE if it deems it necessary to reflate the economy, we think. Limited. With rates at 6%, an economy which looks weak and inflation easing, the standard response would be for the NBH to at least take back the 75bp of rate hikes put in place in late 2010 as inflation risks rose. That said, the bank is more focused on financial stability than anything else, and it will not feel comfortable cutting rates when the risk environment is so unstable, we think. A risk rally, fiscal discipline, slowing inflation and struggling growth are all needed for the NBH to deliver more stimulus, we think. Recall that in 2008, the bank first had to hike rates aggressively to stem HUF weakness, and was only able to cut them when market conditions had calmed down post-IMF involvement. Yes. Rates are at 4.50% now, and the NBP still has a tightening bias; growth is slowing and recent CPI prints have been benign however, so the NBP will end its tightening campaign soon, and move to a neutral bias, we think. We think the NBP would not hesitate to cut rates next year as inflation and GDP growth slow materially. On the currency, we think the NBP will not be opposed to let the zloty weaken gradually. That said, at around 4.15 versus EUR, there is not much room to let the currency weaken without risking an overshoot in the debt/GDP ratio (27% of government debt is denominated in foreign currencies) to above 55%. Some. Inflation is finally giving the NBR some respite and the central bank recently revised down its inflation forecast. That said, senior NBR officials have already made it clear there is no room to cut rates. That may change if the NBR feels that inflation risks are abating fast and the economy needs more help. That said, given real rates are historically not at a high level, it is very unlikely the NBR can cut rates a lot. RRR on FX loans, currently at 20%, can be lowered if the system needs more FX liquidity. Yes. Inflation in South Africa is no longer likely to breach the upper end of the inflation target band. Although the policy repo rate is already 650bp lower than it was in 2008, we note that weak domestic demand is likely to cap inflationary pressures, giving the SARB some scope to ease rates further should the need arise.

Yes. As part of its policy normalisation objective, the CBN has raised its Monetary Policy Rate by a cumulative 275bp since 3Q10, to 8.75% currently. Thus, the current policy rate is lower than the 10.25% that prevailed at the time of the 2008/09 crisis. At that time, the CBN slashed rates not only in response to the global crisis, but also in response to the unfolding domestic banking sector crisis. In our opinion, were global growth conditions to deteriorate markedly, the CBN would have the scope to fully unwind the recent tightening.

Room for Fiscal Policy Stimulus? Yes. Debt/GDP has been declining and remains one of the lowest among its peers in EM (clearly much better than DM). This gives some room to manoeuvre on the fiscal front: Turkey’s fiscal position has been impressively strong on the back of limited expansion in non-interest spending but also the utilisation of cyclical improvement in revenues in lowering net debt issuance. The recent introduction of a restructuring of state receivables brought in a higher-than-anticipated sum and, if saved, it would make the fiscal deficit negligible. The officials made assurances that the possible stimulus would be limited with monetary policy and that the aim to lower debt/GDP and budget deficit/GDP would be kept in place. Some. The fiscal performance of the government has been noteworthy as the budget law (and the fiscal rule) have been effectively implemented. This, coupled with a high growth rate, helped cut debt to GDP to some extent and the government’s aim to achieve the 60% of GDP ratio (in the next 10 years or so) seems realistic. However, any rapid acceleration in spending and/or the combined impact of a cyclical downturn in tax revenues might easily reverse the outlook for debt dynamics and might become a risk factor. Hence, we see the fiscal stimulus as the last option and see only limited room. Yes. Russia still has a strong fiscal position, with a 2.7% of GDP surplus YTD, low government debt (9.3% of GDP) and oil funds of 8.3% of GDP. It can respond to short-term shocks, while low taxes and unreformed expenditure give it mediumterm fiscal options. A major fiscal expansion – net stimulus of 4% of GDP – is already programmed for 2H11-1Q12, led by public sector wage increases, which we see driving up growth to 5%. No. Ukraine has an IMF programme and limited market access, so IMF agreement would be needed. The aim of the IMF programme has been to get the deficit under control, so the barrier to fiscal stimulus is high, particularly since release of funding has been held up by disagreement on reducing the deficit to 3.5% of GDP. But in extremis, the IMF might be willing to trade short-term fiscal stimulus for mediumterm structural reform. Yes. Kazakhstan has a strong fiscal position, running a budget surplus this year of 2.4% of GDP, low debt of 4.1% of GDP and 22% of GDP saved in the oil fund. There has already been substantial fiscal stimulus in this election year, with significant public sector pension and wage increases, and Kazakhstan has scope for further stimulus if desired. Some. The authorities claim that there no room to deviate from fiscal consolidation efforts, and they target a deficit of 4.7% of GDP this year and 4.2% next year. That said, with debt/GDP at just over 40% and a solid ‘low-risk’ reputation, we think the Czech authorities do have room for fiscal stimulus should the economy double-dip. No. Following a rocky start, the authorities gained markets’ confidence earlier this year by presenting an ambitious structural reform programme, which contemplates fiscal tightening worth over 3% of GDP by 2013. These are aimed at reining in a structural deficit which is around 6% of GDP. Markets will be focused on implementation so there is little room for slippage. Any ‘unorthodox’ measures like the crisis taxes of 2010 will be badly received by the markets, we think. No. The Polish authorities applied fiscal stimulus worth around 2% of GDP in 2009, allowing the deficit to rise sharply in the following years from a previously low level. This helped Poland outperform its CEE peers. Given falling yet still high deficit to GDP (-5.6%) and how close we are now to the 55% debt/GDP ratio (which would trigger automatic fiscal tightening), the fiscal lever is not available this time around, we believe. Not much. Romania is in the midst of a fiscal adjustment process, and will need to run a tight ship in order to ensure continued compliance with IMF targets in order to qualify for the precautionary SBA assistance. That said, some fiscal loosening ahead of the 2012 elections remains a possibility. Yes. Central government debt has risen sharply from 23% of GDP in 2008 to 34% presently. Even so, it is important to note that, on a net basis, the absolute public debt stock is still less than 35% of GDP, giving the authorities some scope to act should the need arise. Also, we forecast the fiscal deficit at some 5% of GDP for this year and next, while the overall public sector borrowing requirement remains in single-digit territory over the next several years. This relatively boisterous fiscal position is a clear attraction for EM fixed income investors. Some. A steady uptrend in both the price and volume of oil exports should reward the authorities with a fairly significant fiscal envelope in 2011. On the expenditure front, we believe that recent election spending will fall out the wash this year, resulting in a relatively sharp normalisation in the fiscal deficit to GDP ratio in 2011 (from -6.1% to -3.0%). This is worse than the 0.2% of GDP deficit reading that was attained in 2008; however, we believe that, at 3% of GDP presently, the fiscal deficit is low enough to allow the authorities the scope for implementation of counter-cyclical fiscal stimulus, were the need to arise.

Source: Morgan Stanley Research estimates

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MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Hungary: Fiscal Risks on The Rise as Growth Downshifts  The economy stalled in 2Q, highlighting downside growth risks; we see weaker growth in 2012 also (just 1.4%).  PM Orban sticks to fiscal targets, but says new measures will be needed to meet the deficit/GDP target in 2012.

Hungary stalled in 2Q: GDP growth basically stalled in 2Q (0.0%Q), which took the year-over-year rate down from 2.4%Y to 1.5%Y. This is much worse than consensus expected (2.5%Y) and also worse than the NBH's expectations of around 2.2%Y. There are no details at this stage but the monthly data suggest the pull from net trade weakened substantially. This is clearly negative for an economy that has been firing on one cylinder only: foreign demand. We have turned more bearish on growth, and see GDP averaging just 1.6% this year and 1.4% next year. Exhibit 1

IP Growth Has Stalled… 18

6

12

3

6 0

0 Jan-07 -3

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

-6 -12 -18

-6

-24

-9

-30

-12

-36 %m/m, sa (LHS)

%3m/3m, ar, RHS

Source: Haver, Morgan Stanley Research

Exhibit 2

…As Have Trade Flows 80 60

%

40 20

Ja n0 Ap 7 r-0 7 Ju l-0 7 O ct -0 Ja 7 n0 Ap 8 r-0 8 Ju l-0 8 O ct -0 Ja 8 n0 Ap 9 r-0 9 Ju l-0 9 O ct -0 Ja 9 n1 Ap 0 r-1 0 Ju l-1 0 O ct -1 Ja 0 n1 Ap 1 r-1 1

0 -20 -40 -60 Exports, 3m/3m, ar

Source: Haver, Morgan Stanley Research

Imports 3m/3m, ar

Pasquale Diana

Domestic demand still weak: Hungarian domestic demand has been depressed for years, as a result of low disposable income growth, a restrictive fiscal stance (since 2006) and more recently the stellar rise in CHF loan instalments (for more on this see CEE: On a Swiss Knife-Edge). The scheme to help FX debtors will start in September, but is unlikely to be a game-changer for consumption. As a result, we cannot see how domestic demand can take over as the main engine of growth. With net exports slowing, so will overall GDP growth. Fiscal targets are at risk: PM Orban said that as a result of weaker growth this year there may be an overshoot of around 100bn HUF (0.4% of GDP). Note that the PM referred to a growth forecast of 2% vs the 3% assumed in the budget. We think even 2% is on the optimistic side, so the hole may turn out to be bigger. Even so, the PM was adamant that the budget deficit would be sub-3% of GDP in 2012 (current target: -2.5%). Between now and the end of 2012, we see a cumulative GDP shortfall of over 2 percentage points, so by the end of next year the budget “hole” could be almost 1% of GDP, using standard sensitivity coefficients (around 50%). All this means that further austerity measures may be on the way, if the PM sticks with its promise. The next budget (end-September) may detail what they are. As we have argued many times since our last visit to Hungary (see Are Markets Being Complacent?), we see a lot of good news in the government’s reform plan. That said, it is crystal-clear that fiscal adjustments in Europe over the last two years have come at the cost of lower growth. It is hard to imagine this will not be the case in Hungary also. Therefore, something will have to give: either Hungary will have to postpone tax cuts or raise more one-off taxes, to stick to its current targets (and depress growth further in the process); or the fiscal targets will have to be abandoned, to avoid hurting growth further. In either case, it seems to us that Hungary will remain under significant pressure, aggravated by the uncertain situation in core Europe. Hungarian CDS spreads have widened significantly over the last few weeks, by more than regional peers. Note also that, following the transfer of pension fund assets to AKK, non-residents are now holding approximately 50% of all HUF bonds. Increased foreign ownership in itself is not a concern: after all, we have seen the same in many countries across the

8


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

region, as foreign investors diversify into EM assets. That said, it is fair to say that with the pension funds gone, a source of local liquidity has disappeared. If foreign investors all rush for the exit, yields would spike much higher. Exhibit 3

Non-resident Holdings of HUF Debt 55

4000 3500

50

3000 45

2500 2000

40

1500

35

1000 30

500

0 25 Jan-08 May-08 Sep-08 Jan-09 Jun-09 Oct-09 Feb-10 Jul-10 Nov-10 Mar-11 Jul-11 Total non-res holdings of debt (bil. HUF)

% of HUF Bonds, RHS

Source: AKK, Morgan Stanley Research

What can the NBH do? With GDP and CPI growth both revised lower in our forecast, we have shaved 50bp off the NBH profile, leaving rates unchanged at 6%. Why were we not more aggressive? Surely it is conceivable that in the new macro environment the NBH would at the very least remove the 75bp of rate hikes implemented in late 2010/early 2011. That said, the bank knows very well that the monetary transmission mechanism is broken, and that cutting rates once or twice has hardly any consequence on growth. Its main contribution to macro stability in Hungary is to maintain financial stability. In Hungary, this means preserving the value of the HUF in order to cushion the impact on FX borrowers and anchoring inflation expectations.

Would rate cuts in Hungary at a time of cuts elsewhere (including the ECB, in our new forecast) really be a dramatic move that would weaken HUF? Probably not, but this is not the point. The NBH values policy consistency, in our view. And having made it abundantly clear that both inflation and financial stability lie at the heart of its decision-making, the bank needs both inflation sub-3% in the medium term and a supportive risk environment to cut rates. The worse scenario for the NBH in our view would be one where it cuts rates by, say 100bp and it is then forced to hike them a few months later by much more in order to support the currency. Such policy-making would look erratic in the eyes of the market. This is why we think that conservatism will prevail at the core of the MPC, and rate cuts will remain off the agenda until the external situation looks a lot more stable. Exhibit 4

Hungary Risk Back In Focus 450

5y CDS spreads, bp

400 350 300 250 200 150 1/1/2010

7/1/2010

1/1/2011 HU

BG

7/1/2011 RO

Source: Bloomberg, Morgan Stanley Research

9


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Poland: Growth, the MPC and the Zloty  The latest data show clearly that the economy is downshifting, which validates our recent forecast revision.  The MPC’s tone will change soon, and we think the NBP will move to a neutral bias as early as in September.  No objections to PLN weakness from the MPC, so long as it remains orderly and based on fundamentals. But the zloty will matter also for the debt ratio at year-end. Interventions close to year-end remain a distinct possibility.

The latest Polish data make it clear that the economy is slowing: IP was up just 0.4%M (sa) in July, after a large (-2.2%M) fall in June. True, the working-day adjusted data showed year-over-year growth of 4.6%Y, which was much better than the work-day depressed headline (1.8%Y). That said, the slowdown in the 3m annualized rate of growth is unmistakeable and shows we have entered a soft patch. Exhibit 1

Poland: IP Momentum Is Slowing 25 Industrial output 20 15 10 5 0 -5 -10 -15 -20 -25 -30 Jan-07 Jul-07 Jan-08

Pasquale Diana/Jaroslaw Strzalkowski (-1.7%M), and this was enough to offset the rise in gas prices in July. Fuel prices were also surprisingly tame, down 0.2%M. Inflation likely to hover around this level until year-end: we think that barring major surprises inflation should hover around 4% until year-end, even falling even below it at yearend (3.7-3.9% in December). This will be followed by a large drop in 1Q12, which is base-effect related (VAT hike in Jan 11). Only a few months ago we saw good chances of inflation ending the year at close to 5%Y on fast food and fuel price dynamics, so this is a material change in the outlook, and will please the NBP. Given what is going on in the data, how long will it take the NBP to change bias? Not long, we think. Kazmierczak was the only supporter of a rate hike in July, and he signaled he is ready to change his stance if inflation falls decisively, which we think will happen. We think the tightening bias will be removed explicitly in September (Sept 7). Rate cuts are likely as early as 1Q of next year (50bp in total, concentrated in the first half). Exhibit 2

Employment Growth Eased 14

%Y

12 10

Jul-08

Jan-09

%Y, RHS

Jul-09

Jan-10

Jul-10

Jan-11

Jul-11

3m/3m, saar

Source: Haver, Morgan Stanley Research

8 6 4 2

The labour market data also show that employment growth has moderated, with the annual rate easing from 3.6%Y to 3.3%Y. In level terms, the economy has created just 14k jobs in the three months to July, just one-third of the jobs created over the same period in 2010. Wage growth was not far from expectations, at 5.2%Y. On the price front, inflation continued to surprise on the downside. This contributed to the significant downgrade we have made to our inflation forecasts (see focus piece). CPI eased by 0.3%M in July, taking the headline rate down from 4.2%Y to 4.1%Y. This was below consensus expectations of 4.3%Y and a tenth lower than our forecast of 4.2%Y. The components show that most of the downside pressures came once again from food and non-alcoholic beverages prices

0 Jan-04 -2

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

-4 Wages

Employment

Source: Haver, Morgan Stanley Research

What about the PLN? The PLN continues to be affected by market turbulence, trading close to 4.20 vs EUR at the time of writing. More encouragingly, the zloty has rallied almost 10% vs the CHF (due to Swiss Franc depreciation vs EUR), which will at least in part ease the pain of the 700k Poles who borrowed in CHF and now face much higher servicing costs (see also CEE: On a Swiss Knife-Edge). The currency also matters a great deal in terms of the debt ratio: last year, the debt/GDP ratio (on the national

10


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

definition) reached 52.8% of GDP. Around a quarter of total debt is denominated in foreign currency, and the rate used to calculate the debt/GDP ratio is that of Dec 31. Breaching 55% would trigger automatic tightening next year. The Polish Public Finance Law contains thresholds of Debt/GDP whose breach automatically triggers austerity measures (see Exhibit 3). The severity of the 55% and 60% thresholds provides a large incentive for policy makers to keep the debt below these levels, as tightening would act as a significant drag on growth. Although the government has started tightening its fiscal policy this year, aiming at the general government deficit of 5.6% of GDP compared to 7.9% in 2010, the recent FX volatility, possible economic slowdown in 2H this year and the still narrow security margin do not allow for much comfort.

Debt/GDP to around 53.0% at year end, using the MinFin’s 2011 nominal GDP estimate from the budget. 2% of GDP seems to be a safe margin, but the risks are still material. Among the main risks lying ahead we see: 

Nominal debt increase. The assumption of no nominal debt increase is obviously a bold one. Although the MinFin has largely covered its funding needs for this year, it is plausible that it would tap the markets to prefund the next year’s deficit in H2.

Local government sector. Due to considerable lags in reporting their deficit and most spending concentrated in Q4 due to bills for investment spending, the sector is always a source of uncertainty about the general government deficit.

Nominal GDP size is likely to surprise on the upside. The 2011 GDP estimate used by MinFin might be underestimated, as it was based on 3.5% GDP growth and 2.0% CPI assumptions, the latter being much below what it is likely to print. If one used the other estimates, like the European Commission one published in spring, it would take the debt/GDP growth down by about 0.95pp.

The largest risk lies in the exchange rate. About 27% of the central government debt is denominated in FX, mostly EUR. According to our estimates, every 1% depreciation of PLN against G10 currencies increases the debt/GDP ratio by about 0.15pp.

Exhibit 3

Debt/GDP Thresholds and Triggers Public debt between 50% and 55% of GDP in year t The draft budget for year t+2 must not propose a higher deficit-to-revenue ratio than in the year t+1. This applies to every territorial entity (i.e. to local governments also). Public debt between 55% and 60% of GDP in year t Draft budget must not increase the ratio of State Treasury (practically the same as central government) debt to GDP in year t+2. Also, no increase in public sector salaries, no new loans from the State Budget and no revaluation of pensions above CPI (in year t) is allowed. VAT increases by 1pp. automatically in June of year (t+1), further 1pp. increase comes into force a year later, to be gradually unwound in the following years. Finally, the cabinet must present an adjustment programme to parliament to take the debt/GDP ratio down. Public debt above 60% of GDP in year t Any government borrowing is forbidden in year t+2, and ministers have one month to provide an adjustment programme to take the debt ratio below 60%. Source: Ministry of Finance,, Morgan Stanley Research

Our estimates point to debt still being close to the threshold, at around 53.0%. The data published on the government debt in Q1 pointed to Debt/GDP ratio running as high as 54.0%. We have made a ‘real-time’ bottom-up estimate of the government debt, incorporating local as well as FX bonds, T-bills, retail bonds, foreign loans as well as an estimate of local government debt. According to these estimates, the total stock of debt at the end of August, given the exchange rates from August 18 was equal to 789.9 bil. PLN. Assuming this number was held constant between now and year-end, implying new debt would have been issued only to roll over the maturing one, this would take the

What can MinFin do then? Interventions are likely as we approach year-end, we believe. Just like the last year, in the event that debt/GDP was threatening to exceed the 55% threshold, we think that MinFin would intervene in the market, and support the currency. It is important to keep in mind that the decision to intervene would have to be taken without having full knowledge of the government accounts (especially on the local authorities’ level). In other words, we think the Min Fin will have every incentive to be overcautious, given negative surprises from the local authorities’ level are possible. This, of course, increases the risk of interventions at year-end if the PLN were to keep trading close to its current levels or weaker.

11


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Russia: Debt Set to Double?

Jacob Nell/Alina Slyusarchuk

 The government has approved a 2012-2014 debt policy framework allowing the government to double debt to 17% of GDP.  The primary focus is the OFZ market, where the government plans to issue 2 trillion RUB pa (~3.5% of GDP), and improve access.  We see this as a preemptive strike by the MinFin, in advance of the first draft of Budget2012, to head off excessive spending bids.

The government has approved a new 2012-2014 debt policy. The new borrowing policy is based on the assumptions in the Ministry of Economic Development’s base case 2b forecast from April this year, together with the latest budget deficit projections. Exhibit 1

Current Official Russian Macro-Assumptions GDP growth Oil, USD/bbl Urals Inflation RUBUSD Federal deficit, % of GDP

2012 3.50% 93 6 27.9 2.7

2013 4.20% 95 5.5 27.9 2.7

2014 4.60% 97 5 28 2.3

larger and more liquid OFZ market. As a measure of its determination, Russia plans to save 844 bn RUB in oil revenues in the Reserve Fund between 2011-2013, where last year the return on investments was 1.5%, while borrowing in OFZ at a yield of approximately 7%. Russia also plans to issue a limited number of external bonds to serve as benchmarks, with the aim of reducing the cost of borrowing for Russian corporates borrowing abroad. Plus, measures to liberalise access to the OFZ market. The paper proposes measures to liberalise access to the OFZ market to attract a wide investor base, and reduce volatility and the cost of borrowing. The measures include permitting OFZ to be settled on a foreign depository and clearing system, equalizing taxation on corporate and government bonds, and permitting OTC trades with OFZ. There is also mention of issuing a OFZ with a constant coupon, although an inflation-linked OFZ is ruled out for the time being. If implemented, these could increase foreign investor demand for OFZs. Exhibit 3

75% of OFZs Owned by Russian Banks

Source: Ministry of Finance, Morgan Stanley Research CBR 10%

The policy authorizes a doubling in debt… Russia has a very low level of debt (11.2% of GDP, 6 trillion RUB end2011), and will continue to have a low level of debt, even if it doubles to the authorised 12 trillion RUB (17% of GDP) by end-2014.

Nonresidents 3% Rusian banks 30%

Vneshekonombank 16%

Exhibit 2

Russia’s Growing Domestic Debt Sberbank 29%

25%

14000 12000

20%

Financial companies/funds 12%

Source: Ministry of Finance, Morgan Stanley Research

10000 15%

8000 6000

10%

4000 5% 2000 0

0% 2004

2005

2006

2007

domestic debt, bn RUB

2008

2009

2010

2011

external debt, bn RUB

2012

2013

Further steps to develop the Russian debt markets The policy also proposes a series of measures which have the combined effect of encouraging borrowers to raise funds from the market rather than from the government :

2014

% of GDP (rhs)

Source: Ministry of Finance, Morgan Stanley Research

..led by an increase in domestic issuance. In particular, Russia intends to concentrate its efforts on developing a

-

A gradual reduction in the annual limit on government guarantees to keep them under 20% of total government debt, responding to the dramatic rise in guaranteed loans from 3.4% in 2008 to 17.5% in 2011 of total government debt;

12


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

-

A sharp (six-fold) reduction in the practice of budget loans, requiring subnational governments to borrow through the market rather than from the federal budget;

-

Activation of the proposed “Russian financial agency”, proposed in 2008, to manage Russian debt and, in due course, the oil funds on an armslength basis.

No to compensation for Soviet-era savers. In the early 1990s, during the initial period of very high inflation following the break-up of the Soviet Union, the Russian government blocked access to funds in savings accounts. This prevented these funds, which had been created by excess money creation to cover a massive and growing deficit during the last years of the Soviet Union, from further fuelling the high inflation. However, even if justified by the circumstances, there has subsequently been a long campaign for compensation by the many Russians who saw their life-savings wiped out. In the policy document, the Ministry of Finance crisply states that this would not be possible, because of the scale of the compensation – 25 trillion rubles or 50% of GDP - but it does agree to set up a commission to consider options. An opening salvo in the Budget 2012 battle… While we see this document as sensible and welcome, we suspect the timing, in advance of the first version of Budget 2012, is designed to preempt bids for spending, by showing that any additional spending would require borrowing over and above the level in the document, which is already a major increase. After all, in terms of budget logic it is backwards to approve the borrowing before the budget, since the deficit that has to be financed won’t be known until the budget has been drawn up. Exhibit 4

CBR Reserves Replenished; Oil Funds Still Depleted 600000

USD mil National Welfare Fund

500000

Reserve Fund Stabilisation Fund (to Jan 08)

400000

CBR reserves (ex oil funds) 300000 200000

..Or bringing back a fiscal rule by stealth? Perhaps the most intriguing possibility is that this document may be the first step in a campaign to return to a fiscal rule for the consumption of oil revenues. During the crisis, Russia abandoned the policy framework developed in the last decade under which all oil revenues in excess of 4.7% of GDP – the sustainable level of consumption of oil revenues – were saved in the oil fund. Officially, the budget is supposed to prepare for a return to such a system by 2015. However we think there is an outside possibility that there may be an early return to such a system. The case for the return of the policy anchor. The idea is that setting a limit on the consumption of oil revenues prevents over-consumption during high oil prices, which drives inflation and excess currency appreciation, and allows the build up of reserves to mitigate fluctuations and finance future investment during low oil price periods. Additionally, reimposing the rule would create a deficit which requires financing, and so would (i) justify a major increases in OFZ borrowing, which would create a sufficiently deep and liquid market for the CBR to move from managing ruble liquidity in the FX market to managing ruble liquidity in the government bond market; and (ii) justify the privatization programme, which needs, for political reasons, a fiscal as well as an economic justification. Unfortunately, evidence for the theory is lacking. The document does note a saving of approximately $30 bn USD in the Reserve Fund, which quietly re-establishes the principle of saving excess oil revenues in the oil fund. It also sets the oil price at $93/bbl, about $15/bbl lower than the YTD price, which could be seen as an effort to move back towards a more credible medium-term oil price. And the MinFin is currently recalculating the sustainable level of consumption of oil revenues. If it found that the sustainable level of consumption of oil revenues is now somewhat higher than the previous 4-5% of GDP, and allowed 1-2% of investment in capital, then the gap between the current nonoil deficit and the sustainable level of consumption of oil revenues could conceivably be bridged. It is due to report in December, which could make it an input into a launch of the presidential campaign. However, in the absence of a clear policy steer, we reluctantly conclude that as yet there is no plan to return to using fiscal rules for the use of oil revenues.

100000 0

Jan 97

Jan 99

Jan 01

Jan 03

Jan 05

Jan 07

Jan 09

Jan 11

Source: CBR, Haver, Morgan Stanley Research

13


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

South Africa: 2Q GDP Collapse; July CPI Rising Further  We expect July CPI inflation to print at 5.3%Y next week. Electricity costs and municipal rates & taxes account for 0.6pp of our 0.9%M increase in headline CPI.  We see 2Q11 GDP printing at just 0.5%Q, a sharp deceleration from the 4.8%Q reading in 1Q11. Weakness in the manufacturing explains most of the decline.  The SARB releases July monetary aggregates too; we expect private sector credit extension and M3 money supply to print at 4.5%Y and 5.2%Y, respectively.

Andrea Masia/Michael Kafe

supply chains of the vehicle and related industries (glass, metals, rubber, etc.) – and the Easter holiday effect which resulted in an unusually long period of down time this particular year. In fact in level terms, manufacturing is back to where it was in July 2010, far below its pre-crisis peak. On the whole, we expect manufacturing value add to have contracted by some 8%Q in 2Q11. Exhibit 1

Manufacturing Output Well Below Pre-Crisis Levels 120

July consumer inflation data should rise to 5.3%Y from 5.0%Y on our estimates. Stats SA releases the data on August 24, and the key factors to watch are the electricity and water & other services components. We have penciled in readings of some 16%M and 9%M, respectively, enough to contribute a full 0.6pp to our overall 0.9%M increase in headline CPI. Although the National Energy Regulator of South Africa awarded Eskom a 25% increase in electricity prices in 2011 (as it did in 2010), one must recall that, at the municipal level, electricity itself only accounts for roughly two-thirds of the final end-user cost. The remaining third is in the form of transmission, grid maintenance, wages and sundries which usually rise by an inflation-related amount. Further diluting end-user pricing is the inclining block tariff structure, which includes tariff declines for the first two consumption buckets, and incremental price increases for the remaining two consumption buckets. Elsewhere, we expect to see continued weakness in goods inflation, particularly in vehicles, household’s items and fuel. We believe insurance costs have the potential to surprise us to the upside however (1.5%M assumption), particularly after the string of negative readings at each survey in 2010. 2Q11 GDP bound to disappoint as manufacturing contracts: Statistics South Africa is scheduled to release second quarter GDP numbers on August 30, which we believe will show a sharp deceleration to just 0.5%Q (seasonally adjusted and annualised) in 2Q11, from 4.8%Q in 1Q11. After registering a healthy 3.4%Q rebound in 1Q11, the manufacturing sector was bound to show some softening in the second quarter. Unfortunately, not only is the sector coming off a high base, manufacturers were also faced with the dual shocks of the Japan quake − which interrupted the

2005 = 100

110

100

90

80 Jan-00 Apr-01 Jul-02 Oct-03 Jan-05 Apr-06 Jul-07 Oct-08 Jan-10 Apr-11 Manufacturing production (seasonally adjusted) Source: Statistics South Africa, Morgan Stanley Research

Growth across the non-manufacturing sectors of the economy posted reasonable performances compared to 1Q11, on our estimates, particularly within the construction, wholesale & retail and general business services sectors. Unfortunately, we see these performances being mostly offset by weakness in the finance, transport and mining sectors. In fact, we believe that the latter is set to show an outright contraction of some 3.0%Q. Some upside does surround our financial sector forecast of 2.0%Q, however, particularly since confidence levels within retail banking appear to have improved markedly relative to the first quarter. Private sector credit extension likely decelerated in July to 4.5%Y compared to the 5.3%Y pace recorded in June. We expect mortgage growth and other loans & advances to come in at some R3.5 billion a piece – broadly similar to June levels of R3.0 billion and R4.0 billion, respectively. The deceleration in the annual reading, therefore, is mainly on account of the high base in July 2010.

14


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Turkey: Growth Data Likely to Disappoint in Near Term

We expect negative quarterly GDP growth in 2Q and a marginal increase in 3Q: As we stated recently, our sequential real GDP growth forecast points to a negative growth rate of 1%Q in 2Q (Turkey Economics: Overcooling: Negative GDP Growth Ahead?, Aug. 8, 2011), which is likely to recover marginally in 3Q and 4Q on a sequential basis. In a recent TV interview, CBT Governor Erdem Basci made a similar comment stating that the CBT expected a flat reading in 2Q and a slight positive in 3Q. That said, the year-on-year growth rate in 2Q11 should still be strong at around 3.7%Y. In our view, the main take here is that a noticeable cooling off has already taken place, against the consensus view that the economy had been overheating, and this had been on the back of the CBT’s successful policy actions in our view.

Exhibit 2

Unemployment Rate: Does Not Support Overheating Argument 18

18

17

16

15 14

14 12

12

11

10

9 8

8 6

6

Unemployment Rate

Exhibit 1

%Q (saar)

20 15 10 5 0 -5 -10

MS Forecast

-15

Unemployment Rate (SA, %)

Source: Company data, Morgan Stanley Research

Will a Negative GDP Print Surprise? 25

unadjusted unemployment rate will bottom out in June and rise to around 10.5% at year-end. With the ongoing slowdown in Turkey coupled with heightened risks of a further loss of growth momentum in Europe, there is a risk that the unemployment rate might escalate even further.

Ja n M -05 ay Se 05 pJa 05 n M -06 ay Se 06 pJa 06 n M -07 ay Se 07 pJa 07 n M -08 ay Se 08 pJa 08 n M -09 ay Se 09 pJa 09 n M -10 ay Se 10 pJa 10 n M -11 ay -1 1

 We have revised our growth forecast for 2011 up to 5.9%Y from 5.5% but cut our 2012 forecast significantly to 3.5%Y from 4.5%Y. We expect inflation to remain manageable and the current account deficit to GDP to go through a significant adjustment, easing to 7% of GDP next year from 9.4% that we envisage for 2011.

Tevfik Aksoy

-20

20 0

3Q 20 4 04 Q 20 2 04 Q 20 4 05 Q 20 2 05 Q 20 4 06 Q 20 2 06 Q 20 4 07 Q 20 2 07 Q 20 4 08 Q 20 2 08 Q 20 4 09 Q 20 2 09 Q 20 4 10 Q 20 2 10 Q 20 4 11 Q 2

-25

GDP Growth (Seasonally and Working Day Adj.) Source: Company data, Morgan Stanley Research

Unemployment rate to rise gradually: Unemployment eased to 9.4% in May, which was equal to the previous low seen back in June 2010. While the headline number seems encouraging from a growth perspective, a closer look reveals a different picture. The seasonally adjusted unemployment rate actually increased for a second consecutive month to 10.3% after seeing the bottom at 9.9% in March. Based on the historical seasonal patterns, we believe that the

Bias to lower the policy rate might remain, but limited easing in RRR seems more likely: Given the volatility in global markets and constantly changing mood towards macro dynamics, we cannot rule out further policy rate cuts by the CBT in the coming months. However, we believe that rates are already low and, instead of policy rate cuts, the CBT might opt to lower the required reserve ratio on both TRY and FX deposits to release some liquidity to the banking system. Revised currency forecasts for 2011-12: In line with various forecast revisions including growth, rates, current account and various EM currencies, we have revised our USDTRY forecast for end-2011 to 1.80 (previously 1.67) and end-2012 forecast to 1.70. We expect the average USDTRY rate to be 1.75 during 2012. When will current account numbers improve? According to our projects we are getting close to that. Turkey’s current account deficit has been widening on a 12m rolling cumulative basis since October 2009. We expect the deficit to start shrinking beginning with November data. However, the signs of improvement are likely to be appearing much earlier with the monthly deficit numbers easing noticeably starting as early as with July data.

15


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Strategy: CEEMEA FX Still Underperforming  We expect CEEMEA currencies to continue underperforming the rest of EM. RUB and ILS will likely trade more resiliently than the rest of the region. AXJ should outperform.

Exhibit 1

 We maintain our receiver position in ILS 10y swap. We think the contract could reach 4.2% soon. With the HUF curve pricing in cuts, we think that the time is right to begin paying the front end of the HUF swap curve.

USD/ZAR

FX Forecast Changes Current

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

7.24

6.90

7.00

7.10

7.20

7.35

7.50

6.80

7.00

7.10

7.20

7.35

7.50

4.10

4.15

4.15

4.10

4.00

3.95

Old EUR/PLN

4.18

Old EUR/CZK

3.95

3.95

3.95

3.90

3.80

3.80

24.2

24.2

24.1

24.0

24.0

23.8

24.20

24.20

24.10

24.00

24.00

23.80

265

270

270

267

265

265

265

267

267

265

262

258

4.26

4.20

4.25

4.20

4.15

4.15

4.10

4.20

4.20

4.15

4.10

4.00

4.05

3.56

3.40

3.50

3.45

3.45

3.40

3.40

3.35

3.30

3.30

3.35

3.40

3.40

1.79

1.75

1.80

1.79

1.75

1.75

1.70

1.63

1.67

1.63

1.60

1.58

1.58

29.11

28.60

28.40

29.04

27.96

27.75

27.14

24.5

Old

We have made some adjustments to our EM FX forecasts in light of the changes made to our Global Economics forecasts. None of our forecast changes represent a major shift in view – we continue to see CEEMEA currencies underperforming those that are supported by economies with much stronger balance sheets, such as those in Emerging Asia region.

EUR/HUF

For the remainder of 2012, we expect to see further weakness in EM currencies versus the USD. Versus the EUR, performance should be much better (provided that funding markets do not freeze up entirely). Markets are likely to be volatile, and there will be periods of relief from the generally weakening trend, particularly if policy makers in the developed world are able to craft a policy response to the ongoing market turmoil. Given the possibility of this, we have not factored in an overly bearish forecast for EM currencies until the end of the year.

USD/RUB

There will very likely be periods where our forecasts are overshot, when we see greater weakness than our forecasts suggest. For example, we have penciled in a 1.80 figure in USD/TRY by the end of the year, but we fully expect to see weaker levels for the TRY in the interim. However, a policy response (whether it is QE3 or some other form of assistance) may well provide some relief by year end. We think that CEE currencies and Latin American ones will underperform, falling around 4% versus the USD by the end of the year. AXJ should outperform, and rise by around 2% by year-end, anchored by an ongoing decline in USD/CNY, which we expect to reach 6.2 by the end of the year. Please see FX Pulse: FX Forecast Changes, August 18 for full details.

CEEMEA Strategy Team

273

Old EUR/RON Old USD/ILS Old USD/TRY Old Old RUB Basket Old

34.76

27.54

28.01

27.97

27.55

27.55

27.55

34.00

33.00

34.00

33.50

33.50

33.00

32.50

32.55

32.75

33.00

33.25

33.50

Source: Company data, Morgan Stanley Research

Within the CEEMEA region, we continue to believe that the RUB and the ILS will outperform. We would highlight the RUB, in particular, as a currency that was unduly punished during the recent sell-off. Russia runs a significant current account surplus and we would expect it to be an outperformer during the current uncertain period. Indeed, the RUB is close to levels versus the basket where the Central Bank of Russia (CBR) would intervene to support the currency, which thus limits the downside. In the event that we see any tactical market rebound in risky assets over the coming weeks, RUB is likely to be a significant outperformer. The Israeli economy retains very robust fundamentals, and we do expect the currency to outperform others in the CEEMEA region as well. However, there are downside risks to our ILS forecasts, which currently see USD/ILS at 3.5 by the end of the year. We do believe that ILS will outperform, and signal this by maintaining a more or less flat profile until year-end. But with the current account surplus narrowing and the Bank of Israel potentially going to ease rates in the near term, there are some risks to be mindful of.

16


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Exhibit 2

RUB vs. Basket – Approaching the USD “Sell Zone” 40

39

38

CBR sells $400m a day

37

CBR sells $250m a day

36

CBR sells $120m a day

35 CBR does not intervene

34

CBR buys $120m a day CBR buys $250m a day

33

CBR buys $400m a day

32 Jun-09

Oct-09

Feb-10

Jun-10

Oct-10

Feb-11

Jun-11

Oct-11

Feb-12

Source: Morgan Stanley, Bloomberg

What’s more, political risk in the region remains high and while the ILS has historically been very resilient to regional security issues in the past, there are reasons to think that market participants could become more concerned. The currency with the least basis for appreciation in our view is the TRY, so of all the currency rallies that we might see in the near term, we think investors should fade the one seen in the TRY. The current account position, while likely to improve in the coming months, will continue to weigh on the currency, while Central Bank of Turkey’s policy bias is firmly to the easing side. As for the CEE region, the anticipated weakness of the EUR should limit the downside for CEE currencies versus their natural trading cross, the EUR. But underperformance versus the rest of EM is likely, given that weakness versus the USD is likely to be more substantial. The bottom line is that given the ongoing uncertainties related to the global backdrop we prefer to own currencies that have strong current account positions and are less reliant on external funding. This generally means favouring RUB and ILS versus TRY, HUF and PLN. Staying Received in ILS rates: We continue to recommend receiving rates in Israel. We have preferred the 10y point on the curve, and initiated a receiver recommendation when the contract was trading up at 5.19%. We took 50% profit after our initial target was reached at 4.8%, and we have now reached our second target at 4.5%. We are not taking the position off just yet. Given the aggressive move lower in Israeli yields in recent weeks, it would not be surprising to see some temporary retracement, and we would likely use this opportunity to add to our receiver positions. Unless new information comes to

light, we would add on any move above 4.7%. We think that a move down toward 4.2% is quite possible. Macroeconomic data over the past few weeks have been very conducive to a further move lower in rates. Israel’s PMI came in at 49.4, below the 50 threshold that theoretically separates contraction from expansion. More importantly, Israeli CPI for July dropped down to 3.4% y/y from a revised 4.7% y/y previously, compared to a 4.0% forecast. This brings the rate of inflation much closer to the Bank of Israel’s 1-3% target range and will help to bring inflation expectations lower too. The Bank of Israel was already sounding quite dovish ahead of the most recent bout of market turmoil and the possibility that the central bank cuts rates cannot be ruled out. The curve remains flat, with little premium between the 1y1y forward swap rate and the 1y swap rate. Accordingly, we think there is further room for Israeli yields to fall, and we are comfortable staying received at the 10y points of the curve. Exhibit 3

Falling Israeli Inflation Will Help Swap Yields Drop 7 6 CPI % y/y

5 4 3 2 1 0 -1 -2 -3 -4 Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Source: Morgan Stanley, Bloomberg

Time to Pay HUF rates? We think that Hungarian rates have moved lower too far, too quickly. MS thinks there is very little chance of the National Bank of Hungary cutting rates in the current environment. Indeed, the downward pressure that would emerge on the HUF as a result of monetary easing would make life more difficult for Hungarian households that have significant foreign currency liabilities. The HUF swap curve is pricing in around 25bps in cuts over the remainder of the year, which we think is unlikely. Paying front-end rates (1y) is good strategy. One risk, however, would be if the external environment stabilised to such a degree that HUF rallied aggressively and Hungarian CDS fell. The improvement in these risk metrics that the NBH looks at could give them some room to ease policy and support growth without having such a detrimental impact on the currency.

17


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Recent Research in CEEMEA Title

Analyst

Date

Turkey Economics: Overcooling: Negative GDP Growth

Tevfik Aksoy

08/08/11

Back to 2008? Contagion Risks and Policy Responses in CEEMEA Continued weakness in global markets and a possible and sharp slowdown in DM growth in 2H11 and in 2012 will heavily impact the region. We see two main channels of contagion on growth and asset prices: The first will be via lower growth in Europe (and in the US) and the second will be via lower commodity prices. We look at each country individually to asses what type of policy measure the authorities might employ.

CEEMEA Economics Team

09/08/11

CEEMEA Macro Monitor We take a closer look at the impact of the strong fiscal expansion we see over the next three quarters on Russian consumption, which should drive real wages and real retail sales growth rates to double-digits in 1Q12. We also look at what the sharp rise in the CHF versus CEE currencies means for households in Hungary and Poland. It seems to us that the NBP continues to have significantly more room for manoeuvre than the NBH has.

CEEMEA Economics Team

29/07/11

South Africa 3Q11 Chartbook: Household Debt Metrics and Susceptibility in the Upcoming Michael Kafe/Andrea Masia Cycle We take a deep dive into South African household income, expenditure and leverage metrics by income decile, using data published by the National Credit Regulator and Statistics South Africa – as opposed to the traditional use of SARB data. We attempt to gauge the impact of the upcoming tightening cycle on the lower, middle and upper-income consumer. Finally, we revisit our FX, inflation and interest rate calls.

25/07/11

Russia: Heading for Higher Growth After worse performance during the crisis than its EM peers, we think that Russia is back, with growth poised to accelerate to 5% in 2011 and 5.5% in 2012. Beyond 2012, continued strong performance depends on success in implementing structural reforms, we think. From 2013, as the economy reaches full capacity, the range of potential outcomes widens. Without reforms, Russia’s new normal could sink to 3% per annum, while a structural reform agenda could, if implemented, maintain trend growth at +5%.

21/07/11

Sequential industrial production eased sharply in June, confirming our view that the economy has been slowing noticeably despite the consensus view that it has been overheating. We expect a negative 2Q GDP print on September 12.

Jacob Nell/Alina Slyusarchuk

CEEMEA Macro Monitor CEEMEA Economics Team We look at the possible channels of contagion from the euro area to CEE, and see increasing risks, despite the region’s vastly improved fundamentals compared to 2008. We stay cautious on CEE credits, particularly given the current fair to slightly rich valuations, and are Underweight CEE FX relative to the rest of EM. We also go into detail on recent changes to our forecasts for Turkey and South Africa. Russia, Ukraine, Kazakhstan and Belarus Chartbook We provide our outlook for the remainder of 2011 and our views on the CIS region.

Jacob Nell/Alina Slyusarchuk

CEEMEA Macro Monitor CEEMEA Economics Team We present the key conclusions of our recent research trip to Israel. We remain positive on the Israeli economy. We revise some of our some macro forecasts as well as some changes in our policy rate call, and take note of some geopolitical concerns surrounding the possible declaration of an independent state by the Palestinians in September and the possible noise (at a minimum) or extended macro weakness (at worst) associated with it.

15/07/11

11/07/11 01/07/11

18


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Sovereign Rating Monitor As of August 19, 2011 Moody’s

AAA Aa1 Aa2

AAA AA+ AA

Aa3

AA-

Czech Rep. (S, 11/02) Slovakia (S, 10/06) Estonia (S, 04/09) Israel (S, 04/08)

A1

A+

Poland (S, 11/02)

A2

A

S. Africa (S, 07/09)

A3

A-

Slovenia (S, 07/06) Qatar (S, 07/07) Saudi Arabia (S, 02/10)

S&P

Slovenia (N, 05/06) Qatar (S, 03/07) Saudi Arabia (S, 7/07) Estonia (S, 08/11) Slovakia (S, 11/08)

Czech Rep. (P, 10/07) Israel (S,11/07) Poland (S, 03/07)

Russia (S, 07/08) Lithuania (S,09/09) Kazakhstan (S,01/11) Bulgaria (S, 07/11)

Baa1

BBB+ S. Africa (S, 08/05)

Baa2

BBB

Croatia (S, 01/02) Romania (S, 10/06) Latvia (N, 04/09) Hungary (N, 12/10) Morocco (S, 06/03) Azerbaijan (P, 07/08)

Baa3

Jordan (N, 08/03)

Ba2

BB

Egypt (N, 03/11)

Ba3

BB-

Lebanon (S, 04/10)

B1

B+

Ukraine (S, 05/09)

B2

B

Belarus (N, 07/11)

B3

B-

Caa1 Caa2 Caa3 Ca C

CCC+ CCC CCCCC SD*

Ba1

Bulgaria (S, 10/08) Russia (S, 12/08) Lithuania (S, 08/09) BBB- Croatia (N, 12/10) Kazakhstan (S,10/07) Hungary (N, 03/09) Morocco (S,03/10) BB+ Romania (S, 10/08) Azerbaijan (P, 07/09) Latvia (P, 12/10) Egypt (N, 02/11) Jordan (N, 07/03) Serbia (S, 03/11)

Ukraine (S, 07/10) Nigeria (S, 08/09) Lebanon (S, 12/09) Belarus (N, 05/11)

Outlook: P = Positive; N = Negative; S = Stable; D = Developing; *SD = Selective Default Source: Moody’s, S&P

19


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Inflation Monitor Czech Republic

Poland 6.0

8.0 7.0

5.0

6.0

4.0

5.0 4.0

3.0

3.0

2.0

2.0 1.0

1.0

0.0

-

-1.0 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Hungary

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Romania

10.0 9.0 8.0

10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Jan-06

Jan-06

Jan-12

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-06

Jan-12

South Africa

Israel 6.0

12.0

5.0

10.0

4.0

8.0

3.0 2.0

6.0

1.0

4.0

-

2.0

-1.0 -2.0

0.0 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Turkey

Jan-06

Russia

14.0

16.0

12.0

14.0 12.0

10.0

10.0

8.0

8.0

6.0

6.0

4.0

4.0

2.0

2.0 0.0

0.0 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-06

Source for all charts: Haver, Morgan Stanley Research estimates

20


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Real Exchange Rate Monitor Czech Republic

Poland 130

140 130

124.8

120

120

110

110

100

100

90 80

90 Jan-06

104.3

Jan-07

Jan-08

Jan-09

Jan-10

Jan-06

Jan-11

Hungary

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Romania 130

130 120

120 108.3

110

110 100

106.0 100

90

90

80 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-06

Jan-11

South Africa

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Israel 130

110 100.0

100

120.8

120

90 110

80 100

70

90

60 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-06

Jan-11

Turkey

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Russia

120

150 140

110

134.5

130 100

120 97.0

110

90

100 90

80 Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Source for all charts: BIS, Haver; Solid line stands for the average over the last five years, the dashed line for the last ten years. For all indices, 100 is the average real effective exchange rate in 2005.

21


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Global Monetary Policy Rate Forecasts Global Economics Team (as of August 17, 2011) 2011

2012

%

1Q11

2Q11E

3Q11E

4Q11E

1Q12E

2Q12E

3Q12E

4Q12E

United States Euro Area Japan United Kingdom Canada Switzerland Sweden Australia New Zealand Russia Poland Czech Republic Hungary Turkey Israel South Africa Nigeria China India Hong Kong Korea Taiwan Singapore Indonesia Malaysia Thailand Brazil Mexico Chile Peru Colombia

0.125 1.00 0.05 0.50 1.00 0.00 1.50 4.75 2.50 8.00 3.75 0.75 6.00 6.25 3.00 5.50 7.50 6.06 6.75 0.50 3.00 1.75 0.44 6.75 2.75 2.50 11.75 4.50 4.00 3.75 3.50

0.125 1.25 0.05 0.50 1.00 0.00 1.75 4.75 2.50 8.25 4.50 0.75 6.00 6.25 3.25 5.50 8.00 6.31 7.50 0.50 3.25 1.88 0.44 6.75 3.00 3.00 12.25 4.50 5.25 4.25 4.25

0.125 1.50 0.05 0.50 1.00 0.00 2.00 4.75 2.50 8.25 4.50 0.75 6.00 5.75 3.25 5.50 9.00 6.56 8.25 0.50 3.25 1.88 0.40 6.75 3.00 3.50 12.50 4.50 5.25 4.25 4.50

0.00 1.50 0.05 0.50 1.00 0.00 2.25 4.75 2.50 8.25 4.50 0.75 6.00 5.75 3.25 5.50 9.00 6.56 8.25 0.50 3.25 1.88 0.40 6.75 3.00 3.50 12.50 4.50 5.25 4.25 4.50

0.00 1.25 0.05 0.50 1.25 0.00 2.25 4.50 2.50 8.50 4.25 0.75 6.00 5.50 3.00 5.50 9.00 6.56 8.25 0.50 3.25 1.88 0.40 6.75 2.50 3.00 12.50 4.50 5.25 4.25 4.50

0.00 1.00 0.05 0.50 1.50 0.00 2.25 4.25 2.50 8.50 4.00 0.75 6.00 5.50 2.75 5.50 9.00 6.56 8.25 0.50 3.25 1.88 0.40 6.75 2.50 3.00 12.50 4.50 5.25 4.25 4.50

0.00 1.00 0.05 0.75 1.75 0.00 2.25 4.25 2.75 8.50 4.00 0.75 6.00 5.50 2.75 5.50 9.00 6.56 8.25 0.50 3.25 1.88 0.40 6.75 2.75 3.25 12.00 4.50 5.25 4.25 4.50

0.00 1.00 0.05 1.00 2.00 0.00 2.25 4.25 3.00 8.50 4.00 0.75 6.00 5.50 2.75 5.50 9.00 6.56 8.25 0.50 3.25 1.88 0.40 6.75 3.00 3.50 11.50 4.50 5.25 4.25 4.50

Source: Morgan Stanley Research; E = Morgan Stanley Research estimates

22


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Structural Indicators External Debt and Reserves Cz. Rep.

Hungary

Israel

Kazakhstan

Poland

Romania

Russia

South Africa

Turkey

Ukraine

International Reserves (USD bn) External Debt % Exports External Debt % GDP

43.2 60.1 47.8

51.5 156.7 139.4

77.9 131.6 46.8

37.0 161.3 83.4

106.7 154.5 67.3

52.0 198.4 79.2

533.9 113.5 32.7

50.1 106.5 26.9

37.8 149.8 84.0

ST External Debt % GDP Med. and LT External Debt % GDP Intercompany Loans % GDP Short-Term Debt/Reserves (%) Total Reserves/Import (%) Fiscal

12.8 28.9 6.1 62.6 26.9

24.7 85.5 29.2 68.2 44.5

17.5 23.0 na 52.5 97.3

8.4 37.9 37.1 33.7 77.1

18.1 34.4 14.8 87.7 45.3

13.0 52.6 13.6 43.7 66.5

4.0 23.5 5.3 11.7 154.4

5.4 16.6 4.9 41.4 47.4

93.0 176.2 39.4 10.2

Budget Balance % of GDP (2010) Revenue, % GDP (2010) Expenditure % GDP (2010) Government Debt % GDP (2010) Credit and Banking Sector

-4.7 40.5 45.2 38.5

-4.2 44.6 48.8 80.2

-3.7 30.0 34.5 76.6

-2.4 20.3 22.7 14.5

-7.9 39.2 46.0 55.0

-6.5 34.3 40.8 33.2

-3.5 35.0 38.5 8.0

Private Sector Credit % GDP HH Credit % GDP FX % Total HH Credit NFC Credit % GDP FX % Total NFC Credit Private Sector Credit % yoy

50.8 28.8 0.1 21.9 17.3 6.6

55.5 29.7 65.1 25.8 55.3 -5.7

80.2 38.0 na 53.0 na 1.2

36.2 10.1 31.8 26.1 41.4 6.1

51.0 34.9 37.6 16.1 23.3 8.4

40.6 19.6 65.2 21.0 61.3 4.4

Loan/Deposit Ratio GDP and Population

0.79

1.17

1.1

1.38

1.17

196 3686 10.52

131 27915 10.01

233 841 7.62

149 21888 16.43

18589

13097

30584

9056

External Debt and Reserves

Nominal GDP (USD bn, 4q sum) Nominal GDP (bn, local currency, 4q sum) Population (mil people) GDP per capita (USD)

29.3 na 83.0 39.7

17.7 60.6 4.3 67.3 42.9

-5.0 28.3 33.6 30.8

-3.8 21.6 25.4 42.0

-7.0 28.7 35.7 40.0

42.4 9.5 7.1 33.0 24.1 18.8

77.0 44.6 na na na 5.0

50.8 18.2 0.1 32.6 46.1 38.7

66.0 18.3 72.0 47.7 38.0 9.8

1.29

1.15

1.01

0.93

1.65

478 1440 38.20

163 520 21.43

1557 46777 142.90

383 2748 49.99

758 1148 73.00

144 1139 45.78

12525

7611

10897

7658

10376

3139

Source: Haver, National Central Banks, MoF, Morgan Stanley Research; latest available data

23


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Annual Economic Forecasts Real GDP growth (%)

2008 2009 2010 2011E 2012E Private 2008 consumption (%) 2009 2010 2011E 2012E Gross fixed 2008 investment (%) 2009 2010 2011E 2012E Exports (%) 2008 2009 2010 2011E 2012E Imports (%) 2008 2009 2010 2011E 2012E Unemployment 2008 rate (%) 2009 2010 2011E 2012E CPI inflation 2008 (Annual average) 2009 2010 2011E 2012E CPI inflation 2008 (% year-end) 2009 2010 2011E 2012E FX rate (year-end, 2008 vs. EUR for CE5; 2009 US$ for others) 2010 2011E 2012E C/A balance 2008 (% of GDP) 2009 2010 2011E 2012E Government debt 2008 (% of GDP) 2009 2010 2011E 2012E Public sector balance 2008 (% of GDP) 2009 2010 2011E 2012E

Cz. Rep.

Hungary

Israel

Kazakhstan

Nigeria

Poland

Romania

Russia

S. Africa

Turkey

Ukraine

2.3 -4.0 2.1 2.1 1.7 3.5 -0.2 -0.1 0.2 1.4 -1.4 -7.9 -3.2 2.7 3.9 6.0 -10.0 17.7 11.4 2.5 5.1 -10.5 18.0 9.3 2.5 5.4 8.2 9.0 8.5 8.1 6.4 1.0 1.5 1.9 2.9 3.6 1.0 2.3 1.9 2.9 26.9 26.5 25.0 24.2 23.8 -0.6 -3.2 -3.8 -4.1 -4.2 30.0 35.3 38.5 41.1 43.2 -2.7 -5.8 -4.7 -4.0 -4.2

0.9 -6.7 1.2 1.6 1.4 -1.0 -6.5 -1.8 0.9 1.4 11.9 -34.0 1.4 1.2 2.0 5.9 -9.1 14.2 8.9 1.8 5.6 -13.9 12.0 8.5 1.8 7.8 10.0 11.3 10.5 9.9 6.1 4.2 4.9 3.9 3.3 3.5 5.6 4.7 3.7 3.5 265 271 275 270 265 -7.3 0.4 2.0 2.2 2.6 72.9 78.4 80.2 75.0 75.1 -3.8 -4.4 -4.2 2.5 -4.0

4.2 0.8 4.7 4.8 3.4 3.0 1.7 4.9 4.0 3.0 3.9 -5.8 12.4 12.0 8.0 5.9 -12.5 13.6 6.1 4.0 2.4 -14.1 12.4 11.0 5.0 6.1 7.4 6.7 5.8 5.8 4.6 3.3 2.7 3.6 2.9 3.8 3.9 2.6 3.2 2.7 3.78 3.77 3.52 3.50 3.40 0.9 3.6 3.1 0.9 0.4 77.1 79.3 76.6 74.0 72.0 -2.4 -5.1 -3.7 -2.5 -2.0

3.3 1.2 7.0 7.0 6.0 6.3 -3.0 8.0 6.0 4.5 1.0 1.1 -5.0 3.0 5.0 0.8 -6.2 9.0 5.0 5.0 -11.5 -15.9 2.0 21.0 12.0 6.7 6.3 5.8 6.0 5.5 17.3 7.3 7.1 8.5 9.0 9.5 6.2 7.8 9.0 8.0 121 148 147 138 136 4.6 -3.2 3.0 10.7 7.5 6.6 10.9 14.5 16.5 16.5 1.1 -1.5 -2.4 -1.5 -2.0

6.0 7.0 7.9 8.4 8.0 -34.3 6.4 -26.7 na na 4.4 -8.1 17.9 na na 43.4 -30.0 11.4 na na -18.8 -15.8 -15.3 na na 14.9 19.7 21.1 20.0 18.5 11.5 12.6 13.8 10.3 10.4 15.1 13.9 11.7 8.7 12.2 136 150 152 153 150 20.4 13.0 4.1 12.3 12.7 11.3 15.4 18.0 19.4 20.5 -0.2 -3.3 -6.1 -3.0 -3.1

5.2 1.6 3.8 3.7 3.2 5.8 2.1 3.0 3.0 2.6 6.4 -13.7 8.0 8.9 5.4 7.3 -6.8 10.1 3.9 2.5 8.4 -12.4 11.5 3.9 2.5 7.6 7.8 9.4 8.7 8.4 4.3 3.4 2.6 4.1 2.7 3.3 3.5 3.1 3.8 2.7 4.15 4.10 4.00 4.15 3.95 -6.5 -3.9 -4.5 -6.0 -5.5 47.2 50.9 55.0 56.8 57.9 -3.7 -7.2 -7.9 -5.6 -4.2

7.7 -7.1 -1.3 1.1 2.1 9.9 -10.7 -1.7 -0.6 1.3 18.4 -21.4 -14.1 -2.3 2.0 7.7 -4.7 14.4 17.5 2.2 8.0 -20.9 12.4 10.2 2.2 4.0 6.3 7.6 7.5 7.1 7.9 5.6 6.1 6.3 4.1 6.4 4.7 7.9 4.8 4.6 4.0 4.2 4.3 4.3 4.1 -11.6 -4.2 -4.2 -4.0 -4.3 19.5 27.4 33.2 36.3 38.3 -4.8 -7.3 -6.5 -5.0 -4.6

5.2 -7.8 4.0 4.7 5.2 10.6 -4.8 3.0 6.0 6.1 10.6 -14.4 6.1 1.9 7.5 0.6 -4.7 7.1 4.0 3.0 14.8 -30.4 25.6 19.0 13.0 7.8 8.2 7.2 6.8 6.5 14.1 11.7 6.9 8.9 8.1 13.2 8.8 8.8 8.2 7.2 29.4 30.2 30.5 28.4 27.1 6.3 3.9 5.0 4.3 2.0 6.3 7.1 8.0 9.0 10.2 4.8 -6.3 -3.5 -0.3 -1.8

3.6 -1.7 2.8 3.8 3.7 2.2 -2.0 4.4 4.4 3.7 14.1 -2.0 -3.6 2.9 4.2 1.9 -19.4 4.6 3.5 6.2 1.5 -17.3 9.9 7.1 8.7 23.3 24.3 24.0 23.6 23.1 11.3 7.2 4.3 5.0 5.9 10.3 6.4 3.5 6.0 5.7 10.0 7.4 6.6 7.0 7.5 -7.9 -4.0 -3.5 -3.7 -4.5 22.7 27.6 30.8 34.3 37.5 -1.2 -6.6 -5.0 -4.9 -4.8

0.7 -4.8 8.9 5.9 3.5 0.5 -2.3 6.6 6.1 2.3 -8.2 -19.0 29.9 12.8 5.4 2.7 -5.0 3.4 7.2 5.6 -4.2 -14.3 20.7 12.0 3.8 10.5 13.5 11.4 10.5 10.5 10.4 6.3 8.6 5.7 6.4 10.1 6.5 6.4 7.0 6.0 1.54 1.50 1.50 1.80 1.70 -5.7 -2.3 -6.6 -9.4 -7.0 39.5 45.5 42.0 39.0 38.5 -1.8 -5.5 -3.8 -2.7 -2.5

2.1 -14.8 4.2 4.6 4.2 10.2 -14.2 7.0 9.0 7.0 1.6 -46.2 4.9 8.0 6.0 -4.0 -25.6 4.5 15.0 8.0 12.0 -38.6 11.1 15.0 10.0 6.9 9.6 9.0 8.5 8.3 25.3 16.0 9.4 9.3 9.1 22.3 12.3 9.1 10.1 8.7 9.00 8.00 7.96 7.96 7.96 -7.1 -1.5 -1.9 -4.0 -3.4 20.0 33.0 40.0 42.0 42.5 -1.5 -8.5 -7.0 -4.0 -3.0

Source: Morgan Stanley EMEA Economics. Notes: E= Morgan Stanley EMEA Estimates; FX rate vs. EUR (Czech Republic, Hungary, Poland, Romania); FX rate vs. USD (others)

24


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Macro Calendar (August 22-September 2) Mon 22

Rus FDI (Q2, YTD) MS: NA, Cons: NA Prev: US$ 3.89 bil.

Mon 29

Hun Unemployment Rate (Jul) MS: NA, Cons: 10.6% Prev: 10.8% Isr Base Rate MS: 3.25%, Cons: 3.25% Prev: 3.25%

Tue 23

Hun Base Rate MS: 6.00%, Cons: 6.00% Prev: 6.00% Tur Base Rate MS: 5.75%, Cons: 5.75% Prev: 5.75%

Tue 30

Pol GDP (Q2) MS: NA, Cons: 4.2%Y Prev: 4.4%Y Pol Retail Sales (Jul) MS: 8.6%Y, Cons: 10.5%Y Prev: 10.9%Y Pol Unemployment Rate (Jul) MS: 11.7%, Cons: 11.6% Prev: 11.8% SA GDP (Q2) MS: 0.5%Q, Cons: NA Prev: 4.8%Q SA M3 (Jul) MS: 5.2%Y, Cons: NA Prev: 6.0%Y SA Private Sector Credit (Jul) MS: 4.5%Y, Cons: NA Prev: 5.3%Y

Wed 24

Czk Cons. & Bus. Conf. (Aug) MS: NA, Cons: NA Prev: 5.0 Hun Retail Sales (Jun) MS: -0.1%Y, Cons: 0.4%Y Prev: 0.7%Y SA CPI (Jul) MS: 5.3%Y, Cons: 5.2%Y Prev: 5.0%Y Wed 31

Hun PPI (Jul) MS: NA, Cons: -0.5%Y Prev: -1.0%Y Isr Unemployment Rate (Q2) MS: NA, Cons: NA Prev: 6.0%Y Pol Inflation Expectations (Aug) MS: 4.0%Y, Cons: NA Prev: 4.7% SA Trade Bal (Jul) MS: -ZAR2.0 bln, Cons: NA Prev: ZAR4.9 bln

Thu 25

Tur Industrial Confidence (Aug) MS: NA, Cons: NA Prev: 114.1 Tur Capacity Utilization (Aug) MS: NA, Cons: NA Prev: 75.4% SA PPI (Jul) MS: NA, Cons: NA Prev: 7.4%Y Thu 1

Czk PMI (Aug) MS: NA, Cons: NA Prev: 53.4 Czk Budget Balance (Aug) MS: NA, Cons: NA Prev: -CZK 61.1 bil. Hun PMI (Aug) MS: NA, Cons: NA Prev: 52.2 Kaz CPI (Aug) MS: NA, Cons: NA Prev: 8.8%Y Pol PMI (Aug) MS: NA, Cons: NA Prev: 52.9 Rus PMI (Aug) MS: NA, Cons: NA Prev: 49.8 Tur PMI (Aug) MS: NA, Cons: NA Prev: 52.3 SA PMI (Aug) MS: 48.0, Cons: NA Prev: 44.2

Fri 26

Tur Trade Balance (Jul) MS: NA, Cons: NA Prev: -US$ 10.2 bil

Fri 2

Czk Retail Sales (Jul) MS: 0.4%Y, Cons: NA Prev: -3.5%Y Hun Trade Balance (Jun, Fin.) MS: NA, Cons: NA Prev: â‚Ź730.4 mil. Rom PPI (Jul) MS: NA, Cons: NA Prev: 8.4%Y

Source: Morgan Stanley Research, Bloomberg

25


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Disclosure Section Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. As used in this disclosure section, Morgan Stanley includes RMB Morgan Stanley (Proprietary) Limited, Morgan Stanley & Co International plc and its affiliates. For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.

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26


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

Stock Rating Category

Coverage Universe Investment Banking Clients (IBC) % of % of % of Rating Count Total Count Total IBC Category

Overweight/Buy Equal-weight/Hold Not-Rated/Hold Underweight/Sell Total

1107 1136 114 384 2,741

40% 41% 4% 14%

451 372 20 97 940

48% 40% 2% 10%

41% 33% 18% 25%

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months.

Analyst Stock Ratings

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Analyst Industry Views

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Morgan Stanley & Co. International PLC and its affiliates have a significant financial interest in the debt securities of CZECH REPUBLIC, REPUBLIC OF HUNGARY, REPUBLIC OF KAZAKHSTAN, REPUBLIC OF POLAND, REPUBLIC OF SOUTH AFRICA, REPUBLIC OF TURKEY, ROMANIA, RUSSIAN FEDERATION, STATE OF ISRAEL, ALROSA COMPANY LIMITED, OAO GAZPROM. Morgan Stanley is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 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 the recommendations 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 financial circumstances and objectives of persons who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. The fixed income research analysts, strategists or economists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading and capital markets profitability or revenues), client feedback and competitive factors. Fixed Income Research analysts', strategists'

27


MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

or economists' compensation is not linked to investment banking or capital markets transactions 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 an investment of less than 1% in securities/instruments or derivatives of securities/instruments of companies and may trade them in ways different from those discussed in Morgan Stanley Research. 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MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

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Additional information on recommended securities/instruments is available on request. Jf19/08/11

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MORGAN STANLEY RESEARCH August 19, 2011 CEEMEA Macro Monitor

CEEMEA Economics Team Tevfik Aksoy (Head of CEEMEA Economics)

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pasquale.diana@morganstanley.com

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South Africa, Nigeria, Ghana Andrea Masia South Africa, Nigeria Jacob Nell Russia, Ukraine, Kazakhstan Alina Slyusarchuk Russia, Ukraine, Kazakhstan Jaroslaw Strzalkowski

Poland, Hungary, Czech Republic, Romania

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CEEMEA Macro Monitor  

Poland: Growth, the MPC and the Zloty 10 Russia: Debt Set to Double? 12 South Africa: 2Q GDP Collapse; July CPI Rising Further MORGAN STANLE...