em currencies 0610

Why we like Emerging Market currencies

Marshall GittlerChief Strategist, InternationalDeutsche Bank (Suisse) SA

22 June, 2010

Tel: +41(0)22 739 0463e-mail: [email protected]

Global Investment Solutions

Why we like Emerging Market (EM) currencies on all time horizons

Short-term: China has started to allow its currency to appreciate.That should allow other Asian countries to let their currencies rise as well without losing relative competitiveness.It may also spur speculation about upward pressure on EM currencies in general.

Medium-term: We expect EM countries to raise rates & let their currencies appreciate to restrain inflation.

One reason inflation is rising in EM countries is because of FX intervention.Raising interest rates is one way to deal with inflationary pressures. Rising interest rates should cause currencies to appreciate.Allowing FX appreciation should also dampen inflationary pressures as well as alleviating problems arising from intervention.

Long-term: Currencies tend to appreciate as countries grow richer. Rising wealth in the developing world is likely to be one of the major global trends over the next decade.


CNY has room to appreciate

CNY appreciation, halted last year, has resumedWhy we like EM currencies

Source: Bloomberg Finance LP, DB Private Wealth Management

CNY was on an appreciating trend until the global financial crisis hit in mid-2008 and the government called a halt. Had they let it continue on the same path, it would currently be around 26% stronger vis-à-vis the USD.The government announced that it would "further reform the exchange rate regime and enhance the exchange rate flexibility" by resuming the previously announced daily trading bands (±0.5%) around the daily fixing rate announced by the Chinese government.The currency appreciated by 0.45% on June 21st, the first day of trading after the news. The market was forecasting the currency would rise 2.3% over the next 12 months, vs 1.8% on the previous trading day.

USD/CNY: actual* vs previous trend

5.00

5.50

6.00

6.50

7.00

7.50

8.00

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

USD/CNY

May '07~Jul '08 trend

= 26% appreciation

*until Friday, June 18th


US trade deficit with China starting to widen again

US-China trade tension pushed China to revalueWhy we like EM currencies


Tensions between the US and China have been increasing as the US Congress looks for an issue that everyone can agree on, while China becomes more assertive in the world political arena.Against this hostile background, Treasury Secretary Geithner delayed the annual Treasury report on currencies, which would probably have branded China a “currency manipulator” and forced the US to take retaliatory measures. He probably did this to give China time to allow the CNY to appreciate without seeming to give in to foreign pressure. (Apparently, it worked.)

US trade with China

12m moving sum

0

50

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250

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350

400

00 01 02 03 04 05 06 07 08 09 10

-300

-250

-200

-150

-100

-50

0

Balance (R)Imports from China (L)Exports to China (L)

$bn $bn


CNY has been stable to lower since 2009

G20 meeting was the last strawWhy we like EM currencies


Pressure was building on China not only from the US, but also from other countries, including some other EM countries. Brazil and India have publicly criticized China’s FX policy. That put China in a bind ahead of the June 26/27 G20 meeting, where China should be playing a leading role among the developing nations. It was looking as if the CNY would be a major topic of discussion this weekend.By allowing the CNY to appreciate again, China has defused this issue for now.The move does not satisfy those who were looking for a large one-off revaluation, and there are still questions about how rapidly the government will allow the currency to appreciate.

Recent movement of the Renminbi against various currencies

80

90

100

110

120

130

140

150

2008 2009 2010

USDEURJPYBRLMXNINR

1 Jan 2008 = 100


Real estate prices are rising again

Domestic pressures another incentive for China to revalueWhy we like EM currencies

China inflation

-5

0

5

10

15

20

25

2005 2006 2007 2008 2009 2010

CPI - general

CPI - food

% yoy


Domestic pressures also are forcing China to revalue. The main problem is that inflation is heating up again, led by food. This is a lagging indicator of last year’s expansive monetary policy.

Food prices are not that responsive to monetary policy, but housing prices may be.

Inflation continues to rise, led by food

China house prices vs money supply

-2

0

2

4

6

8

10

12

14

2006 2007 2008 2009 201013

15

17

19

21

23

25

27

House prices (L)M2 Money supply (R)

% yoy% yoy


Money supply grows along with FX reserves

FX reserve accumulation fuelling money supply growthWhy we like EM currencies


One of the reason why monetary growth in China is so high is that the government intervenes heavily in the FX market to prevent the CNY from appreciating. It creates and sells CNY and buys dollars.If officials want to slow the pace of monetary growth to cool the economy, they will have to slow the pace of reserve accumulation.

China FX reserve accumulation vs money supply

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45

2002 2003 2004 2005 2006 2007 2008 2009 2010

5

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25

30

35

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12m increase in ChinaFX reserves (L)

M1 (R)

$bn % yoy


The impossible trinity

The “Impossible trinity:” Countries can’t control everything at onceWhy we like EM currencies

The problem for China (and other EM countries) is called the “Impossible Trinity:” a country cannot control its exchange rate and maintain an independent monetary policy while still being integrated into the world financial system through free capital flows. It can only control two and must let the market control the third.

Fixed exchange rate

Only 2 are possible atone time

Independentmonetary policy

Free capitalflows


Asian countries reducing intervention

Rising intervention fuels money supply growth, inflationWhy we like EM currencies

Change in FX reserves in AxJ

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

India

China

Taiwan

S. Kore

a

S'pore HK

Thaila

ndMala

ysia

Philipp

ines

Six months previousLatest month

% yoy


Many EM countries have chosen to control their exchange rates, but by doing so they lost control of their monetary policy as they sold their currency and thereby increased the money supply. This trend has been especially strong in Asia, where rising monetary growth has fuelled inflationary pressures and given rise to fears of a financial bubble.This may be one reason why several Asian countries have slowed their pace of reserve accumulation recently despite the rising dollar. Money supply growth is slowing as a result.

Rising money supply growth fuels inflation

Asia: money supply vs inflationAsia ex-Japan countries weighted by PPP

10

12

14

16

18

20

22

24

2001 2002 2003 2004 2005 2006 2007 2008 2009 20101

2

3

4

5

6

7

8

Nominal broad moneysupply growth (L)

Inflation (R)

% yoy


India, Malaysia start tightening cycles as inflation rises; FX appreciatingWhy we like EM currencies

India policy rate, inflation & FX

2

4

6

8

10

12

14

16

2005 2006 2007 2008 2009 2010

38

40

42

44

46

48

50

52

RBI Reverse repo yield (L) India CPI (L) USD/INR (R, inverted)

%


India and Malaysia have already started down this path. They have let their currencies appreciate since the beginning of 2009, while the central banks of both countries recently started a tightening cycle.

Malaysia policy rate, inflation & FX

-3

-1

1

3

5

7

9

2005 2006 2007 2008 2009 2010

3.1

3.2

3.3

3.4

3.5

3.6

3.7

3.8

3.9

Malaysia overnight policy rate (L) Malaysia CPI (L) USD/MYR (R, inverted)

%


Singapore NEER already outside its band

India, Malaysia, now Singapore; others to follow?Why we like EM currencies

The Monetary Authority of Singapore (MAS) surprised the market on 14 April by a combined "recentering of the policy band at the prevailing level of the SGD NEER" (nominal effective exchange rate) and a shift in the policy band’s slope to "modest and gradual appreciation". This was the first time MAS has adjusted both simultaneously and thus was an aggressive tightening, in our view.

MAS explained that Singapore’s recovery “has been stronger than expected, and more entrenched.” It said it expects the economy to continue to improve and inflation to continue to rise for the rest of the year.

We expect that other Asian countries are thinking the same way but have been waiting for China to move first before they too allow further FX appreciation.

Estimated Singapore NEER with upper and lower bands

98

99

100

101

102

103

104

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10

Source: Bloomberg Finance LP, Goldman Sachs, DB Private Wealth Management


AxJ-USD 3m spreads is generally widening

As short rates rise, FX should appreciate as wellWhy we like EM currencies

We have seen how several Asian central banks have begun to tighten policy to deal with the inflationary threat. As a result, their short-term interest rates have been rising.

In the US however there is currently little fear of higher inflation and the Fed has stated that short rates are likely to remain low “for an extended period of time.”

The spread between short-term Asian interest rates and USD rates is rising as a result. This widening interest rate differential is likely to support Asian currencies going forward – and other EM currencies as well.


Spread of AxJ 3m rates vs USD 3m

-5-4-3-2-10123456789

1011

2007 2008 2009 2010

India IndonesiaKorea MalaysiaPhilippinesSingaporeTaiwanThailand

%


Other currencies outpaced CNY after 2005 unpegging

How did other Asian currencies react when CNY was floated in 2005?Why we like EM currencies


Most Asian currencies underperformed the CNY in the days after the USD peg was dropped in 2005.

However, after a few months, the currencies generally appreciated more than the CNY (except for INR).

The Chinese Yuan did not move during the 2008 crisis (as seen on pgs. 3 and 5).

Movement of Asian currencies vs USD

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Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06

CNY KRW IDR

INR SGD THB

22 July 2005 = 100


Inflation turning up in Latam, Asia; slowing in EMEA

Other EM countries also feeling inflationary pressureWhy we like EM currencies

Inflation is turning up in Latin America. The high level of inflation in Eastern Europe and the Middle East (EMEA) has been coming down recently, but it remains relatively high.

Rising interest rates (which should help EM currencies to appreciate) and rising currencies are two of the ways that we expect EM central banks to deal with the inflationary danger.


CPI inflation ratesweighted by GDP at PPP

-2

0

2

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6

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10

12

2004 2005 2006 2007 2008 2009 2010

G3 (inc UK) East Asia (ex Japan)Latam EMEA

%


Capital controls didn’t work for THB or BRL

Capital controls are not likely to be a long-term solutionWhy we like EM currencies

Some countries have tried capital controls as another way of dealing with the “impossible trinity,” that is, keeping hold of FX and monetary policy by restraining capital flows.

Previous attempts at controlling FX rates through capital controls have generally proved ineffective. Brazil tried something similar back in 2008, but it had only a temporary effect. Thailand also tried to restrict inflows in 2006, but this too caused only a short-term plateau in the upward trend.

We see this as a way of slowing the trend, but not defeating it. Source: Bloomberg Finance LP, DB Private Wealth Management

95

100

105

110

115

Dec-07 Feb-08 Apr-08 Jun-08

Week when controls were imposed

(19 Dec '06 for THB)

BRL

THB (9/06 to 4/07

4m before date of imposition = 100


Richer countries tend to have richer currencies

EM currencies likely to appreciate as EM countries get wealthierWhy we like EM currencies

As countries become more developed, their export sectors become more efficient & more competitive and labor costs start to rise. Other sectors have to raise their wages too in order to keep pace. As a result, wages – and price levels –tend to rise1.

If wages and price levels rise simultaneously, it means that the purchasing power of the currency rises relative to that of other countries.

We expect rising prosperity in EM to be one of the major economic themes of the next decade. Rising FX rates should accompany this trend.

1This is known as the “Balassa-Samuelson effect” Source: Bloomberg Finance LP, IMF, DB Private Wealth Management

Currency valuation vs GDP

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0 5,000 10,000 15,000 20,000 25,000

GDP/capita (based on PPP)

Cur

renc

y ov

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valu

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ased

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nom

ists

' Big

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inde

x

BrazilTurkey

Hungary

Czech

ColombiaChile

Mexico

Argentina

Russia

Poland

Indonesia

PhilippinesChina

Thailand Malaysia

South Africa


Why we like EM currenciesOther reasons for EM currencies to appreciate

Annual growth rateat PPP

-2%

0%

2%

4%

6%

8%

10%

12%

14%

1980 1985 1990 1995 2000 2005 2010

Advanced economies Emerging and developing economies

Forecast

EM countries forecast to grow faster than DM

Growth gap: Growth potential in the G7 countries has been further reduced by the crisis but also by structural factors. The already strong growth lead of the EMs, especially in Asia, should therefore continue to widen.

Relative importance of exports is declining. In some countries domestic consumption is becoming increasingly powerful driver of economic growth. This means that the importance of a weak exchange rate for exports is declining.

Solid fundamentals (this applies above all to EM Asia and Latin America).

Capital inflows: Privatisations are in the pipeline in several countries (India, Malaysia), as well as the largest share offers ever (Brazil, China). Huge infrastructure projects (India, China) should also attract foreign capital.

Source: IMF World Economic Outlook


EM debt levels are likely to fall as a percent of GDP over the next five years while DM debt levels soar, according to the IMF. Yet the pension burden that DM countries face is still far away. In fact, EM countries could even afford higher debt levels, thanks to their higher growth potential. Productivity increases, positive demographics, liberalization and deregulation give EM better long-term growth potential than in DM. The combination of higher growth, and thus greater sources of revenue for debt servicing, and much lower debt levels should further reduce the historical spreads paid on emerging market debt.

Why we like EM currenciesReasons to invest in EM currencies through EM bonds: improved risk profile

Public debt as % of GDP

30

40

50

60

70

80

90

100

110

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Advanced economies

Emerging and developing economies

%

Forecast

Dependency ratios # of children and elderly as a % of working-age population

40

50

60

70

80

90

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Developed countries Developing countries (ex least developed)

Forecast

EM demographics still improvingEM debt burden is falling

Source: IMF World Economic Outlook Source: United Nations World Population Prospects 2008 Revision, DB PWM


EM bond yields are generally higher than DMYields are generally higher in EM bond markets than in DM bond markets. That not only means greater income, but also more room for price appreciation if yields decline and greater cushion if interest rates move up.

Yet some EM countries have a lower risk of being downgraded (or looked at another way, a greater possibility of being upgraded) than the developed countries that offer lower yields. These include Brazil, South Africa, India, Colombia, Mexico and Russia, among others.

Reasons to invest in EM currencies through EM bonds: higher return potentialWhy we like EM currencies

EM vs DM 10yr bond yields

0

2

4

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Brazil

South

Africa

Indon

esia

Colombia Ind

iaHun

gary

Mexico Peru

Poland

Russia

Malays

ia UKChin

aCan

ada US

German

yJa

pan

EM countries

DM countries

%

Data as of 22 June 2010

Source: Bloomberg Finance LP, IMF, DB Private Wealth Management


Rapid development, growing size, importance and liquidity of these marketsLocal Currency bonds have overtaken hard currency bonds in importance. Over the past five years the local market has grown by 18.8% p.a. compared to 8% p.a. for hard currency bonds. In addition to fixed coupon bonds, there is also an increasing supply of inflation linkers.

Positive diversificationLocal bond markets are driven above all by domestic factors, such as the fiscal situation, inflation, external balances, etc., rather than US or ECB monetary policy, which affect many other asset classes globally.

Why we like EM currenciesReasons to invest in EM currencies through EM bonds: liquidity, diversification


India and China are reclaiming their historical role in the world economy

The new world will be more like the old worldWhy we like EM currencies

The emergence of the EM countries is more of re-emergence. For most of history, China and India have been the major forces in the global economy.

0%

20%

40%

60%

80%

100%

0 500 1000 1500 2000

Rest of world

Europe & N. America

India

China

Japan

Year

Share of World GDP

Source: Angus Maddison, The World Economy


Which ship would you rather be on?Why we like EM currencies

The ship used by Chinese Admiral ZhengHe in 1405 compared to Columbus’. The Ming Dynasty's fleet of giant ships predates the Columbus expedition across the Atlantic by some 85 years.

Photograph of the display in the China Court of the Ibn Battuta Mall in Dubai. Source: Wikipedia


Why we like EM currencies

Pure FXCarry trades that involve borrowing in developed-country currencies and investing the funds in EM currencies.FX indices to take advantage of FX appreciation.

BondsWe expect higher short-term rates in EM countries. Shorter-maturity bonds should hold up better than the long end during a tightening cycle. Later in the cycle, switch into longer-maturity bonds after rate hikes dampens inflation expectations.Index-linked bonds would benefit from currency appreciation plus growth rates (andhence inflation rates) that are likely to be higher than in the developed countries.

Real assetsReal assets, such as property, or claims on real assets, such as stocks, can be bought now in currencies that we believe are likely to appreciate in the future.

Strategy recommendations


Important notesPrivate Wealth Management offers wealth management solutions for wealthy individuals, their families and select institutions worldwide. Deutsche Bank Private Wealth Management, through Deutsche Bank AG, its affiliated companies and its officers and employees (collectively “Deutsche Bank”) have published this document in good faith and on the following basis.This document has been prepared without consideration of the investment needs, objectives or financial circumstances of any investor. Before making an investment decision, investors need to consider, with or without the assistance of an investment adviser, whether the investments and strategies described or provided by Deutsche Bank, are appropriate, in light of their particular investment needs, objectives and financial circumstances. Furthermore, this document is for information/discussion purposes only and does not constitute an offer, recommendation or solicitation to conclude a transaction and should not be treated as giving investment advice.Deutsche Bank does not give tax or legal advice. Investors should seek advice from their own tax experts and lawyers, in considering investments and strategies suggested by Deutsche Bank. Investments with Deutsche Bank are not guaranteed, unless specified. Unless notified to the contrary in a particular case, investment instruments are not insured by the Federal Deposit Insurance Corporation ("FDIC") or any other governmental entity, and are not guaranteed by or obligations of Deutsche Bank AG or its affiliates.Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice and involve a number of assumptions which may not prove valid.Investments are subject to investment risk, including market fluctuations, regulatory change, possible delays in repayment and loss of income and principal invested. The value of investments can fall as well as rise and you might not get back the amount originally invested at any point in time.This publication contains forward looking statements. Forward looking statements include, but are not limited to assumptions, estimates, projections, opinions, models and hypothetical performance analysis. The forward looking statements expressed constitute the author’s judgement as of the date of this material. Forward looking statements involve significant elements of subjective judgements and analyses and changes thereto and/or consideration of different or additional factors could have a material impact on the results indicated. Therefore, actual results may vary, perhaps materially, from the results contained herein. No representation or warranty is made by Deutsche Bank as to the reasonableness or completeness of such forward looking statements or to any other financial information contained herein.The terms of any investment will be exclusively subject to the detailed provisions, including risk considerations, contained in the Offering Documents. When making an investment decision, you should rely solely on the final documentation relating to the transaction and not the summary contained herein. This document may not be reproduced or circulated without our written authority. The manner of circulation and distribution of this document may be restricted by law or regulation in certain countries, including the United States. This document is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, including the United States, where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Deutsche Bank to any registration or licensing requirement within such jurisdiction not currently met within such jurisdiction. Persons into whose possession this document may come are required to inform themselves of, and to observe, such restrictions. Past performance is no guarantee of future results; nothing contained herein shall constitute any representation or warranty as to future performance. Further information is available upon investor's request.

em currencies 0610

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